| MARLIN BUSINESS SERVICES CORP Item 1A Risk Factors Set forth below and elsewhere in this report and in other documents we file with the Securities and Exchange Commission are risks and uncertainties that could cause our actual results to differ materially from the results contemplated by the forward-looking statements contained in this report and other periodic statements we make |
| If we cannot obtain external financing, we may be unable to fund our operations |
| Our cash requirements will increase if our lease originations increase |
| We historically have obtained a substantial amount of the cash required for operations through a variety of external financing sources, such as borrowings under our revolving bank facility, financing of leases through commercial paper (“CP”) conduit warehouse facilities, and term note securitizations |
| A failure to renew or increase the funding commitment under our existing CP conduit warehouse facilities or add new CP conduit warehouse facilities could affect our ability to refinance leases originated through our revolving bank facility and, accordingly, our ability to fund and originate new leases |
| An inability to complete term note securitizations would result in our inability to 12 _________________________________________________________________ [63]Table of Contents refinance amounts outstanding under our CP conduit warehouse facilities and revolving bank facility and would also negatively impact our ability to originate and service new leases |
| Our ability to complete CP conduit transactions and term note securitizations, as well as obtain renewals of lenders’ commitments, is affected by a number of factors, including: • conditions in the securities and asset-backed securities markets; • conditions in the market for commercial bank liquidity support for CP programs; • compliance of our leases with the eligibility requirements established in connection with our CP conduit warehouse facilities and term note securitizations, including the level of lease delinquencies and defaults; and • our ability to service the leases |
| We are and will continue to be dependent upon the availability of credit from these external financing sources to continue to originate leases and to satisfy our other working capital needs |
| We may be unable to obtain additional financing on acceptable terms or at all, as a result of prevailing interest rates or other factors at the time, including the presence of covenants or other restrictions under existing financing arrangements |
| If any or all of our funding sources become unavailable on acceptable terms or at all, we may not have access to the financing necessary to conduct our business, which would limit our ability to fund our operations |
| We do not have long term commitments from any of our current funding sources |
| As a result, we may be unable to continue to access these or other funding sources |
| In the event we seek to obtain equity financing, our shareholders may experience dilution as a result of the issuance of additional equity securities |
| This dilution may be significant depending upon the amount of equity securities that we issue and the prices at which we issue such securities |
| Our financing sources impose covenants, restrictions and default provisions on us, which could lead to termination of our financing facilities, acceleration of amounts outstanding under our financing facilities and our removal as servicer |
| The legal agreements relating to our revolving bank facility, our CP conduit warehouse facilities and our term note securitizations contain numerous covenants, restrictions and default provisions relating to, among other things, maximum lease delinquency and default levels, a minimum net worth requirement and a maximum debt to equity ratio |
| In addition, a change in our Chief Executive Officer or President is an event of default under our revolving bank facility and CP conduit warehouse facilities unless we hire a replacement acceptable to our lenders within 90 days |
| Such a change is also an immediate event of servicer termination under our term note securitizations |
| A merger or consolidation with another company in which we are not the surviving entity, likewise, is an event of default under our financing facilities |
| Further, our revolving bank facility and CP conduit warehouse facilities contain cross default provisions whereby certain defaults under one facility would also be an event of default under the other facilities |
| An event of default under the revolving bank facility or a CP conduit warehouse facility could result in termination of further funds being made available under these facilities |
| An event of default under any of our facilities could result in an acceleration of amounts outstanding under the facilities, foreclosure on all or a portion of the leases financed by the facilities and/or our removal as a servicer of the leases financed by the facility |
| This would reduce our revenues from servicing and, by delaying any cash payment allowed to us under the financing facilities until the lenders have been paid in full, reduce our liquidity and cash flow |
| If we inaccurately assess the creditworthiness of our end user customers, we may experience a higher number of lease defaults, which may restrict our ability to obtain additional financing and reduce our earnings |
| We specialize in leasing equipment to small businesses |
| Small businesses may be more vulnerable than large businesses to economic downturns, typically depend upon the management talents and efforts of one person or a small group of persons and often need substantial additional capital to expand or compete |
| Small business leases, therefore, may entail a greater risk of delinquencies and defaults than leases entered into with larger, more creditworthy leasing customers |
| In addition, there is typically only limited publicly available financial and other information about small businesses and they often do not have audited financial statements |
| Accordingly, in making credit decisions, our underwriting guidelines rely upon the accuracy of information about these small businesses obtained from the small business owner and/or third party sources, such as credit reporting agencies |
| If the information we obtain from small business owners and/or third party sources is incorrect, our ability to make appropriate credit decisions will be 13 _________________________________________________________________ [64]Table of Contents impaired |
| If we inaccurately assess the creditworthiness of our end user customers, we may experience a higher number of lease defaults and related decreases in our earnings |
| Defaulted leases and certain delinquent leases also do not qualify as collateral against which initial advances may be made under our revolving bank facility or CP conduit warehouse facilities, and we cannot include them in our term note securitizations |
| An increase in delinquencies or lease defaults could reduce the funding available to us under our facilities and could adversely affect our earnings, possibly materially |
| In addition, increasing rates of delinquencies or charge-offs could result in adverse changes in the structure of our future financing facilities, including increased interest rates payable to investors and the imposition of more burdensome covenants and credit enhancement requirements |
| Any of these occurrences may cause us to experience reduced earnings |
| If we are unable to effectively manage any future growth, we may suffer material operating losses |
| We have grown our lease originations and overall business significantly since we commenced operations |
| However, our ability to continue to increase originations at a comparable rate depends upon our ability to implement our disciplined growth strategy and upon our ability to evaluate, finance and service increasing volumes of leases of suitable yield and credit quality |
| Accomplishing such a result on a cost-effective basis is largely a function of our marketing capabilities, our management of the leasing process, our credit underwriting guidelines, our ability to provide competent, attentive and efficient servicing to our end user customers, our access to financing sources on acceptable terms and our ability to attract and retain high quality employees in all areas of our business |
| Our future success will be dependent upon our ability to manage growth |
| Among the factors we need to manage are the training, supervision and integration of new employees, as well as the development of infrastructure, systems and procedures within our origination, underwriting, servicing, collections and financing functions in a manner which enables us to maintain higher volume in originations |
| Failure to effectively manage these and other factors related to growth in originations and our overall operations may cause us to suffer material operating losses |
| If losses from leases exceed our allowance for credit losses, our operating income will be reduced or eliminated |
| In connection with our financing of leases, we record an allowance for credit losses to provide for estimated losses |
| Our allowance for credit losses is based on, among other things, past collection experience, industry data, lease delinquency data and our assessment of prospective collection risks |
| Determining the appropriate level of the allowance is an inherently uncertain process and therefore our determination of this allowance may prove to be inadequate to cover losses in connection with our portfolio of leases |
| Factors that could lead to the inadequacy of our allowance may include our inability to effectively manage collections, unanticipated adverse changes in the economy or discrete events adversely affecting specific leasing customers, industries or geographic areas |
| Losses in excess of our allowance for credit losses would cause us to increase our provision for credit losses, reducing or eliminating our operating income |
| If we cannot effectively compete within the equipment leasing industry, we may be unable to increase our revenues or maintain our current levels of operations |
| The business of small-ticket equipment leasing is highly fragmented and competitive |
| Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do |
| For example, some competitors may have a lower cost of funds and access to funding sources that are not available to us |
| A lower cost of funds could enable a competitor to offer leases with yields that are lower than those we use to price our leases, potentially forcing us to decrease our yields or lose origination volume |
| In addition, certain of our competitors may have higher risk tolerances or different risk assessments, which could allow them to establish more origination source and end user customer relationships and increase their market share |
| There are few barriers to entry with respect to our business and, therefore, new competitors could enter the business of small-ticket equipment leasing at any time |
| The companies that typically provide financing for large-ticket or middle-market transactions could begin competing with us on small-ticket equipment leases |
| If this occurs, or we are unable to compete effectively with our competitors, we may be unable to sustain our operations at their current levels or generate revenue growth |
| If we cannot maintain our relationships with origination sources, our ability to generate lease transactions and related revenues may be significantly impeded |
| We have formed relationships with thousands of origination sources, comprised primarily of independent equipment dealers and, to a lesser extent, lease brokers |
| We rely on these relationships to generate lease applications and originations |
| Most of these relationships are not formalized in written agreements and those that are formalized by written agreements are typically terminable at will |
| Our typical 14 _________________________________________________________________ [65]Table of Contents relationship does not commit the origination source to provide a minimum number of lease transactions to us nor does it require the origination source to direct all of its lease transactions to us |
| The decision by a significant number of our origination sources to refer their leasing transactions to another company could impede our ability to generate lease transactions and related revenues |
| If interest rates change significantly, we may be subject to higher interest costs on future term note securitizations and we may be unable to effectively hedge our variable rate borrowings, which may cause us to suffer material losses |
| Because we generally fund our leases through a revolving bank facility, CP conduit warehouse facilities and term note securitizations, our margins could be reduced by an increase in interest rates |
| Each of our leases is structured so that the sum of all scheduled lease payments will equal the cost of the equipment to us, less the residual, plus a return on the amount of our investment |
| The yield on our leases is fixed because the scheduled payments are fixed at the time of lease origination |
| When we originate or acquire leases, we base our pricing in part on the spread we expect to achieve between the yield on each lease and the effective interest rate we expect to pay when we finance the lease |
| To the extent that a lease is financed with variable rate funding, increases in interest rates during the term of a lease could narrow or eliminate the spread, or result in a negative spread |
| A negative spread is an interest cost greater than the yield on the lease |
| Currently, our revolving bank facility and our CP conduit warehouse facilities have variable rates based on LIBOR, prime rate or commercial paper interest rates |
| As a result, because our assets have a fixed interest rate, increases in LIBOR, prime rate or commercial paper interest rates would negatively impact our earnings |
| If interest rates increase faster than we are able to adjust the pricing under our new leases, our net interest margin would be reduced |
| As required under our financing facility agreements, we enter into interest rate cap agreements to hedge against the risk of interest rate increases in our CP conduit warehouse facilities |
| If our hedging strategies are imperfectly implemented or if a counterparty defaults on a hedging agreement, we could suffer losses relating to our hedging activities |
| In addition, with respect to our fixed rate borrowings, such as our term note securitizations, increases in interest rates could have the effect of increasing our borrowing costs on future term note transactions |
| Deteriorated economic or business conditions may lead to greater than anticipated lease defaults and credit losses, which could limit our ability to obtain additional financing and reduce our operating income |
| Our operating income may be reduced by various economic factors and business conditions, including the level of economic activity in the markets in which we operate |
| Delinquencies and credit losses generally increase during economic slowdowns or recessions |
| Because we extend credit primarily to small businesses, many of our customers may be particularly susceptible to economic slowdowns or recessions and may be unable to make scheduled lease payments during these periods |
| Therefore, to the extent that economic activity or business conditions deteriorate, our delinquencies and credit losses may increase |
| Unfavorable economic conditions may also make it more difficult for us to maintain both our new lease origination volume and the credit quality of new leases at levels previously attained |
| Unfavorable economic conditions could also increase our funding costs or operating cost structure, limit our access to the securitization and other capital markets or result in a decision by lenders not to extend credit to us |
| The departure of any of our key management personnel or our inability to hire suitable replacements for our management may result in defaults under our financing facilities, which could restrict our ability to access funding and effectively operate our business |
| Our future success depends to a significant extent on the continued service of our senior management team |
| A change in our Chief Executive Officer or President is an event of default under our revolving bank facility and CP conduit warehouse facilities unless we hire a replacement acceptable to our lenders within 90 days |
| Such a change is also an immediate event of servicer termination under our term note securitizations |
| The departure of any of our executive officers or key employees could limit our access to funding and ability to operate our business effectively |
| Bruce E Sickel, our Senior Vice President and Chief Financial Officer, has resigned from his position effective as of March 3, 2006 |
| We are currently seeking a new Chief Financial Officer |
| We do not expect the change in Chief Financial Officer to have any material adverse effect on our financing arrangements |
| The termination or interruption of, or a decrease in volume under, our property insurance program would cause us to experience lower revenues and may result in a significant reduction in our net income |
| Our end user customers are required to obtain all-risk property insurance for the replacement value of the leased equipment |
| The end user customer has the option of either delivering a certificate of insurance listing us as loss payee under a 15 _________________________________________________________________ [66]Table of Contents commercial property policy issued by a third party insurer or satisfying their insurance obligation through our insurance program |
| Under our program, the end user customer purchases coverage under a master property insurance policy written by a national third party insurer (our “primary insurer”) with whom our captive insurance subsidiary, AssuranceOne, Ltd, has entered into a 100prca reinsurance arrangement |
| Termination or interruption of our program could occur for a variety of reasons, including: 1) adverse changes in laws or regulations affecting our primary insurer or AssuranceOne; 2) a change in the financial condition or financial strength ratings of our primary insurer or AssuranceOne; 3) negative developments in the loss reserves or future loss experience of AssuranceOne which render it uneconomical for us to continue the program; 4) termination or expiration of the reinsurance agreement with our primary insurer, coupled with an inability by us to quickly identify and negotiate an acceptable arrangement with a replacement carrier; or 5) competitive factors in the property insurance market |
| If there is a termination or interruption of this program or if fewer end user customers elected to satisfy their insurance obligations through our program, we would experience lower revenues and our net income may be reduced |
| Regulatory and legal uncertainties could result in significant financial losses and may require us to alter our business strategy and operations |
| Laws or regulations may be adopted with respect to our equipment leases or the equipment leasing, telemarketing and collection processes |
| Any new legislation or regulation, or changes in the interpretation of existing laws, which affect the equipment leasing industry could increase our costs of compliance or require us to alter our business strategy |
| We, like other finance companies, face the risk of litigation, including class action litigation, and regulatory investigations and actions in connection with our business activities |
| These matters may be difficult to assess or quantify, and their magnitude may remain unknown for substantial periods of time |
| A substantial legal liability or a significant regulatory action against us could cause us to suffer significant costs and expenses, and could require us to alter our business strategy and the manner in which we operate our business |
| We estimate the residual value of the equipment which is recorded as an asset on our balance sheet |
| Realization of residual values depends on numerous factors including: the general market conditions at the time of expiration of the lease; the cost of comparable new equipment; the obsolescence of the leased equipment; any unusual or excessive wear and tear on or damage to the equipment; the effect of any additional or amended government regulations; and the foreclosure by a secured party of our interest in a defaulted lease |
| Our failure to realize our recorded residual values would reduce the residual value of equipment recorded as assets on our balance sheet and may reduce our operating income |
| Hurricane Katrina could negatively affect our operations, which could have an adverse effect on our business or results of operations |
| In late August 2005, Hurricane Katrina struck the gulf coast of Louisiana, Mississippi and Alabama and caused substantial property damage |
| Damage caused by Hurricane Katrina could result in a decline in our leasing activity, a decline in the value or destruction of leased property and an increase in the risk of lease delinquencies and defaults |
| Our business or results of operations may be adversely affected by these and other negative effects of Hurricane Katrina |
| If we experience significant telecommunications or technology downtime, our operations would be disrupted and our ability to generate operating income could be negatively impacted |
| Our business depends in large part on our telecommunications and information management systems |
| The temporary or permanent loss of our computer systems, telecommunications equipment or software systems, through casualty or operating malfunction, could disrupt our operations and negatively impact our ability to service our customers and lead to significant declines in our operating income |
| We face risks relating to our recent accounting restatement |
| If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results |
| As a result, current and potential investors could lose confidence in our financial reporting which would harm our business and the trading price of our stock |
| Effective internal controls are necessary for us to provide reliable financial statements |
| If we cannot provide reliable financial statements, our business and operating results could be harmed |
| We have in the past discovered, and may in the future discover, areas of our internal controls that need improvement including control deficiencies 16 _________________________________________________________________ [67]Table of Contents that may constitute material weaknesses |
| A material weakness is a significant deficiency, as defined in Public Company Accounting Oversight Board Audit Standard Nodtta 2 or a combination of significant deficiencies, that results in more than a remote likelihood that material misstatements of our annual or interim financial statements would not be prevented or detected by company personnel in the normal course of performing their assigned functions |
| In connection with the preparation of our Annual Report on Form 10-K for the fiscal year ended December 31, 2004, an evaluation was performed under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures |
| As a result of this evaluation, during the first fiscal quarter of 2005, management identified and concluded that a material weakness existed at December 31, 2004 in our controls over the selection and application of accounting policies |
| Specifically, management concluded that we had misapplied generally accepted accounting principles as they pertain to the timing of recognition of interim rental income since our inception in 1997 and, accordingly, we restated our financial statements for the fiscal years ended December 31, 2003 and December 31, 2002, and for the four quarters of fiscal years 2004 and 2003, to correct this error |
| The identified material weakness was remediated during the first fiscal quarter of 2005 |
| Consequently, management, including our CEO and CFO, have concluded that our internal controls over financial reporting were not designed or functioning effectively as of December 31, 2004 to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding disclosure |
| Any failure to implement and maintain the improvements in our internal control over financial reporting, or difficulties encountered in the implementation of these improvements in our controls, could cause us to fail to meet our reporting obligations |
| Any failure to improve our internal controls to address the identified material weakness could also cause investors to lose confidence in our reported financial information, which could have a negative impact on the trading price of our stock |
| Our quarterly operating results may fluctuate significantly |
| Our operating results may differ from quarter to quarter, and these differences may be significant |
| Factors that may cause these differences include: changes in the volume of lease applications, approvals and originations; changes in interest rates; the timing of term note securitizations; the availability of capital; the degree of competition we face; and general economic conditions and other factors |
| The results of any one quarter may not indicate what our performance may be in the future |
| Our common stock price is volatile |
| The trading price of our common stock may fluctuate substantially depending on many factors, some of which are beyond our control and may not be related to our operating performance |
| These fluctuations could cause you to lose part or all of your investment in our shares of common stock |
| Those factors that could cause fluctuations include, but are not limited to, the following: • price and volume fluctuations in the overall stock market from time to time; • significant volatility in the market price and trading volume of financial services companies; • actual or anticipated changes in our earnings or fluctuations in our operating results or in the expectations of market analysts; • investor perceptions of the equipment leasing industry in general and our company in particular; • the operating and stock performance of comparable companies; • general economic conditions and trends; • major catastrophic events; • loss of external funding sources; • sales of large blocks of our stock or sales by insiders; or 17 _________________________________________________________________ [68]Table of Contents • departures of key personnel |
| It is possible that in some future quarter our operating results may be below the expectations of financial market analysts and investors and, as a result of these and other factors, the price of our common stock may decline |
| Certain investors continue to own a large percentage of our common stock and have filed a shelf registration statement, which could result in additional shares being sold into the public market and thereby affect the market price of our common stock |
| Two institutional investors that first purchased our common stock in private placement transactions prior to our IPO owned approximately 37prca of the outstanding shares of our common stock as of December 31, 2005 |
| A shelf registration statement on Form S-3 (Nodtta 333-128329) registering 4cmam294cmam947 shares of common stock owned by these two investors became effective on December 19, 2005 |
| A sale by these investors of all or a portion of their shares pursuant to the shelf registration statement or otherwise could ultimately affect the market price of our common stock |
| Anti-takeover provisions and our right to issue preferred stock could make a third-party acquisition of us difficult |
| We are a Pennsylvania corporation |
| Anti-takeover provisions of Pennsylvania law could make it more difficult for a third party to acquire control of us, even if such change in control would be beneficial to our shareholders |
| Our amended and restated articles of incorporation and our bylaws will contain certain other provisions that would make it more difficult for a third party to acquire control of us, including a provision that our board of directors may issue preferred stock without shareholder approval |