Q2 2023 Medallion Financial Corp Earnings Call

Participants

Andrew M. Murstein; President, COO & Non-Independent Director; Medallion Financial Corp.

Anthony N. Cutrone; Executive VP & CFO; Medallion Financial Corp.

Christopher Whitbread Patrick Nolan; EVP of Equity Research; Ladenburg Thalmann & Co. Inc., Research Division

Michael Schafer; Research Analyst; B. Riley Securities, Inc., Research Division

Michael John Grondahl; Senior Research Analyst & Head of Equity Research; Northland Capital Markets, Research Division

Ken Cooper

Presentation

Operator

Greetings, and welcome to the Medallion Financial Second Quarter 2023 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded.
I would now like to turn the conference over to your host, Mr. Ken Cooper, Investor Relations for Medallion Financial. Thank you. You may begin.

Ken Cooper

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.

Andrew M. Murstein

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 U.S.
As I mentioned, our consumer lending businesses surged in the second quarter and had more strength than we have seen over the past several quarters. We believe that this is in part due to resilient U.S. consumers who continue to invest in home remodel projects, boats and RVs. We also believe some industry players have scaled back on this business or even left it all together. 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 have lower-than-usual loan provisions in 2021 and 2022, we said that they would bounce back to a more normalized level. And they are doing just that. Similarly, our origination levels are higher than normal.
With the growth of our loan portfolio, we increased net interest income 20% year-over-year to $46.7 million. This has been fueled by our ability to raise our own rates, combined with the growth of our loan portfolio. We will continue to maintain flexibility in the pricing of new originations to counteract further increases in borrowing rates.
Home improvement continues to be our fastest-growing segment. While the growth continues to put pressure on our total company net interest margin, our net interest income continues to expand.
Our rec business continues to deliver our highest average interest rates 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.

Anthony N. Cutrone

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 continued 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 6 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 head count 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.

Question and Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Mike Grondahl with Northland Securities.

Michael John Grondahl

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.

Andrew M. Murstein

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, '09 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.

Michael John Grondahl

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

Anthony N. Cutrone

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.

Michael John Grondahl

Okay, okay. And then, hey, lastly, could you talk about -- I didn't see in the press release sort of net charge-offs kind of by vertical in sort of dollars and percent in 2Q '23 as compared to 2Q '22?

Anthony N. Cutrone

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

Operator

Our next question comes from the line of Matt Howlett with B. Riley Securities.

Michael Schafer

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.

Anthony N. Cutrone

Sure. Yes. So for a number of quarters now, with new originations, we've been increasing the rate we charge on these new loans. This started probably about a year ago as the Fed went down the path of raising interest rates, we took -- we didn't jump right in with increasing our rates, but we did eventually do that, pull the trigger about a year ago.
Given the size of our book of business, it's slow for that rate increase to trickle through in terms of the yield. Essentially, all of our loans are fixed rate. So the new ones come on at a higher rate. The old ones that are amortizing off are at a lower rate. So it's slow to -- for that yield to come up.
But we have for 2 or 3 quarters now, 4 quarters, actually seen modest increases in the weighted average coupon of these loans. And I think that's what's flowing through.
This is something that we've been saying for a couple of quarters now is that even with interest rates and our cost of borrowing is increasing, we expected there to be compression in our NIM. But at the same time, we thought we'd be able to grow net interest income because our top line is growing not as fast as our -- as the cost of funds, but pretty close to it.

Michael Schafer

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

Anthony N. Cutrone

Yes. 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 and the average year rate.

Michael Schafer

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?

Anthony N. Cutrone

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

Michael Schafer

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.

Anthony N. Cutrone

Yes. 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.

Operator

Our next question comes from the line of Christopher Nolan with Ladenburg Thalmann.

Christopher Whitbread Patrick Nolan

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

Anthony N. Cutrone

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

Andrew M. Murstein

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 2 things, on the buybacks and the dividends.

Christopher Whitbread Patrick Nolan

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

Anthony N. Cutrone

Yes. Yes, that's -- I mean, that's our crown jewel. That's where a vast amount of our income is generated. And that's where significant volumes of originations occur.

Christopher Whitbread Patrick Nolan

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

Anthony N. Cutrone

No. I think for 3 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 -- I think that's the current run rate.

Christopher Whitbread Patrick Nolan

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 nonaccruals, so any repayment you get were treated as a recovery.

Anthony N. Cutrone

Yes. So as the recoveries come in, as the cash comes in, they reduce the asset. We don't recognize any income until the asset is reduced to 0, 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 that we recognized on the disposition of actual foreclosed medallions. And then the difference between what we collected in those 2 numbers, that reduced our total exposure.

Christopher Whitbread Patrick Nolan

Okay. So part of it is already reserved.

Anthony N. Cutrone

Yes.

Christopher Whitbread Patrick Nolan

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

Anthony N. Cutrone

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

Operator

Our next question comes from the line of Mike Grondahl with Northland Securities.

Michael John Grondahl

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 are sort of current CD prices and what's sort of the overall outlook for the net interest margin?

Andrew M. Murstein

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 for forever. Frankly, about a year ago, we thought it would 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.

Anthony N. Cutrone

Yes. And the only thing I'll just add to what Andrew said is that even though we're seeing some competitors leave the market, we've taken -- we haven't just picked up all of that excess. We've stepped up credit. Our average FICO has gone up again. And we've increased the rates that we're charging on new originations.
So we see it as a win. And I don't want to speak about what Andrew already said, but this is similar to what we experienced a number of years back during the Great Recession.
As far as CD rates, we're seeing they've come down some in the past month or so. Three-year CDs we're seeing at about 4.85% all in and 5-year new issuances are around 4.60%. Our average deposit rate is 2.70%. I mean this isn't a shock to anyone. We've been saying this all along, we expect our cost of funds to continue to increase. We were seeing 5-year CDs north of 5.25% just a few months ago. So they have come down some. And I guess we'll see what the Fed decides to do in the next couple of meetings.
But again, we've passed along a significant amount of that. So although our NIM has compressed year-over-year and we do expect a little bit more compression, we do think that our top line growth is enough to make sure that our net interest income continues to grow.

Michael John Grondahl

Yes, you've done it. You've done it so far. Hey, 2 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?

Anthony N. Cutrone

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 3 components there, the largest one being $36 million of private notes that come due in March 2024. So we'll -- we've got a couple of options there. We've got -- 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 8 1/4%. 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 2.
The other large piece in that, we had $28 million of borrowings with the Federal Reserve through the Fed window at Medallion Bank. It just so happened that it landed at quarter end and it was just a mechanism to increase cash on hand and liquidity. I think we had it outstanding for 3 or 4 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 1 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.

Michael John Grondahl

Got it, got it.

Anthony N. Cutrone

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

Operator

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.

Andrew M. Murstein

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.

Operator

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