Medallion Bank

Ladies and gentlemen, good morning and welcome to the Medallion Financial Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star and zero on the telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ken Cooper. Please go ahead.

Thank you, and good morning, everyone. Welcome to Medallion Financial Corp's third quarter earnings call. Joining me today are Andrew Merstein, President and Chief Operating Officer, and Anthony Catrone, Chief Financial Officer. Certain statements made during the call today constitute forward-looking statements made pursuant to and within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 as amended. Such forward-looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from such statements. Those risks and uncertainties are described in our earnings press release issued yesterday and in our filings with the SEC. The forward-looking statements made today are as of the date of this call, and we do not undertake any obligation to update these forward-looking statements. In addition to our earnings press release, you can find our third quarter supplement presentation on our website by visiting medallion.com and clicking investor relations. The presentation is near the top of the page. With that, I'll turn it over to Andrew Merstein, president.

Thank you, Ken. Good morning, everyone. Medallion Financial had a strong third quarter that culminated with our best earnings for the nine months ended September 30th in any year since our IPO over 27 years ago. In the third quarter, we generated $11.2 million of net income and $0.48 of earnings per share. Year-to-date, we are at $40.8 million of net income and $1.77 of earnings per share. These results have again been driven by higher-than-normal originations in our consumer lending, solid results from our commercial lending, continued success in cash collections from our taxing medallion loans, and a successful effort to leverage our operating costs. We have been clear for some time now that our strategy is to grow net interest income by offsetting rising costs to borrow with continued growth in loan originations. We have done that for another quarter even as origination activity has started to normalize back to historical levels. As we look to the future, we will continue to take proactive steps to raise our credit standards and increase pricing. With total assets at over $2.5 billion, we anticipate loan growth to moderate from the levels we have seen over the past two years, which should enhance earnings with reduced credit allowances needed at origination. This provides more flexibility and options for us to consider around capital allocation such as a 25% increase in the dividend of board authorized starting next month, which enhances shareholder returns. Moving to the update for each of our segments. Our consumer lending business had another quarter of heightened activity of originations. We believe this robust origination activity is due to our target customer still being active in purchasing towable RVs, small boats, and single project home improvements. These all have active markets today as compared to the higher-end cruiser RVs, yachts, and multi-project or whole house remodels, which has significantly higher costs and may be more susceptible to a slowdown. As a reminder, our average loan at origination is around a very manageable $25,000, with a prime or near-prime borrower more focused on the payment level than the rates. In addition, we continue to see some industry players scale back or exit these business lines, which helps us. The dealers and contractors who we work with know that we have great service levels and will be here long-term, which helps them refer business to us. Our commercial business originated $9 million of loans in the quarter and ended the quarter with $100 million of loans outstanding. The segment generated after-tax earnings of $2 million during the quarter, which included net after-tax gains related to equity investments of $1.6 million. Our bottom line benefited again from another good quarter of cash collections on taxi medallion assets. This quarter, we collected $5.7 million, which translated into $0.10 of earnings per share. Also of note, shortly after the quarter ended, we executed a structured settlement with one of our larger taxi medallion borrowers and collected an additional $9.4 million, which will result in a pre-tax gain of approximately $8 million in the fourth quarter. We continue to be delighted with our taxi medallion collection performance, but I again stress that payment patterns are expected to fluctuate. Finally, as I mentioned earlier, our board has authorized a 25% increase in our quarterly dividends from $0.08 to $0.10 per share per quarter. With that, I will now turn the call over to Anthony, who will provide some additional insight into our quarter.

Thank you, Andrew. Good morning, everyone. For the quarter, net interest income grew 16% to $48.8 million from the prior year, driven by increased interest rates on new originations coupled with the loan growth we've experienced since the prior year. These two factors have been able to counteract the rising cost of funds we continue to experience. Our net interest margin on gross loans was 8.35% for the quarter as compared to 8.48% in the second quarter and 8.63% in the prior year quarter. The compression in net interest margins is related to two things. First, home improvement lending has been the fastest growing component of our consumer lending business, with these prime credits having a much lower interest rate than compared to our much larger recreation portfolio. The second is the rising cost of funds we are experiencing in tandem with the current interest rate environment. Although we have been successful in increasing our own rates, it is not on a one-to-one basis. Specific to originations, we are currently writing at an average rate of 11.75% on home improvement loans, up from approximately 9% a year ago, and an average rate of approximately 16.25% on recreation loans, up from 14.75% a year ago. In addition to passing along interest rate increases, we continue to take proactive measures to tighten credit in our consumer lending. At the end of 2018, subprime loans were 66% of the recreation portfolio. Today, subprime loans are 38% of that portfolio. Our provision for credit loss was $14.5 million for the quarter compared to $10 million in the prior year quarter. The increased provision is primarily a result of, one, the continued normalization of loss experience in our consumer portfolio up from the unprecedented lows experienced during the pandemic and two, the growth of our overall portfolio. The provision is inclusive of a $1.8 million benefit related to recoveries on taxi medallion loans during the quarter. Operating expenses were $19.1 million during the quarter, down from $19.4 million in the prior year quarter. The drop was primarily the result of lower legal and professional fees in the current period, offset by higher salary and benefit costs and higher servicing costs, associated with a larger book of loans for the quarter net income attributable to our shareholders was 11.2 million and our diluted earnings per share was 48 cents just a quick final comment on the balance sheet on september 29th we closed a 39 million dollar private placement of nine and a quarter percent notes a large portion of which has been used to settle 33 million of the eight and a quarter percent notes which mature in march 2024 with the remaining $3 million of those notes anticipated to be repaid at maturity. It's important to note that this new issuance priced at a rate 75 basis points above prime as compared to our previous notes issuance in 2021, which priced at 400 basis points above prime. Our ability to price the instruments at a lower spread to prime from just a few years ago speaks to our underlying business as a whole and the progress that we've made in transforming the company. At the end of the quarter, the company had $160 million of debt at the parent company, which continues to fund the investments in our operating subsidiaries, with that debt being less than 50% of our equity. That covers our third quarter financial results. Andrew and I are now happy to take your questions.

Thank you.

Ladies and gentlemen, we will now be conducting a question and answer session. If you would like to ask a question, please press star and 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star and 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Ladies and gentlemen, we will wait for a moment while we poll for questions. Our first question comes from the line of Mike Grondahl with Nordland Securities. Please go ahead.

Hey, guys. Thanks a lot. Two questions maybe to start off with. Could you kind of give us a sense of your margin outlook going forward? And then, Anthony, I think we typically get net charge-offs kind of by category.

in dollars and percents could you also provide those sure so with with regards to the margin you know we still believe as as we've said for a couple quarters that there's going to continue to be compression but we think we bottom out at around eight net interest margin you know we still have a ways to go in terms of our cost of funds you know rising and But I think what's important to note is that we've passed along, especially in the most recent year, a large number of increased rates on new originations. So we think, you know, as we get, you know, closer to the top of the credit cycle, you know, there'll be a little bit more compression. But then as we've increased the rates on, you know, and our book matures in terms of a higher average interest rate, that should help us long term.

Got it, got it. So a couple more quarters of compression until you hit about 8%. Did I hear that right?

Yeah, I think that's fair. And obviously what the Fed decides to do is going to be a catalyst for a lot of things, but that's how we're seeing it. And to your other question about charge-offs for the quarter, charge-offs in rec and home improvement were $9 million and $3 million. Commercial was $0 million. And we had 1.7 million of recoveries on taxis.

Got it.

And then on your CDs, what was the average rate you're paying at the end of 3Q kind of compared to market?

We're probably about 150 to 175 basis points below what a current three-year CD would be. So we think, you know, we creep up. And again, that goes back to what we were just talking about. You know, our cost of funds is going to increase, you know, towards that 475-ish, 500 level over the next several quarters. But again, our top line is going to continue to increase as we've seen it do for the past several quarters now.

Yeah, you've done a good job of raising yield. That's for sure. And then, Andy, two questions for you. One, how are you thinking about the $160 million in debt at the holding company as you get these taxicab medallion collections? And then secondly, how are you thinking about 2024?

So let me just also touch on the net interest margin. The net interest income we expect, of course, to increase, just to be clear there. So the margin, as Anthony's been saying accurately for several quarters now, should go down to about that 8%. But as the portfolio grows, the margins continue to shrink, but the net interest income continues to increase significantly. because of the volume of the portfolio, the originations. The debt amount we think is conservative at that level. We're not really leveraged too much. We've always operated, as you know, Mike, you've known us for many, many years. So for about 30 years, we were a regulated investment company, BDC. So we were limited to about one-to-one debt-to-equity investments. So we've always kind of operated at a low leverage ratio. So we refinanced that debt, as you know. That was nice to put behind us. We have debt coming due in March 2024, which we refinanced, as we announced, on September 30th. So we don't anticipate adding significant new debt, if any debt at all, for the next year or so. In terms of the outlook for 2024, I'd say overall we're pretty optimistic as the numbers continue to show and the results continue to show. We've had strong loan demand in RV, Marine, Home Improvement. Mezzanine continues to be very strong, too. This is probably one of the highest deal flow we've seen from that division in the 25 years that we've owned them. So across the board, continued growth. hopefully more collections from the Medallion portfolio. We've done a great job collecting on a lot of loans there. We still are owed about $200 million, and we'll do whatever we can to collect as much of that. You have congestion pricing hitting New York City soon, so that could be a boost for Medallion prices. When they try to keep consumer cars out of the city, more people ideally will be taking taxis as well as Ubers. and we increased the dividends. So as everybody can kind of sit back and watch the growth in 2024, they'll be able to receive a $0.40 per share dividend. So overall, I'd say we're bullish on the year ahead.

Great. Hey, thanks again.

Thank you.

Thank you. Our next question comes from the line of Christopher Nolan with Leidenberg Talman. Please go ahead.

Hi, Andrew. Did I hear you say that there was $200 million in medallions outstanding?

That's what we're owed, correct. As you know, they're written down to a much lower number. It's less than 1% of our assets today, but that's how much legally we're owed. The collections can come through by either foreclosing on the medallions, which are worth a About 150 or so now in New York City. We're carrying them, as you know, at a lower number. But all these, and we've been saying this for many, many years, all the loans have personal guarantees attached to them. So thankfully we're seeing a lot of settlements this year. I don't know if the borrowers are bullish on the congestion pricing plan or just business in general, but they're coming in and settling with us. So hopefully that continues.

Gotcha. For the $9.4 million medallion recovery in the fourth quarter, why is that a gain? Shouldn't that be a recovery?

So, yeah, no, it is a recovery. It's going to be a benefit and a provision. So these assets had been written down to a book value of $1.4 million. So it's the difference between the cash collected and the asset that goes away. That's the $8 million.

Okay, so that's simply just – we could potentially have a lower loan loss provision than normal, right?

Right, yeah. So that $8 million should all flow through as a benefit in the loan loss provision. That's correct.

And then were you thinking of taking the reserve ratio?

So currently, we're around 420 on REC and just about 220 or so on home improvement. We think those are good numbers. So in connection with the adoption of CECL on January 1, we do a lot more quantitative forecasting, and we look at future expected losses. If the economy were to take a sudden downturn, which we've been expecting – those rates could step up, but if we continue at the pace where we are, we think those are good numbers, and that's where the allowances should remain.

Okay, and then given, final question, given your comments in terms of loan growth to moderate, should we expect relatively, what does moderate mean? I mean, what sort of growth are you looking for?

So I think in the nine months, consumer loans grew around 16%, and we've been experiencing 20% to 30% growth year over year in those two categories. And that was good, and we intentionally did that and took the opportunity to take these recoveries and this capital that we generated from these medallion collections and reinvested in the business I think going forward we would expect somewhere in the ballpark of 8% to 12% growth, you know, with the ability to increase that or decrease it as necessary. I think, you know, growing at 20% is different when you've got a $1 billion balance sheet as opposed to growing at 20% when you've got a $2.5 billion balance sheet.

Okay. So for me, thank you.

Thank you. Our next question comes from the line of Matt Howlett with BRID Securities. Please go ahead.

Thanks, guys. Thanks for taking my question. Another fine quarter. And there just seems to be this disconnect between how you guys are performing and what the market views you at. And I want to get to that. But the first question is with the moderation of loan growth, the excess capital, I mean, you just raised the dividend margin. You have a high-class problem where you have a lot of capital. You're above, I think, well above 15%. It looks like you'll generate more capital. You've got that gain coming into the third quarter, so you've already got sort of 25 cents in the bank already. My question to you is what do you think about in terms of excess capital? Could you get more aggressive buying another platform, buying back shares? Just talk to me about how you've been running at this breakneck speed in loan growth. It's going to slow. It's going to free up a lot of capital. You've got great earnings. Anything we should think about in terms of that capital?

I think while we're always looking at new businesses and acquisitions, it's really not a good time to go off base and go into new lines of business. All of our businesses are doing so well, so we're going to continue to focus on them. I'd say that we probably have a lot of good options since we don't plan on going into new businesses. That could be buying back more stock. Last year, I think we bought about 10% of the company back in 2022. The buyback has another $20 million to go. It lets us raise the dividend, as you state. We're now paying $0.40 a share, so we raised it 25%. So we can put more money into the bank if need be. If we're surprised and loan growth is stronger and we're able to really pass on a lot of the increases in prices to our borrowers and charge more, that's always a good option for us too. But, you know, it's nice to have options.

Yeah, and I think the one thing that I'd add to that is, you know, We do have a large amount of capital, regulatory capital at the bank, but we also have a high minimum that we've got to maintain, a 15% capital maintenance ratio, as you're aware. So given the size of book that we have now, a slight deviation because of CECL in what we need to record as an allowance could have a meaningful impact on that ratio. So if we need to stay at 15%, staying just above 15% at the size we are doesn't actually, it doesn't work for us. So we need a larger buffer to account for that variability, which we haven't yet experienced in the nine months since we've adopted CECL. But if the economy does take a downturn, you know, we might. And I think that's why we want to make sure that we've got ample capital cushion, as well as to what Andrew said, you know, increasing the dividend and providing other shareholder returns that we can.

Yeah, look, it's a high-class problem to have, and it looks like your capital generation is only going to increase. So when I look at slide 11, the charges, and most of the banks have been out there saying, you know, charge us on their credit card, or it's going to be kind of pre-pandemic levels in, you know, by early next year. You guys are a little over, you guys are almost, you guys are not quite there, but you're almost there in charges. When I look at that chart, though, given the moving up in credit, you know, the FICO, the more home improvement you have, I mean, You kind of show a 6% charge-off in 2009, but it doesn't seem like you'll ever get ever close to that, even if we go into a major recession.

Yeah, we hope not. I think what I said earlier is important. Just in 2018, two-thirds of our recreational portfolio was subprime. Subprime, that's the regulatory definition, 660 FICO. Today, that's a third. So we've drastically changed the credit quality of this portfolio over a number of years, and we hope that that, as well as, you know, in the past year, stepping up the rates that we're getting on new origination. So we think that all of those things are, you know, good steps and should help us, you know, undoubtedly when we hit the next downturn.

Yeah, and then, you know, my final question is for both of you, and Especially, Andy, you've been obviously running the company a long time. What's the disconnect here between the numbers you're putting out, the 20-plus ROEs, the significant discount to book? What's the disconnect between your performance and the market? Are people just looking at prior cycles? Are they looking at the banks? Are they not appreciating your underwriting, your movement up in credit, all your pricing? Can you just maybe just go over that for me? Thank you very much.

Yeah, that's a tough one to answer. It's a great question, though. You know, years ago, you're right, we've been at this a long time. In the late 90s, I think we were making a dollar a share. The stock was at 30. We were trading at 30 times earnings. Now we're at, as you point out in your note this morning, Matt, I don't know, three and a half times earnings. Yes. Kind of shockingly low. So I really hope we just can get in front of more buyers, more institutional buyers. You know, it doesn't take much to move business. if we can get some good institutional support in the stock and a large volume of stock being bought, that will surely drive up the price. And we're doing more conferences, getting more eyeballs, getting more phone calls these days. So I just think if we continue to produce, it's going to be hard for the market to ignore us for much longer.

Yeah, look, and the taxi medallion is now a tailwind for you, given the But you already have $8 million in pre-tax again in October. Did I read that correctly?

Yes, exactly. Yeah, that's been icing on the cake for us, the last pretty big cake, I guess, because we're collecting a lot of money there. So we'll continue to do so, I hope. Again, the business is picking up, the medallion business. It bottomed out at about $79,000 a medallion. It's been picking up ever since the last few years.

And I would just add that this is consistent with what we're experiencing in the medallion space right now. It's consistent with what Andrew and management here has been saying all along. If you go back a number of years, when we were in the height of the issues that the taxi medallion space was encountering, we always knew, and we were transparent about it, that eventually we'd get to a point where the prices aren't going to go down any further. And at that point, then we would benefit significantly. as we had already taken the pain. So I think that's what we've experienced, not just the past nine months, but also last year as well.

Well, there just looks like there's significant off-balance sheet value in those tax seats. It's obviously a huge tailwind here. Earnings going forward on top of really great performance. And hopefully people will see the performance versus what we're seeing from the banks, what the problems they're experiencing, and some of your performance. So congratulations. Thanks, Anthony. Thanks, Anthony. Thanks a lot.

Thank you, Matt. Thank you. Thank you. As there are no further questions, I would now hand the conference over to Andrew Murstein, President, for any closing comments.

Thank you again for joining us this morning. Our company is doing well and we have a lot to be proud of. We're working hard and seeing great results. We're positioned as well to continue to deliver shareholder value. As always, if you have any questions, please feel free to contact our investor relations team. The contact information is on the last page of our earnings supplement as well as the IR section of our website. Thanks again and have a great rest of your day.

Thank you. The conference of Medallion Financial has now concluded. Thank you for your participation. You may now disconnect your lines.