Medallion Financial Corp (MFIN) Q2 2024 Earnings Call Transcript

Good day, and welcome to the Medallion Financial Second Quarter Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Ken Cooper, Investor Relations. Please go ahead.

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, 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 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.

Thank you, Ken, and good morning. We were pleased with another solid quarter. We produced $7.1 million of net income and $0.30 of earnings per share. For the first half of the year, we have delivered $17.1 million of net income to our shareholders. This has been driven by the performance of our loan portfolio and the high yields we earn. Looking at our segments, Rec lending, our largest segment, had another strong quarter. The highlight was originating more than $200 million of loans. Importantly, most of these loans came from high interest rates as we continue to have success passing through elevated market rates to borrowers. Our average interest rate as of June 30 was 14.8%, up 18 basis points from a year ago. In addition, we continue to originate loans to individuals with stronger credit profiles in the prime and near-prime segment of the credit spectrum. Our Home Improvement Lending segment grew 6% over the prior year quarter and now sits at $773 million. This segment continues to be dominated by super-prime borrowers with strong credit scores. Like Direct segment, we have passed on some of the Fed rate increases to our borrowers and our current average rate of 9.71% is 50 basis points higher than a year ago. Our Commercial Lending segment had a steady quarter, generating $500,000 of earnings. The loan portfolio grew 19% from a year ago and is now at $110 million with an average interest rate of 13.05%. I'd like to briefly mention two other items. One, after an absence of about five years, we were pleased to again be included in the Russell 3000. This is another testament to the continued growth and performance of our company; and two, we continue to effectively deploy capital for shareholders. During the quarter, we repurchased $1.5 million of our common stock, which left us with $16.4 million remaining on our authorized $40 million share buyback plan. We have now utilized nearly 60% of the current buyback plan authorized just two years ago. We expect to remain opportunistic on any future share repurchases. Our share buyback activity, together with our $0.10 per quarter dividend and net income performance continues to deliver positive results for our shareholders. 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 7% to $49.9 million from the prior year and grew 4% from the first quarter. Growth in our net interest income is driven by loan portfolio growth along with the increased rates charged on our recent loan originations, offset by the higher interest expense as a result of increased borrowing costs and larger amounts borrowed. Our net interest margin on gross loans was 8.12% for the quarter, down 36 basis points from the second quarter of last year and up 2 basis points from the first quarter. During the quarter, we rated recreation loans at an average rate of 14.94% and home improvement loans at an average rate of 11.67%, both in excess of current weighted average coupons in these portfolios. Current average origination rates in July are at above 16% for recreation loans and around 11% for home improvement loans. For the past several quarters, we have been focused on increasing the average coupon and yield on our loan portfolio, and we'll continue to do so with originations being at rates above that of our current portfolio. This is a slower process than we experienced with the rise in our cost of funds. We anticipate that our average coupon and yield will continue to increase well after our cost of funds plateaus at which point we will experience expansion in our net interest margin. During the quarter, we originated $309 million of loans, including $210 million of recreation loans and $68 million of home improvement loans. Total loans outstanding increased 11% from a year ago to $2.4 billion, with the corresponding yield during the quarter increasing to 11.52%. We maintained our Titan credit criteria, which we believe had and will continue to help us constrain losses long term. During the quarter, prime originations in our Recreation portfolio were 68% of total originations. And as of June 30, 65% of our Recreation portfolio were prime credits. Consumer loans more than 90 days past due were $7.2 million or 0.33% of the total loan portfolio as compared to $6.1 million or 0.3% a year ago. Our provision for credit loss was $18.6 million for the quarter, an increase from $17.2 million in the first quarter and $10.1 million in the prior year quarter. Both the current and prior quarter included a net benefit related to Taxi Medallion loans of roughly $1 million, and in the prior year quarter included a benefit of $5.3 million. $4.2 million of the current quarter's credit provision is specifically related to the growth in our consumer portfolio, particularly recreation loans. As our portfolio continues to grow, we'll continue to experience this growth penalty, which causes an immediate reduction in current earnings. The seasonality in our business, with the second quarter typically having stronger origination levels than other quarters, exacerbates this growth penalty. However, looking ahead, a larger portfolio at our current origination rates, coupled with the credit criteria we require should enhance our earnings long term. Operating expenses were $20 million during the quarter, up from $18.2 million in the first quarter and up from $19 million in the second quarter of 2023. The current quarter operating expenses were higher primarily due to elevated legal and professional fees associated with the company's successful defense against an activist proxy campaign. We continue to believe that the growth in our net interest income will outpace any increase in our operating costs as we continue to scale our lending businesses. For the quarter, net income attributable to our shareholders was $7.1 million or $0.30 per diluted share, which included approximately $0.12 per share related to additional credit allowances tied to consumer loan growth as well as approximately $0.04 per share related to the elevated legal and professional fees. Our net book value as of June 30 was $15.25 per share, up from $13.66 a year ago. That covers our second quarter results. Andrew and I are now happy to take your questions.

We will now begin the question and answer session. The first question is from Mike Grondahl with Northland Securities. Please go ahead.

Hey, guys. Could you talk a little bit about your outlook for RV and boat and also home improvement, just growth margin credit kind of, how are you thinking about the second half in those two big areas?

Sure. Mike, good to speak to you. So as it relates to RV, we grew 10% in Q2. Q2 is typically our largest origination quarter. We'll see those originations peak in terms of the levels in July and then try to begin to settle in August and September. And then Q4 is somewhat quiet. So we would expect Q3 to look somewhere between the originations in Q1 and Q2, a blend of those two. We'd probably end the year around $1.5 billion, a little more than $1.5 billion, so a little bit higher from where we are. I think we end the year with about 15% growth in Rec. And on the home improvement, Q3 is typically the larger origination quarter for home improvement. That's really where that space hits its stride. There's a 3- to 4-month lag between when a loan gets approved when it actually gets funded just because of the time it takes to actually fulfill these improvements. So we should see some bigger growth in Q3.

Got it. And then kind of two follow-ups on that. Is home improvement gotten more competitive? Is that down year-over-year because of less demand or you guys tightened credit more? And then just kind of a credit outlook for each one.

Yeah. I wouldn't say that it's gotten more competitive. Home improvement has always been competitive with the super prime FICOs there. I think we've held it back a little bit. As we look to grow, we're looking to make sure that we're deploying in the right space. Obviously, we're looking at credit from a credit perspective, everyone knows how good the credits are in home improvement. Two-thirds of our originations on the Rec side are now prime credits and 65% of the total portfolio is prime. So I think we're focusing on that to make sure that we're cognizant of where our margin is and where we want our yield to be and we're making decisions there. But we do expect that to pick up in Q3, like I said.

Got it. Just credit overall?

I think the term we use is cautiously optimistic. The average FICO in the Rec portfolio was 685. 2024 originations, the average originations for the six months, 689. So this is a different portfolio than we had five and 10 years ago.

And as you know, Mike, we did a new debt offering last week, I think, of June or so, so very recently. And that had an A minus investment grade rating as well.

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

The next question is from Christopher Nolan with Ladenburg Thalmann. Please go ahead.

Hey, guys. Congratulations on the quarter. Congratulations on the inclusion in the Russell. I guess first question is going to be professional fees. Should we expect operating expenses to decrease in coming quarters and guidance on that?

The legal and professional fees were higher in the second quarter due to the proxy season, totaling just over $1 million. This impacted our earnings per share by approximately $0.04. We do not anticipate this happening again in the third quarter.

Great. And then net charge-offs in the quarter, I didn't see it in the press release. Do you guys have a hard number you can provide?

Yeah. We have it in the supplement on our website. But yes, net charge-offs for the quarter, $12.6 million. That's $10.7 million in rec, 2.8 in home improvement and then a $900,000 benefit in taxi.

Great. Final question. Do you guys have any breakdown in terms of employment by your borrowers? I mean, what percentage of those work for the government? Which percentage work for private industry, things like that?

I don't know that we disclosed that, and it's not a metric that we look at, particularly as to the type of employment. All of our borrowers are employed. And we do typically lend to borrowers, even though their credit might not be a plus on the Rec side, they usually have a higher wage than you would typically see in near prime lending.

Okay. The reason I ask is there's a large amount of government debt, which has to be refinanced, federal government debt at much higher rates. And given that we're in an election year, things can go in a lot of different directions in terms of government employment and want to see whether or not you guys have a particularly heavy exposure to government employees.

Right. I don't believe we do. I'm just thinking through loan applications that we've looked at recently, and very few would have fit that category.

Great. Thank you very much for taking my questions.

Thanks, Chris.

The next question is from Matthew Howlett with B. Riley. Please go ahead.

Hey. Good morning, Andrew and Anthony. Thanks for taking my question.

Sure, Matt. Good morning.

First on the margin here, look, a little bit of an outperformance in the quarter. I think Anthony said last quarter, it could tick down to that you might have said. But here, we're going to hear from the Fed this afternoon and really I think it's 100% we're going to start gaining cuts by September. What's the outlook? I mean where are CD rates now? I mean, five year CD rates, where could they go with federal funds go down 200 basis points from here next year? And will you begin lowering kind of your coupons? I mean at some point, just give me the outlook here. You guys have done a great job defending the NIM. You have one of the highest in the banking sector, you raised coupons. Well, here we're going probably change in the cycle here and a monthly how this is going to impact what your strategy is?

Yeah. So as of yesterday, short-duration CDs, three, six months, are hovering around 5%. If you go out to three years, we've got 4.5 and then five years, new issuances are 4.3%. So hopefully, you're right, we do get the rate cut in September, and we should start seeing those come in. The overall CD cost is 3.5%. So again, I don't think anything has changed. We did see a benefit. The 2 basis point increase from Q1. We're definitely closer to the bottom of that NIM compression we've been talking about for a while than not.

I'm sorry, what was the last part then you're closer to the bottom than what?

Yeah. We definitely feel that we're closer to the bottom of the NIM compression that we've been talking about than not being there. And just in terms of yield, we don't have any discussions right now about lowering the rates that we're originating on. I think we're comfortable where we are. But obviously, the market will dictate to a certain extent where we lend and at what rates.

Yeah. look, I mean, a great job with raising rates and offsetting what's been a tightening cycle here. We look forward to the next cycle here.

Some of the common questions we receive are whether we can increase our Rec portfolio, potentially by another 200 or 300 basis points. After examining this, the short answer is that we can. However, the longer answer is that we prefer not to due to concerns about adverse selection. Additionally, with the current credit we are receiving, it would lead us to fund loans that we typically do not wish to support.

Absolutely. No, I hear you. On the growth penalty on the reserve penalty, how would you recommend us look at it by backing out all the $0.12 and say you'll make up for that over the life of the loan, you're just getting penalized by what was exceptional growth. And what I'm assuming is you're using probably very harsh forward loss assumptions really booking these at U.S. booking them at 4% or 5% charge-off rates. And is it just something that we're trying to get more used to? I just want to hear from you again on the growth penalty.

It was $4.2 million, which is the cost associated with booking new loans. This amount represents the allowance we need as we expand our portfolio. We won't be growing at 10% each quarter, but year-to-date, we're around 15%. So, if you consider what a typical quarterly growth would look like, that would be the adjustment we expect.

Right. Got you. Look, I appreciate the conservatism and it's certainly something that's impacting earnings and the artificially weighing down results but I think to the benefit of all shareholders. Next question, just two more on the solar deal you did, Andy, any update on just how that's going?

It's going well. This area of strategic partnerships is where, as many of you know, fintechs are sending us loans. We're funding them and charging a fee for that. We get the flow for a couple of days, and then they buy the loans back. So it's a bit slower than we expected at the start, but I believe it has considerable long-term potential. Generally, when we initiate new programs, there's quite a bit of exploration and evaluation we prefer to conduct. It's a promising business; we just need to ensure we're compliant, which we are here. We have a strong team in Utah. Typically, they like to go through everything carefully, and once the program has been running for a quarter or so, the volume should increase significantly.

What type of yields do you get? You probably have a mid-teens yield for a little while, and they likely receive one success fee or origination fee; that's how it works.

Yeah. Origination fees can range from 15 basis points to 50 basis points upfront on the loan. And then you'll have the float for a couple of days. The paper could be across the board from 12% up to 24% or so. We're talking to some new partners now. Again, compliance is very key here. So some of the other banks in this space have gotten consent orders over the last year or two because they grew too quickly. We don't want to make that mistake, but that's also an opportunity for us now because many of the fintechs are not going to them because the regulators are telling them basically to slow down. And therefore, we're seeing those opportunities ourselves now for the first time.

Yeah. And I would just add, we're selective about the type of partner we want. A lot of other players in this space, they operate on razor-thin margins and just do a whole lot of volume. And to what Andrew said, with the compliance that's key to this, there's a lot of opportunity for footfall if you're not careful. So that's where we are.

Thanks for that. We look forward to the update and possibly new announcements on new partnerships. Last one for me. The buybacks intangible book, where the tangible book come in this quarter? And congratulations on buying back stock, I think it was $8.23. And I just want to look at how you think about the dynamic of buybacks, intangible book and so forth.

Yes. The book value is $15.25. We have addressed this before; we don't consider tangible book to be a significant metric because it doesn't capture the full picture regarding our goodwill. Therefore, we calculated an adjusted tangible book of $9.74 per share. In this calculation, we take the traditional tangible book approach and exclude goodwill and intangible assets from common equity. We also add back a $43 million tax liability specifically related to those goodwill and intangible assets. After going through this calculation, we arrive at $9.74 million.

Okay. So you're still buying back stock well below GAAP book value and still below tangible book value?

Correct.

Yes.

Would you prefer to continue focusing on buybacks, Andrew? You have a solid dividend. How do you view the balance between increasing the dividend, engaging in more buybacks, or investing more for growth, considering you have numerous attractive opportunities available? I'm guessing you tend to focus on book value more, viewing your NAV as closer to 15% rather than 9.74.

Yes, that's right. They are all very positive options for shareholders. Our aim is to combine both maintaining and eventually increasing the dividend while also buying back stock. We've experienced significant growth. While a 10% increase from one quarter to the next may not continue at that rate, it translates to an annualized growth of 40%. As Anthony mentioned, we're looking at approximately 15% recurring revenue growth for the year. These are good challenges to have. We need to balance investing more money to ensure it continues to grow by 15% or more per year, especially given our high return on equities. We have increased the dividend, which is our goal to do again. We also need to consider when to buy back stock, and fortunately, we've been able to pursue all three strategies. We aim for a mix of these approaches based on the timing and available opportunities.

Yeah. Look, I mean you've been really a great allocator of capital, I mean, and the share count keeps on getting knocked down, and I think people were missing it. You bought back a lot of stock less or we or so. You externally keep up the good work and look forward to sharing you the next quarter.

Thanks very much, Matt.

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

Hello, everyone. I have two quick follow-up questions. Regarding the EPS, you mentioned a $0.04 impact from professional fees and a $0.12 impact from portfolio growth. However, did you discuss the benefit of the $2.3 million from taxi medallion collections? Anthony, could you provide some clarity on that?

The $2.3 million after tax amounts to about $0.04. However, we consider that $2.3 million to be a reasonable estimate for future collections. The impacts reflected in the income statement for Q2 and similarly for Q1 will be ongoing. This situation is influenced by how these assets are valued on our balance sheet and the cash inflows. Therefore, I wouldn't categorize this as an add-back; it simply represents our current run rate.

Got it. Fair enough.

Yeah. I think it was fair last year, we quantified those numbers were significantly higher, and we sure we can understand the add back. But at these levels, this is where we expect to be, and we don't see anything changing.

Got it. And for both of you, maybe, anything 3Q, 4Q '25, just looking ahead, anything you want to call out as you guys are driving this business? Any trends you're seeing or is I don't know, roughly $0.35, $0.40 kind of the right core earnings level to kind of grow off of. I don't know, just anything in your business you're seeing that you want to talk about.

I'd say the goal has been, which we've been doing very successfully just increasing the size of this portfolio. It throws off an enormous amount of cash. I mean you have $2 billion plus of loans throwing off hundreds of millions of dollars a year. So the key for all of us, I think, is to continue that, but don't get carried away and maintain strong credit quality. Which we believe we have and the rating agencies believe that we have. And then the rate cuts will kick in shortly. Maybe September, where no one knows when and how many. But once that starts to happen, the wind is going to be at our back. We’re going to have this large portfolio with an enormous spread already of 800-plus basis points that should only get larger over time.

Got it. Hey, thanks, guys.

Thank you, Mike.

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

Just wanted to thank everyone again for joining us this morning. As I mentioned, we are pleased with the performance halfway through the year. As we move to the second half, we're going to remain focused on delivering shareholder value by driving our businesses to our high standards and delivering smart capital allocation. As always, if you have any questions, please feel free to contact our Investor Relations team. The contact information 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.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines. Good-bye.