Greetings, and welcome to the Medallion Financial Fourth Quarter 2022 Earnings Conference Call. [Operator Instructions]. It is now my pleasure to introduce your host, Ken Cooper, Investor Relations. Thank you, Mr. Cooper, you may begin.

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, 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. Medallion Financial had a great year, highlighted by the continued growth of our consumer lending businesses. Our people have done an exceptional job growing our assets with our long-term success in mind. Also noteworthy is that after more than five years, we were able to reinstate our quarterly dividend in 2022. We were able to purchase over $20 million of our common stock during the year, and we were able to get back to what we had done best for so long to provide a cash return to shareholders. We generated $43.8 million of net income in 2022 as compared to $54.1 million in 2021. I'd like to unpack that for you so you can appreciate how strong both years were for us. In 2022, with the growth of our loan portfolio, we saw an increase of $32.6 million in our net interest income despite rising interest rate. A loan loss provision trended back towards its normalized level as we in our provision for the year of $30.1 million, which was $25.5 million greater than last year's historically low provision of $4.6 million. Additionally, last year, we had $16.3 million of gains, which were not repeated this year. This included sales of investments that resulted in the combined gain of $11 million, the gain on extinguishment of debt of $4.6 million on the sale of a noncore asset for $700,000 gain. Taking all of these items into consideration, our 2022 performance was excellent across the board. In 2022, Home Improvement continued to be our fastest-growing segment with 43% loan growth to $626 million. We also saw growth in our Marine and RV business, which had 23% loan growth to $1.2 billion of loans and our commercial segment had 21% loan growth to $93 million.…

Thank you, Andrew. Good morning, everyone. As Andrew mentioned, we had a great fourth quarter. We capped off a great year. For the quarter, net interest income grew 22% to $44 million from the prior year quarter and grew 26% to $160 million for the year. The driver of this being growth in our loan portfolio, which now stands at $1.9 billion and reflects a 29% increase from a year ago. Our net interest margin for the quarter was 8.86% and was 9.05% for the year. During the year, we saw a compression in our net interest margin, the result attributable to two factors. The continued growth in our Home Improvement segment, the prime loans of which carry a lower coupon than our other lending segments as well as and, to a lesser extent, an increase in our average cost of funds. For the quarter, our average cost of funds was 2.49%, with certificates of deposits, our largest source of borrowing, having an average rate of 1.91% at the end of the year. As we've said for some time now, we expect our cost of funds to increase throughout 2023 as we issue new certificates at current market rates that will fund our continued growth and to replace those maturing. Increase in our cost of borrowing will continue to impact our net interest margin, but despite this, we do expect that the continued growth in our loan portfolio will counteract this compression and allow us to grow our net interest income. Our loan loss provision continued to gravitate back to historical levels in the fourth quarter. The loan loss provision was $9 million for the quarter, up from $3 million in the 2021 fourth quarter. For the year, our provision for loan loss was $30 million, increasing $25 million from a year ago. The increase over last year is a result of higher net charge-offs as we get back to a more normal level of charge-off experience, an increase in our loan loss allowance rates for the consumer loans, an 18 basis point increase for recreation loans and a 13 basis point increase for home improvement loans as well as the need for increased allowances specific to new loans as we grow our portfolios. Our operating costs decreased to $16 million from the prior quarter, primarily due to lower salary and benefit costs and lower professional fees. We were pleased with this reduction in cost during the quarter, but do expect volatility in our professional fees to continue over the near term. Net income attributable to Medallion Financial shareholders was $13.1 million for the quarter and $43.8 million for the year. Our diluted earnings per share was $0.57 for the quarter and $1.83 for the year. That covers our fourth quarter and full year financial overview. With that, Andrew and I are now happy to take your questions.

[Operator Instructions]. Our first question comes from Matthew Howlett with B. Riley Securities.

Excellent performance here. And I want to touch on a few things. First on the ability to pass through these higher funding costs. I recognize the mix shift here in the quarter, but the lower home improvement, the higher prime home improvement growing. But what's the sort of outlook and ability to just continue to raise pricing for the mix things from some of the banks in the auto space. I'd love to hear what you guys are seeing in your segment.

We can go into that. So we have -- throughout 2022, we have been able to raise rates on both consumer products, the rec and the home improvement. At the end of the year, we're probably about 300 basis points higher on new loans than we were at the end of 2021 for rec loans. And Home Improvement is about 150 basis points higher. It hasn't quite translated and shown up in the income statement yet in our yield just because the new loans going on and the ones coming off probably written three years ago, more or less. So the rates are somewhat comparable. We do expect over time to that, that will show up.

To 300 and 150. Is that -- did I hear you correctly? Year-over-year?

Yes.

I'm just, incredible. Okay. Well, it sounds like you can really continue to originate that and raise the -- so I guess my next question is on the consumer. I mean, obviously, everyone talks about it. We know that pullback's coming at some point or a slowdown. How do you -- obviously, the credit is holding up here, it's been resilient. And what -- in your segments, I mean, it's higher quality than we've seen in the past, especially with the prime home improvement. What can you just tell us about the pullback in demand and/or some normalization losses? I mean can you give us a cadence this year? Had you not really seen it yet so far? Just anything on that is the topic to your [indiscernible], please.

Home improvement demand continues to be strong. We haven't seen any significant pullback. We think in terms of going into 2023, we -- originations will be strong. We don't know that we'll be able to grow. We don't think we'll be able to grow originations at the levels we have over the past two years. But we do think, overall, that portfolio will continue to grow throughout the year. And similarly, in rec, we do expect to grow that portfolio in 2023, although somewhat nice to see. In 2022, we saw a return to normalized activity in terms of volume. The seasonality associated with the rec portfolio, which we didn't experience in 2021. We did see that started in Q3, and we did see that in Q4 in the rec. We think demand drops on the rec side, but even with the drop, I think we get back to more normalized levels of demand with our increased rates, the drop, we still think we're able to grow that book.

Got you. And in the rec, just remind me again the second and third quarter are the strongest seasonality-wise? Volumes?

Yes. It follows the seasons, right? So Q4 is slow, Q1, it's slow and then it starts to pick up, weather gets nice, people want to be outdoors.

Got you. Okay. And then just the last question. Looked like we get excited when I see these expense management. I know that -- I think you said professional fees line, it's going to be lumpy, obviously. But I mean, can you just tell us anything on that operating expense now you took a lot of cost out. I'd love to see the professional fee line steady from here. But any sort of -- what's the volatility we can expect on the operating expense line in '23?

Yes. Professional fees, like stated it earlier, we expect that to fluctuate some in the near term. As far as other operating costs, we'll see those -- as we're trying to grow this business. We're trying to grow our balance sheet. We're trying to grow our bank. So as that happens, we're going to have to increase costs. But obviously, those increased costs should correlate at a lower rate than the increase on the assets and the increase on our top line.

Our next question comes from Mike Grondahl with Northland Securities.

My first question is, Anthony, would you say that the 300 basis point increase on the rec pricing and the 150 basis points on the Home Improvement, do you think that's going to offset the higher CD pricing? Like how do those two balance out?

Yes. It doesn't offset it. It's not dollar for dollar. We're dealing with higher-priced loans than a traditional bank. So for every 100 basis points of cost of funds, we can't push through that 100 basis points. But that's just -- that's just part of it when you've got a high-yield portfolio. You can't always push through every cost. But we've probably seen -- I mean we know what interest rates have gone up over the past year. So being able to push through 300 on our rec portfolio. We like those numbers. And on the prime lending and the Home Improvement being able to push through 150, we still think that's good. Just unfortunately, it's not going to be dollar for dollar.

Got it. And then the $5.2 million of Medallion collections, which was nice to see again, how did that flow through the P&L?

Sure. So about $2 million flow through the P&L in terms of recoveries in Q4, both on loans and on the Medallion assets, and then $3 million or so was the reduction in our Medallion exposure from the end of Q3.

Got it. Got it. And with CECL, the press release talks about, I think it was $13.8 million more added to reserves for adopting that, what is pro forma Tier 1 capital? Usually, you guys have disclosed that in the past. But where is Tier 1 capital, pro forma for CECL?

Yes. The $11 million doesn't have a significant impact where we think it's going to -- and we've got the ability on that $11. It's $13.8 million in consolidation, $11 million is specifically a Medallion Bank related to the consumer products. So that $11 million is not going to have a huge impact on our Tier 1, and we've got the ability over three years to phase that impact in the Tier 1 calculation. So we don't see that being a big burden for us. Where we will see it is on the origination side, as we continue to grow, our provisioning is going to be higher than what it was up until the adoption of CECL. And that's going to run through our income statement. It's going to reduce our income some, and that's going to be where we've got some constraints in terms of capital.

Got it. Can you tell us how to think about, at a high level, how we should model that? So, obviously, I think you're saying your provisions are going to be a little bit higher because you need to recognize those at the time of origination. I don't know what is a normal origination environment in 1Q '23? What does provision look like?

So on new loans in the Home Improvement segment, we -- our initial reserve is about 181 basis points. With CECL, we're going to be around 205. We got about a 24%, 25% basis point increase in the initial reserve. And then when we move to rec, we're at 355 up until the end of 2022, that goes to 447 with day one transition. And when you do the math, that's how the $11 million on the consumer -- the initial reserve impact. That's how it comes about -- comes to play. With CECL, we're going to looking at future expected losses from a 12-month -- as opposed to looking at a 12-month period. So to the extent that losses increase, charge-offs increase, we're going to see some volatility in our reserving, our allowance, our initial allowances are going to have to go up. So there could be some swings, but -- that's just part of gap that we have to live with now going forward.

Got it. And so there's nothing constraining on your growth from a capital standpoint, like Tier 1, I remember at the bank, you needed 15%, because of CECL, you don't have any governor on growth or anything like that. You have ample capital to keep growing.

I think that's fair. So at the end of the year, the bank's Tier 1 was 16.2%. So -- and the CECL impact, the day 1 CECL impact doesn't have -- doesn't really affect that number because we are able to pull it in and adjust it over three years. Like I said before, it's -- to the extent that the provisioning is higher because of CECL with our growth, that's going to trickle down to the bottom line and that increase in equity isn't going to allow for excessive growth and growth at the levels that we've seen in the past couple of years. But we're also expecting growth to come in. So we don't necessarily think it's going to hurt us all that much.

Got it. And then, hey, just lastly, credit quality is normalizing from a very low level. CECL kind of catches that up even a little bit more. How are you guys feeling about charge-offs over the course of '23?

We think Home Improvement is actually back to the historical levels of what we've seen. Rec is still low. We think we get a normalized charge-offs are in the high 2s. We haven't gotten there yet. So we do expect that to tick up a little bit. But we've been surprised for the past two years about how low charge-offs are to be in. So we'll see what happens.

And , I'll add on that point, there's a good slide on our website that we just put up showing loan losses in rec and Home Improvement for many years, over 15 or so years. So it shows how we did through a recession and how we manage. So I'd recommend people look at that. We feel comfortable in that the last big recession we saw in 2008, '09, the losses went up but never really to a level that alarmed us and then they went significantly down after that. And our portfolio is in a lot better shape today than it was back in 2008 and '09. And we've raised our FICO scores in the rec through the years. And Home Improvement, we don't even have back then. We only started out in 2012 and that 760 FICO scores, A quality paper. So we're even in better shape today than we were in the last recession.

Yes. No, I saw the chart. It's helpful. And just speaks to the long track record. Good credit quality. Thanks. I appreciate that.

Thank you. There are no further questions at this time. I would like to turn the floor back over to Andrew Murstein for closing comments.

Thank you again for joining us to hear our business update. One item to note, we just added several slides, as I just mentioned, to our earnings supplement presentation, which can be found on our home page, and I encourage you to review this stack. It gives a nice snapshot as to our strategy and performance. We appreciate your interest in our company. Our entire team is working hard to deliver shareholder value. We have accomplished a lot over the years and believe we have a very bright future. As always, if you have any questions, please reach out the contact information for our Investor Relations team is on the last page of our earnings supplement as well as within the IR section of our website, medallion.com. Thank you, and have a great rest of your day.

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