Medallion Bank

Good morning and welcome to the Medallion Financial Corporation fourth quarter and full year 2023 earnings conference call. All participants will be in listen only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touchtone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Ken Cooper of Investor Relations. Please go ahead.

Thank you and good morning everyone. Welcome to Medallion Financial Corp's fourth quarter and full year earnings call. Joining me today are Andrew Mirstein, President and Chief Operating Officer and Anthony Catrone, Executive Vice President and 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 fourth 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 Mirstein, President. Thank you

Ken. Good morning everyone. With the tremendous team effort throughout our entire organization, Medallion Financial had an exceptional year with total earnings and earnings per share the highest in our history. We grew loans within our largest and most established business, the recreational lending segment by 13% to $1.3 billion. We did this while increasing the average interest rate on the portfolio, which was 51 basis points higher at the end of the year compared to last year and helped to cover some of the cost of funds increases we saw this year. We grew this segment while maintaining tighter credit standards and a sharp focus on the type of assets we lend against, which are generally smaller dollar assets such as towable RVs and small boats. These assets have not had the volatility that catches the headlines like large cruiser RVs on larger scale boats and yachts. The average loan size in our portfolio stayed roughly at just over $19,000. Our home improvement segment continued to be the fastest growing part of our business. As expected, the growth rate slowed in 2023 as we were another year removed from the unprecedented spike in pandemic driven home remodel activity. However, with growth of 21% for this segment, there continues to be a steady flow of projects especially for the smaller roofing, windows, or swimming pool projects that we are known for. Like our recreational segment, we maintain tighter credit standards and a consistent average loan size in our portfolio of approximately $20,000. Nearly this entire segment is made up of prime customers with an average FICO score of over 760. Our commercial lending segment also had a very strong year. We grew the loan portfolio 24% to $115 million with our average interest rate of 64 basis points at 12.87%. With a range of typical loan size generally around $3 million to $6 million, our goal is to continue to grow this segment prudently over time. The segment generated after-tax earnings of approximately $6.8 million during the year. Finally, our taxi medallion segment collected $45 million of cash during the year, $16.2 million of this coming in the fourth quarter. The majority of the cash generated from taxi medallion collections was in the medallion bank and was reinvested into consumer lending businesses. We continue to mention that these settlements are unpredictable and we expect our collection activity to decrease in 2024. One item to note as a reminder, we adopted CSIL at the beginning of the year which now requires a larger allowance for credit loss to be booked upfront when loans are originated. This increased our provision this year. In addition, our current loss rates are more closely aligned with our historical trends and are consistent with what we have been indicating they would be as we come out of the low credit loss environment experienced during and after the pandemic. Even with the adoption of CSIL and normalization of our loss rates, our strong execution across our entire company led to $0.60 of diluted earnings per share in the quarter and $2.37 for the year which was an all-time high for us. Our strategy continues to be grow net interest income. We are doing this with smart loan growth and by offsetting elevated cost of funds with our own rate increases where possible. We expect that as we proceed through 2024, we will maintain our focus on high credit standards and using pricing to our advantage. We anticipate loan growth to continue to moderate from the levels we saw in 2022 and for us to maintain a conservative approach on credit and growth. Finally, during the fourth quarter, our board authorized a 25% increase in our quarterly dividend from $0.08 to $0.10 per share which began with our last declared dividend. We feel great about what we have accomplished over the past three years and how we are positioned for the future success. 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 12% to $49 million from the prior year, driven by increased interest rates on new loan originations and the growth in our loan portfolio during the past 12 months. For the year, net interest income increased 17% to $188.1 million. Our ability to increase our rates on new originations and our overall loan growth have enabled us to counteract some of the rising cost of funds we experienced during the year. Our net interest margin on gross loans was .20% for the quarter and .38% for the year, compared to .59% and .73% in the prior year quarter and year. We have spoken about the compression in our NIM for some time now and it continues to trend as expected. Rising interest rates on our brokered CDs have increased our borrowing costs over the prior year. However, we've taken the opportunity to pass along a portion of those rising costs in our pricing on new originations. Specific to originations, during the year, we wrote home improvement loans at an average rate of .02% up from approximately .75% in 2022 and wrote recreation loans at an average rate of .16% up from approximately .25% in 2022. At the end of the year, we were writing home improvement loans at an average rate of .65% and recreation loans at an average rate of 16.14%. As of the end of the year, our average coupon on recreation loans were up 51 basis points to .79% from a year ago and on home improvement loans were up 86 basis points to 9.51%. In addition to passing along interest rate increases, we have continued with our tightened credit criteria. Non-prime loans were 38% of the recreation portfolio and continue to be only 1% of the home improvement portfolio at the end of the year. To put this into some comparative context regarding how we've tightened credit over the past few years, at the end of 2019, non-prime loans were 61% of the recreation portfolio. Our provision for credit loss was $10.8 million for the quarter compared to $9.0 million in the prior year quarter. For the year, the provision for credit loss was $37.8 million and $30.1 million in 2022. The provision included a net benefit of $12.1 million in the current quarter and a net benefit of $26.3 million for the full year related to taxi medallion loan recoveries compared to benefits of $1.6 million and $6.2 million in the prior year periods. Excluding taxi medallion related recoveries, the increased provision is a result of the continued migration of loss experience to levels more comparable with pre-pandemic historical norms. The growth penalty we incur by growing our portfolio as well as the variability in our provisioning as a result of the adoption of CISA this year. On a full year basis, we incurred approximately $8.5 million of additional provisions connected to the growth in our consumer loan portfolio and approximately $3.4 million of additional provisions associated with the higher allowance coverage rates tied to CISA, a majority of which were incurred in the fourth quarter. At the end of the year, our allowance for credit losses as a percentage of loans were .31% for recreation loans and .76% for home improvement loans, up from .55% and .81% a year ago and compared to .39% and .05% at the beginning of the year post our adoption of CISA. Operating expenses were $19.1 million during the quarter, which were in line sequentially from the third quarter. For the year, operating expenses were $75.6 million compared to $72.1 million a year ago. The growth is mostly related to scaling our lending operations offset by lower legal and professional costs. For the quarter, net income attributable to our shareholders was $14.3 million or $0.60 per diluted share. For the year, net income attributable to our shareholders was $55.1 million or $2.37 per diluted share. That covers our fourth quarter and full year financial results. Andrew and I are now happy to take

your questions. We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you'd like to withdraw your question, please press star then 2. At this time, we'll pause momentarily to assemble our roster. Our first question comes from Christopher Nolan from Lattenberg-Fallman. Please go ahead.

Anthony, what do you think the medallion recoveries contributed to EPS in the quarter?

I think as we put in the press release, the recoveries were I think about $0.33 a share based upon what we brought in. A large portion of that was one specific large relationship that came in in October. We had spoken about it last quarter when we were going over Q3 and a few other not as large but significant items.

The second question is the reserve allowance. Where do you think he goes as percentage of loans going forward? Should we see him continue to step up through 2024?

I think when we look year over year, we adopted CISO this year and with that adoption, we were up 21% on the rec allowance and over 50% on home improvement. Our CISO model is a function of historical losses. We try and project that out as to expected losses over the life of the entire portfolio. We take into account various economic circumstances. I think what we saw is that provision stepped up and our allowance coverage stepped up in Q4. It was actually something we were expecting to see throughout the entire year. That didn't happen for the first nine months and we saw it step up in Q4. Some of it has to do with the seasonality of our portfolio. Charge-offs are typically higher in December, January and then settle back down towards the end of Q1. As the weather starts getting nicer, I think it's going to be a function of the economy. We get a nice soft landing like some are suggesting. I think we should be okay. If things are a little bit bumpier, we might see a little bit higher provisioning.

Okay. Then I guess the final question is given the regional banks are sort of everyone's waiting for the shoe to drop on commercial real estate, do you anticipate that FDIC could require a higher capital ratio for the bank?

We've got a pretty high capital ratio, so I don't think it would be specific to us. We've got a capital maintenance agreement where our tier one leverage ratio is 15%. We're north of 16% now. I would imagine if there was something to come out that wouldn't be specific to our institution, it would be across the board. I think that we'd probably be comfortable where we are now. Great.

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Please go ahead. I was going to say I'd confirm that. Ours is extremely high as well capitalized. I think it's about 6%. We're at 15% or so. Today, as Anthony said, we're above 16%. The commercial real estate issues of others I think could have a positive effect in that several of them could be leaving some of our business lines. We've stuck to our knitting. We really focused on what we do best and have not strayed. In times like this, banks that have issues with the commercial portfolios in real estate tend to get out of home improvement RV and marine lending, and that's when historically we picked up market share.

Great. Final question, when should we expect the K to be released?

Probably another week and a half.

Great. That's it for me. Thank you.

Thanks, Chris.

Our next question comes from Mike Grondle from Northland Securities. Please go ahead.

Hey, thanks, guys. Could you talk a little bit about kind of your origination outlook and how that might translate into sort of growth in the various loan books?

Sure. I think it's a good question, Mike, and it's something that we think about on a regular basis. Coming out of the pandemic, 2021, 2022, we saw record growth, and even 2023 was larger than I think a traditional year. I think what we're targeting long term is annual growth, plus or minus 10% over the long term. I think 2024 will probably be in the high single digits. A portion of that is, one, there's still a lot of uncertainty with the economy. How does that affect demand? We'll see. And the other is that we've taken a pretty strong stance on credit. We've stepped up our criteria, and we've never been ones to chase volume, even though we've grown so much. We're not going to chase originations. But I think we're just looking at 2024, high single digits, somewhere in that 6% to 9% range. That's probably where we end up across the board.

Okay, thanks. Was there a one-time gain related to equity investments or any other noise to call out with the 60-cent EPS other than the taxicab

collection? We did have some equity gains. We don't view them as one time. Essentially all of our equity portfolio, it's about $11 million at the end of the year. It's tied to our mezzanine lending business that's operated out of Medallion Capital. When we make an investment there, up to 10% of the investment goes into some sort of equity security there. We've got a $100-plus million book of loans, and then we've got $10- or $11 million of equity securities. We did have net gains of about $3 million in the quarter. But again, these aren't one-time items. We've had those in the past. It's tied to

that book. It's tied to the commercial book.

Yes, and Brandon's point, Mike, is you know we bought that company in 1998. So we've got 26 years of a history there of great success. Hopefully it continues, but it's hard to estimate when we're going to have those pops from time to time. But it does have a nice steady income stream. It's lending money at %-plus rates, and then you have these kickers that kick in from time to time.

Yeah, and like I said, those kickers, book value is $11 million at the end of the year. And it's across some 34 portfolio companies that we've invested in.

Cool. I didn't know if it was tied to the commercial book, or sometimes you guys in the past have made some one-off investments and whatnot. So I just wanted some clarity there. Any comment kind of for 24 on that the net margin was like $850. I know sometimes you guys talk about gross margin. But is that margin pressure largely done, or do we see kind of a tail end of it in 24?

I wouldn't say it's done. We think that there's still a little compression to come. We saw our cost of funds increase in 23, but we also saw our top line, our yield go up. And that's part of it. It's the slow to turn ship. When we talk about new originations at a higher level with a $2 billion book, it takes a while for that to trickle through to the income statement and show up in the yield. But we're starting to see that. We think we still can see that the yields rise in 24. Cost of funds will also come up. There's a little bit more compression, but I think we're still comfortable thinking that it bottoms out around 8%, plus or minus a few basis points sometime towards the second half of the year.

Got it. And then on the provision, Anthony, if I take your actual provision expense in the quarter, the $10.8 million, and if I add in back to it the $12.1 million benefit from the taxi cab collections, am I thinking about it right saying, hey, that provision was really $22.9 million? And you had said, hey, it stepped up in 4Q. Is that about the right level to think about on a quarterly basis now? I think

Q4 is always our worst performing quarter from a delinquency in charge off. If you think about in the coastal areas where we do a lot of our business, selling boats and outdoor activity, RVs, people are outside more when the weather is nice. So the end of November, December, January, things are worse. People aren't as concerned about making the payments on their boat, right? But once the warm weather starts coming around, those delinquencies typically drop. So this is the seasonality we've seen over the 20-year period. We didn't experience it for the year or two following COVID. We started to see it a little bit last year, and we think it's back. Now time will tell if the delinquencies and the charge-offs that we experienced in Q4 are just seasonality, or if there's something bigger in the economy. And that's something we're tuned to. And that goes back to the credit standards we have and really trying to change the composition of our book.

Got it. Got it. Okay. And then, hey, have you collected anything in January or February so far tied to the taxi cab medallions?

Everyone wants a home run two years in a row. We have collections coming in every day. Unfortunately, we don't expect them to be anywhere near the level that they were in 2023. We always knew, and Andrew's spoken about this for a long time, is that there was going to be a significant amount of recoveries. We expected that over a longer period of time. What we found is a lot of that showed up in 2023. So at the end of 2023, we still have a few larger relationships that have the potential for some meaningful recoveries. A lot of them are actually – we've got structured settlements with them, and they're actually meeting those settlements. So we don't expect any windfalls as of now for 2024. And

to add to that, Mike, there's a little bit of a wait and see in the medallion industry in New York City now. Congestion pricing is supposed to kick in in a couple of months. The hope of the medallion industry is that that's going to be very positive for them. The concept behind that is to keep consumer cars out of Midtown. And if that works, then you would think more people would take not only more medallion rides, yellow cab rides, but also Uber and Lyft rides. But that whole sector should do better if this is done implemented the right way. So hopefully there could be collections the second half of the year if more taxi usage increases, which is what we think will happen.

Fair, fair. And Anthony, we got 16 inches of ice on our lakes in northern Minnesota. So I understand that seasonality a little bit. Thanks, guys.

Thanks, Mike.

Thanks, Mike.

The last question comes from Matthew Hallett from B. Riley. Please go ahead.

Hey, thanks, everybody. Good morning. Another strong quarter. I guess the first question is just on your capital strength. I mean, you're probably one of the highest ROE-generating banks out there. You're incredibly efficient, 40 percent. You look at your capital ratios. They look like they're just going to build as you slow down portfolio growth. I think you said what, mid to high single digits. I know you're being cautious, and I want to ask about the Cecil Reserve in a second. But as the capital continues to build, Anthony and Andrew, do you feel like when you look at – you just raised a dividend. When you look at more at buybacks, obviously you talked about looking at other platforms. You're in an envious position as the capital continues to grow. And it looks like it's just going to continue to increase through 2024. I just want to hear, would you look at more speeding up loan growth? Just curious what the thoughts are initially.

Yeah, I think with the loan growth that we're looking at for 2024, like we just spoke about, we do need a fair amount of capital with the 15 percent maintenance requirement to actually retain. So we take that coupled in with the dividend that we've got in place to our shareholders. We think we're deploying that capital and the generation of that capital appropriately. Obviously we're always opportunistic. The opportunity to raise preferred debt or preferred equity at the bank like we've done in the past, we look to that. But I think for now, there's nothing on the horizon in terms of what could happen. But buybacks, we still have 20 million available. We're going to remain opportunistic with that. If something were to happen and it's a creative to shareholders that could be in the market, we're going to do that. Growing our business the way we have and the way we continue to do, we think that's the best thing long term for our shareholders.

Yes, as you know, Matt, these are good problems to have, right? If you look at our balance sheet, we've got a lot of cash on hand now. So there's a lot of options that we have available to us.

Yeah, and let me just say with that cash on hand, the consolidated balance sheet, a lot of that is liquidity at Medallion Bank. They keep a fair amount of cash on hand and that could move based upon originations pretty rapidly.

Right. Look, you have a great track record of returning capital and you did that with the buybacks. You raised the dividend. Clearly you want to keep over that 50, that cushion to 15%, but it'll be interesting to see. You guys are always opportunistic with capital and certainly the buybacks went a long way, so we'll look forward to that. And then getting back to the CISO, Anthony and Andrew, is there a way to quantify? I mean, look, it just weighed down your results throughout 2023, particularly in the fourth quarter. I mean, I get the front loading of it and everyone has to do it, but it seems like it's more onerous to you guys than everybody else. I know you talked about whether you want to be cautious of the stop or hard landing, but is there any way to sort of tell us, quantify here, what really the CISO reserve could be 24? It seems like with the slower loan growth versus 2023 and then the movement up in credit, you clearly don't have as much subprime as you did several years ago. Could we see sort of a normalization in that line so it doesn't throw off the earnings and the RE? You're already generating a 70% RE, but I'm assuming it's going to be a lot higher if we get a normalization in that provision line.

Yeah, so it's a fairly complex analytical model that we've designed. And essentially what it does is it tries to predict. It's the probable default weighted model that tries to predict what our future losses are going to be. So any time there's a change in outside economic variables, inflation changes, primary changes, unemployment changes, things of that nature, it's going to have an effect. Additionally, it looks at historical losses. So if we see an uptick like we did in Q4, it's going to affect the provisioning as well. We expect that as we get through the first half of the year and charge-offs, assuming that seasonality is what we expect it to be, charge-offs come down some after maybe January, February. We should see maybe a reduction in some of that. But it's so closely tied to economic variables that it really is hard to predict. I think it's one of the things we were concerned about. And frankly, this unpredictability or this variability that we saw in Q4 is what we were expecting the full year. It's just that the first nine months it didn't show.

Right. No, look, it definitely had to – it certainly looked like it was overly punitive here in the fourth quarter. But we look forward to more of a normalization of that. It would be interesting if you could run – so how – ex-CISO, how you used to do it, how the earnings would have looked this year versus the new CISO adoption. But we'll take a look at that. I guess in the last question, just on – you've done a great job pricing. I think you said your rates now are over 16% on the rec and close to 12% on the home improvement. I mean, it's been terrific. You're bumping into anybody. I mean, can you just increase – I mean, where are you pricing? I mean, it seems like it's going to level off or you're running into anybody. It's competition. As you said, Andrew, the banks tend to back out at these parts of the cycle. I mean, just give us a little sense on competition and who you're bumping into.

Yeah, I think, obviously, as we raise pricing, that's going to have an effect on our origination. So there's definitely – there's a fair way we want to operate it. We're not looking to price ourselves out of the market, but we definitely want to stay – but we're not as concerned with being competitive as we are with generating the type of returns that we typically see. So I wouldn't expect to see any meaningful decrease from these levels. That said, if the Fed comes in with some rate cuts down the line, we're going to factor that into our pricing. Again, we don't want to price ourselves out of the market, but we're also not going to drop rates just to chase volume.

Exactly. That could be certainly a big boom for you guys. Really appreciate it. Thanks a lot.

Thanks, Matt. We have a follow-up question from Mike Grondo from Northland Securities. Please go ahead.

Yeah, hey, Anthony, operating expenses were like $75.5 million in 2023, really only up a couple million on 2022. Is that $75.5 million like the right base level for 2024? Do you see a couple million growth throughout the year? How should we think about operating expenses in 2024?

Yeah, it's about there. Inflation isn't just a factor in terms of what it does to our borrowers. We've got over 100 employees, and we give them standard of living increases so that they can keep up. Salaries will go up some. Because of our earnings, compensation was higher this year than it was maybe in past years, so that might come down a little bit. I don't know that there's any extraordinary items in operating expenses that would cause it to fluctuate when we look at 2023. Obviously, professional fees could vary down the line, but I think in terms of a normalized run rate, I think this looks about where we should be. That said, if you look two years ago, we're significantly higher, but over the course of three years, we've more than doubled our loan books. As we scale, there's going to be additional costs that we incur, and that's just part of the business we're in.

Fair enough.

Okay,

thank

you.

This concludes our question and answer session. I would like to turn the conference back over to Andrew Merstein for any closing remarks.

Thank you again for joining us this morning. We had a great year, and we're proud of everything that we accomplished. Not only in 2023, but over the last several years. For 2024 and beyond, we'll position well with a strong balance sheet, prudent reserve levels, and most importantly, an incredible team. We believe this will continue to deliver significant shareholder value. As always, if you have any questions, please feel free to call our Investor Relations team. The contact info is on the last page of our earnings supplement, as well as the IR section of our website. Thank you again, everyone, and have a great rest of your day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.