Medallion Financial Corp (MFIN) Q2 2023 Earnings Call Transcript

Greetings, and welcome to the Medallion Financial Second Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded. I'd 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 Cutrone, 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 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 Murstein, 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 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 on 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 Murstein, who is possibly one of, if not the most knowledgeable authority on the taxi medallion industry in the US. 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 US 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 teams within our consumer segments who are doing an exceptional job day in and day out. This also happened in 2008 and 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 recreational business continues to deliver our highest average interest rates of 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 earned 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. Our first question comes from the 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. 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 taxes that offset that. So do I think of kind of the gross provision as like $13.8 million, could you just clarify there?

Yes. So the $5.3 million 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 yes, if you were looking for a provision excluding the Medallion segment, you'd add back that $5.3 million.

Could you provide details on net charge-offs by vertical in dollars and percentages for the second quarter of 2023 compared to the second quarter of 2022?

Sure. If we exclude the medallion segment, we are noticing that charge-offs have increased over the last few quarters. Net charge-offs amounted to $3.8 million, which included a net benefit of $4.9 million from the medallion space. When that is removed, we had net charge-offs of $5.9 million for the recovery side, with home improvement at 1.9% and commercial at $900,000. In terms of the weighted average percentage across the portfolio, the recovery side is around 187 basis points, while home improvement is approximately 112 basis points for the current quarter.

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

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

Good morning, everyone. This is Michael on for Matt. I just want to lead off with the congrats on the great quarter. So noticed 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. For several quarters now, we have been raising the rates on new loans as a response to the Federal Reserve's interest rate hikes that began about a year ago. We didn’t immediately increase our rates, but we eventually decided to do so around that time. Given the size of our portfolio, this rate increase has been gradual in impacting our yield. Most of our loans are fixed-rate, meaning that the new loans are at a higher rate while the existing loans that are being paid off carry lower rates. Consequently, the yield increase has been slow. However, over the past four quarters, we have observed modest increases in the weighted average coupon for these loans. This trend has been consistent, and despite rising interest rates and increased borrowing costs, we anticipated a compression in our net interest margin. Nevertheless, we expected to see growth in net interest income as our revenue is increasing, albeit not as quickly as our funding costs, but still closely aligned.

Got it. Okay. You mentioned that yields are coming in slower. Specifically for home improvement, we noticed there wasn’t an increase in the second quarter. Do you have any specific comments on that?

Yeah. In terms of home improvement our average coupon is about 9.21%. At the end of the quarter, it was 8.83%. So there is some improvement. We're writing new paper at 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 in 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?

What we observed in the first half of the year, especially in the second quarter, was a return to seasonality. Originations were very strong in the second quarter, which aligns with what we typically saw before COVID. We experienced significant growth in that quarter, but we don't expect to maintain that same level of growth in the third quarter. We have taken measures to moderate our growth by increasing rates and tightening credit. Historically, the third quarter has been a period where activity slows down, then picks up slightly before declining again. This seasonality is something we haven't seen in a couple of years, but we believe we have returned to that pattern.

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?

Yeah. So I think for 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 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.

Got it. Much appreciate it. Again, congrats on the great quarter.

Thank you, Michael.

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

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

I can't comment on that. These are decisions that the Board has to make. When we reinstated the dividend just over a year ago, our goal was to pay a solid dividend that we could increase over time. Given the growth we saw in Q2, we didn't feel it was wise to raise the dividend. How the next couple of quarters unfold will influence the dividend policy moving forward.

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 in 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?

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. They'll fluctuate from time to time going forward. But for right now that's the current run rate.

Great. And last question. The taxi medallion recoveries, you guys had $10.6 million in medallion repays but only $5.3 million in recoveries. I thought that all the medallion loans were non-accruals. So any repayment 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 assets reduced to zero at which point we start recovering. So we had the $5.3 million that was in the provision. There was another $1 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. For my final question, it appears that the competitive environment is improving. What is your perspective on the outlook for your reserve ratio? Are you planning to build reserves, keep them steady, or how should we interpret that?

We believe we have strong reserves at the moment. For the recreation sector, we are above 400 basis points, and for home improvement, we are over 200 basis points. This is nearly double what our charge-off experience was last quarter. The long-term outlook will depend on the economy. My predictions haven't been very accurate lately, but if the economy shifts and our consumers begin to feel pressure, I expect those rates to increase. If we maintain the current conditions, I anticipate they will remain stable.

Okay. Perfect for me. Thank you.

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

Hi, guys. Just a 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 where 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 marine and 40% on home improvement. Those are very impressive numbers. It won't continue 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 typical growth which is less than that. In terms of the CD rates Anthony could address.

Yes. I want to add to what Andrew mentioned that, although we are seeing some competitors exit the market, we haven't completely absorbed that surplus. We have increased our credit offerings, our average credit score has risen again, and we have raised the rates on new originations. We view this as a positive development. This situation is reminiscent of what we faced several years ago during the Great Recession. Regarding CD rates, they have decreased somewhat over the past month; three-year CDs are currently around 4.85% and five-year issuances are approximately 4.60%. Our average deposit rate is 2.70%. This is not unexpected, as we have been indicating that we anticipate our cost of funds to keep rising. Just a few months ago, five-year CDs were above 5.25%. They have declined somewhat since then. We will see how the Fed proceeds in the upcoming meetings. Despite a year-over-year compression in our net interest margin, which we expect to continue slightly, we believe that our top-line growth will be sufficient to ensure that our net interest income continues to rise.

Yes, 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 will be determined. So we've got some options there. In terms of pricing, that $36 million has a coupon of eight in the quarter. 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 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 taken steps to pledge them with the Fed, 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 make sure that we operationally understood how we worked and everything and how the mechanics work. Those borrowings have since been replaced with CDs.

Got it.

There is a small portion of SBA debentures and borrowings that are part of our regular operations. These are 10-year debentures. When they mature, we typically secure another commitment to issue a new debenture to repay the ones that are maturing.

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. Murstein 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.