NewtekOne, Inc. 8.50% Fixed Rate Senior Notes due 2029 (NEWTG) Q1 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Newtek Business Services Inc. Q1 2014 Earnings Conference Call. [Operator Instructions] As a reminder, this call is being recorded. I would now like to turn the call over to your host for today's conference, Mr. Barry Sloane, President, Founder and CEO. Sir, the floor is yours.

Thank you. Good afternoon, everyone. And welcome to the first quarter 2014 shareholder conference call. I'm Barry Sloane, President and CEO of Newtek Business Services, stock symbol NEWT. And here today to help with the presentation and present the financial aspects is Jenny Elson, our Chief Accounting Officer. Jenny, would you read the Safe Harbor statement.

Sure. The statements in this slide presentation, including statements regarding anticipated future financial performance, Newtek's beliefs, expectations, intentions or strategies for the future, may be forward-looking statements under the Private Securities Litigation Reform Act of 1995. All forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially from the plans, intentions and expectations reflected in or suggested by the forward-looking statements. Such risks and uncertainties include, among others: intensified competition; operating problems and their impacts on revenues and profit margins; anticipated future business strategies and financial performance; anticipated future number of customers, business prospects, legislative developments, and similar matters. Risk factors, cautionary statements and other conditions, which could cause Newtek's actual results to differ from management's current expectations, are contained in Newtek's filings with the Securities and Exchange Commission and available through www.sec.gov.

Thanks, Jenny. For those of you that would like to follow the presentation, you can find it on our website, thesba.com. Go to the Investor Relations section, and you'll be able to see the first quarter 2014 PowerPoint presentation and follow along. We will begin on Slide #3. Business Development Company. The company expects to present to its shareholders a proposal to convert to a Business Development Company once we're cleared to do so by the Securities Exchange Commission. The particular document can be found under the name Newtek Business Services Corp., which is a Merrill Incorporation and can be found on the SEC's website. In addition, the company has filed preliminary materials to conduct the public offering with connection of the conversion to a BDC of up to $50 million in shares in the BDC. And on the registration statement, you will see the book managers of Stifel, KMP and William Blair. We will not be able to offer any further information or take any questions regarding this proposed conversion or offering. Q1 2014 financial highlights. We first want to announce that we are reaffirming our 2014 consolidated guidance for the year. We expect a double-digit topline and bottom line percentage growth in 2014. We'll talk about that throughout the presentation. The company has excelled in meeting or exceeding our pretax net income and EBITDA guidance in years 2011, 2012, 2013. We look forward to being able to perform in that manner as well, this year, and we are reaffirming our guidance. In the first quarter, adjusted EBITDA was $4.8 million, a year-over-year increase of 10.6%. Operating revenues were $36.1 million, a year-over-year increase of 5.7%. Pretax net income was $2.2 million, essentially flat from the year prior. Our diluted EPS of $0.04 was equal to Q1 2013. In the Small Business Finance segment, revenue was $10 million, a year-over-year increase of 34.8%. And pretax income of $2.7 million, a year-over-year increase of 23.7%. Looking at some operational highlights. We originated close to $46 million in 7(a) loans, a 31% increase on our way to originate between $240 million and $260 million worth of loans in 2014. I will add that the lending business, similar to the merchant processing business very seasonal. The first quarter is typically the weakest. The lenders on a run rate to receive over $6 billion in referrals in 2014 versus a little over $4 billion in referrals received in 2013. Our loan servicing portfolio grew by 95% to $1.1 billion in Q1 2014. Throughout Q1 2014, the company reached a milestone, which we should put a press release out on. We have received over 500,000 individual referrals from independent business owners through the NewTracker system. This is an asset that we are in the process of positioning ourselves today in line that we haven't gotten to that yet at this point in time. In the first quarter, we have expanded our alliance partnerships with nationally recognized firms such as the Hartford, Teachers Federal Credit Union and Paragon Financial Group. We're also expanding the depth and breadth of management team with the hiring of senior executives. We will actually name 2 of those executives today, and we hope to name 2 additional ones within the next 1 to 2 weeks. One of the things the company is going to focus on and talk about today is reducing its cost of capital. We obviously talked about the potential BDC equity raise under Newtek Business Services Corp. We are currently working on potentially closing a $20 million facility with Capital One Bank, which will refinance $10 million of Summit Capital Partners debt. The debt was taken out over 2 years ago. There's a 15% interest rate on it. And we stand to save somewhere in the neighborhood of 9% to 10% in our cost of funds. We took this debt down. We obviously -- we have a lot of conversations which is why we were borrowing money that was so expensive. Obviously, if you could look at the company's performance over the course of 2 years, as mezzanine capital clearly paid off, the company was able to generate returns in excess of that cost of capital. And now, we're prepared to pay it off without any penalty. We're also working on closing our $75 million Goldman Sachs small business lending warehouse line. That is in the process. And you could see us, we're moving forward. The company has capital providers both in the lending and equity side that it's looking to capitalize on and reduce its overall cost of capital. On Slide #7. We would like to announce the building out of our senior executive team. Richard Rebetti, has recently been named President and Chief Operating Officer of Newtek Technology Services. Rich has over 20 years’ worth of experience in business development and operations of high-tech and communications companies. He was former COO of Data Storage Corp and Telco Inc., and former Chief Technology Officer of STi Prepaid. Rich, in taking over the operations and P&L responsibility of Managed Technology Solutions, will be working closely with C J Brunet, who historically has functioned as our Chief Information and Chief Technology Officer. Taking some of the responsibility of managing the operating business, of Managed Technology Solutions, we believe we'll further enhance our ability to grow Managed Technology Solutions and reverse the current trend. Two, enable us to get a lot of our technology products developed faster with C J having renewed focus on his CIO and CTO duties. We were also proud to announce that Susan Streich has joined our organization. She'll be beginning on Monday, as Chief Risk and Chief Compliance Officer for Newtek Business Services and Newtek Small Business Finance. Susan has over 30 years of experience in the executive level, particularly in the small business lending area. She formally was Senior Advisor, Project lead, and a subject matter expert at Booz Allen Hamilton and working for the U.S. Treasury Department. Susan also formally worked at Capital One Bank for about 7 years. And while she was there originated and ran the SBA lending business for Capital One Bank, and originated $1.5 billion worth of loans. She was also President of Transamerica Small Business Capital, one of the largest non-bank SB lendors in the United States. Today, we are announcing the reaffirmation of our 2014 guidance. We're looking at revenue growth in 2014 of 12.1% over 2013. Pretax income of -- increase of 21.6% over 2013. Diluted EPS of $0.23, previously $0.20, an increase of 15%. And adjusted EBITDA, approximately $26 million. Looking at our balance sheet. You can take a look at the, obviously, the amount of leverage that we have. When you take a look at the real unsecured debt, which is primarily Summit, and small $400,000 to $500,000 current debt outstanding with Capital One Bank. The company has very little debt on its books. Most of the other debt is in securitizations, which in the history of finance would be considered off balance sheet. In today's accounting vernacular is on balance sheet as well as our Capital One Bank leverage lines. So we look at our business with $78 million of equity on March 31, 2014, with most of the liabilities that you see there are at $113 million, and a $100 million is secured by loans, that we really cannot believe we have a highly levered business at this point in time. Looking at Small Business Finance. Our Q1 revenue was up 34%. We funded approximately $46 million worth of loans, 31% increase. We talked about our servicing portfolio growing to $1.1 billion, and getting lots of opportunity referrals in a $6 billion. I will tell you as we hope to convert into the potential BDC, we'll be able to put more of those referrals to work. Our current limitations in the lending space are limited to our Newtek business credit, our receivable line of credit product. We do merchant cash advances in Asia, and we do 7(a) lending. Under the BDC umbrella, we clearly plan on expanding our lending menu. We will be able to put more money to work and grow our lending business. On Slide #11, there is the classic example that I'm going to spend a little bit time on today. Of the -- your typical $1 million of an SBA 7(a) loan. We make the $1 million loan. $750,000 is full faith and credit, U.S. Government guaranteed in a government guaranteed loan participation. $250,000 is uninsured, but importantly, losses occur across the participations on a pro rate, or prior to sub[ph] basis not subordinate. So the $250,000 piece which typically remains on new textbooks is not subordinated to the senior piece. The accounting for that is when we sell $1 million loan, we typically sell it on average 112.5% premium in this particular example, which I think is consistent Jenny with what we got in the first quarter, would you remember we now that have 112.5.

Yes.

112.5% net to us. We also created a servicing asset, which is worth about $18,630. And we've added those 2 incomes up together of $112,000. That's the value of the servicing asset plus the cash gain on sale. We take a piece of that. We load it into a discount, which is currently 6% on the uninsured piece. If you take a look at our 10-Q, and this information was also in our 10-K. You could see what a discounted cash flow analysis to mark the uninsured pieces to market. We run through a full model. We will run through a 25% historic to full rate. We run them through a 35% severity over the course of time. And we basically use a market clearing yield at a spread of about 135 basis points behind where our single area insecurities have traded to come up with a $94 price on our uninsured loan participations with the 6% floating rate coupon over prime. So if you take a look at the discount, the referral piece to pay the third parties, direct expenses of $22,000, we had a net lease return risk-adjusted profit of $92,000 on a $1 million loan. The next thing I wanted to talk about is how much cash that's created post securitization, which is typically in a 6 to 12 month cycle when we do a $1 million loan. So on Slide #12, we created a $1 million loan, to sell the government guaranteed piece of $750,000 into 11 pool assemblers on Wall Street, you get a premium of approximately $93,750. Then typically what we do is we put the uninsured piece of $250,000 in our Capital One Bank line at approximately a 55% advanced rate. We put it into a securitization. You get a 67% advanced rate. So on a $250,000 phase, you get $167,000 of cash. So the amount of equity that basically goes into that $250,000 loan is $250,000 less $167,000, which is approximately $82,000 and you get $93,000 of cash gain. So therefore on every million dollar loan, you create $11,250 once you really strip into a securitization. My view, there is no accounting gain only due to securitization. That is a finance transaction, the loans are on the books. So we've historically in the course of lending 11 years, due to extremely conservative accounting. We've been through many lending cycles. We're not a new lender. We're not new in the business. We've been around the block, and we've managed our risks very well. And we're very excited about how we're growing the book. On Slide #13, you can take a look at the improvement of the credit quality over time. And when you look at what our portfolio looked like on December 31, 2010, to March 31, 2014, you could see our FICO scores have improved, our percentage of first-liens on the real estate, whether it's commercial or the residents of the owner, is up to 95%. About -- over half of our loans is secured by the commercial real estate on the business. We've clearly reduced concentrations in the industries, you could see our largest concentration is about 7%. And in state concentrations, our largest state is New York with 13%. Our servicing portfolio has continued to grow. It's about a 50-50 split between servicing our own loans versus servicing third-party loans. Our own loans tend to have a longer average life and durations. Our own loans, I would say, have got about a 5-year average life and a 4-year duration. The servicing portfolio for others can be quite volatile, but it typically sits somewhere around a year for the larger portfolios. We actually do have smaller portfolios that have stayed with us for many years, which we are servicing for third-party financial institutions. But in many cases, we will get a big portfolio of loans, were brought into clean it up. We get asset management fees for doing that, and then they wind up getting sold to other third parties. Our third-party servicing portfolio wound up increasing by 95.6% to $1.1 billion. And we do have quite a few opportunities in the pipeline to service for others, we are hopeful, optimistic and would love to announce future large increases in that particular business line. Looking at the Electronic Payment Processing space, which for those of you that follow the company historically has no debt on. It currently has no debt on, and historically, has no debt on it. Revenue growth was very slight, it was close to flat declining 0.7%. And growth in the payment processing business going forward. We believe it's going to be dependent upon 2 important trends. One is POS in the Cloud strategy. For those of you that have gone to restaurants recently, where you have seen people taking your order on a smartphone or a tablet-based POS system. Those forms of taking a POS, putting on a tablet, significant cost reductions over MICROS systems, MCR systems, Aloha systems. So we are embracing several different POS providers. We are planning on rolling out our product offerings in a big way. In this quarter, we've actually put some POS product out in the market already. We will have our white label version. We will also be offering other people's POSs. The big benefit to business owners, significant cost reduction on POS software, and also more attractive data reporting and information to the business owner from these POSs. The other important change in the payments industry is EMV, Euro-Master-Visa. It's basically the chip card, which is very popular in Europe. We will be rolling out a program to take advantage of other competitors quite that currently do not have the appropriate chip card terminals. And mixed with their own clients have a terminal that can't take a chip for security reasons. The big issue here, an incentive for merchants to change over that terminal is that in October of 2015, Visa and MasterCard have indicated that merchants taking fraudulent cards will be responsible for the fraud, no longer their issuing bank. So the risk is going to shift from the issuing bank to the merchant, and having a compliant terminal is important. We are aggressively out there talking to our customers as we speak. Managed Technology Solutions. The first quarter 2014, MTS revenue declined by 7.7%. We've discussed historically that we are transitioning the business to take advantage of the shift to cloud-based businesses, upgrading to Linux-based platforms. It's an important part of our overall strategy. Some of our results in this particular segment are attributed -- have been attributed to a decline in a number of lower-priced shared hosting plans, a decrease in the number of higher-priced dedicated hosting plans. That we've had and obviously did significant investment in software development costs. The key -- our turnaround in this area is to execute on the hyper growth plans for Cloud offerings. Growth in the higher-priced dedicated server plans and to make sure our products are integrated into our existing Cloud offering, things like payroll, POS in the Cloud, products of that nature. We are very optimistic with the new addition of Rich Rebetti, the President and Chief Operating Officer with P&L responsibility with an intense focus on the business and the operating team out of Phoenix, that we will achieve levels of success in the near future. Looking at Newtek going forward, as we continue to position ourself as the brand presence. We talk about our operating model. I think what's important, we've always been true to our clients and true to our brand. We are the payroll company. We are the 50 state license in the Penn [ph] insurance agent. We are the company that manages the data center that actually handles client's hardware, software needs. We are the company that makes the loans. And we are the company that does the payment processing. We are not a broker. We are in their dealing with the customer every single day, unlike Amazon, who is positioned to sell everybody else's products. We are a little bit more like Wal-Mart. Well, how do we succeed in this business strategy. The key is, the company has been positioned over the course of 11 years as a FinTech company, acquiring business clients cost effectively, not using expensive feet on the street reps in the marketplace, but to basically use the NewTracker system where our leaks are coming in from strategic alliance partners, to offer our services in the Cloud through the Newtek Advantage, and basically, to make sure all of our business services are integrated with one another where we view business services going forward will be more as a software as a service function. But also being there 24/7, picking up the phone, being able to talk to customers and service their needs. When we look at the markets today, we're looking at the different trends. I guess, people copying what you're doing is clearly a high level of flattery. So we've noticed that Heartland, for example, made a $20 million investment in the leads to take their POS, make sure that it dumps into their software, make sure it dumps into accounting information for their clients. Heartland is also integrated into the payroll business. So Heartland, we could see is moving more towards a more complete offering for business owners. When the business owner gets a solution, they get accounting software, they get payroll, and POS and processing, all dumping into one spot. We own and operate all of these businesses today. We think we have a very valuable business proposition that currently isn't receiving the value that we hope and anticipate it will get in the future. Looking at our marketing strategy. We're going to continue to present ourselves as The Small Business Authority. We've expanded our national TV advertising program. For those of you that have seen us on CNN, Fox, Fox Business News, MSNBC, Bloomberg, the History channel and the Discovery channel. We're pretty much on 7:00 a.m. to 7:00 p.m. We run somewhere between 200 to 350 commercials a month, depending upon the month in the quarter. And we do believe this strategy is paying off. We've recently announced the expansion of several alliance relationships. We just signed a deal with the Hartford. The Hartford is over $1 million small business customers. The Hartford also has 40,000 property and casualty agents, and health and benefits agents that write for them. Hartford will be introducing us to their clientele and distribution partners over the course of time. We also announced an alliance with Teachers Federal Credit Union with 234 members. And the CTAA, Community Transportation Association of America, basically providing all forms of financial services to many transporters and their alliance relationship. When we look at people that are in the public domain for comparables, we've given you a full array of entities on Page #24, some big, some small. We do think that what is unique about Newtek is we do many more things than these companies. We are a FinTech Company. We actually see so many companies gravitating more towards our model. On Slide #25, there's been a lot of attention to non-bank lending. Obviously that is something that we are highlighting ourselves financially. And as a BDC, it will be the primary focus of many investors. Despite the fact on the other the business services respectively, it will be under the BDC, non-bank lending has clearly become a very, very hot item. Entities like the Lending Club, which is in discussion to go public, have recently attracted capitalization in the $3.8 billion market cap. On their capital -- raising over $180 million in venture capital. A lot of companies that we compare to have real high valuations. We feel very good about where we are, what we're doing in the market. We've always run our business on a long-term basis. We've never paid much attention to month-to-month deviations quarter-to-quarter. Our last 3 years, we've met or exceeded our bottom line guidance for pretax, EPS, EBITDA. We feel very good about the quarter and very good about the year ahead. I will now turn the rest of the presentation over to Jenny

Thank you, Barry. To summarize, our consolidated first quarter results, we had operating revenue of $36.1 million, a 6% increase over the first quarter of 2013. Consolidated pretax income of $2.2 million or 1% increase over the year ago quarter. Net income decreased by 4% to $1.4 million. And we reported diluted EPS of $0.04 per share unchanged from the year-ago period. Please turn to Slide #30 for a summary of our first quarter 2014 revenue, pretax income or loss and adjusted EBITDA by segments compared with the year ago period. Electronics Payment Processing segment revenue decreased to $21.5 million or 1% from $21.7 million. Processing revenue, less processing costs or margin also decreased from 15.7% in Q1 2013 to 14.8% in the current quarter, due in part to competitive pricing as well as in the mix of merchant sales volumes generated in the current quarter. While there was a reduction in total expenses between periods, overall pretax income decreased by $117,000 to $1.7 million for the first quarter of 2014, compared with $1.8 million a year ago. The Small Business Finance segment had a 35% improvement in total revenue, increasing by $2.6 million to $10 million for the first quarter of 2014. The majority of this increase was in servicing fee income, which increased to $2.6 million for our combined portfolios. Our aggregate servicing portfolio grew by 96% quarter-over-quarter, exceeding $1 billion at March 31, 2014. During the current quarter, the lender originated $45.7 million in loans, a 31% increase in dollar volumes as well as a 40% increase in the total number of loans funded. Interest income also increased by 55% to $1.6 million as the average outstanding performing loan portfolio increased along with the total volume of loan originations during the year. Total expenses to the lending segment increased by $1.2 million. Interest expense and other G&A costs, primarily related to various loan-related expenses, increased by combined $800,000, and salaries and benefits increased by $460,000 due to additional staff added to our Lending division. Overall, the Lending segment had pretax income of $2.7 million, a 24% improvement over the first quarter of 2013. Managed Technology Solutions segment revenue totaled $4.1 million for the first 3 months of 2014, a decrease of 8% compared with the first quarter of 2013. The segment had a decrease in the average number of total plans, and both web posting and web design revenue decreased by combined $390,000 in the current quarter. Total expenses also decreased primarily in G&A costs, resulting in a $193,000 reduction in total expenses compared to the year-ago quarter. Pretax income was $751,000, down 16% from the first quarter of 2013. The All Other segment, which primary represents results from our insurance and payable subsidiaries, had a pretax loss of $400,000 in 2014, a $60,000 improvement over the year-ago quarter. While current year revenue decreased by $70,000, mostly related to our insurance division, total expenses decreased by $130,000 and included reductions in insurance broker commission, other G&A cost, as well as a reduction in salaries and benefits during the quarter. The pretax loss for our corporate segment increased by 12% to $2.2 million in the current quarter, due primarily to an increase in marketing expenses included in other G&A costs. The pretax loss in our CAPCO segment remained essentially unchanged in the quarter, decreasing to a pretax loss of $270,000. And finally, on Slide 31, we've got our reaffirmed consolidated guidance for 2014, as well as the guidance by segments for revenues, pretax income and adjusted EBITDA. I would now like to turn the call back to Barry.

Thank you, Jenny. Operator, we are open to take any questions.

[Operator Instructions] And our first question comes from the line of Brian Walsh with Oppenheimer & Co.

Barry, you had somewhat of a modest quarter relatively speaking, but your reaffirmed your guidance on several occasions during the discussion. Do you expect to make any changes going forward to assure that you're going to meet your guidance for 2014?

I appreciate that. I think from our perspective, we are constantly making changes to the operating business. We're constantly improving our technology, we're constantly improving our process, we're constantly adding more relationships, and we talked about improvement in cost to capital. So I think that before doing this, I worked on Wall Street. I know we roll out there with our advocacies and slight rules and looking for the exact linear movement. We give our guidance on an annual basis. We've beaten our guidance 3 years in a row. We feel very good about it. Jenny and I sat down, we went through every segment, had every President on the phone with us, we scrubbed them all raw. So we're good to go.

Our next question comes from the line of Peter Checkalon [ph] with Barrett & Company.

One question I have. How does the conversion to a BDC help the shareholder both in the long term. It doesn't seem to be helping us right now. But can you explain a little bit why converting to a BDC will be beneficial for the shareholders?

Sure. And what I'm going to do, Peter, be a little bit careful. I'm not allowed to talk about our transaction, but I certainly can talk about a BDC in general. I guess, the first thing, obviously, we did our filing in the fourth quarter of last year. So that's always one of these hurry up and wait things, and obviously, dealing with bureaucracies and putting filings out there, that will take longer than you think. I think you could tell from our perspective, and in fact, that we haven't said anything other than we are moving ahead. And we are pointing you towards public filings. It's not a typical loan that someone goes out and tries to raise money. The knee jerk reaction is, well, let me just push this thing down for the moment. BDC's are attractive investment vehicle, because the average BDC is paying dividends of 7%, 8%, 9%. With respect to our expectation, I would point you to the registration statement. I'm not even going to tell you what's in there at this point in time because I have been invited by Council that -- they're going to put me in the woodchip. So I would direct you to that document. The other thing that's attractive to a BDC is there is no corporate tax, and that's a tremendous advantage. One of the company's historic weaknesses, which is having different businesses together, perspectively is the strength in this case, because management believes it will be able to pay the dividend, still develop these businesses, which ultimately will benefit shareholders upon some kind of an exit or some kind of an execution. So we think that for a company that can convert to a BDC has tax advantage, investor can pay the banks healthy dividend. And if the activity within the BDC could actually grow over a period of time, an investor in a BDC could be rewarded nicely. And I'm speaking just generically at the moment.

Right, right. And you are not too specific -- not specifically. Does our cost of funds for the lender come down dramatically or substantially?

One thing I would point to. The Summit Capital Partners debt was 15%, and there were also other fees. And if you think about dividends of a typical BDC from an equity standpoint, right, or a micro cap company if you think about it, that's not that high, given -- and more of the benefits is see single, it's not that high. I'm an investor, I'm getting screwed. But the reason why I'm getting screwed is the money would be paid in taxes. So Jenny, what we paid in taxes last year?

$6 million.

We paid $6 million in taxes last year. So they swept. Was that a good explanation?

Our next question comes from the line of Jim Fowler with Harvest Capital.

I wanted to ask you on the Tech Tracker. I know that the 7(a)long program robust, I'm wondering what you think the market opportunity is to get into some other leading products away from the 7(a)?

Sure. Well, NewTracker, which gives us the ability to not use brokers and to use financial institutions, trade associations, insurance companies, people with large pools of small business clients that will just ride the opportunity. So there's no packagers, there's no assemblers, there's no one skewing the underwriting guidelines. We have currently limited capital base, just a few programs to offer. We believe that the borrower base, that's looking to borrow $50,000 to $15 million, which is typically not the market that BDCs are competitive on, is very firm. Most BDCs are doing $15 million and up. It's a mezz loan with an equity kicker. It's a high coupon. It's kind of what -- the deal what we did with Summit. That's not we are all going to be fighting for. So we'll be in there servicing small business clients in a market that is just not competitive. The banks and the financial institutions, they are not active in this market. When you look at the top 4 major money center banks, and I'm just guessing, but I think they represent about 65% of the market today. We just had a major money center bank told us they're hiring 6,000 compliance officers. So those money center banks are more concerned about knowing their customer, total compliance and not expanding the universe into the small business market. So we see our opportunity to do conventional small business loans with 8% to 12% pay coupons on them, not SBA, with long amortization schedules, converting that fixed rate, I just talked to, into a floating and providing good value to season businesses with hard collateral and have great lending opportunity. Use the experience that we've gotten over 11 years’ worth of lending to small businesses in an SBA structure format, and do it in a conventional format, and we think we'll be very successful doing that.

Got it. And then maybe just a follow up there. Your strategy is for -- I mean a lot of the loans come from referrals, is there a -- this strategy in place to continue to increase in broad in the referral network that you can leverage?

Absolutely. We will have some real nice large announcements going forward, both on new alliance partners that load the NewTracker system because it works just like Salesforce.com for a business referral process. We have a patent on it. There are a lot of players, there were just significant conference out in your neck of the woods with the lended conference, right?

Yes, that's it.

And people are lended they--the imbalance of the lending conference was there's too much money, but they can't their arms around the customer base. We have that customer base. We have that front end referral origination network, and we make -- and we developed this over 10 years. So we have the ability to work with credit union, the community bank, a major money center bank, the insurance company, accountants, lawyers, and have them pass referral to us, give them complete transparency into our back office, crediting and order compliance trail. And without using expensive 6-figure salary bankers, assemble, package, get separate for underwriting and process the business in a very automated basis. That's the value proposition to what we have in our lending world and universe.

Our next question comes from the line of Eric Weinstein with Chancellor Capital.

I guess, the BDC registration statement has been out for some time, I kind of want to get a sense of how much time you have been spending on this, the amount of distraction? And in part, I guess, when I look at the context in the first question sort of brought this up, growth in the first quarter on revenue and pretax, it's sort of well below that of the full year midpoint guidance. But I guess to the extent that you seemed happy with the performance over the quarter, was it -- what you are estimating internally and the rest was only to be made up during the rest of the year, or are there other things going on?

Yes, we're just working hard. And as I said, Eric, I do appreciate the call and the question, and it's not an out of the ordinary call question or comment. We don't look at things on a quarter-to-quarter basis, and we spend a lot of time developing a business and an enterprise. And we don't really wig out about a quarter. We're very focused. We know we are a publicly traded company, we have to deliver results. We really focus on what we are doing for the year. I will tell you that getting a BDC in the market, getting Goldman Sachs line of credit or Capital One Bank, the remediation that we had in the merchant processing business last year, caused by one of our executives, we clearly had a lot going on. Now through that, we're hiring and bringing on better -- more qualified people. We are further developing our software product. So bottom line is you got to keep the machine going, and we are on a very good trajectory. If you go back in the -- I guess, if you took the slide ruler out and you looked at the last 12 quarters, you'd be pretty happy. The numbers weren't necessarily 10% to 15%. At times, they were 30% and 50% and some wild numbers, but it is what it is. We look to grow this business. We look to grow the enterprise value, we're in the right space. We are not attracted by what -- some kind person referred to as a modest first quarter. From my perspective, the underpinnings of growth and a building of first-class organization are more intact than they've ever been.

Got it. And then I guess to the extent that you've had professional fees and other things associated with the convergent proposal, is that impacting profitability much at all? And also as you have been beefing up the human resources infrastructure with a the number of hires, is that being done on a sort of business as usual basis or are you vetting in anticipation of a more single the business?

I'll make a few things. I think in the lending business, we've clearly added some expenses in the first quarter in terms of beefing up personnel and that's not -- that's why we think it's not a straight line, because when you grow your servicing portfolio as fast as we did, you have to make sure that you have the right talent. When you're growing your loan originations as fast as we are, you have to make sure you've got really good solid underwriters and business service specialists. So that's one area where, for the most part, it was little bit more expense pumped into the business in Q1. There was one other anomaly, sort of in Q1, the price of the government bonds in Q1 of last year were at the all-time highs because that was the lower rates. So that kind of skewed things a little bit. Relative to the expense of the offering, now that's part of the offering, that's all capitalized when the offering gets done. I will tell you, we probably spent, I would say, couple of million bucks last year, just dealing with that remediation issue. Am I -- is that a fair comment, Jenny?

Yes.

Yes. Both from accounting, bringing in people to make sure that our policies and procedures are tied in the merchant business. So more of a drain last year than where we are now. I feel pretty good about where we are.

Our next question comes from the line of Joe Petro with Active Owners Fund. [Operator Instructions]

Due to no response, we will be moving onto the next person in queue, which is Marc Silk from Silk Investment Advisers.

So a few questions. With such a low GDP number in Q1, and discussions of catch-up later in the year, how do you feel about the visibility, the economy, and more importantly, how does that affect Newtek?

Well, I guess, thank you for the question. I think if you notice the one thing, we didn't do as blame up a weak first quarter GDP. I guess, depending upon who you talk to is the economy is strong or weak as you had this kind of big non-form payroll number that you said. The first quarter GDP was up 1/10 of 1%, and the government didn't generate[ph] -- the PCI deflator would have been negative. The GDP is very -- obviously, sales driven. So some of the businesses are clearly harder to push. I think that from our perspective, our job, whether it's in credit and lending or in the payments business or in the cloud computing business, is you've got $27 million businesses that are defined as small, to be able to go to customers that are clearly bigger than the average, been in business 2 to 3 years, have collateral, have good history and have good business models. So we seem to think that the economy, generally speaking, will be a headwind. However, we look at the markets that we are in. Lending, we see not a lot of competition. We're in a nice market. I was going to say it's a niche, but for us, it could be significant. I mean, there is no reason why, over the course of time, this company can't do -- double the current originations that it's doing in 2012. When we look at the area of cloud computing, the gardener surveys have got cloud computing expenditures doubling over the course of 3 years. Our independent business always going to give rid of the tower under their desk and give and give rid of the server in cloud. We look at the payments business, it got the people kind of change their terminals to make them EMV compliant and where businesses can really reduce their expenses through better POS, better reporting, getting information on a tablet. We are very well positioned for that. So the economy is a drag, clearly. We've just got to be able to execute on our strategy, and we will be fine.

Okay. And with regards to the marking with banks to help with, let's just say, with the loans, how does that come about? These institutions find you, you are aggressively pursuing your -- of your sales effort or both, and then can you expect more of these in the future? And lastly, what are the average margins on that for Newtek?

You mean 7(a) loan?

No, on the -- you're having processing loans for banks and just like being a right hand man for the SBA?

Well, most of our revenues, Marc, were a principal. So if you look for a case and cues, if a bank gives us a referral, which I'm going to say is 95% of our business today, we pay them a referral fee, which averages about 75 basis points, that's it. So we are the principal. They are not participating in it. So when you look at our returns -- let's look at it this way. Last year, on around $30 million equity base, we made about $10 million of pretax profits in the lender. So if you sort of look at the lenders simplistically in that manner, you have a 30% return on equity. And we're not really cranking this thing yet or putting a lot of leverage on it. So with more equity, we think we'll be able to generate those types of returns. Mind you, we were able to absorb a 15% net capital interest expense and grow the business. So that was one of the things I really wanted to point out earlier. We did a lot of stuff, but we just talked about few different areas where we'll be able to potentially reduce our cost to capital, get more capital and feed it into the business.

Not -- impressive margins.

[Operator Instructions] Our next question comes from the line of Brendan Mackey with -- and he's a private investor.

I was just wondering in the long term, is there any concern after the regulatory wave passes, will be big [ph] money center banks kind of looking down the small business area and trying to take share from you?

I wish I have signed the googlers [ph], but if you look at -- JPMorgan, Wells Fargo, Citibank and Bank of America, that's like 65% of the whole banking industry today. So I guess, Todd Frank did a really good job of taking these banks smaller. In turns, they are huge. The SBA business will always be Nat compared to a major money center bank. It's $18 billion, $19 billion origination business a year. So if we did a $0.5 billion -- sorry, $600 million, that will be great for us and great for our shareholders. That won't even -- that won't pay a day’s worth of legal fees for JPMorgan today. So we don't have any worry or concern that they actually care about the SBA 7(a) business. Now, when it comes down to small business lending, which we clearly want to position ourselves conventionally as well, their cost structure is so high. They can originate a loan the way we originate a loan using, what I call it, a FinTech acquisition system and do it cost-effectively. So I just don't ever see them competing in this phase. Now, the next set of perspective competitor would be community banks. While they can't do anything typically beyond their region, and they typically can't do enough volume or scale to cover the expense of doing the business, because in order to do the business, you've got to generate enough volume. I mean, you can't be in the SBA 7(a) business and do $25 million worth of loan. You just won't make any money, because the infrastructure that's required to do it and do it right is too expensive. Just like we can't be in the small business, lending business, if you're going to do small volumes of loans in a local community bank. So we're not -- we are just really not concerned about it, and we are happy with what we've built, and we think we have a terrific franchise in that area. And that's the business I have the least worry and concern about to this date.

And then looking at some of these comps that you've shared, give me an idea how much loan volume, the lending club does?

Yes. It's pretty significant, and it's ramping up quickly. Mind you, today, most of the lending clubs -- not most, all the lending clubs' loans are $35,000 personal loans, okay. That's the max loan, actually. So the average is less than that. And they are typically unsecured. And they've just started a small business product with a 150 max loan. I think the lending club did about $1 billion last year. I need to check that, but it's probably not less than that. Matter of fact, it might have been $2 billion. I think the run rate toward the end of the year was $200 million to $300 million a month, that's kind of sticks out in my head.

Okay. And my last question just switching to the Managed Technology part of the business, how are you differentiating your product against free and low-cost offering that just modify your hosting platform like you'll host?

Well, you get what you pay for. And business owners that are getting anything for free, they're not getting service and they got to be paying for it elsewhere. So I mean that's -- to be honest with you, that's the answer to that question. I think that when you give a provider your technology, your hardware and software, you are giving that provider your most valuable asset. So entities that are "doing this for free". That is not a long-term business model. It just doesn't work. Square, for example, in a different area, they are now up for sale. They went to an aggregation strategy, they need to change their ranks. Giving stuff away for free is not a long-term strategy. And I think that if you're a business owner, and you've got your data or your sensitive information, you want somebody that's going to be there 24/7. And frankly, we've been in this business for about 10 years and that's been our strength. So that's where we're going to stick to.

Thank you. And with that, I'm not showing any further questions in the queue. I would like to turn the call back over to Mr. Barry Sloane for any closing remarks.

Well, we greatly appreciate the attendance. This is one of the highest attended conferences we've had in a long time. I appreciate the great questions from the investor community and the audience. We thank you, and we look forward to delivering good results in the second quarter. Thank you very much.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect.