Medallion Financial Corp (NASDAQ:MFIN) Q2 2021 Earnings Conference Call August 3, 2021 9:00 AM ET
Andrew Murstein - President & Chief Operating Officer
Larry Hall - Chief Financial Officer
Conference Call Participants
Steve Moss - B. Riley Securities
Alex Twerdahl - Piper Sandler
Mike Grondahl - Northland Securities
Thank you for standing by. This is the conference operator. Welcome to the Medallion Financial Second Quarter 2021 Earnings Conference Call. As a reminder, all participants are in a listen-only mode and the conference is being recorded. After presentation, there will be an opportunity to ask questions. [Operator Instructions]
I would now like to turn the conference over to Ken Cooper [ph] with Investor Relations. Please go ahead.
Unidentified Company Representative
Thank you, and good morning, everyone. Welcome to Medallion Financial's second quarter earnings call. Joining me today are Andrew Murstein, President and Chief Operating Officer; and Larry Hall, 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 earlier 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.
With that, let me turn the call over to Andrew. Andrew?
Thank you, Ken. Good morning, everyone. Over the last several quarters, we have truly transformed the company into a very profitable business with several strong segments namely, recreational and home improvement lending. This resulted in strong bottom-line performance for Medallion Financial driven by record-breaking quarterly net income by our largest subsidiary Medallion Bank.
We believe we are just starting to hit our stride as evidenced by our third straight quarter of strong top and bottom-line performance. Our growth strategy of investing in our consumer loan business continues to deliver for us. We had a number of achievements during the quarter.
Net income was $10.3 million. Net interest income grew 5% to $37.4 million based on a strong net interest margin of 8.84%. This is well above when compared to our peers.
We grew our gross consumer loan portfolio 17% year-over-year to $1.3 billion. This included nearly 30% growth in our home improvement segment as that market remained active and very robust. We kept our credit quality standards high and our loan losses low. Our loan loss provision was at historic lows.
Our growth strategy is straightforward with three main initiatives; one, grow our consumer lending businesses; two, reaccelerate growth of our commercial lending business; and three, become a leaner more focused organization.
As it relates to growing our consumer lending businesses, we continued to execute. Those businesses are managed at our Medallion Bank subsidiary in Salt Lake City and our team there continues to do a great job delivering an ROE of over 25% for the quarter.
Loan origination volumes stayed strong and helped deliver growth rates consistent with the first quarter. Our net recreational loan portfolio grew nearly 13% and our net home improvement portfolio grew over 30%. Combined the consumer portfolio grew over 17% to $1.2 billion and now represents 94% of our net consolidated total loans.
We believe this trend can continue. The biggest driver for this is that we believe there is still significant demand driving the industries our consumer businesses serve today.
We see similar strength in the home improvement market, where sweet spots within home improvement continue to be new swimming pool installations, siding and windows and replacement roofs. All of these are good prospects for continued growth down the road.
We don't know how long this will last, but we are taking it one quarter at a time. As I indicated earlier, home improvement is our fastest-growing business segment.
One item I would like to point out is the levels of loan losses in the consumer lending business have been historically low over the past quarter. We attribute this to solid borrower payment activity and increased recoveries of prior loan losses. Larry will discuss this more shortly.
Our number two growth initiative is in our commercial lending business. The model for our commercial lending business is proven. The focus within our commercial business is on helping small businesses get up and running.
We saw a bump in the second quarter of new business as we had $11 million of originations. The positive to what we have seen recently has really shown how good our credit evaluation process is since; a, we are receiving timely principal payments from our existing borrowers; and B, more importantly we have had virtually no change in commercial loan default levels.
Our number three growth initiative is to become a leaner and more focused organization. We are attacking this on two fronts. The first is on the P&L front. We continue to look at reducing operating costs. The other front is to divest noncore assets and redeploy that cash in a manner which aligns with shareholder value. To this end, we advanced this strategy in the quarter by retaining an investment bank to help advise and assist us with strategic alternatives for some of our noncore assets. Due to the sensitive nature of these potential transactions, we do not intend to discuss any transaction individually. As we complete transactions, we will of course keep you updated.
With that I will now turn the call over to Larry who will provide additional financial highlights on the quarter.
Thank you, Andy. We had another very strong quarter and experienced strong top line growth. We delivered improved net income, EPS and strong cash generation. We maintained a solid balance sheet and continued to manage our risk profile. I'd like to update you on several key topics.
First, as Andy mentioned, we had another quarter of low loan loss activity in our consumer lending segments. Total provision for loan losses was a $700,000 benefit as compared to a $3-million expense in the 2021 first quarter. This was driven by reductions in losses in the portfolios and solid recovery efforts as well. We believe loan losses and recoveries will ultimately start to normalize in the coming quarters which will cause the loan loss provision to rise back toward typical rates.
Ideally the normalization of our loan loss provision will be partially offset by the continued growth of net interest income. We had several nonrecurring items in the quarter. This included a gain on extinguishment of debt of $2.9 million. This was related to the settlement of bank borrowings with several of our lenders. We also had an after-tax gain on the sale of approximately 44% of our investment in the FinTech company called Upgrade of $2.4 million.
Upgrade is a FinTech company that we made a small $250,000 investment in. We will also explore making similar investments in similar companies in the future. Lastly, we recorded a $1.6-million valuation allowance within our tax provision that is specifically related to one of our noncore investments.
Moving to some other financial highlights. We continued to show strength in net interest income and net interest margin. Salaries and benefits increased sequentially from $5.7 million in the first quarter to $7.9 million in the second quarter. This was driven primarily by accruing incentive compensation related to our performance year-to-date. Net cash provided by operating activities increased nearly 41% quarter-over-quarter to $23.4 million from $16.6 million in the 2020 second quarter. We continued to generate strong cash flow primarily at Medallion Bank.
Moving to a review of our growth segments. The consumer loan portfolio's average interest rate was 13.14% this quarter. This compared to 14.14% from last year's second quarter and reflects some market rate decline in our efforts to remain competitive particularly in recreation lending. The home improvement lending segment again outpaced the growth of our recreation lending segment the latter of which has a much larger base.
Both are showing growth and producing low charge-offs and delinquencies. Net income from the company's consumer and commercial lending segments increased to $16.2 million in the second quarter compared to $9 million a year ago. Net interest income for the 2021 second quarter was $29.5 million compared to $26.8 million in the 2020 second quarter, a 10% increase.
The net commercial lending portfolio was $66.2 million at the end of the second quarter compared to $55.6 million at the end of the first quarter. This growth was driven by a strong quarter of loan originations. The average interest yield was 12.69% compared to 13.08% a year ago. This is a strong yield and when combined with virtually no write-offs or loan losses are primarily reasons why investing in the growth of this segment is a key growth initiative for us.
Lastly a quick update on our Medallion lending segment. During the quarter, we collected $2.4 million of principal payments and $3.2 million related to collateral. We saw low Medallion values triggered by below-market sales in Chicago, which resulted in a $2.4-million write-down.
In addition, we had a write-off of Medallion loan premium of $1.5 million. The company's net Medallion lending portfolio was $5.8 million as of June 30, plus we had $48.2 million of loan collateral in the process of foreclosure.
With that, I'll now turn the call back to Andrew.
Thanks Larry. A couple of more items to mention. Within the past year, we have launched two strategic partnerships within our Medallion Bank subsidiary. These are loan origination programs with Select FinTechs operating within healthcare lending niches.
With relationships of this type, we receive a loan origination fee plus interest between the origination date and the date the loan is ultimately sold, which is generally two to five days. This incremental revenue is high margin for us. We continue to believe that this will be a very good business segment over the long term.
I want to take a moment and thank all of our team members, banking partners, vendors and shareholders. Our record performance would not be possible without the efforts of each of you. We are seeing the results of our hard work over many years pay off and we are excited to strive to keep our profitable growth going.
Larry and I are now happy to take your questions.
We’ll now begin the question-and-answer session. [Operator Instructions] The first question comes from Steve Moss from B. Riley Securities. Please go ahead.
Good morning, Steve.
Good morning, Andrew. Maybe just starting with the expense dynamics this quarter it's a little bit elevated perhaps from last quarter, and it sounds like there's probably some one-time items, just kind of curious the drivers of the expenses and how to think about that into the third quarter?
I think that if you look at the year-to-date expense number, it's pretty comparable to what it was a year ago. And even though there was some choppiness with things like legal and salaries, the overall expense load ought to probably remain at that roughly $17-million level.
Okay. Okay that's helpful. And then, in terms of just the loan growth here, it looks -- it was very strong for the quarter. Just wondering if it was a little bit back-end weighted just on the timing, and just you guys sound very optimistic about third quarter trends. Just a little more color as to how you're thinking about that.
We think loan growth should continue. We're in very good niches. It's probably been accelerated growth due to the pandemic with people traveling less, less airplanes and hotels. So these are really like little self-quarantine units that we finance, whether it's a boat or an RV home improvement lending, many people obviously staying home. So, right now, it looks like we're at the right place at the right time.
Okay. All right. Well, that’s all for me. Thank you very much.
The next question comes from Alex Twerdahl from Piper Sandler. Please go ahead.
Hey. Good morning, guys.
First question for me, the non-core assets that you referred to that you're exploring strategic alternatives for, is that referring to exclusively Medallions and Medallion loans?
We're really looking at everything. We've made an effort the last couple of years to really focus more and more on our bank where the returns are so high. The return on equity in our rec lending is over 30%, so it's a great use of our efforts and proceeds to put money into that area and continue to grow.
So, the largest ones left and really the only non-core assets left are Medallion loans and our NASCAR investment, so we're really looking at both of those things to divest both of them potentially over time.
We're not going to sell, if the price isn't right; we want to do what's best for the shareholders and time it right. So it's really opportunistic on our part. When the right proposal comes along for either, we'll pull the trigger.
Right. What about the gain that you had in the fintech this quarter? Are there more investments like that that are still on the balance sheet that could potentially be unlocked over the next couple quarters or years?
We hope so. That was a big win for us. We invested at about $0.10 a share, $0.09 or $0.10 a share, and we sold some stock recently off at $3.80 or so, so 38 times our investment, and they're all not that good obviously. But in the past we've been very successful with Medallion Capital with our mezzanine group. They have a portfolio of about 25 companies. And their model has been lending at about 12% rates about $3 million and taking warrants or options in companies and they've been very successful over time. That's been a bit choppy; it's hard to predict when you're going to hit the next home run.
But hopefully in their portfolio something will come through. And then in the strategic partnership program in our bank that's a great feeder system for us because these fintech companies come to the bank looking to pay us fee income by sending us the loans and we book them and then they buy them back, and we move very cautiously with them. It takes us about six months to do due diligence on companies, but we kind of have a first look. So when these companies come to us and they want to enter into these strategic partnerships with us a natural question for us is going to be should we invest in them? Can we find the next Upgrade? And hopefully we do.
Great. And then just keeping on the theme of the strategic partnerships, when do you think that these two relationships you have so far are going to translate to something that we can see in the P&L in terms of earnings?
Unlike most fintech companies that take years to be profitable and then get valued at billions of dollars at valuation, we're profitable already in this area. The volume is still light. It's building. It's going to continue to build, but we're already operating on a profit there. So right now we have two partnerships in place. The hope is to get a third signed up within the next three months or so.
Got it. And then can you talk a little bit about the capacity that Medallion Bank has for these types of loans? I mean, certainly, the economics seem pretty rewarding. But in terms of the ability to sort of process the flows, what's the capacity? What kind of goes into it?
It's very compliance-driven. So what you need to do is really build a good compliance department, which they've done. They've really hired great people at the bank in Salt Lake. And then each new deal is immediately accretive, because you have the right procedures in place. So we've already invested in that infrastructure, and again, are already profitable. But we can quickly grow if the right players come into contact with us. We can go from two to five or six over the next couple of years very easily.
Would there be a flow agreement with those partners that they would basically -- you agree to take on a certain amount of their loan generation or a percentage, or how would that arrangement actually -- the partnership actually work?
You usually get all of their production. So not that these are the numbers, but let's say, a fintech company is generating $300 million a year of loans. It would come to us we would book it. We would charge about 75 basis points or so as a fee. And then the rates we've been very cautious here too. We're not doing anything with rates above 36%. Other banks are doing deals at 100-plus percent interest rates, but we're not.
So right now we're not holding any of the paper, so we're just getting the fee income. So in that case you're getting the 75 basis points and the bank is buying it back to two days -- the fintech partner is buying it back from our bank two days later or so. So you have the flow for two days. But we could certainly start holding some of the paper if we feel comfortable with the partner.
So it's very possible to build a large portfolio quickly here if we like the credit quality coming in, and we want to hold say 10% or 20% of the paper that they're sending us and not sell it all back to them.
Interesting. And then final question from me. When I look at the charge-offs in the second quarter, it looks like it was about $10 million or so of -- and I presume mostly related to Medallion loans. Did you actually have some loan dispositions this quarter that drove those charge-offs, or was there a change in the valuation level or something else we should think of?
There was actually a settlement with one of the large institutional borrowers that we had. And yes pretty much all of the charge-offs related to Medallion lending.
Q – Alex Twerdahl
Great. Thanks for taking my questions.
Your next question comes from Mike Grondahl from Northland Securities. Please go ahead.
Hi, guys. Thanks. Could you give us the net charge-offs by category just so we can kind of have those?
For the quarter it was $10.9 million for Medallion's about $300,000 for home improvement and it was a net recovery position of $500,000 in the recreation area.
That's great. That's great. Thanks Larry. And hey, Larry, I think you mentioned in your prepared remarks, that yields were down a little bit in the RV consumer space just the competitive environment a little bit there. Could you just go into a little bit more detail kind of what you're seeing competitively?
I'd say that, there's not new competition there. I think we've just been raising our standards over time. The home improvement lending for example, we're at FICO scores of about 760. So that's A-plus-quality paper yet we're getting yields of 9% or so, which is really wonderful given that credit quality. In the rec, we've been raising the FICO scores. We're probably at about 670 or so; years ago we were probably at 600. So we're kind of getting our best credits funded because we're getting so much volume coming in; we're able to choose and have just elected to really go for the better credits in the meantime.
Which are at slightly lower rates.
Got it. Got it. And then you had that debt settlement gain. How much debt was actually settled?
I think we had about $31 million over the first six months of the year. So we paid off all of our bank debt since December 31.
Substantially all. There's still $700,000.
Got it. Got it. Hey that’s all from me. Thanks guys.
This concludes the question-and-answer session. I would like to turn the conference back over to Andrew Murstein for any closing remarks.
I want to thank everyone for attending this morning's call. It's certainly an exciting time for Medallion. As always, if you have additional questions or needs please do not hesitate to contact our Investor Relations department at 212-328-2176 or via e-mail at email@example.com. Thanks and have a great day everybody.
This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.