Medallion Financial Corp.

Greetings and welcome to the Medallion Financial second quarter 2023 earnings call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Ken Cooper, Investor Relations for Medallion Financial. Thank you. You may begin.

Thank you and good morning everyone. Welcome to Medallion Financial Corp's second quarter earnings call. Joining me today are Andrew Murstein, 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 and Form 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 second 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 great second quarter with continued growth and profitability. For the second quarter, we generated $14.2 million of net income and $0.62 of earnings per share. Our return on equity was 18.2%, and our return on assets was 2.6%. All remain strong and reflect the healthy state of our business. The main driver of our bottom line continues to be our consumer lending businesses, which had another quarter of significant origination volumes. Our consistent performance validates our strategy of using a national base of 3,000 dealers and 1,000 contractors to source loans. We then deliver a premium customer service to make it easy to do business with us. This customer service reinforces loyalty to Medallion, which is important in times like we are in. Further, by maintaining rigorous underwriting standards, we are targeting borrowers that have a high propensity to timely pay their loans. This has helped us keep our returns high and our losses low. Our performance was also driven by our second straight quarter of cash collections over $10 million on taxi medallion assets. Our entire team is doing a wonderful job in this. However, I again stress that payment patterns are not expected to be linear. We expect quarters to be low, high, and in between. We have a talented team led by Alvin Merstein, who is possibly one of, if not the most knowledgeable authority on the taxi medallion industry in the U.S., As I mentioned, our consumer lending businesses surged in the second quarter and had more strength than we have seen over the past several quarters. We believe that this is in part due to resilient U.S. consumers who continue to invest in home remodel projects, boats, and RVs. We also believe some industry players have scaled back on this business or even left it altogether. When this happens, it creates an opportunity for us to pick up market share. And of course, it's related to our team's within our consumer segments who are doing an exceptional job day in and day out. This also happened in 2008. We, of course, came out at that time larger and stronger. When we had lower than usual loan provisions in 2021 and 2022, we said that they would bounce back to a more normalized level, and they are doing just that. Similarly, our origination levels are higher than normal. With the growth of our loan portfolio, we increased net interest income 20% year over year to $46.7 million. This has been fueled by our ability to raise our own rates combined with the growth of our loan portfolio. We will continue to maintain flexibility in the pricing of new originations to counteract further increases in borrowing rates. Home improvement continues to be our fastest growing segment. While the growth continues to put pressure on our total company net interest margin, our net interest income continues to expand. Our REC business continues to deliver our highest average interest rates at 14.62%. It is also our most profitable segment and our biggest, now at $1.3 billion of assets. Finally, our commercial business stayed flat compared to the first quarter, in which we originated $5 million of loans, and had roughly that same amount of payoff activity on loans. Commercial earns just over $1 million for the quarter again and has a solid pipeline that should lead to increased originations in the future. 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 20% to $47 million from the prior year, The driver of this being growth in our loan portfolio, in addition to increasingly higher interest rates on our loans, which have helped to counter the rising cost of funds we continue to experience. Our net interest margin on gross loans was 8.48% for the quarter, as compared to 8.78% in the prior year quarter. The compression in net interest margin has been expected for some time now, and although we experienced a 30 basis point reduction from the prior year, When compared to the first quarter, our margin increased six basis points. We have seen for a few quarters the weighted average coupon on our loans increase. This increase is reflected in our yield, and although our cost of funds continues to track higher, we've been able to pass along a portion of that increase. Specific to originations, we are currently writing at rates of 10% to 11% on home improvement loans and around 16% on recreation loans. Our provision for credit loss was $8.5 million for the quarter compared to $7.8 million in the prior year quarter. The increased provision is a result of the continued normalization of losses in our consumer portfolio as well as the provision taken in connection with growing all of our loan portfolios, both of which were offset by $5.3 million of recoveries on taxi medallion loans. Our operating expenses of $19 million increased 1% from the prior year and reflect increases in employee-related costs associated with a growing headcount at our operating subsidiaries, Medallion Bank and Medallion Capital. This increase is offset by lower legal and professional fees. For the quarter, net income attributable to our shareholders was $14.2 million, and our diluted earnings per share was $0.62. That covers our second quarter financial results. Andrew and I are now happy to take your questions.

Thank you. At this time, we'll be conducting a question and answer session. If you'd like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd 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. One moment, please, while we poll for questions. Thank you. Our first question comes in line of Mike Grondahl with Northland Securities. Please proceed with your question.

Hey, guys. Thanks. Hey, the first question, Andrew, you talked a little bit about competition in the consumer space sort of scaling back, pulling back, similar to 2008. I don't know. Could you just provide maybe some more details there about the competitive environment. I mean, I think RV sales industry-wide were down about 40%, but you guys grew consumer loans nicely. So just trying to understand that a little bit more.

Sure. I think that's really the story of the quarter, is that there is less competition out there, and we continue to take and grow our market share more. We did that even though we tightened credit and raised rates. We just still had very strong loan demand. And, Mike, as you mentioned, it was exactly the same scenario in 2008, 2009 or so. It's just that we've been in this business for so long. The management team has been doing it for 30 years or so. They really have a loyal following. Other lenders come in and leave. The dealers know we're in it for the long haul and continue to send us a lot of their business.

Got it. Got it. And then one for Anthony. Anthony, the provision was $8.5 million in the quarter. And you said – I think you said that was offset or there was a $5.3 million recovery tied to taxis that offset that. So do I think of kind of the gross provision as like $13.8 million, or could you just clarify there?

Yeah, so the $5.3, that's the benefit we got. We recognized on these settlements that have led to the cash that's come in the door these past couple of quarters. But yeah, if you were looking for a provision excluding the medallion segment, you'd add back that $5.3.

Okay, okay. And then, hey, lastly, could you talk about – I didn't see him in the press release – sort of net charge-offs kind of bivertical in sort of dollars and percents in 2Q23 as compared to 2Q22?

Sure. So, you know, we're seeing, you know, if we exclude the medallion piece, we're seeing charge-offs. You know, they've ticked up the past couple of quarters. You know, net charge-offs were $3.8 million, and that included $4.9 million of a net benefit from the medallion space. So if you back that out, we had net charge-offs of $5.9 million on the rec side. Home improvement was $1.9 million, and commercial was $900,000. in terms of a weighted average percentage on the portfolio, we're probably around 187 basis points on the REC and 112 or so on home improvement current quarter.

Got it. Thanks. I'll jump back in the queue.

Thank you. Our next question comes from the line of Matt Hullett with B. Reilly Securities. Please proceed with your question.

Morning, everyone. This is Michael on for Matt. I just want to lead off with the congrats on the great quarter. So notice that average interest rates ticked up slightly across the board. Could you speak to your 2Q pricing strategy and if that's changed at all to date?

Sure. Yeah. So for a number of quarters now, you know, with new originations, we've been increasing the rate we charge on these new loans. This started probably, you know, About a year ago, as the Fed went down the path of raising interest rates, we didn't jump right in with increasing our rates, but we did eventually do that, pull the trigger about a year ago. Given the size of our book of business, it's slow for that rate increase to trickle through in terms of the yield. Essentially, all of our loans are fixed rate loans. So the new ones come on at a higher rate. The old ones that are amortizing off are at a lower rate. So it's slow for that yield to come up. But we have for two or three quarters now, four quarters, actually seen modest increases in the weighted average coupon of these loans. And I think that's what's flowing through. This is something that we've been saying for a couple of quarters now is that even with interest rates and our cost of borrowings increasing, we expected there to be compression in our NIMH. But at the same time, we thought we'd be able to grow net interest income because our top line is growing not as fast as the cost of funds, but pretty close to it.

Got it. Okay. And so we spoke to yields a little bit. They're slower to trickle in. So for home improvement specifically, we saw that that didn't pick up in the second quarter. Do you have any commentary there in particular?

Yeah, you know, in terms of home improvement, you know, our average coupon is about $921 at the end of the quarter. It was $883. So there is some improvement. You know, we're writing new paper at, you know, just below 11% on new originations. So, again, it's a function of the size of the portfolio. And as we write those new loans at higher rates, slowly it lifts up the yield and the average year rate.

Got it. Makes sense. So second here, for overall portfolio growth, another great point for the quarter, could you speak kind of quarter to date, any guidance on where that is?

I think what we saw in the first half of the year, particularly the second quarter, is that return to seasonality. So originations were very strong in Q2. which is, you know, if we go back to a pre-COVID era, that's typically what we saw. And then they come in some. We grew a lot in Q2. We don't anticipate growing at that level in Q3. But, you know, we've taken steps to moderate our growth. We've increased rates. We'll continue to do that. And we've tightened credit. But I think, you know, Q3 historically is, is one of those ones where things start to slow down and then it bumps up a little bit and then comes down. So it's that seasonality that we haven't experienced in a couple of years. We think we're back there.

Sure. Okay. And last question here. So as far as current capital levels go, could you give any updates there as well as just some commentary on your general market outlook? I'll jump back in a few.

So I think at Medallion Bank, we ended the quarter with Tier 1 just over 16%. We declared a dividend of $0.08 a share. I think we experienced a lot of growth, and in order to maintain that growth, we need to retain a fair amount of our capital. So to the extent that we have earnings like we do, we think our best outlook and the best thing we could do for the for the future is to reinvest in our businesses. And that's where we're taking a significant portion of our earnings, putting it back in the business, retaining it there, and growing our balance sheet.

Much appreciated. Again, congrats on the great quarter.

Thank you.

Thank you. Our next question comes from the line of Christopher Nolan with Landberg Thalman. Please proceed with your question.

Anthony, on the comment you just made on retaining capital growth balance sheet, we should imply from that that dividend increase is not in the cards?

Yeah, I wouldn't say it's – I'm not going to comment. You know, these are actions that the board has to take. You know, when we reestablished the dividend and put it back, you know, just over a year ago, you know, the intent is to pay a good dividend that over time can increase. You know, the Given the growth that we experienced in Q2, we didn't think it prudent to increase that dividend. As we see how the next couple of quarters unfold, that will determine the dividend policy that's taken.

I'd say also, Chris, dividends and buybacks are very important to us, both of those things. So the hope is to do both of them. As Anthony correctly pointed out, It depends really upon the loan demand. If more of our competitors leave the market, we may want to continue to grow market share. But if the seasonality comes back into play and we don't have the growth as we expect, we won't have the first half of this year, then we start focusing on those two things, on the buybacks and the dividends.

And then is it correct to say that the recreational segment was the driver of the incremental loan growth in the quarter?

Yep. Yeah, that's correct. I mean, that's our crown jewel. That's where a vast amount of our income is generated, and that's where significant volumes of originations occur.

Great. Should we read anything in terms of lower professional fee expenses?

No. I think for three quarters now, we've experienced what we see as normalized professional and legal fees, and that's a good thing. You know, they'll fluctuate from time to time going forward, but for right now, you know, I think that's the current run rate.

Great. And last question. The taxi medallion recoveries, you guys had $10.6 million in medallion repayments, but only $5.3 million in recoveries. I thought that all the medallion loans were non-accrual, so any repayments you get were treated as a recovery.

Yeah, so as the recoveries come in, as the cash comes in, they reduce the asset. We don't recognize any income until the asset's reduced to zero, at which point we start recovering. So we had the $5.3 million that was in the provision. There was another million or so dollars that we recognized on the disposition of actual foreclosed medallions. And then the difference between what we collected in those two numbers that reduced our total exposure.

Okay, so part of it is already reserved.

Yes.

Okay, and I guess final question. You guys are sort of in a, it looks like, you know, the competitive environment's improving, and the operating, what's your thinking about in terms of your reserve ratio outlook? And I'm trying to get a sense as to, are you guys in a mode to build reserves or keep it steady, or how should we look at that?

We think we've got fairly healthy reserves right now. On the rec side, we're over 400 basis points. And on the home improvement side, we're over 200 basis points. That's nearly double in both of those what our charge-off experience has been this past quarter. So what's going to determine this long-term is what the economy does. My crystal ball isn't working very well right now. And it hasn't been for a couple of years. But, you know, if the economy takes a turn and the consumer, particularly our consumers, start to feel pressure, I think those rates will tick up. If we continue at this level, I would expect them to stay the same.

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

Thank you. Our next question comes from the line of Mike Grondahl with Northland Securities. Please proceed with your question.

Hey guys, just to follow up on sort of overall loan growth, I think what you guys are saying is, hey, 2Q was really strong, seasonality historically kicked in, so it was like historic trends. Are you sort of saying, hey, we expect some natural moderation in the second half? And then secondly, we're sort of current CD prices, and what's sort of the overall outlook for the net interest margin?

So you'd expect growth to slow. I mean, we've been growing 20% on the RV and marina and 40% on home improvement. Those are very impressive numbers. They won't continue for forever. Frankly, about a year ago, we thought it was slow, and it didn't. So it's hard to predict when our competitors leave the market as they've been doing. We just are pleasantly surprised, and it really is a boost to our earnings and our growth. So we think it will return to seasonality, but, again, you don't really know. This business continues to do tremendously well for us, and the hope is we continue to grow it. at those rates, but we really plan for a typical growth, which is less than that. In terms of the CD rates, Anthony could address.

Yeah, and the only thing I'll just add to what Andrew said is that even though we're seeing some competitors leave the market, we haven't just picked up all of that excess. We've stepped up credit. Our average FICO has gone up again, and we've increased the rates that we're charging on new originations So we see it as a win. And, you know, I don't want to speak about, you know, what Andrew already said, but, you know, this is similar to what we experienced, you know, a number of years back during the Great Recession. As far as CD rates, you know, we're seeing, you know, they've come down some in the past month or so. Three-year CDs we're seeing at about 485 all in, and five-year new issuances are around 460. You know, our average deposit rate is 270. So, I mean, this isn't a shock to anyone. We've been saying this all along. We expect our cost of funds to continue to increase. We were seeing five-year CDs north of 525 just a few months ago. So they have come down some. And I guess we'll see what the Fed decides to do the next couple of meetings. But again, we've passed along a significant amount of that. So although our NIM has compressed year over year, and we do expect a little bit more compression, we do think that our top-line growth is enough to make sure that our net interest income continues to grow.

Yeah, you've done it. You've done it so far. Hey, two last quick questions. Was there any stock buyback in the quarter? And then secondly, just in the financial statements, I think there's roughly $68 million of short-term debt now. Can you just remind us what that is and sort of how you're dealing with that?

Sure. So first question, no, we didn't buy back any stock in the quarter. Second question on short-term debt, there's pretty much three components there, the largest one being $36 million of private notes that come due in March 2024. So we've got a couple of options there. We've had discussions with the current holders. and we're speaking with new holders, the intent is to roll that credit, whether it's with the existing lenders or new lenders. That'll be determined. So we've got some options there. In terms of pricing, that $36 million has a coupon of $8.25. It's probably 50 to 75 basis points below where we think it would reprice today. So that's something we'll be doing and working through in the next quarter or two. The other large piece in that, we had $28 million of borrowings with the Federal Reserve through the Fed window at Medallion Bank. It just so happened that it landed at quarter end, and it was just a mechanism to increase cash on hand and liquidity. I think we had it outstanding for three or four days. Earlier in the quarter, we had taken a bunch of our investment securities and, you know, taken steps to pledge them with the Fed. So... So that borrowing you saw at the end of the quarter, one, increased liquidity just for a short amount of time, and two, we wanted to test it and make sure that we operationally understood how it worked and everything and how the mechanics worked. Those borrowings have since been replaced with CDs.

Got it. Got it.

And then there's a small piece of SBA debentures and borrowings. That's just ordinary course. Those are 10-year debentures. You know, upon maturity, we usually get another commitment and take down another debenture to take off to repay the maturing ones.

Got it. Okay. Hey, thank you.

Thank you. Ladies and gentlemen, this concludes our time allowed for questions. I'll turn the floor back to Mr. Marstein for any final comments.

Thank you again for joining us on our earnings call. As always, if you have any questions, please feel free to contact 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 and have a great rest of your day.

Thank you. This concludes today's conference call. You may disconnect your lines at this time. Thank you for your participation.