Marlin Business Services Corp. (MRLN) CEO Jeff Hilzinger on Q3 2019 Results - Earnings Call Transcript

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Marlin Business Services Corp. (NASDAQ:MRLN) Q3 2019 Earnings Conference Call November 1, 2019 9:00 AM ET

Company Participants

Lasse Glassen - ADDO Investor Relations

Jeff Hilzinger - President and Chief Executive Officer

Lou Maslowe - Senior Vice President and Chief Risk Officer

Mike Bogansky - Senior Vice President and Chief Financial Officer.

Conference Call Participants


Greetings and welcome to the Marlin Business Services Third Quarter 2019 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Lasse Glassen, with ADDO Investor Relations. Thank you, sir. You may begin.

Lasse Glassen

Good morning and thank you for joining us today for Marlin Business Service Corp.’s 2019 third quarter results conference call. On the call today is Jeff Hilzinger, President and Chief Executive Officer; Lou Maslowe, Senior Vice President and Chief Risk Officer; and Mike Bogansky, Senior Vice President and Chief Financial Officer.

Before we begin today, let me remind you that some of the statements made on today’s call will be forward-looking, and are made under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those projected or implied due to a variety of factors. We refer you to Marlin’s recent filings with the SEC for a more detailed discussion of the risks that could impact the company’s future operating results and financial condition.

With that, it’s now my pleasure to turn the call over to Marlin’s President and CEO, Jeff Hilzinger. Jeff?

Jeff Hilzinger

Thank you, Lasse. Good morning and thank you everyone for joining us to discuss our 2019 third quarter results. I’ll begin with an overview of the key highlights from this past quarter, along with an update on the continued execution of our strategy to transform Marlin from an equipment lessor into a nationwide provider of capital solutions to small businesses.

Lou Maslowe, our Chief Risk Officer will comment on portfolio performance and Mike Bogansky, our Chief Financial Officer will follow with additional details on our financial results and financial guidance for the remainder of the year.

During the third quarter, we delivered strong growth in earnings and double-digit growth in total sourced origination volume on a year-over-year basis. While there was only a modest increase in net charge-offs during the quarter, earnings growth was tempered by an increase in our allowance for credit losses due to an increase in delinquencies and a $936,000 specific provision related to fraudulent activities within a specific equipment dealer’s portfolio.

Looking in more detail at total sourced originations, volume in the third quarter totaled $201.6 million, up 12.3% year-over-year. Year-to-date through the end of the third quarter, total sourced originations of $641.5 million are up 22.7%. Although volume growth was more moderate than during the first two quarters of the year, third quarter year-over-year growth was driven by both our Equipment Finance and Working Capital Loan products, as well as from both our direct and indirect origination channels.

While lease and loan application volume was up by more than 20%, growth in origination volume was below expectations in both the Equipment Finance and Working Capital Loan products as our approval and booking rates declined during the quarter. However, our capital markets execution was better than anticipated, because we took advantage of favorable capital markets conditions and sold more loans and leases than expected given that our origination mix has been skewed towards lower-yielding origination flows throughout the year.

As a result of these origination and capital markets activities, our net investment in leases and loans stood at $1.035 billion at quarter end, up 6.6% from a year ago. Total managed assets which includes both our balance sheet portfolio and assets we’ve sold but continue to service for others, expanded to nearly $1.3 billion, an increase of 18.2% from the third quarter last year.

For the quarter, we reported GAAP earnings of $0.60 per diluted share, up nearly 28% compared with $0.47 per diluted share for the third quarter last year. However, despite the strong third quarter earnings growth, the lower than expected origination volume in the quarter, particularly with respect to Working Capital Loans coupled with the higher third quarter provision for credit losses, we are reducing our full-year earnings per share guidance to a range of $2.15 to $2.20. Mike Bogansky will provide additional details on the change to our earnings guidance in his remarks.

I’d now like to move to an update on our Marlin 2.0 business transformation initiatives. Through Marlin 2.0, we expect to drive growth and improve returns on equity by first, strategically expanding our target market; second, better leveraging the company’s capital base and fixed costs to origination and portfolio growth; third, improving our operating efficiency by better leveraging fixed costs through scale and through operational improvements to reduce unit processing costs; and fourth, proactively managing the company’s risk profile to be consistent with our risk appetite.

I’d like to share with you the progress we’ve made on in each of these areas since our last call. First, with respect to our strategic market expansion, rather than thinking of ourselves as solely an equipment lessor, Marlin remains focused on providing multiple products and financing solutions to meet the needs of our small business customers. In addition, we have also expanded our go-to market strategy by not only continuing to originate through our equipment vendor partners, but also directly with our end-user customers.

A key component of the market expansion strategy is our Working Capital Loan product, while below our expectations, third quarter Working Capital Loan origination volume increased by 34% year-over-year to $26.2 million, delivering a portfolio balance of $53.7 million at quarter end, representing 65% year-over-year growth. In terms of credit performance, the Working Capital Loan portfolio continues to perform better than our expectations.

Although Marlin has historically originated through equipment vendors and other intermediaries, another key part of our market expansion strategy is focused on providing financing solutions directly to our end-user customers. This strategy leverages approximately 200,000 solicitable relationships the company has built with its small business customers over time.

The objective under our direct strategy is to identify additional financing opportunities with these customers by offering multiple products and to create ongoing relationships with these customers by meeting a broader set of their financing needs. It is important to keep in mind, that this repeat business significantly lowers our blended customer acquisition costs over time, because we do not pay customer acquisition costs beyond the initial transaction.

During the quarter, direct origination volume increased to $41.6 million, up from $35.5 million in the third quarter last year and resulting in a year-over-year increase of 17%. We also continue to make headway on our second key priority which focuses on leveraging Marlin’s capital and fixed costs through growth. Thanks to solid portfolio growth over the past year, coupled with close to $5.7 million in stock repurchases, we have reduced Marlin’s equity to assets ratio to 16.7% from 17.2% a year ago.

Our asset syndication program also remains very active. Overall, we see asset sales as an opportunity to use our capital more productively, to further diversify our funding sources and as an efficient way to optimize our portfolio by better managing its overall composition in terms of returns, credit risk and exposure to particular industries, geographies and asset classes.

Further, given our decreasing equity to assets ratio, asset sales allow us to continue to take full advantage of our origination opportunity and to meet the financing needs of our customers by allowing us to intermediate or retain assets to our maximum advantage. To this end, during the first nine months of the year and particularly during the third quarter, we originated an unusually high percentage of equipment leases and loans with very strong credit quality that carry correspondingly lower yields.

This volume coupled with robust investor demand for Marlin’s product and favorable market conditions resulted in the sale of $85.4 million in assets that generated an immediate net pre-tax gain on sale of approximately $6.5 million. We continue to service these assets which allows us to maintain an ongoing relationship with these customers in support of our direct strategy. In total, we are now servicing approximately $264 million in assets for our capital markets partners.

Turning to our third area of focus, we continue to make strides in better leveraging the company’s fixed costs through growth and by improving operating efficiencies through ongoing process improvements and automation.

On a GAAP basis, our non-interest expense as a percentage of average managed finance receivables improved to 5.3% compared to 5.9% for the third quarter last year. After adjusting for certain expenses, our adjusted non-GAAP non-interest expense as a percentage of average managed finance receivables for the third quarter improved to 5.1%, compared with 5.5% for the third quarter last year.

Moreover, the company’s operating efficiency ratio adjusted on the same basis improved to 46.1% for the third quarter versus 51.7% for the same period last year, and improved to 52.9% for the first nine months versus 54% for the same period last year. On a GAAP basis, the company’s efficiency ratio was 48% for the third quarter versus 55.7% for the same period last year and 58.2% for the first nine months versus 56.1% for the same period last year.

We expect our adjusted efficiency ratio to continue to improve as we leverage our fixed costs through portfolio growth and operate more efficiently through our various process renewal and automation initiatives.

And fourth, we remain focused on proactively managing the company’s risk profile such that it is commensurate with our risk appetite. We continue to make underwriting adjustments to address underperforming areas of the portfolio and have also added collection staff in response to the upward pressure on delinquency that Marlin and the industry are experiencing. We also continue to make adjustments to our dealer onboarding and surveillance processes to better identify and mitigate dealer performance problems. Lou will provide additional details on the portfolio’s performance in his remarks.

Finally, I would like to welcome Ryan Melcher, who joins Marlin today as the company’s new Deputy General Counsel and who will become Marlin’s General Counsel and Corporate Secretary on January 1st. Ryan joins us from PHH Corporation, where he was Deputy General Counsel and Corporate Secretary.

Ryan has significant experience in Securities Law and SEC matters, complex financing transactions, corporate governance matters of a public company and compliance matters within a rigorous regulatory environment. I’m thrilled to have Ryan part of the team. I would also like to take this opportunity to thank Ed Dietz, Marlin’s current General Counsel, who will be leaving the company on December 31st for his years of excellent counsel and service.

In summary, we continue to grow prudently, while proactively managing the credit performance of the portfolio. Importantly, we are also realizing the expected cost savings from the reorganization we implemented last quarter and still expect strong earnings growth this year and we expect that momentum to continue next year. Overall, the fundamentals of our business remain very strong, and we continue to make good progress on both our near-term profitability and longer-term strategic objectives during the quarter.

With that, I’d like to now turn the call over to Lou Maslowe, our Chief Risk Officer to discuss the performance of our portfolio in more detail. Lou?

Lou Maslowe

Thank you, Jeff and good morning everyone. Looking at the key asset quality metrics, Equipment Finance receivables over 30 days delinquent were 1.28%, up 23 basis points from the prior quarter and up 26 basis points from the third quarter of 2018. Equipment Finance receivables over 60 days delinquent were 0.88%, up 21 basis points from the prior quarter and up 31 basis points from the third quarter of 2018.

The increase in Equipment Finance delinquency in the third quarter was observed across the portfolio, although there were several specific factors to call out that had the greatest impact. First, the dealer fraud issue that Jeff mentioned earlier had a 6 basis points impact on the Q3 30 plus day delinquency. I will elaborate on the dealer issue later in my comments.

The second factor was the increased delinquency in Marlin’s legacy over the road transportation portfolio, which had a small impact from Q2 to Q3, but a more significant impact year-over-year. It is important to note that the portfolio that has been originated through our acquisition of Fleet Financing Resources is performing well with no delinquency or charge-off thus far.

Marlin’s transportation portfolio 30-plus and 60-plus delinquency increased by 86 basis points and 88 basis points year-over-year respectively. This increase is comparable to PayNet’s transportation industry delinquency increase of 75 basis points. Another factor contributing to higher delinquency, both quarter-over-quarter and year-over-year is the significant amount of assets sales in 2019, which had the effect of reducing the total portfolio, while having minimal impact on the delinquent dollars since all contracts are occurring at the time of sale.

The managed portfolio delinquency over 30-days and 60-days is more in line with historical results, at 1.1% and 0.75% respectively. Marlin’s increasing delinquency is consistent with the industry trend, a benchmark that we utilize as the PayNet 31-day to 90-day small business delinquency index, which increased 19 basis points year-over-year, while Marlin’s comparable managed portfolio of 30-plus day delinquency increased 16 basis points.

We have taken steps in response to the upward pressure on delinquency and charge-offs, including implementation of a behavioral scorecard to prioritize and improve the efficiency of our collections team calling activity and the hiring of additional collection staff.

Aggregate net charge-offs increased in the third quarter to 1.99% of average finance receivables on an annualized basis, as compared with 1.88% in the prior quarter and 1.9% in the third quarter of 2018. Equipment Finance charge-offs increased by 27 basis points quarter-over-quarter and 21 basis points year-over-year to 2.02%.

Although we observed higher charge-offs in several areas of our portfolio, the legacy transportation portfolio had the single most significant impact. Marlin’s annualized transportation industry net charge-offs increased from 1.26% and 1.74% in Q3 2018 and Q2 2019 respectively to 2.61% in Q3 2019. In comparison, PayNet’s transportation default rate increased 67 basis points year-over-year to 3.84%.

Credit related charge-offs have reached a level not experienced since 2011. The trend we’re seeing is in line with small business trends across the industry. PayNet small business default index increased 19 basis points year-over-year to 2.03%, a level not seen since 2012. We continue to closely monitor the performance of the Equipment Finance portfolio and we’re making underwriting adjustments as deemed necessary to ensure a stable portfolio performance.

We have recently tightened underwriting criteria in certain sectors and while we tightened our Equipment Finance transportation underwriting criteria at the beginning of 2018, we are analyzing recent portfolio performance to determine what further adjustments are needed considering the weakening transportation sector. Tighter underwriting and lower application quality contributed to an Equipment Finance approval rate of 53% in Q3 as compared to an average of 57% the prior four quarters.

Transitioning now to discuss Working Capital Loans, 15-plus day delinquency increased 137 basis points in the third quarter to 1.89% from the second quarter, while 30-plus day delinquency increased by 87 basis points to 1.34%.

Working Capital Loan net charge-offs in the third quarter decreased to 1.42% of average Working Capital Loans on an annualized basis from 4.82% in the second quarter and 4.42% in the third quarter of 2018. Results in Q3 benefited from a $177,000 recovery on a customer that was charged-off in Q1 of this year.

Excluding the recovery, net charge-offs for working capital on Q3 would have still been an excellent 2.75% on an annualized basis. We continue to be very pleased with a better than target performance of the working capital portfolio. As discussed on prior calls, Working Capital Loan delinquency and charge-offs tend to be more volatile than Equipment Finance, given the larger balances and smaller number of contracts.

The allowance for credit losses was 1.86% of average finance receivables, up 27 basis points in the third quarter due to an increased allowance for the Equipment Finance and working capital portfolios of 28 basis points and 1 basis point respectively. The increase in the Equipment Finance allowance percentage is primarily attributable to the noted dealer fraud issue as well as higher delinquency and charge-off migration rates in the third quarter.

Beginning in 2020, Marlin will be required to adopt the new allowance for credit losses methodology, commonly referred to as CECL or Current Expected Credit Losses. The CECL pronouncement replaces the current allowance for loan and lease losses accounting standard. Marlin’s project to prepare for CECL implementation is progressing and we plan to provide an estimate of the financial impact during our Q4 earnings call.

With respect to the equipment dealer fraud, a number of lessees have refused to pay due to equipment delivery or invoicing related issues. As there is litigation in process, we cannot provide too much detail, but it is important to note that all of the lessees are creditworthy entities that executed the lease and delivery and acceptance agreements. Marlin will be vigorously pursuing its rights against the lessees and dealer as appropriate.

From an outlook perspective, we monitor small business sentiment, utilizing the National Federation of Independent Small Business Optimism Index, which – while continuing to decline in September remains in the top 20% of all readings in the index’s 46-year history.

From a portfolio performance perspective, we monitor a number of leading indicators including PayNet’s AbsolutePD outlook, which forecasts the commercial loan default rate for businesses across the US based on current macroeconomic statistics. PayNet is forecasting the small business default rate over the next 12 months that is 19 basis points higher than the prior 12 months’ forecast.

In closing, our credit performance in Q3 was mixed with higher than expected charge-offs in Equipment Finance, while working capital was better than anticipated. While we continue to expect overall satisfactory portfolio performance, Marlin will continue to adjust underwriting and pricing as needed to ensure a stable portfolio quality and appropriate risk adjusted returns.

With that, I’ll turn the call over to our CFO, Mike Bogansky for a more detailed discussion of our third quarter financial performance. Mike?

Mike Bogansky

Thank you, Lou, and good morning, everyone. Third quarter net income was $7.4 million or $0.60 per diluted share compared with $5.9 million or $0.47 per diluted share for the third quarter last year.

For the quarter, yield on total originations was 13.38%, up 43 basis points from the prior quarter and up 61 basis points from the third quarter of 2018. Third quarter yield on direct originations was 24.38%, up a 129 basis points from the prior quarter due primarily to the mix of Working Capital Loans. The yield on indirect originations for the quarter was 10.1%, up 25 basis points from the second quarter, due primarily to an increase in Working Capital originations sourced from third-parties to our indirect channel.

For the quarter, net interest margin or NIM was 9.55%, up 17 basis points from the prior quarter and down 39 basis points from the third quarter of 2018. The sequential quarter increase was primarily driven by higher fee income, the growth in the average net investment in loans and leases, and an increase in new origination yields from Working Capital Loans.

The year-over-year decrease in margin percentage was primarily a result of an increase in interest expense resulting from higher deposit rates, which was partially offset by an increase of 61 basis points in new origination loan and lease yield. While the highly competitive pricing environment has persisted, we are continuing to pass through increases in our cost of funds as aggressively as the market will allow.

The company’s interest expense as a percent of average finance receivables increased slightly to 2.5% compared with 2.48% for the previous quarter. Interest expense as a percent of average finance receivables increased from 2.07% for the third quarter of 2018, due primarily to higher deposit costs.

Non-interest income was $10.4 million for the third quarter of 2019, compared with $7.2 million in the prior quarter and $4.4 million in the prior year period. The year-over-year and quarter-over-quarter increase in non-interest income is primarily due to an increase in gains on the sale of assets from the company’s capital market activities.

We sold $85.4 million of assets during the third quarter of 2019 and we realized strong execution gains driven by the current interest rate environment. As Jeff noted, this resulted from our origination growth being derived from a mix of lower yielding, higher quality assets that are more efficiently funded through syndication.

We continue to expect total asset sales for the fourth quarter to increase above the prior year levels due to the aforementioned change in our origination mix as well as an increase in our total sourced originations that had been originated for sale, particularly as a result of our acquisition of Fleet Financing Resources last year.

Moving to expenses, third quarter non-interest expenses were $17 million compared with $18.5 million in the prior quarter and $15.7 million in the third quarter last year. The decrease in non-interest expense compared with the prior quarter was primarily due to a decrease in salary and related expenses as well as a decrease in commission expenses due to the decline in originations. The year-over-year increase in non-interest expense was primarily due to the $1 million reclassification of servicing liability amortization in 2018 that is now recorded as contra-revenue in other income.

I would like to briefly touch on our effective tax rate for the quarter, which increased to 30.6% from 24.4% last quarter. The third quarter 2019 effective tax rate was adversely impacted by $457,000 from changes in state tax laws and an increase in the valuation allowance for certain state net operating losses. Our effective tax rate for the fourth quarter of 2019 is expected to decline to earlier levels.

During the third quarter of 2019, we’ve repurchased approximately 144,000 shares of Marlin common stock for an average price of $23 per share. This activity completed our share repurchase program that was previously announced on May 30th, 2017.

As of September 30th, we have $10 million of remaining authorization available under the new stock repurchase program that was announced in August. As we have previously communicated, we routinely evaluate capital allocation alternatives and we continue to believe that share repurchases are an appropriate use of capital at this time. Additionally, our Board of Directors declared a regular quarterly dividend of $0.14 per share payable on November 21st, 2019 to shareholders of record as of November 11th, 2019.

Now turning to our business outlook, we are updating our previously issued guidance for the full year ending December 31st, 2019 as follows. Total sourced origination volume is expected to finish approximately 20% above 2018 levels. Total assets sold are expected to be $295 million to $305 million as we continue to integrate the acquisition of Fleet Financing Resources and execute loan and lease syndications. We expect to achieve an immediate gain on sale margin of 6.5% to 7.5%.

Delinquencies and charge-offs are expected to remain at the higher end of our expected range. Net interest and fee margin as a percentage of average finance receivables is expected to be between 9.5% and 10%. ROE is expected to continue to improve in 2019 as the company continues to improve operating scale. And lastly, non-GAAP earnings per share is expected to be between $2.15 and $2.20.

As we enter the final quarter of the year, we’ve reset full year non-GAAP earnings per share guidance from the previous range of $2.30 to $2.40 to the new range of $2.15 to $2.20 per share. The reduction of our guidance is attributable to the following factors. First, slower-than-anticipated origination growth in the third quarter, particularly with the high yielding Working Capital Loan product, which was partially offset by improved execution on asset sales.

That said, as noted, we continue to anticipate 20% growth in full year total sourced originations. Second, the unanticipated $936,000 provision related to the specific single vendor fraud issue discussed by Jeff and Lou and lastly, the discrete items reflected in the tax provision during the third quarter.

Given our total asset sales through the first nine months of 2019, we’ve also updated our guidance for total assets sold to a range of $295 million to $305 million. As we have said in the past, we view these transactions as means to optimize both the return profile and credit composition of our portfolio and to enhance Marlin’s ROE over time by monetizing the platform’s ability to originate assets that our customers need, but that ultimately rely more efficiently on others’ balance sheets.

That concludes our prepared remarks. And with that, let’s open up the call for questions. Operator?

Question-and-Answer Session


Thank you. We will now begin the question-and-answer session. [Operator Instructions] Thank you. Mr. Hilzinger, it appears we have no questions at this time. I would now like to turn the floor back over to you for closing comments.

Jeff Hilzinger

Thank you for your support and for joining us on today’s call. I’d like to mention that next month on November 14th, we will be presenting at the JMP Securities Financial Services Conference in New York City. We hope to see some of you at this event, if not, we look forward to speaking with you again when we report our 2019 fourth quarter results in early February 2020. Thanks again, and I hope you have a great rest of your day.


Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.

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