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NEWT > SEC Filings for NEWT > Form 10-Q on 7-Aug-2013All Recent SEC Filings

Show all filings for NEWTEK BUSINESS SERVICES, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for NEWTEK BUSINESS SERVICES, INC.


7-Aug-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Introduction and Certain Cautionary Statements

The following discussion and analysis of our financial condition and results of operations is intended to assist in the understanding and assessment of significant changes and trends related to the results of operations and financial position of the Company together with its subsidiaries. This discussion and analysis should be read in conjunction with the condensed consolidated financial statements and the accompanying notes.

The statements in this Quarterly Report on Form 10-Q may contain forward-looking statements relating to such matters as anticipated future financial performance, business prospects, legislative developments and similar matters. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with the terms of the safe harbor, we note that a variety of factors could cause our actual results to differ materially from the anticipated results expressed in the forward-looking statements such as intensified competition and/or operating problems in its operating business projects and their impact on revenues and profit margins or additional factors as described in the Company's Annual Report on Form 10-K.

Our Capcos operate under a different set of rules in each of the six jurisdictions which place varying requirements on the structure of our investments. In some cases, particularly in Louisiana, we don't control the equity or management of a qualified business but that cannot always be presented orally or in written presentations.

Executive Overview

For the quarter ended June 30, 2013, the Company reported income before income taxes of $2,881,000, a $935,000 or 48% increase over $1,946,000 for the same quarter of 2012. Net income also increased to $1,701,000 in the second quarter of 2013 from $1,214,000 in the same quarter of 2012. Total revenues increased by $4,673,000 to $37,011,000 from $32,338,000 for the quarter ended June 30, 2013, due to increased revenues in the Electronic payment processing, the Small business finance, Managed technology solutions and the All other segments, offset by decreases in revenues in our Corporate and Capco segments. Electronic payment processing, the Small business finance and the Corporate segments also reported improvements in profitability.

In Electronic payment processing, the segment had an increase in revenue primarily due to growth in processing volumes, partially offset by a decrease in operating margin, resulting in a 28% increase in income before income taxes. In the Small business finance segment, the SBA lender doubled its total volume of loan originations increasing the total amount funded by $21,800,000, a 104% increase over the year ago period. Notwithstanding a decline in the third party servicing portfolio by 12% due to a contraction of the FDIC portfolio, we added a new external servicing client at the end of the second quarter increasing our aggregate portfolio by 13%. Servicing fee income on the NSBF portfolio increased by 34%, and interest income improved by 44% as a result of the average outstanding performing portfolio of SBA loans held for investment, which increased by $20,892,000 over the same quarter of 2012. Overall, the lending segment had a 37% increase in income before income taxes for the second quarter of 2013 compared with the three months ended June 30, 2012.

Managed technology solutions segment revenue increased by 1% for the three months ended June 30, 2013. The segment had an increase in web design revenue, which was partially offset by a decline in web hosting revenue compared with the same quarter in 2012. Total expenses increased by 3%, resulting in a $72,000 decrease in income before income taxes between quarters. In the All Other segment, total revenue increased by 46% for the quarter ended June 30, 2013 compared with the same period in 2012, due primarily to the acquisition of an insurance book of business serviced by NIA and additional clients added to our payroll processing company. Increases in salaries and benefits, as well as costs associated with a new start-up company, ACS, also included in this segment, offset the increase to revenue and resulted in a $201,000 increase in loss before income taxes for the quarter over quarter period. Corporate activities remained essentially unchanged and reported a $1,924,000 loss for the second quarter of 2013, and the loss in the Capco segment decreased by 26% to $293,000 for the three months ended June 30, 2013.

In July 2013 the SBA lender received an extension on the maturity of its warehouse lines of credit, totaling $27 million, with Capital One, N.A. from September 30, 2013 to May 31, 2015, at which time the outstanding balance will be converted into a three-year term loan. The extension also enhanced the terms of the credit facilities by removing the $15 million funding sublimit for the non-guaranteed portions of the SBA 7(a) loans NSBF originates, and increasing the advance rate to 55% from 50% for the non-guaranteed portions of the SBA 7(a) loans.


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Business Segment Results:

The results of the Company's reportable segments for the three and six months ended June 30, 2013 and 2012 are discussed below:

Electronic Payment Processing



                                                 Three months
                                                ended June 30:
(In thousands):                               2013           2012          $ Change         % Change
Revenue:
Electronic payment processing               $ 23,446       $ 21,371       $    2,075               10 %
Interest income                                    1              2               (1 )            (50 )%

Total revenue                                 23,447         21,373            2,074               10 %

Expenses:
Electronic payment processing costs           19,616         17,833            1,783               10 %
Salaries and benefits                            882          1,022             (140 )            (14 )%
Professional fees                                 70             56               14               25 %
Depreciation and amortization                     91            169              (78 )            (46 )%
Insurance expense - related party                 12             -                12              100 %
Other general and administrative costs           311            373              (62 )            (17 )%

Total expenses                                20,982         19,453            1,529                8 %

Income before income taxes                  $  2,465       $  1,920       $      545               28 %

Three Months Ended June 30, 2013 and 2012

Electronic payment processing ("EPP") revenue increased $2,075,000 or 10% between years. Revenue increased primarily due to growth in processing volumes. In addition, a change in the frequency of assessing a security compliance measurement fee to certain merchants from one measurement period per year to two times per year (at a reduced rate per measurement period) also positively affected revenues on a year over year basis by approximately $400,000. Processing volumes were favorably impacted by an increase of 2% in the average number of processing merchants under contract between periods. In addition, growth in revenue between periods increased due to an increase of approximately 8% in the average monthly processing volume per merchant. The increase in the average monthly processing volume per merchant is due in part to the addition of several larger volume processing merchants as well as year-over-year growth in processing volumes from existing merchants. The overall increase in revenue between years due to growth in processing volumes and the average number of merchants serviced was partially offset by lower average pricing between years due to both competitive pricing considerations, particularly for larger processing volume merchants, and the mix of merchant sales volumes realized between periods.

EPP costs increased $1,783,000 or 10% between years. Processing revenues less electronic payment processing costs ("margin") decreased to 16.3% in 2013 from 16.6% in 2012. The change in timing of assessing the security compliance measurement fee noted above and new lower contract pricing from the company's third-party processor favorably impacted the margin percentage between periods but such favorable impact was slightly more than offset by lower price for our services associated with the mix of new merchants added between periods. Overall, the increase in margin dollars was $292,000 between years.

Salaries and benefits decreased $140,000 or 14% between years principally as the result of a reduction in staffing levels. Depreciation and amortization decreased $78,000 between years as the result of previously acquired portfolios of intangible assets becoming fully amortized between periods. Remaining costs decreased $36,000 or 8% between years. In 2012, approximately $50,000 of office relocation costs were incurred.

Income before income taxes increased $545,000 to $2,465,000 in 2013 from $1,920,000 in 2012. The increase in income before income taxes was principally due to the increase in the dollar margin of operating revenues less electronic payment processing costs of $292,000 due to the reasons noted above including a reduction in staffing and related costs and depreciation and amortization cost between years.


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                                                  Six months
                                                ended June 30:
(In thousands):                               2013           2012          $ Change         % Change
Revenue:
Electronic payment processing               $ 45,123       $ 41,988       $    3,135                7 %
Interest income                                    3              3               -                -  %

Total revenue                                 45,126         41,991            3,135                7 %

Expenses:
Electronic payment processing costs           37,887         35,186            2,701                8 %
Salaries and benefits                          1,864          2,087             (223 )            (11 )%
Professional fees                                217            120               97               81 %
Depreciation and amortization                    204            410             (206 )            (50 )%
Insurance expense - related party                 25             -                25              100 %
Other general and administrative costs           629            674              (45 )             (7 )%

Total expenses                                40,826         38,477            2,349                6 %

Income before income taxes                  $  4,300       $  3,514       $      786               22 %

Six Months Ended June 30, 2013 and 2012

EPP revenue increased $3,135,000 or 7% between years. Revenue increased primarily due to growth in processing volumes and the effect of card association cost increases passed through to merchants. In addition, a change in the frequency of assessing a security compliance measurement fee to certain merchants from one measurement period per year to two times per year (at a reduced rate per measurement period) also positively affected revenues on a year over year basis by approximately $400,000. Processing volumes were favorably impacted by an increase in the average number of processing merchants under contract between periods of 2%. In addition, growth in revenue between periods increased due to an increase of approximately 6% in the average monthly processing volume per merchant. The increase in the average monthly processing volume per merchant is due in part to the addition of several larger volume processing merchants as well as year-over-year growth in processing volumes from existing merchants. The overall increase in revenue between years due to growth in processing volumes and the average number of merchants serviced was partially offset by lower average pricing between years due to both competitive pricing considerations, particularly for larger processing volume merchants, and the mix of merchant sales volumes realized between periods.

Electronic payment processing costs increased by $2,701,000 or 8% between years. EPP costs in 2013 and 2012 included provisions for charge-back losses of $290,000 and $745,000, respectively. The provision for charge-back losses in 2012 included losses of $456,000 related to a group of merchants affiliated with one of its independent sales agents. The group of merchants related to such sales agent was unilaterally approved by a former senior manager of the EPP division and such charge-back losses resulted from violations of credit policy by such senior manager. Processing revenues less electronic payment processing costs ("margin") decreased from 16.2% in 2012 to 16.0% in 2013. Margin was favorably impacted by the reduction in provisions for charge-backs between years by 1.1%. In addition, margin was favorably impacted by the change in timing of assessing the security compliance measurement fee noted above and new lower contract pricing from the company's third-party processor. However, the favorable impact on margin of the aforementioned factors were slightly more than offset by lower average pricing between years due to both competitive pricing considerations, particularly for larger volume merchants, and the mix of merchant sales volumes realized between periods. Overall, the increase in margin dollars was $434,000 between years.

Salaries and benefits decreased $223,000 or 11% between years principally as the result of a reduction in staffing levels and lower payroll taxes due to the acceleration of the payment of 2012 bonus payments into 2012. Professional fees increased $97,000 principally due to costs incurred in assessing the loss related to and the actions of the agent and former senior management member related to the charge-back losses associated with a group of merchants discussed above. Depreciation and amortization decreased $206,000 between periods as the result of previously acquired portfolio intangible assets becoming fully amortized between periods. Remaining costs decreased $20,000 or 3% between years. During 2012, office relocation costs of approximately $50,000 were incurred.

Income before taxes increased $786,000 to $4,300,000 in 2013 from $3,514,000 in 2012. The increase in income before taxes was principally due to the increase in margin of $434,000 due to the reasons noted above and the decreases in other costs, principally payroll and related costs and depreciation and amortization cost between years.


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Small Business Finance



                                                 Three months
                                                ended June 30:
(In thousands):                              2013           2012           $ Change          % Change
Revenue:
Premium income                              $ 4,937        $ 2,414        $    2,523               105 %
Servicing fee - NSBF portfolio                  666            496               170                34 %
Servicing fee - external portfolio              893          1,475              (582 )             (39 )%
Interest income                               1,162            807               355                44 %
Management fees - related party                  -             146              (146 )            (100 )%
Other income                                    718            625                93                15 %

Total revenue                               $ 8,376        $ 5,963        $    2,413                40 %


Net change in fair value of:
SBA loans held for sale                         (21 )         (130 )             109                84 %
SBA loans held for investment                  (750 )         (439 )            (311 )             (71 )%
Warrant liability                                -            (111 )             111               100 %

Total net change in fair value                 (771 )         (680 )             (91 )             (13 )%

Expenses:
Salaries and benefits                         2,004          1,439               565                39 %
Interest                                      1,323            969               354                37 %
Professional fees                               215            153                62                41 %
Depreciation and amortization                   295            206                89                43 %
Provision for loan losses                       209            155                54                35 %
Other general and administrative costs        1,529            883               646                73 %

Total expenses                                5,575          3,805             1,770                47 %

Income before income taxes                  $ 2,030        $ 1,478        $      552                37 %

Business Overview

The Newtek Business lending segment is comprised of NSBF which is a non-bank SBA lender that originates, sells and services loans for its own portfolio as well as portfolios of other institutions and NBC which provides accounts receivable financing and billing services to businesses. As such, revenue is derived primarily from premium income generated by the sale of the guaranteed portions of SBA loans, interest income on SBA loans held for investment and held for sale, servicing fee income on the guaranteed portions of SBA loans sold, servicing income for loans originated by other lenders for which NSBF is the servicer, and financing and billing services, classified as other income above, provided by NBC. Most SBA loans originated by NSBF charge an interest rate equal to the Prime rate plus an additional percentage amount; the interest rate resets to the current Prime rate on a monthly or quarterly basis, which will result in changes to the amount of interest accrued for that month and going forward and a re-amortization of a loan's payment amount until maturity.

Accounting Policy

On October 1, 2010, the Company elected to utilize the fair value option for SBA 7(a) loans funded on or after that date. For these fair value loans, premium on loan sales equals the cash premium and servicing asset paid by the purchaser in the secondary market, the discount created on the unguaranteed portion from the sale which formerly reduced premium income is now included in the fair value line item, and, by not capitalizing various transaction expenses, the salary and benefit and loan processing expense lines portray a value closer to the cash cost to operate the lending business. The fair value measurement, currently recorded as a 7.5% upfront discount of the unguaranteed principal balance of SBA loans held for investment, is based upon internal quantitative data on our portfolio with respect to historical default rates and future expected losses as well as the investor price paid for the senior interest in our unguaranteed loans with respect to the 2013 securitized transaction, and adjusted for the


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estimated servicing and interest income to be retained by the trust over an estimated repayment term of three years. This was further adjusted to reflect the estimated default rate on the senior notes based on the default rate on our loan portfolio, assuming a worst case scenario of no recoveries. Should the performance of the underlying loans of the senior notes change, this could impact the assumptions used in the estimated repayment term as well as the estimated default rate and thus result in a higher or lower discount rate taken in the future; management reviews these assumptions regularly. If a loan measured at fair value is subsequently impaired, then the fair value of the loan is measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, or the fair value of the collateral if the loan is collateral dependent. The significant unobservable inputs used in the fair value measurement of the impaired loans involve management's judgment in the use of market data and third party estimates regarding collateral values. Such estimates are further discounted by 20% - 80% to reflect the cost of liquidating the various assets under collateral. Any subsequent increases or decreases in any of the inputs would result in a corresponding decrease or increase in the reserve for loan loss or fair value of SBA loans, depending on whether the loan was originated prior or subsequent to October 1, 2010. Because the loans bear interest at a variable rate, NSBF does not have to factor in interest rate risk.

Consideration in arriving at the provision for loan loss includes past and current loss experience, current portfolio composition, future estimated cash flows, and the evaluation of real estate and other collateral as well as current economic conditions. For all loans originated on or prior to September 30, 2010, management performed a loan-by-loan review for the estimated uncollectible portion of non-performing loans; subsequent to September 30, 2010, management began recording all loan originations on a fair value basis which requires a valuation reduction of the unguaranteed portion of loans held for investment to a level that takes into consideration future losses. This valuation reduction is reflected in the line item above: Net Change in Fair Value of SBA Loans Held for Investment.

Small Business Finance Summary



                                                   Three months                       Three months
                                               ended June 30, 2013                ended June 30, 2012
                                           # Loans           $0,000           # Loans           $0,000

Loans sold in the quarter                        35       $      32,817             25       $      16,732
Loans originated in the quarter                  38       $      42,825             28       $      21,025
Premium income recognized                        -        $       4,937             -        $       2,414

Average sale price as a percent of
principal balance (1)                                            112.53 %                           112.16 %

(1) Premiums greater than 110.00% must be split 50/50 with the SBA. The premium income recognized above reflects amounts net of split with the SBA.

For the three months ended June 30, 2013, the Company recognized $4,937,000 of premium income from 35 loans sold aggregating $32,817,000 as compared with $2,414,000 of premium income from 25 loans sold aggregating $16,732,000 for the three months ended June 30, 2012. Premiums on guaranteed loan sales averaged 112.53% with 1% servicing for the quarter ended June 30, 2013 compared with 112.16% with 1% servicing for the quarter ended June 30, 2012.

                                                  Three months
                                                 ended June 30:
(In thousands):                               2013           2012         $ Change        % Change

Total NSBF originated servicing
portfolio (2)                               $ 413,824      $ 309,457      $ 104,367              34 %
Third party servicing portfolio               226,020        257,009         30,989             (12 )%

Aggregate servicing portfolio               $ 639,844      $ 566,466      $  73,378              13 %


Total servicing income earned NSBF
portfolio                                   $     666      $     496      $     170              34 %
Total servicing income earned external
portfolio                                         893          1,475           (582 )           (39 )%

Total servicing income earned               $   1,559      $   1,971      $    (412 )           (21 )%

(2) Of this amount, total average NSBF originated portfolio earning servicing income was $303,614,000 and $234,431,000 for the three month periods ended June 30, 2013 and 2012, respectively.


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We are the contractor managing and servicing portfolios of SBA 7(a), USDA and other loans acquired by the FDIC from failed financial institutions, and we assist the FDIC in the packaging of these loans for sale. During November 2012 and April 2013 the FDIC was successful in selling a significant group of loans with our assistance, which resulted in a reduction in current and future servicing income from the FDIC, offset by the addition of servicing income from other third party financial institutions. Our existing servicing facilities and personnel perform these activities supplemented by contract workers as needed. The size of the portfolio we will service for the FDIC, and thus the revenue earned, varies and depends on the level of bank failures and the needs of the FDIC in managing portfolios acquired from those banks as well as the success of being able to sell such portfolios. We continue to add other third party loan servicing contracts in 2013 which we expect will mitigate the declining FDIC portfolio.

The $412,000 decrease in servicing fee income was attributable primarily to the reduction of FDIC Servicing Income which decreased by $717,000 for the three months ended June 30, 2013 compared with the three months ended June 30, 2012. This decrease was offset by an increase in other third party loan servicing of $135,000. The average third party servicing portfolio including the FDIC portfolio decreased to $165,470,000 from $240,897,000 in for the same three month period in 2012. This decrease in the FDIC portfolio was partially offset by the addition of a new external servicing client portfolio of approximately $55,000,000, the associated income for which will begin to be recognized during the third quarter of 2013. In addition, servicing fees received on the NSBF portfolio increased by $170,000 quarter over quarter and was attributable to the expansion of the NSBF portfolio, in which we earn servicing income. The portfolio increased from an average of $234,431,000 for the three month period ended June 30, 2012 to an average of $303,614,000 for the same three month period in 2013. This increase was the direct result of increased loan originations throughout 2012 and the first half of 2013.

Interest income increased by $355,000 for the three month period ended June 30, 2013 as compared to the same period in 2012. This increase was attributable to the average outstanding performing portfolio of SBA loans held for investment increasing from $46,993,000 to $67,885,000 for the quarters ended June 30, 2012 and 2013, respectively.

Other income increased by $93,000 for the three month period ended June 30, 2013 as compared to the same period in 2012, primarily due to a $67,000 increase at NSBF. The increase was attributable to packaging fee income as a result of the increase in the number of loans originated period over period as well as an increase in income on recoveries.

The increase in the change in fair value associated with SBA loans held for sale of $109,000 results from $994,000 increase in the amount of unsold guaranteed loans at June 30, 2013 when compared to June 30, 2012 as well as the increased premium being received on sold loans period over period, as discussed above.

The decrease in the change in fair value on SBA loans held for investment of $311,000 is a result of the amount of unguaranteed loans originated during each period. During the quarter ended June 30, 2013, loans originated, held for . . .

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