Medallion Financial Corp (MFIN) Q4 2023 Earnings Call Transcript

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. 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 Murstein, President and Chief Operating Officer; and Anthony Cutrone, 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 Murstein, 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 cruise or RVs and 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 maintained 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 of 24% to $115 million, with our average interest rate up 64 basis points to 12.87%. With the 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, with $16.2 million of this coming in the fourth quarter. The majority of the cash generated from Taxi Medallion collections was a 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 CECL 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 CECL 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 growing 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 8.20% for the quarter and 8.38% for the year compared to 8.59% and 8.73% in the prior year quarter and year. We've 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 11.02%, up from approximately 8.75% in 2022 and wrote recreation loans at an average rate of 16.16% up from approximately 14.25% in 2022. At the end of the year, we were writing home improvement loans at an average rate of 11.65% and recreation loans at an average rate of 16.14%. As of the end of the year, our average coupon on recreation loans was up 51 basis points to 14.79% from a year ago. And on home improvement loans was up 86 basis points to 9.51%. In addition to passing along interest rate increases, we have continued with our tightened credit criteria. Nonprime loans were 38% of the recreation portfolio and continued 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, nonprime 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 the 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 CECL 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 CECL, 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 was 4.31% for recreation loans and 2.76% for home improvement loans, up from 3.55% and 1.81% a year ago and compared to 4.39% and 2.05% at the beginning of the year post our adoption of CECL. Operating expenses were $19.1 million during the quarter, which were in line sequentially with 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.

And our first question comes from Christopher Nolan from Ladenburg Thalmann. 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, and a large portion of that was one specific large relationship that came in, in October. We've spoken about it last quarter when we were going over Q3 and a few other not as large but significant items.

Second question is the reserve allowance. Where do you think it goes as a percentage of loans going forward? Should we see it continue to step up through 2024?

I think when we look year-over-year, we adopted CECL this year. And with that adoption, we were up 21% on the rec allowance and over 50% on home improvement. Our CECL model is a function of historical losses; we try and project that out as to expected losses over the life of the entire portfolio. And when we take into account various economic circumstances, I think what we saw is that provisions 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 and 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. My final question is, considering that everyone is concerned about commercial real estate in regional banks, do you think the FDIC might 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. I mean we've got a capital maintenance agreement where our Tier 1 leverage ratio is 15%. We're north of 16% now. I would imagine if there was something to come out, it wouldn't be specific to our institution; it will be across the Board. I mean I think that we'd probably be comfortable where we are now.

Great. And when do we expect the K to be released?

In probably another week and a half.

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

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

Sure, that's a great question, Mike, and it's something we regularly consider. After the pandemic in 2021 and 2022, we experienced record growth, and 2023 has also been stronger than a typical year. Our long-term target is an annual growth rate of around 10%. For 2024, we expect it to be in the high single digits. This is influenced by the current uncertainty in the economy and its potential impact on demand. Additionally, we have tightened our credit criteria, as we have never focused on chasing volume. Despite our significant growth, we will not pursue originations aggressively. Therefore, for 2024, we anticipate growth in the 6% to 9% range overall.

Okay. And was there a one-time gain related to equity investments or any other noise to call out with the $0.60 EPS other than the taxi cap collection?

We did have some equity gains, and 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. So when we make an investment there, up to 10% of the investment goes into some sort of equity security there. So we've got a $100-plus million book of loans and then we've got $10 million 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, and then we'll have them in the future.

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

Correct. Yes. And for Anthony's point, Mike, as you know, we bought that company in 1998. So we've got 26 years of history there of great success. So 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 13% plus rates, and then you have these kickers that kick in from time to time. Yes. As I mentioned, the book value of those kickers is $11 million at the end of the year, spread across 34 portfolio companies that we've invested in.

I’m not sure if it was related to the commercial book, or if you have made some one-off investments in the past. I would like some clarity on that. Can you provide any insights for 2024 regarding the net margin, which was around 850? I know you sometimes discuss gross margin, but is the margin pressure mostly over, or should we expect to see some lingering effects in 2024?

I wouldn't say it's finished. We believe there's still a bit of compression to occur. We observed an increase in our cost of funds in 2023, but our top line yield also rose. It's a gradual process when we discuss new originations at a higher level with a $2 billion book; it takes time for that to flow through to the income statement and be reflected in the yield. However, we are beginning to witness that. We expect to see the yield continue to rise in 2024. The cost of funds will also increase. There might be a bit more compression, but we remain confident that it will bottom out around 8%, give or take a few basis points, sometime in the latter 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 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. 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 and charge-offs; if you think about 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. 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. 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. 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. Okay. And then have you collected anything in January or February so far tied to the taxi cab Medallion?

Everyone aims for great results year after year. We are receiving collections daily, but we do not anticipate them to reach the levels seen in 2023. We were aware, as Andrew has indicated for a considerable time, that there would be a large amount of recoveries, which we expected to occur over an extended timeframe. However, much of this materialized in 2023. By the end of 2023, we still have a few significant relationships that could yield meaningful recoveries. Many of these involve structured settlements, and they are fulfilling those agreements. Therefore, we do not foresee any major windfalls occurring in 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 this is going to be very positive for them. The concept behind that is to keep consumer cars out of Midtown. As that works, then you would think more people will take not only more Medallion rides, Yellow Cab rides, but also Uber and Lyft rides. That whole sector should do better if this is implemented the right way. Hopefully, it could be collections in 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, Mike.

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

Thank you, everyone. Good morning. We had another strong quarter. My first question is about your capital strength. You are likely one of the banks generating the highest return on equity, and your efficiency is impressive at 40%. Your capital ratios appear to be on track to improve as you slow down portfolio growth, which you mentioned would be in the mid- to high single digits. I know you are being cautious, and I will ask about the CECL reserve shortly. However, as your capital continues to build, Anthony and Andrew, do you believe that with the recent dividend increase and potential for more buybacks, along with your exploration of other platforms, you are in a favorable position? It seems likely that your capital will keep increasing throughout 2024. I am curious if you are considering accelerating loan growth and what your initial thoughts are on that.

Yes. With the loan growth we anticipate for 2024, we will require a significant amount of capital to meet the 15% maintenance requirement. We believe that combining this with the dividend we have established for our shareholders allows us to deploy capital effectively. While we remain open to opportunities for raising preferred debt or equity as we have in the past, there are currently no immediate plans in that regard. We still have $20 million available for buybacks and will stay opportunistic with that. If a favorable opportunity arises that benefits shareholders, we will act accordingly. We believe that the way we are growing our business is the best approach for our shareholders in the long term.

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.

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

You have a strong history of returning capital, as demonstrated by the buybacks and the increased dividend. It's clear that you want to maintain a 15% cushion, but it would be interesting to see how you approach capital opportunities, especially since the buybacks have been effective. Regarding the CECL, is there a way to quantify its impact? It has impacted your results throughout 2023, especially in the fourth quarter. I understand the front-loading aspect that everyone has to manage, but it appears to be more burdensome for you than for others. You mentioned your cautious stance on potential economic outcomes, but could you provide some insight into what the CECL reserve might look like in 2024? With slower loan growth compared to 2023 and rising credit metrics, it seems you're not as exposed to subprime loans as you were in the past. Could we expect a normalization in that area, so it doesn't negatively affect earnings and ROE? You're already generating a 70% ROE, but a normalization in the provision line could potentially improve that significantly.

Yes. We have developed a complex analytical model aimed at predicting future losses using a probable default weighted approach. Whenever there are changes in economic factors such as inflation, prime rates, or unemployment, our model will be affected. It also considers past losses, so any increase, like we experienced in Q4, will influence our provisioning. As we move into the first half of the year and charge-offs, assuming we follow typical seasonal patterns, we might see some reduction after January or February. However, predicting this is challenging due to its close relationship with economic variables, which was a concern for us. The unpredictability we noticed in Q4 is something we anticipated for the entire year, even though it did not manifest in the first nine months.

Right. It certainly appeared to be a difficult year in the fourth quarter. However, we anticipate a return to more normal conditions. It would be interesting to analyze how earnings look this year compared to previous periods before the new CECL adoption. We will examine that. Additionally, you have done an excellent job with pricing; your rates are now over 16% for recreational loans and close to 12% for home improvement loans, which is impressive. Are you experiencing any limitations on increasing rates? Where are you currently pricing? It seems like it might level off, or you're facing competition, as banks usually reduce their presence in these market cycles. Can you provide some insight into the competition and who you are encountering?

Yes, clearly, as we increase pricing, it will impact our originations. We want to find a balance in our operations. We're not aiming to price ourselves out of the market, but our focus is more on generating the type of returns we usually achieve rather than just being competitive. Therefore, I don't anticipate a significant decrease in our pricing. However, if the Fed implements rate cuts in the future, we will take that into account when adjusting our pricing. While we don't want to lose market presence, we also won't reduce rates simply to increase volume.

Is that correct? That certainly could be a big boom for you guys. Really appreciate it.

Thanks, Matt.

We have a follow-up question from Mike Grondahl from Northland Securities. Please go ahead.

Yes. Anthony, operating expenses were like $75.5 million in 2023. Really only up a couple of million on 2022. Is that $75.5 million like the right base level for '24? Do you see like a couple of million growth throughout the year? How should we think about operating expenses in '24?

Yes, 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 so we give them standard of living increases so that you 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. But I think 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 book. So as we scale, there are going to be additional costs that we incur, and that's just part of the business we're in.

This concludes our question-and-answer session. I would like to turn the conference back over to Andrew Murstein 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're positioned 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.