Medallion Financial Corp (MFIN) Q4 2020 Earnings Call Transcript

Good morning, and welcome everyone to Medallion Financial's 2020 Fourth Quarter and Full Year Earnings call. By now, everyone should have access to the earnings announcement, which was released prior to this call, and which also may be found on the company's website at Medallion.com. Before we begin formal remarks, we need to remind everyone that matters discussed on this call include forward-looking statements, or projected financial information that involves risks and uncertainties that may cause the actual results to differ materially from those projected in such forward-looking statements and projected financial information. These statements are not guarantees of future performance, and therefore, undue reliance should not be placed upon them. For further information on factors that could impact the company and the statements and projections contained herein, please refer to the company’s filings with the Securities and Exchange Commission. Each forward-looking statement and projection of financial information made during this call is based on information available to us as of the date of this call. We disclaim any obligations to update any forward-looking statements unless required by law. I would now like to introduce Andrew Murstein, President of Medallion Financial. Please go ahead, sir.

Good morning, everyone, and thank you for participating in our 2020 fourth quarter and year-end earnings call. Joining me on today's call is our CEO, Alvin Murstein; our CFO, Larry Hall; and our Director of Investor Relations, Alex Arzeno. Medallion Financial took the appropriate steps in 2020 to build a strong foundation for the eventful year that provided a challenging operating environment. During the year, we deemed the Medallion portfolio as impaired as a result of the impact of COVID-19 on our borrowers, resulting in all loans being placed on non-accrual status and their carrying value adjusted down to their net collateral value. In the fourth quarter, we lowered our Medallion value slightly. We hope you will also have recoveries on a portion of the over $250 million of loans that we wrote off over the last five or so years. Net Medallion loans dropped 88% from $105 million as of December 31, 2019, to $12.7 million at year-end 2020. When looking at our consumer portfolio, we commend the Medallion Bank for not only navigating this pandemic but having a record year. Applications grew significantly despite the bank raising its credit standards, resulting in the recreation and home improvement net loan portfolios growing 10% and 34% from December 31, 2019. COVID-related payment deferrals were largely resolved while average FICO scores at origination continued to be relatively high and slightly below 700 in the recreational segment and just above 750 in the home improvement segment. That complements the consumer growth we've seen this year. The bank began originating loans with its first FinTech partner in the second quarter and also executed a non-binding term sheet with another potential partner, both of which provide consumer finance services. Our partnership program is expected to grow this year. In January, we began to see an uptick in originations and look to provide a further update at the end of the first quarter of this year. On the commercial side, liquidity remains strong as Medallion Capital was approved for an additional $25 million of SBA leverage in the second quarter, which provides for a 10-year term and interest of less than 2% based on current rates. Only one loan was put on non-accrual in 2020, which we took a full reserve against an equity investment in the third and fourth quarter. We expect a gradual recovery of performance within the overall portfolio in 2021, as many companies are now operating at pre-COVID levels. For those most negatively impacted by COVID, we are seeing a gradual improvement in operating conditions. With respect to the overall business, deal flow remains strong and Medallion Capital continues to pursue new opportunities. Before turning the call over to Larry, I will quickly touch upon additional fourth quarter and full year highlights. Net income from the company's consumer and commercial lending segments was $14.2 million for the quarter, compared to $7.2 million in the prior year quarter, a 97% increase. 2020 net income from Medallion's consumer and commercial segments was $41.6 million compared to $31.9 million in 2019, a 30% increase. Medallion Bank closed the year with a 16.93% Tier 1 leverage ratio, $218.5 million of total capital, and a 34% efficiency ratio. The consumer and home improvement lending segments contributed $48 million in annual net income to the bank and $15 million in the fourth quarter, both the highest since they began originating loans in 2004. Excluding loan collateral in the process of foreclosure and own Chicago Medallion assets, total Medallion exposure comprised just 4% of our total assets at year-end compared to 10% at December 31, 2019. So with that, I will now turn the call over to Larry, who will provide additional highlights in the fourth quarter and full year.

Thank you, Andrew. Net income was $6.5 million or $0.26 per share compared to a net loss of $500,000 or $0.02 per share in the prior year quarter. 2020 total net loss was $34.8 million compared to a net loss of $1.8 million in 2019. Our high net interest margins have been consistent in our reporting. We ended the fourth quarter with the strongest net interest margin in 13 years of 8.89%. For the full year, our net interest margin was 8.65%. Cash flow from operations increased 21% year-over-year to $79 million in 2020, up from $65 million in 2019. As Andrew previously discussed, as a result of lowering New York City Medallion values from $90,300 net to $79,500 net in the fourth quarter, we recorded a loss of $3.6 million for the Medallion segment for the quarter. We remain optimistic that Medallion values have bottomed and that the segment's losses, if any, will be manageable as our higher-yielding and profitable consumer and commercial segments will continue to be our focus moving forward. Net medallion loans dropped 88% from $105 million at the end of 2019 to $12.7 million at the end of 2020. When including loans in the process of foreclosure and own Chicago medallion assets, total medallion exposure was $68.8 million or 4% of assets as of December 31, 2020, compared to $159.3 million or 10% a year ago. Total provision for loan loss benefit was $3.4 million in the 2020 fourth quarter compared to a provision for loan losses of $10.5 million in the prior year quarter. For the full year 2020, the provision for loan losses was $69.8 million compared to $47.4 million in 2019. The higher consumer reserves are mainly due to the growth we are experiencing in that lending segment as reserves are first established when the loans are booked. The large difference in reserves was once again driven by the $42.3 million provision we took on the medallion portfolio this year. As a result of the impairment of the Medallion portfolio and the write-down in New York City and almost all other market medallion collateral values, the company recorded a net increase in reserves of approximately $11.5 million for the full year 2020. Consumer loans still in the state of deferral were $6.7 million or 0.6% as of December 31, 2020 compared to the total gross extensions of $116.3 million for the year. We believe consumer loans in a state of deferral at year-end were manageable and will decrease in 2021 as our borrowers become current again and the economy continues to open up. The consumer loan portfolio's average interest rate was 13.64% this quarter, a slight drop from the 13.87% we recorded last quarter as we continue to be cautious and more selective on the loans we choose to underwrite. In addition, we continue to see the home improvement segment outpace the growth of our recreation segment, which has lower losses and yields. However, both are showing noteworthy growth, which should continue into 2021. Net income from our consumer lending segment was $40.7 million for the year compared to $29.7 million in 2019. Our Commercial Lending segment recorded net income of $32,000 in the fourth quarter and $893,000 for the full year. The net commercial lending portfolio was $62 million at the end of 2020 compared to $66.5 million at the end of 2019. The average interest yield was 13.39% compared to 13.63% a year ago. We expect the continued gradual recovery of performance and growth within the overall portfolio in 2021. With that, I'll now turn the call back to Andrew.

Thank you, Larry. Operator, we can now begin the Q&A portion of the call.

Thank you. Ladies and gentlemen, the floor is now open for questions. Our first question today is coming from Alex Twerdahl of Piper Sandler. Please go ahead.

Good morning, guys.

Good morning, Alex.

First off, I was wondering, Larry, if you could go through the moving parts of the loan loss reserve during the quarter, including how much of the provision was associated with the Medallion, the home improvement, and the recreation portfolios as well as the charge-off levels associated with each of those during the quarter?

Sure. The consumer segment, the recreation business had about a $3 million provision for the quarter. The home improvement had $737,000, and there was a benefit of $7.2 million in the Medallion segment. A lot of that had to do with recoveries that we received during the quarter. The charge-off ratio remained very low in the consumer businesses: under 2% for the recreation business and under 0.5% for the home improvement business. And there are net recoveries in the Medallion segment. That's the reason the provision was negative.

Okay. And then just thinking about the provision going forward, certainly the timing of recoveries is going to be hard to project, but how do you think we should be thinking about a normalized provision level for 2021 for the consumer business and what would be the underlying assumptions in terms of portfolio growth, etc., that would drive that?

I'd say that it would probably be similar to what it's been in the past. We had pretty good growth there: 10% in the recreation and 34% or so in home improvement. So I think things should continue pretty much the same as they've been. Larry, I don't know if you want to add anything to that?

No, I think it's consistent. I mean, we've got a long track record in the consumer business of what the loss ratios have been, and they've been pretty consistent quarter after quarter, year after year. So we're not really expecting anything unusual there. And on the Medallion side it's going to depend on whether the valuation of the collateral changes at all. We think we're at the bottom, but time will tell. The recoveries we're working hard on that and that can be a plus going forward.

Okay. And then just kind of on that last point, have you guys given any more thought to selling the Medallion portfolio and just finally washing your hands of it? And if you decide to do that, do you think there will be a market for it?

Yes, we are open to that possibility. Our main focus is on the bank and consumer lending moving forward. If the price is right, we would consider selling. As Larry mentioned, current valuations are quite low. Things have been extremely challenging across all industries. We empathize with the drivers; they were just beginning to recover when the pandemic hit, and there hasn’t been much support from the government. While it may not be the ideal time to sell, if we can secure a fair price that allows us to realize a gain, we would be interested in pursuing a sale.

Understood. And then just finally, as I look at expenses, I was hoping maybe Larry you could give us a little bit of color on sort of how we should be thinking about run rate expenses for 2021. I mean certainly 2020 had its fair share of noise with the pandemic, etc. I recall you guys did do a cost saving and furloughing program around mid-year. However, it hasn't really seemed to impact at least the salaries line where we would have expected to see that impact. So maybe talk a little bit about why we haven't seen that impact and if in 2021, if we're expecting expenses to trend lower or if there's something else we should be thinking about?

I think it will start to drop. You're right; we furloughed a lot of people and haven't released them yet. And I think, unfortunately, that's probably the next phase for us, so we're going to pick up some savings when we have to pull the trigger there.

Understood. Thanks for taking my question.

Thank you, Alex.

Thank you. Our next question is coming from Steve Moss of B. Riley Securities. Please go ahead.

Good morning.

Good morning, Steve.

I'll start off with loan pricing here. Just kind of curious what you're seeing in terms of trends for recreation and home improvement. Is there any increase in competition? Just kind of the rates you're originating today?

Things are really continuing as they have, which is a good thing since that's been so profitable for us. The consumer in the recreation side, we're still getting rates of 14% or more on many of those loans. Home improvement has probably come in a little bit. That's been a touch more competitive, but really not much more. But the cost of funds is coming down probably more than the yield is coming down. So we have a lot of CDs rolling off of our books with rates of 2%, 2.5% that we took on in the last couple of years. And we were just checking this morning new CD costs for us for one-year money. It's really unbelievable how low the rates are these days. I think it’s 15 basis points for one-year money. So we think these margins, as impressive as they are now, could probably increase in 2021.

Okay. Great. That's helpful. And then also going back to expenses here. You've seen obviously good profitability here at the bank. Kind of curious as to what the potential is for maybe some efficiency initiatives or a reduction in expenses at the holding company?

That's a good point. We're focused on that. We've been trying to trim back the expenses there. It's a little bit of a double-edged sword honestly because we have $278 million or so of charged-off loans in the Medallion side. But we've got a couple of million dollars of overhead against that with the collection team and workout people. So I think it's going to pay off though. We could come back further, but then you lose the likelihood of collecting as much of that $278 million as you can. So for example, if we're spending $5 million a year trying to collect it and we strike out, it was a waste of money. But if we can collect 1/3 of the $278 million and $90 million in spending over the next three years, $15 million, I'm just doing math against that amount, then it's going to be a windfall for us. So I think we just have to monitor it closely. If we think we're going to have that kind of success, then I think these resources are worth it. But if we're not fortunate enough and the market gets worse for some reason, then I think we have to make some further cuts.

Okay. That's helpful. And then maybe just on the subject of recoveries - good recoveries in the quarter from the Medallion portfolio. Kind of curious if you have any subsequent recoveries subsequent to quarter end if you will?

Nothing that we can go into subsequent. But we're still hopeful that things are going to start falling our way, so to speak. I mean, it's been going the opposite way for so many years now. And I can't imagine the city getting worse than it is now, right? I mean, it's been shut down which is unprecedented. So things are starting to get back a little bit to normal; it's still nowhere near normal. I think it's going to take time, a year or so perhaps maybe even more, but I think we're on the right course and I think it's going to pay off for us.

Great. All right. Thank you very much.

Thank you.

Thank you. Our next question is coming from Mike Grondahl of Northland Securities. Please go ahead.

Hey. Thanks, guys, and good morning. Just, I guess, another question on the roughly $12 million of Medallion collection. Was that from one, two, three borrowers? Sort of, what happened that you ended up collecting that? Because it had been pretty small numbers the previous several quarters. So if you could just shed a little bit more light there, that would be helpful.

Larry, can you touch on that?

Well, I mean, as we've said before, there's kind of a long tail to do these recoveries because of the legal process you have to go through takes a long time. And at the same time, some of these borrowers have some pretty substantial resources they can bring to bear to delay payments and slow the process down. So it's not something you can manage very easily, but our people stay on it and they work hard. And it just was lucky that this quarter, I think there were maybe three pretty good-sized recoveries that came through all at the same time and we're hopeful that will continue.

Got it. So three borrowers made up that $12 million. Just trying to get a feel for it there. And is – historically, your provision expense for sort of the consumer, the bank level was running closer to $6 million, $7 million, maybe $8 million a quarter. In this quarter, home improvement in recreation was a little under $4 million. Obviously, the stimulus and things have helped with credit quality. Do you see that as sort of core, staying at these levels? Or do you see after a quarter or two, we will be up at something $6 million, $7 million, $8 million closer to a core provision level?

Larry, you can just...

I think it's just a growth - they need to book reserves against every loan they put on the books. And the reserve levels haven't changed a lot in terms of percentage coverage because the charge-offs and the loss ratios have been so low. But as the volume continues to increase of originations that are being recorded, those reserves are going to go up a little bit to offset that.

Fair enough. And Andy, at a high level, how do you think about originations for 2021 for RV, boat, and home improvement? The demand seems pretty robust out there, but 2020 was strong. Can you grow this at a 10% rate, a 20% rate? How are you kind of thinking about origination growth, loan growth as you look forward?

It should continue very strong, I think. I mean, we're expecting things to be business as usual. The origination growth for the recreation was I think 14% in 2020, and for home improvement loans, I believe it was 35% origination growth. So they're two great lines of business that they happen to be good pre-pandemic. They're even accelerating in the pandemic, and they're definitely going to do well as soon as this pandemic is over. So we're very happy with the performance of that division. And that's the future of the company.

Got it. Two more questions. One just any comments on the first FinTech partner and how that's ramping up? And then maybe the second FinTech partner you mentioned and how do we just think of the contribution from both of those this year and next year as that scales?

The first one got off to a slow start in the beginning of 2020 because their business was really cosmetic surgery and other elective surgery, and that business was really slow in the beginning of 2020 with the pandemic and hospitals not being able to accommodate them. But we're seeing a big pickup now in 2021. So the January numbers look substantially better than last year's numbers. The second FinTech partnership, I think, we're going to probably see signed up in the next 60 days or so. There's a lot of choices for us, which is a good thing. We've probably spoken to 10 potential partners, but we don't want to grow too fast there. We've got to make sure we don't make any errors, and it's very compliance-driven. We want to be as good as possible in that area. So we should get the second one on the books shortly. It's an extremely profitable business. If you pull up the financials of others in this space, all these banks, as many of you know, have call reports that are available to the public online. So you could see their profitability levels. Companies like WebBank, Celtic Bank, and Cross River and others. I think their ROEs are all well north of 20%. So we're excited about this business. It's very small for us right now. I think it will have a small contribution in 2021, but it could really turn into a very large one in 2022 and beyond.

Got it. And then just lastly, Andy, what are your two or three priorities for 2021?

I'd say we've really done a good job of steering away from the Medallion business. And we had the vision to do that back in 2003, when we set up the bank. Nobody saw Uber and Lyft and these other companies coming, but we were fortunate enough to have the foresight to find new niches that were even more profitable than those businesses we were in, like the Medallion business. So I'd say it's not taking our eye off the ball. We want to continue to block and tackle and stay in these business lines that have been so profitable for us where we're market leaders. And with the growth rates again of 10% and 35% and an ROE north of 20%, I think we're perfectly aligned for the future.

So just deemphasize Medallions and just push on the bank; I mean that's your priority?

Yes. I think we've deemphasized it for many years, but I think people are finally realizing how far we've come. So the Medallion business is just a small fraction now of our total assets. I think it's under 5%. So in our mind, it's long gone, but we just have to keep knocking out good quarters like this quarter. If we can consistently do $0.25 quarters or more, and I'm not projecting that we do that at all, but just this quarter I thought was a very good quarter. It was a turning point for our company. And if we can continue to do that, I think the writing is on the wall for where the stock could possibly go; I think we'll all be in a very good position in the future.

Got it. One last question then, Andy. I mean, basically, you hit $0.25 this quarter because you had the benefit of the Medallion not a provision, but a benefit $7.2 million as was pointed out. So, I mean, you're kind of breakeven without...

No, I wouldn't say that. The Medallion division still had a small loss for the quarter. However, we recognized about an $8 million write-down, which we expect to be a one-time occurrence. We reduced the value of the Medallion from approximately $89,000 to around $79,000. This write-down amounted to between $5 million and $8 million, and it shouldn't be a recurring issue. Overall, we incurred a couple of million dollars in losses in the Medallion division for the quarter. But again, Larry can clarify.

No, we did. We lost $3.6 million in the quarter.

So Mike, you're right. I mean you had some positives one time one way, but you had a big negative with the Medallion value write-down of the $10,000 per Medallion the other way. So we're not projecting anything, but if both those things cease to repeat in the future, it would be a benefit for us, a net benefit.

The bank is very profitable and is just addressing some legacy issues.

The bank made $14.5 million for the quarter. So hopefully, if they continue that, if they continue a run rate like that — again, not projecting that they will or won't, but just doing the math of $14 million plus quarter is $56 million for the year.

At this time, I'd like to turn the floor back over to Mr. Murstein for closing comments.

Great. Well, I want to thank everyone for attending this morning's call. We're happy to follow-up if your question was not answered. To that end, please contact our Investor Relations department at 212-328-2176 or via e-mail at [email protected]. Thanks very much for participating, and please feel free to follow-up with any calls that were unanswered today or any questions. We appreciate it. Thanks again.