Description


Marlin Financial is an interesting, overlooked value opportunity in the small-cap financial space.  It is a mono-line bank focused on the small commercial leasing market.  MRLN offers decent value at the current price for its status-quo operations.  But the status quo is unlikely to last indefinitely, and there are reasonable likelihood catalysts which could deliver an excellent risk-adjusted return.

Marlin holds a nationally diversified portfolio of small-commercial lease assets.  California is the largest geographic exposure at 12%, followed by Florida (9%), Texas (9%), New York (8%), and New Jersey (6%).  Over 100 equipment categories are financed.  Copiers are the largest specific category exposure (27%) with no other category exceeding 5%.  To address the inevitable “melting ice-cube” queries up-front with respect to copier leases, Marlin sees very healthy demand for copier leases and believes they could originate far more high quality assets in this category than they do today, but limit originations to avoid excess credit concentration.  There are no visible concerns regarding residual values on these assets.  

Marlin has a solid credit underwriting track-record.  Net-charge-offs to total finance receivables have been stable for the past five years in the 100-200bps range.  Charge-offs peaked in 2009 at 5.42% of receivables.  That NCO figure should be considered in the context of a 12% yield on lease assets in 2008 (10.5% in today’s rate environment).  

As Marlin is a branch less bank, funding is predominantly provided via CDs where Marlin currently pays around 1%.  It might make sense at some point for Marlin to raise commercial checking deposits via its lease customer relationships but thus far they have not pursued this path.  As is discussed below, it probably makes much more sense for Marlin to simply sell itself to a larger conventional bank with an existing deposit franchise rather than build out this capability out de novo.

Marlin currently operates at an ROE around 11%.  It remains massively overcapitalized even after a recent special dividend of $2 per share.  Tangible equity to assets stand at 20% down from 23% pre-dividend.  Post-dividend tangible book is approx. $12/shr.  Trading at 17.34, MRLN is at 1.4x tangible book which for an 11% ROE bank is decent albeit unexciting value.  

Marlin is currently looking at several initiatives to improve performance.  They are beginning to ramp up a new short term (6-24 month) working capital finance product for small businesses.  Management believes that it can take advantage of cross-sales opportunities and credit data from its existing leasing customers to profitably grow this product.  While the launch of a new credit product always needs to be watched carefully, Marlin appears to be taking a very prudent and measured approach to this rollout.  They are also evaluating the potential to sell excess origination capacity to third party investors for fee income.  Marketplace lenders going after similar assets (i.e., LC, ONDK) certainly seem to enjoy strong demand from institutional investors.  These internal initiatives have the potential to ramp up Marlin’s earnings power from around $1.30 today towards $1.80-$1.90 over the next couple of years, although I prefer to be conservative here and wait for more data before getting too excited.

Ultimately it makes little sense for Marlin to remain a standalone entity.  They are an excellent asset originator in a world of banks flush with cheap deposits and nowhere to put them.  Moreover, combining with another bank would free up tremendous excess capital.  What could Marlin garner in a takeout scenario?  Assume that an acquirer is able to eliminate 20% of Marlin’s SG&A.  This seems reasonable if not conservative based on the fixed expenses inherent to a small public banking corporation.  Using Q215 as a run-rate, an acquirer could get Marlin for roughly $19/share using 10x post-cost save earnings, which would make it accretive to a wide range of buyers.  

A buyer could also operate Marlin’s book of business with far less capital due to greater diversification and eliminating charter limitations Marlin entered into upon forming its bank.  Marlin currently has the obligation to maintain a total RBC ratio of 15%.  This obligation would end if Marlin was acquired into another bank charter.  If Marlin operated at 10% TCE/TA, it would free up an incremental $5.78/share in capital.  This brings the potential purchase price to $24.50 at 10x earnings and $28.50 at 12x.  

Furthermore, a buyer with excess cheap deposit funding would be able to find additional synergies beyond basic SG&A cuts.  Marlin’s current cost of deposit funding runs around 1%.  Many banks exist today awash in excess deposits costing 25-50bps.  This adds several dollars to the price at which a buyer could make MRLN a nicely accretive acquisition.  Combining an excess capital release with SG&A cuts and cost of funds savings would yield a takeout price in the $27-30 range.  Again, none of this incorporates a very possible organic increase in earnings power over the next 24 months due to internal initiatives.  The midpoint of this range is approximately 65% above the current stock price.  

Marlin has an above average likelihood of selling itself in a reasonable timeframe.  Two investors - Red Mountain Capital (23%) and Broad Run (9%) - hold an aggregate 32% of Marlin shares.  Given how illiquid Marlin is, these investors have little realistic exit prospects outside of selling the whole company (although for reasons unknown someone certainly tried in the Aug-Sept timeframe).  Management at least says they have a healthy willingness to sell under the right terms.  This month, Marlin’s longtime CEO stepped down.  Marlin is currently operating under an interim CEO while they search for a replacement.  There is some chance that they elect to sell the institution now rather than bring in new management.  Finally, selling Marlin simply makes compelling economic sense.  This is a fine little company but it is worth much more in someone else’s hands than it is as a standalone operation.  

In summary, Marlin offers fine value today with strong potential for an upside catalyst within the next year or two.  That represents a pretty good buy in a market where bargains are hard to come by.

Catalyst

Sale of company to a larger bank