Medallion Financial Corp. (MFIN) Q2 2017 Earnings Report, Transcript and Summary

Greetings, and welcome to the Medallion Financial Second Quarter 2017 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Garrett Edson of ICR. Thank you. Please, begin.

Thank you, and good afternoon. By now, everyone should have access to the earnings announcement, which was released prior to this call, and which may also be found on the company's website at medallion.com. Before we begin formal remarks, we need to remind everyone that the matters discussed on this call include forward-looking statements or projected financial information that involve risks and uncertainties that may cause the company's actual results to differ materially from those projected in such forward-looking statements and projected financial information. These statements are not guarantees of future performance, and therefore, undue reliance should not be placed upon them. For further information on factors that could impact the company in the statements and projections contained herein, please refer to the company's filings with the Securities and Exchange Commission. Each forward-looking statement and projection of financial information made during this call is based on information available to us as of the date of this call. We disclaim any obligation to update our forward-looking statements unless required by law. I would now like to introduce Andrew Murstein, President of Medallion Financial.

Thank you, Garrett, and welcome, everyone, to Medallion Financial's Second Quarter Earnings Call. We appreciate your continued support of Medallion. Joining me on today's call is our Chairman, Alvin Murstein; and our CFO, Larry Hall. As we did on last quarter's earnings call, I'll focus my remarks more on the quarters highlights, our overall strategy and the progress we've made thus far. Larry will then take us through some brief financial highlights regarding our second quarter, and then we'll take some questions that analysts and investors have provided to us before the call. The story of the second quarter for Medallion was one of continued strong performance in our core Consumer and Mezzanine Lending segments, offset by the ongoing challenges occurring with respect to Medallion lending. Let's start with Medallion Bank and more specifically, our Consumer Lending business, which currently generates the lion's share of our income. As of June 30, we grew our consumer lending portfolio to $730 million of net receivables, after originating a record $232 million of loans in the first half of 2017. We were able to rapidly deploy the capital we received from the sale of our consumer loans in the first quarter into a strong mix that consisted mainly of 15% yield in RV and marine loans, and 10% yield in home improvement loans, where borrowers' average FICO scores are over 760 or prime credit. And perhaps, most importantly, we were able to grow while keeping our total delinquencies in the portfolio stable and further reducing our 90-plus day delinquencies to 0.3% of receivables, a further testament to the focus underwriting and overall excellent work being accomplished by our consumer team. Thanks to their solid performance, we once again generated $17 million in pretax operating income at the bank, and then ROE above 50% in the second quarter from the consumer division, bringing us to over $34 million in pretax income in just the first half of 2017. We will continue to focus on growing this core portfolio, while also acting opportunistically to monetize performing consumer loans at a premium, which will reinforce the bank's leverage ratio. The excellent performance of our Consumer segment was partially offset by the challenges in the bank's Medallion Lending segment, which charge take $9 million on additional unrealized depreciation on write-downs in the quarter. That said, even accounting for the depreciation in write-downs, we still generated another quarter of profitable growth at the Bank and improved bank's capital ratio to 15.7% as of June 30. As we continue to reduce our Medallion exposure, we believe the bank's earnings power, driven by our consumer segment, will become more and more evident over time. In addition to our results during the quarter, we also want to provide a brief update on the potential sale of a minority interest in the bank. We remained in discussions with no specifics news to report, with the bank in a well-capitalized position and booed by the strength of our consumer segment, we remain ready if the right opportunity warrants such action. Our biggest challenge continues to be the Medallion Lending segment, and so we want to spend a little bit more time discussing the current environment, since it's been on the minds of many of you over the past weeks. Many of our fleet customers and our peers have reported that they have seen an uptick in the occupancy levels for their taxi fleets recently, partially as a result of the well-reported problems at rideshare companies, and many drivers that have returned to driving a yellow medallion as they were not earning what they've thought they would from rideshare companies. Even though driving and owning a medallion is still a profitable business, medallion prices have languished as there is little liquidity in the market. Thus certain reported sales were all cash transactions at lower prices. As a result, we reduced the estimated value of New York City unrestricted medallions as of June 30, to a net value of $411,000 and $60,000 for Chicago medallions, all well within the range of our peers. Commensurate with the reduction, we took valuation adjustments on loans that were 90-plus days past due for everything over that price, regardless of the strength of the personal guarantees backing those loans. In addition, we saw an uptick in delinquencies in the second quarter, which came after our first quarter, where we took some charge-offs on nonperforming loans and saw an improvement in total delinquencies. We're getting close on resolving issues with several large delinquent borrowers to bring them current, although there can be no assurances that we will be successful later this year. The ongoing challenges with the medallion industry, and why we have continued focusing our efforts on our consumer business, which has been thriving since 2004, and our mezzanine division, which has also been performing very well since we bought that company back in 1998. Thus, we have very seasoned management teams that are clearly best-in-class, sitting on all cylinders currently and have very strong growth opportunities in those sectors in the years ahead. In terms of reducing medallion exposure, we continue to make progress with the company now managing $453 million of medallion loans, net as of the second quarter 2017, and more than $30 million reduction from March 31, and a 27% reduction from the prior year. On accumulative combined basis, we have now reserved the charge-off over $150 million of medallion loans. At Medallion Bank, medallion loans now comprise just 22% of the bank's net investment portfolio. While we continue to work hard to reduce that exposure, we think it's important to note that having taken significant action to write down and reserve from medallion loans, throughout 2016 and this year, the medallion portfolio at the bank is still 85% current and generating positive cash flow. We clearly want to boost that percentage in subsequent quarters by the bank's medallion portfolio is holding its own in a very difficult environment. Further, we will continue to work closely with our delinquent accounts in order to attempt to bring them back into current status, but where we cannot reach such an agreement, we'll pursue collection efforts as necessary, based on personal guarantees and the medallions pledged as collateral and we'd expect to achieve recoveries over such time as a result. Overall, we remain hopeful that the medallion environment will begin to reach an infection point in terms of stability, but as the cliché goes, hope is not a strategy. We will continue to diversify our business by primarily focusing on growing our profitable Consumer and Mezzanine segments, while further derisking for medallion balance sheet exposure. I'll now turn the call over to Larry, who'll give some brief highlights regarding second quarter results.

Thank you, Andy. And let me take you through some second quarter highlights. In the second quarter, Medallion Financial recorded a net decrease in net assets resulting from operations of $4.8 million or $0.20 per share, compared to net increase in net assets resulting from operations of $4.6 million or $0.19 per diluted share in the prior-year period. A decline in net interest income and net realized and unrealized gains was partially offset by tax benefits related to net investment and net unrealized losses. At Medallion Bank, we generated a second quarter net increase in net assets resulting from operations of $1.9 million, compared to $8.7 million in the prior year period. The difference was primarily due to recording $8.9 million in reserves and charge-offs on nonperforming loans, compared to $4.5 million in the year-ago quarter. Net investment income before taxes was $16.9 million, a slight decrease from $17.5 million in the prior year period. At the bank, our net consumer lending portfolio as of June 30, stood at $730 million, a significant increase from $642 million, as of March 31. The portfolio's average interest rate was 14.6% comparable with the prior year quarter, as higher receivables from higher yielding RV loans were offset by increased lower yielding home improvement loans. 90-plus day delinquencies on the consumer portfolio stood at 0.3%, an improvement from 0.37% in the prior quarter. The bank's net medallion lending portfolio as of June 30 stood at $219 million, a 31% reduction from the prior year and a 6% reduction sequentially. Medallion loans now represent just 22% of Medallion Bank's net investment portfolio. The average interest rate improved on a sequential basis to 4.22% from 3.84% in the prior year quarter. Thus, while one of the negatives in illiquid medallion market has reduced prices, one of the benefit is, us being able to get higher rates from our borrowers. 90-plus day delinquencies were $22.6 million, an increase from $17.9 million on a sequential basis. We incurred $5.6 million in unrealized depreciation as a result of marking the collateral value of New York City medallions down to $411,000 net of sales cost from the previous amount of $500,000, as well as $3.3 million in charge-offs from nonperforming loans. At Medallion Financial and our other subsidiaries, the net medallion lending portfolio as of June 30 stood at $233 million, a 22% decline from the prior year, and a 7% decline sequentially as we continue to steadily lower our exposure. 90-plus day delinquencies as of June 30 were $90 million versus $71 million from the prior quarter. On a managed basis with Medallion Bank, 90 plus day delinquencies were $112 million, up from $89 million in the prior quarter. Reserves in charge-offs on the medallion portfolio at Medallion Financial and our other subsidiaries in the quarter were $12.7 million. Combined, our total net managed medallion loans as of June 30, were $453 million, 29% lower than $641 million as of the prior year. As Andy stated, we have steadily reduced our exposure to medallion loans over the last several years and plan to continue to do so over time. Our net commercial loan portfolio, which is primarily made up of our mezzanine lending portfolio, stood at $78 million, an 11% reduction from the prior-year period due to the disposition of the asset base portfolio in the third quarter of 2016, as well as the decline in other security commercial loans in the portfolio. The average interest rate on commercial loans was 13.18%, an increase from 12.9% in the prior year quarter due to an improvement in the yield mix. As of June 30, the bank's Tier 1 capital to average asset leverage ratio was 15.7%, an improvement from 15.2% in the prior quarter. The bank has $30 million in cash on its balance sheet as of June 30, and remains well capitalized. Medallion financial had debt of $333 million as of June 30, a decline from $338 million as of March 31. We announced last month the extension of our DC bank facility until March 2018, and on those payable they came due since March 31, have been extended. We feel we are in good terms with all of our warehouse lenders and appreciate their continuing support of medallion. With that, I'll now turn the call back to Andy.

Thanks, Larry. As we did on our prior call, we asked for e-mailed questions from the investment community, and we'll now answer your questions.

The first question; Do you currently have a bid on all or any part of Medallion Bank? If not, why don't you write down the bank to a more conservative valuation?

Well as noted in the earlier remarks, while there've been indications of interest, there's not yet been a sale of the minority interest in the bank. If and when a definitive agreement is reached and signed, we'll announce and then provide additional details at that time. And in terms of valuation, the valuation techniques are used by our third-party valuation specialist and they're disclosed on our 10-Q. Specifically, a percentage of the valuation weight is based upon price-to-earnings and price to tangible book valuation of publicly traded comps. A percentage is based on precedent M&A transactions and a percentage is based on discounted cash flow which implicitly values the long-term prospects of the consumer portion of their bank, as the wind down of the medallion exposure continues. As you can see though, the consumer business earned over $30 million in pretax income in the first half of the year alone, so we feel that the bank is doing quite well and is marked very appropriately.

There are over 6 million shares of medallion that are currently being sold short. Once you're eligible to purchase shares after the blackout period ends, are you or Alvin planning on conducting significant insider buying to pressure the shorts and further shows shareholders you are confident in the medallion story?

No, we firmly believe management and other insiders ownership of 15% of our common stock aligns our interest completely with our shareholders. That said, stock purchases by insiders are personal financial decision, and until there is a filing or an announcement, we can't really comment on what someone may or may not do with their personal funds. I will say that, personally, I've never sold a single share of stock, nor do I have any intention of selling any stock at all. In terms of the shorts, we've said that in the past that it's the market's job to determine valuation, but we agree that, we think the company is undervalued based upon the success of our consumer and our mezzanine segments. Our Consumer Lending segment continues to perform extremely well and has a pretax ROE of over 50%. And if we can further reduce to mitigate the impact of the medallion loans, the inherent value of Medallion Bank on our company should definitely become more and more apparent over time.

Thanks. And the next question: With respect to the board, are you currently seeking any additional members?

Well, as you may have seen recently, we just brought on a new independent director, named John Everets, who is an impressive financial pedigree and significantly strengthens our board. I'd also note that we have a Board of Directors at Medallion Bank, which is chiefly represented by independent directors and we recently added Robert Meyer, a veteran and a highly thought of senior banking executive to strengthen that board as well. So between both for the parent company board and the bank board, we now have nine independent board members with extensive experience, which is an extremely deep bench.

Next question; why doesn't the board split the business, either through a sale or spin-off of Medallion Bank? Medallion Financial shareholders could then decide where to risk their capital. Wouldn't there be greater value created if the bank was separated from the umbrella of financial?

With regards to its sale, we already touched upon the minority interest process, but we're not interested in selling a majority stake in the bank at this time. We just feel that there's just too much significant upside in this bank. That said, we're constantly investigating ways to create value for the shareholders, and if we believe spinning off our selling certain divisions on an appropriate valuation will provide us with additional liquidity as well as opportunities to grow. We'd certainly consider it. With respect to the bank in particular, any spinoff would require the approvals of all of our banking partners, as well as regulatory approval and unfortunately, it's far from a simple process.

What is the carrying value of Medallion Bank as of June 30 on the balance sheet?

The bank's value was mark-to-market at $286 million, as of June 30, 2017 and the quarter valuation increased due entirely to just the retained earnings from operations, which was just slightly under $2 million.

Given that the bank had a record quarterly increase in consumer loans of nearly $90 million in this quarter, what is the likelihood of the new consumer loan sales and the second half of this year?

We have nothing specific in the pipeline, but as we said previously, if the opportunity presents itself to enhance the bank's liquidity by selling some of our performing loans at a premium, we'll act on it. We have done two successful loan sales of premiums already, and we really have a great pipeline with several thousand dealers and contractors sending us quality and highly profitable business.

Why did the bank report a loss on loan sales in Q2 of $1.8 million? Was it a reversal of sale premiums recorded earlier? Or losses on loans presumably medallion credit sold in the second quarter? Or some combination of those factors?

Larry, I want you to take that one.

Okay. The loss on a sale isn't really a loss. In the first quarter the gain reflected premium on the sale of the consumer portfolio and during the course of the year, when the bank charges off and forecloses on a medallion loan and moves it to other assets, the charge-off is actually reflected in the gain on sale line of the call report, so they net.

Can management discuss the policy or factors behind the quarterly fluctuations and charge-offs and reserve building?

Larry?

Our policies and procedures with regards to valuation of the portfolio remain unchanged for the last several years. Any significant fluctuations from quarter-to-quarter, primarily arrives just from timing differences between the number of loans that we move into, say, the 90-day-plus category.

When can we expect management to participate in conferences and roadshows to promote the company and its success for future growth?

Well, we focused in the first half of the year on our operations and with some solid results from our Consumer segment now in our back pocket, we're looking to market the company more to investors in the near term and plan to do that right away.

The extension of the borrowing agreement from DZ seem to indicate their continued confidence in your ability to navigate through this difficult period. Can you discuss what's happening? Any relationship with the banks?

Sure. We're in consistent dialogue with our banks and lenders and will provide updates on any material extensions in due course. We did reduce our debt by $5 million in the second quarter, and we'll continue to work on lowering our debt exposure going forward. Of largest facility with DZ Bank was just renewed and in fact, every facility that is come due since the end of the last quarter has also been renewed.

Medallion's Consumer Lending segment continues to perform at a high level, recording the pretext ROE at 50% for second consecutive quarter. With such a high level of ROE, have you seen an increase in delinquencies or competition in most recent months?

As you saw in the second quarter results, total delinquencies did remain stable and 90-plus day delinquencies as a percentage of receivables actually came down from their extremely low levels. There is no question that our primary focus remains on growing this portfolio profitably. In terms of competition, we believe the market is large enough that competition really shouldn't compress yields or originations. Further, the underwriting component is critical for this segment and provides a barrier to entry for those that are lacking this experience. That said, there's been no new significant competitors in this business and we continue to be the market leader.

What is the typical return for someone that buys a New York City taxi medallion?

Well, let's use a hypothetical investor, let's say, who purchases a medallion for $500,000. He'll potentially make about a 7% tax free return, so about $35,000 per year. And it's tax-free because the tax quote permits him to appreciate the purchase price over 15 years. There was also recently a conference call hosted by large investment bank, where they discussed the state of the medallion industry and had another large taxi fleet owner on the call. And he also expressed his optimism about the taxi business, and that he was now operating near a 100% for his taxi fleet.

You noted in a recent CRANE [ph] article, your role advising private equity firms seeing opportunity in the taxi industry. Are you working with private equity firms now that have interest in purchasing your medallion loans or loans from other companies and can you disclose any?

Well, we think there's large potential opportunity out there. And it's no secret that the private equity firms have been looking very closely at the medallion lending space. We've received calls from numerous firms recently, potentially looking to invest. We have nothing official to announce, but we'll continue to have conversations because there are many firms that recognize and appreciate our depth of experience in the space. And have asked us to exclusively work with them. If there's a way for us to work with them with a firm, while keeping our risk at a minimum, we're open to establishing those relationships. It would bring new money in to the industry, we'd receive servicing fees on their portfolios, we'd also receive fees as a percentage of the profits over certain hurdle rate that they get. It would clearly be a win-win relationship all around.

At this time, I don't have any other questions.

Well, we wanted to thank everyone again for attending this afternoon's call, and we look forward to updating you further on the progress on our call next quarter. While we tried to get as many questions as we could, we realize that there are others who are happy to follow up with us and we're happy to answer those questions after this call or tomorrow or whenever at your earliest convenience. To that end, please contact Investor Relations at (212) 328-2176 or via e-mail at investorrelations@medallion.com. Again, investorrelations@medallion.com. We'd like to thank everyone very much again for their support, and have a great afternoon. Thank you.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time and thank you for your participation.