Medallion Financial Corp: Form 10-Q for the period ended Sep 30, 2023

The information contained in this section should be read in conjunction with the consolidated financial statements and the accompanying notes thereto for the three and nine months ended September 30, 2023 and the year ended December 31, 2022. This section is intended to provide management’s perspective of our financial condition and results of operations. In addition, this section contains forward-looking statements. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions. Certain factors that could cause actual results and conditions to differ materially from those projected in these forward-looking statements are described in the Risk Factors section in our Annual Report on Form 10-K.

COMPANY BACKGROUND

We are a specialty finance company whose focus and growth has been our consumer finance and commercial lending businesses operated by Medallion Bank, or the Bank, and Medallion Capital, Inc., or Medallion Capital. The Bank is a wholly-owned subsidiary that originates consumer loans for the purchase of recreational vehicles, boats, and home improvements, and provides loan origination and other services to fintech partners. Medallion Capital is a wholly-owned subsidiary that originates commercial loans through its mezzanine financing business. As of September 30, 2023, our consumer loans represented 95% of our gross loan portfolio, and commercial loans represented 5%. Total assets were $2.6 billion and $2.3 billion as of September 30, 2023 and December 31, 2022, respectively.

Our loan-related earnings depend primarily on our level of net interest income. Net interest income is the difference between the total yield on our loan portfolio and the average cost of borrowed funds. We fund our operations through a wide variety of interest-bearing sources, including bank certificates of deposit issued to consumers, debentures issued to and guaranteed by the SBA, privately placed notes, and preferred securities. Net interest income fluctuates with changes in the yield on our loan portfolios and changes in the cost of borrowed funds, as well as changes in the amount of interest-earning assets and interest-bearing liabilities held by us. Net interest income is also affected by economic, regulatory, and competitive factors that influence interest rates, loan demand, and the availability of funding to finance our lending activities. We, like other financial institutions, are subject to interest rate risk to the degree that our interest-earning assets reprice, either due to inflation or other factors, on a different basis than our interest-bearing liabilities. We continue to monitor global supply chain disruptions, gas prices, labor shortages, unemployment, and other factors contributing to U.S. inflation and economic health, as well as other factors which contribute to competition and changes in the demand for our loan products. We are taking steps in light of a potential economic downturn and the current inflationary environment to moderate the pace of our recent growth.

We also provide debt, mezzanine, and equity investment capital to companies in a variety of commercial industries. These investments may be venture capital style investments which may not be fully collateralized. Our investments are typically in the form of secured debt instruments with fixed interest rates accompanied by an equity stake or warrants to purchase an equity interest for a nominal exercise price (such warrants are included in equity investments on the consolidated balance sheets). Interest income is earned on the debt instruments.

The Bank is an industrial bank regulated by the FDIC and the Utah Department of Financial Institutions that originates consumer loans, raises deposits, and conducts other banking activities. The Bank generally provides us with our lowest cost of funds which it raises through bank certificates of deposit. To take advantage of this low cost of funds, historically we referred a portion of our taxi medallion and commercial loans to the Bank, which originated these loans, and have since been serviced by Medallion Servicing Corp., or MSC. However, other than in connection with dispositions of existing taxi medallion and related assets, the Bank has not originated any new taxi medallion loans since 2014 (and Medallion Financial Corp. has not originated any new taxi medallion loans since 2015) and is working with MSC to service its remaining portfolio, as it winds down. MSC earns referral and servicing fees for these activities.

In 2019, the Bank launched a strategic partnership program to provide lending and other services to financial technology, or fintech, companies. The Bank entered into an initial partnership in 2020 and began issuing its first loans. The Bank continues to evaluate and launch additional partnership programs with fintech companies.

We continue to consider various alternatives for the Bank, which may include an initial public offering of its common stock, the sale of all or part of the Bank, a spin-off or other potential transaction. We do not have a deadline for its consideration of these alternatives, and there can be no assurance that this process will result in any transaction being announced or consummated.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our accounting policies are fundamental to understanding management's discussion and analysis of its financial condition and results of operations. At September 30, 2023, we identified our policies for the allowance for credit losses, goodwill and intangible assets, and deferred taxes, to be critical accounting policies because management has to make subjective and/or complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. Our critical accounting policies are described in detail in Part I, Item 7 in Medallion Financial Corp.'s Annual Report on Form 10-K for the year ended December 31, 2022, and there have been no material changes in such policies and estimates since the date of such report.

RECENTLY ISSUED AND ADOPTED ACCOUNTING STANDARDS

On January 1, 2023, we adopted Accounting Standards Update 2016-13, "Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments", or ASC 326, which replaced the incurred loss methodology that delayed recognition until it was probable a loss had been incurred with a lifetime expected loss methodology using "reasonable and supportable" expectations about the future, referred to as the current expected credit loss (“CECL”) methodology. For consumer loans, we use historical delinquency and actual loss rates modified by quantitative adjustments based on macroeconomic factors over a twelve-month reasonable and supportable forecast period. For commercial loans, we assess the historical impact that macroeconomic indicators have had on the loan portfolio, to determine an approximate allowance for credit loss. Unlike consumer loans, where loans may have similar performing characteristics, each commercial loan is unique. We evaluate each commercial loan for specific impairment with additional allowance for credit losses recognized as necessary. For taxi medallion loans, we maintain specific reserves adjusting the carrying amount of loans down to net collateral value. The allowance is evaluated on a quarterly basis by management based on the collectability of the loans in light of historical experience, the nature and size of the loan portfolio, adverse situations that may affect the borrowers' ability to repay, estimated value of any underlying collateral, prevailing economic conditions, and excess concentration risks. This evaluation is inherently subjective, as it requires estimates, including those based on changes in economic conditions, that are susceptible to significant revision as more information becomes available. Credit losses are deducted from the allowance, and subsequent recoveries are added back to the allowance.

We adopted ASC 326 using the modified retrospective method for all financial assets measured at amortized cost and off-balance-sheet credit exposures. Results for reporting periods beginning after December 15, 2022 are presented under ASC 326. The transition to the CECL methodology on January 1, 2023 resulted in an increase of $13.7 million to our allowance for credit losses on loans (“ACL”) and a net-of-tax cumulative-effect adjustment of $9.9 million to the beginning balance of retained earnings. The CECL methodology transition effects on the allowance for credit losses are shown in the following table:

(Dollars in thousands)

Prior to January 1, 2023, we used historical delinquency and actual loss rates with a three-year look-back period for taxi medallion loans and a one-year look-back period for recreation and home improvement loans and used historical loss experience and other projections for commercial loans. The allowance was evaluated on a quarterly basis by management based on the collectability of the loans in light of historical experience, the nature and size of the loan portfolio, adverse situations that may affect the borrowers' ability to repay, estimated value of any underlying collateral, prevailing economic conditions, and excess concentration risks. This evaluation was inherently subjective, as it required estimates that were susceptible to significant revision as more information became available.

In March 2023, the FASB issued ASU 2023-02, Investments - Equity Method and Joint Ventures, or Topic 323: Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method. The main objective of this new standard is to allow reporting entities to consistently account for equity investments made primarily for the purpose of receiving income tax credits and other income tax benefits. We are assessing the impact of the update on the accompanying financial statements.

In October 2023, the FASB issued ASU 2023-06, Disclosure Improvements. The amendments in this update seek to clarify or improve disclosure and presentation requirements. We are assessing the impact of the update on the accompanying financial statements.

CONTROL STATUTES AND REGULATIONS

Because the Bank is an “insured depository institution” within the meaning of the Federal Deposit Insurance Act and the Change in Bank Control Act and we are a “financial institution holding company” within the meaning of the Utah Financial Institutions Act, federal and Utah law and regulations prohibit any person or company from acquiring control of us and, indirectly, the Bank, without, in most cases, prior written approval of the FDIC or the Commissioner of Utah Department of Financial Institutions, as applicable. Under the Change in Bank Control Act, control is conclusively presumed if, among other things, a person or company acquires 25% or more of any class of our voting stock. A rebuttable presumption of control arises if a person or company acquires 10% or more of any class of voting stock and is subject to a number of specified “control factors” as set forth in the applicable regulations. Although the Bank is an “insured depository institution” within the meaning of the Federal Deposit Insurance Act and the Change in Bank Control Act, your investment in the Company is not insured or guaranteed by the FDIC, or any other agency, and is subject to loss. Under the Utah Financial Institutions Act, control is defined as the power directly or indirectly or through or in concert with one or more persons to (1) direct or exercise a controlling influence over the management or policies of us or the election of a majority of the directors of us, or (2) to vote 20% or more of any class of our voting securities by an individual or to vote more than 10% of any class of our voting securities by a person other than an individual. If any holder of any series of the Bank’s preferred stock is or becomes entitled to vote for the election of the Bank’s directors, such series will be deemed a class of voting stock, and any other person will be required to obtain the non-objection of the FDIC under the Change in Bank Control Act to acquire or maintain 10% or more of that series. Investors are responsible for ensuring that they do not, directly or indirectly, acquire shares of our common stock in excess of the amount which can be acquired without regulatory approval.

In addition to the regulations detailed above, our operations are subject to supervision and regulation by other federal, state, and local laws and regulations. Additionally, our operations may be subject to various laws and judicial and administrative decisions. This oversight may serve to:

• regulate credit granting activities, including establishing licensing requirements, if any, in various jurisdictions;
• establish maximum interest rates, finance charges and other charges;
• require disclosures to customers;
• govern secured transactions;
• set collection, foreclosure, repossession, and claims handling procedures and other trade practices;
• prohibit discrimination in the extension of credit and administration of loans; and
• regulate the use and reporting of information related to a borrower’s credit experience and other data collection.

Changes to laws of states in which we do business could affect the operating environment in substantial and unpredictable ways. We cannot predict whether such changes will occur or, if they occur, the ultimate effect they would have upon our financial condition or results of operations.

COVID-19

For our taxi medallion portfolio, in response to the COVID-19 pandemic, we determined that anticipated payment activity on our taxi medallion portfolio was impossible to quantify, and therefore all taxi medallion loans were deemed impaired, placed on nonaccrual status, and written down to each market’s net collateral value in 2020. We continue to monitor our taxi medallion portfolio and related assets, which may result in additional write-downs, charge-offs or impairments.

The potential future effects of COVID-19, or any new potential variants, on our loan portfolios and businesses remain uncertain, and we could suffer losses on our loan portfolios as a result of the effects on the ability of our borrowers to repay their loans as well as the demand for our loans.

AVERAGE BALANCES AND RATES

The following table shows our consolidated average balance sheet, interest income and expense, and the average interest earning/bearing assets and liabilities, and which reflects the average yield on assets and average costs on liabilities for the three months ended September 30, 2023 and 2022.

(Dollars in thousands)

(1) Includes deferred financing costs of $8.2 million and $7.2 million as of September 30, 2023 and 2022.

The following table shows our consolidated average balance sheet, interest income and expense, and the average interest earning/bearing assets and liabilities, and which reflects the average yield on assets and average costs on liabilities for the nine months ended September 30, 2023 and 2022.

(Dollars in thousands)

(1) Includes deferred financing costs of $8.2 million and $7.2 million as of September 30, 2023 and 2022.

For the three months ended September 30, 2023, our loans receivable yielded 11.73%, as compared to 11.24% for the three months ended September 30, 2022. The 49 basis point increase reflects a higher yield on our loan portfolios, as we have increased the rates charged on new consumer originations over the past year as prevailing market interest rates have increased. Similarly, for the nine months ended September 30, 2023, our loans receivable yielded 11.62%, as compared to 11.35% for the nine months ended September 30, 2022, with the 27 basis point increase reflecting the higher yield on our loan portfolios due to higher interest rates charged on new originations compared to the prior year period. We have used the higher interest rate environment as an opportunity to both increase the rates on newly issued recreation and home improvement loans, which is expected to continue to increase the yield on these portfolios over time, as well as increase the credit quality of our new issuances, particularly in our recreation segment, with the average FICO scores of our recreation loans outstanding being 682 as of September 30, 2023 compared to 671 as of September 30, 2022. We use weighted average FICO scores as an indicator of portfolio risk.

Our debt, with certificates of deposits being our largest source, funds our growing lending business. Our average interest cost for the three and nine months ended September 30, 2023 of 3.28% and 3.02% increased 108 and 93 basis points from the three and nine months ended September 30, 2022, which is attributable to the current higher interest rate environment. To the extent that prevailing market interest rates remain at current levels, we expect our cost of funds to continue to increase as we issue new certificates of deposit to replace maturing certificates of deposit and fund our growth. We have taken, and continue to take, steps to pass along a portion of the interest rate increases on newly originated loans, the process for which is slower than the pace of funding cost increases.

RATE/VOLUME ANALYSIS

The following tables present the change in interest income and expense due to changes in the average balances (volume) and average yield/cost, calculated for the periods indicated.

(Dollars in thousands)

(Dollars in thousands)

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During the three and nine months ended September 30, 2023, the increase in interest income was mainly driven by the increase in volume of consumer loans, a large portion of that increase in the first half of the year, as well as an increase in overall yield on interest-earning assets as we issue new loans at interest rates greater than the weighted average rates of our current portfolio. During the quarter, the increase in interest expense was driven by an increase in borrowing cost, primarily the increases in deposits, as well as an increase in borrowings. Likewise, the increase in interest expense for the nine months was largely attributable to the increased costs on our borrowings, primarily deposits, and to a lesser extent, due to growth in our borrowed funds.

Our interest expense is driven by the interest rates payable on our bank certificates of deposit, privately placed notes, fixed-rate, long-term debentures issued to the SBA, preferred securities, and has historically included credit facilities with banks and other short-term notes payable. The Bank issues brokered time certificates of deposit, which are, on average, our lowest borrowing costs. The Bank is able to bid on these deposits at a variety of maturity options, which allows for more flexible interest rate management strategies. As further described below, in September 2023, we issued and sold $39.0 million aggregate principal amount of 9.25% senior notes due in September 2028, and repurchased $33.0 million aggregate principal amount of our 8.25% senior notes due March 2024.

Our cost of funds is primarily driven by the rates paid on our various borrowings and changes in the levels of average borrowings outstanding. See Note 5 to the consolidated financial statements for details on the terms of our outstanding debt. Our debentures issued to the SBA typically have terms of ten years.

We measure our borrowing costs as our aggregate interest expense for all of our interest-bearing liabilities divided by the average amount of such liabilities outstanding during the period. The above table shows the average borrowings and related borrowing costs for the three and nine months ended September 30, 2023 and 2022. We expect our borrowing costs to further increase as prevailing interest rates continue at, or rise from, these levels.

We continue to seek SBA funding through Medallion Capital, Inc., to the extent it offers attractive rates. SBA financing subjects its recipients to limits on the amount of secured bank debt they may incur. We use SBA funding to fund loans that qualify under the Small Business Investment Act of 1985, as amended, or the SBIA, and SBA regulations. In July 2023, we obtained a $20.0 million commitment from the SBA, $4.8 million of which has been utilized as of September 30, 2023, with $10.2 million currently drawable, and the balance of $5.0 million drawable upon the infusion of $2,5 million of capital. At September 30, 2023 and 2022, adjustable rate debt constituted less than 2% of total debt, and was comprised solely of our preferred securities borrowings.

LOANS

Loans are reported at the principal amount outstanding, inclusive of deferred loan acquisition costs, which primarily includes deferred fees paid to or received from loan originators, and which are amortized to interest income over the life of the loan. During the three and nine months ended September 30, 2023, there was continued growth in the recreation and home improvement segments, offset by a decrease in commercial loans related to repayments exceeding originations for the three and nine months ended September 30, 2023.

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The following table presents the approximate maturities and sensitivity to changes in interest rates for our loans as of September 30, 2023.

(Dollars in thousands)

(1) Excludes strategic partnership loans.

PROVISION AND ALLOWANCE FOR CREDIT LOSSES

The allowance is maintained at a level estimated by management to absorb probable credit losses inherent in the loan portfolios based on management’s quarterly evaluation of the portfolios, the related credit characteristics, and macroeconomic factors affecting the portfolios. As of September 30, 2023 and December 31, 2022, the allowance totaled $79.1 million and $63.8 million, which represented 3.59% and 3.33% of total loans, respectively. The increase in the allowance for credit losses as of September 30, 2023 was primarily driven by the adoption of the CECL accounting standard, which resulted in a $13.7 million increase in our allowance for credit losses, and due to growth in our recreation and home improvement loan portfolios, as well as growth in the commercial loan portfolio, offset by a reduction in allowance specific to the taxi medallion portfolio as the taxi medallion loan portfolio continued to shrink through collections.

The following table sets forth the activity in the allowance for credit losses for the three and nine months ended September 30, 2023 and 2022.

(Dollars in thousands)

(1) Represents allowance prior to the adoption of ASU 2016-13.

(2) As of September 30, 2023, cumulative net charge-offs of loans and loan collateral in process of foreclosure in the taxi medallion portfolio were $201.7 million, some of which may represent collection opportunities for the Company.

(3) As of September 30, 2023, there was no allowance for credit loss and net charge-offs related to the strategic partnership loans.

With the adoption of ASC 326, we also adopted ASU 2022-02, Financial Instruments – Credit Losses, or Topic 326: Troubled Debt Restructurings and Vintage Disclosures. Under this standard, we are required to disclose current period gross write-offs, by year of origination, for financing receivables.

The following table sets forth the gross charge-offs for the three months ended September 30, 2023, by the year of origination:

(Dollars in thousands)

The following table sets forth the gross charge-offs for the nine months ended September 30, 2023, by the year of origination:

(Dollars in thousands)

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The following tables set forth the allowance for credit losses by type as of September 30, 2023 and December 31, 2022.

As of September 30, 2023, the total allowance rate for credit losses increased 15 basis points from December 31, 2022, due to the adoption of CECL and rising loss rates which resulted in higher allowances for recreation, home improvement, and commercial loans, offset by a reduction in the allowance for taxi medallion loans due to recoveries and structured settlements entered into during the current year.

The following table shows the trend in loans 90 days or more past due as of the dates indicated.

(Dollars in thousands)

(1) Percentages are calculated against the total loan portfolio.

(*) Less than 0.1%.

Recreation and taxi medallion loans that reach 120 days past due are charged down to collateral value and reclassified to loan collateral in process of foreclosure. The following tables show the activity of loan collateral in process of foreclosure for the three and nine months ended September 30, 2023 and 2022.

As of September 30, 2023, taxi medallion loans in the process of foreclosure included 429 taxi medallions in the New York City market, 230 taxi medallions in the Chicago market, 32 taxi medallions in the Newark market, and 31 taxi medallions in other markets.

SEGMENT RESULTS

We manage our financial results under four operating segments; recreation lending, home improvement lending, commercial lending, and taxi medallion lending. We also show results for a non-operating segment, corporate and other investments.

Recreation Lending

Recreation lending is a high-growth business focused on originating prime and non-prime recreation loans which is a significant source of income for us, accounting for 67% of our interest income for the three and nine months ended September 30, 2023 and 71% for the three and nine months ended September 30, 2022.

We maintain relationships with approximately 3,200 dealers and financial service providers, or FSPs, not all of which are active at any one time. FSPs are entities that provide finance and insurance, or F&I, services to small dealers that do not have the desire or ability to provide F&I services themselves. The ability of FSPs to aggregate the financing and relationship management for many small dealers makes them valuable. We receive approximately half of our loan volume from dealers and the other half from FSPs. Our top ten dealer and FSP relationships were responsible for 49% and 41% of recreation lending’s new loan originations for the three and nine months ended September 30, 2023. The percentage of new loan originations by the top ten dealer and FSP relationships is a measure of concentration, which management uses to determine whether to undertake diversification efforts, and which provides investors with information about origination concentration.

The recreation loan portfolio consists of thousands of geographically distributed loans with an average loan size of approximately $20,000 as of September 30, 2023. The loans are fixed rate with an average term at origination of 12.8 years. The weighted average maturity of our loans outstanding as of September 30, 2023 is 10 years.

The loans are secured primarily by RVs, boats, and trailers, with RV loans making up 58% of the portfolio, boat loans making up 20%, and trailers making up 6% of the portfolio as of September 30, 2023, compared to 58%, 20% and 13% as of September 30, 2022. Recreation loans are made to borrowers residing nationwide, with the highest concentrations in Texas and Florida at 15% and 10% of loans outstanding, compared to 15% and 9% as of September 30, 2022, and with no other states over 10%. As of September 30, 2023 and 2022, the weighted average FICO scores of our recreation loans outstanding were 682 and 670.

During the nine months ended September 30, 2023, the recreation portfolio grew 13% from $1.2 billion to $1.3 billion, with the average interest rate increasing 52 basis points to 14.73% from a year ago. Additionally, reserve rates increased 76 basis points from September 30, 2022, reflecting an increase in reserves due to the adoption of CECL and rising loss rates.

The following table presents certain financial data and ratios as of and for the three and nine months ended September 30, 2023 and 2022.

(Dollars in thousands)

(1) Loans 90 days or more past due.

Home Improvement Lending

The home improvement lending segment works with contractors and financial service providers to finance home improvements and is concentrated in roofs, swimming pools, and windows at 40%, 19%, and 13% of total loans outstanding as of September 30, 2023, as compared to 37%, 23%, and 12% as of September 30, 2022, with no other collateral types over 10%. Home improvement loans are made to borrowers residing nationwide, with the highest concentrations in Texas and Florida, each representing 10% of loans outstanding September 30, 2023, compared to 10% and 9% as of September 30, 2022, with no other states over 10%. As of September 30, 2023 and 2022, the weighted average FICO scores of our home improvement loans outstanding were 763 and 753.

A large proportion of our home improvement-financed sales are facilitated by contractor salespeople with limited financing backgrounds rather than by contractor employees who provide F&I services. The result is contractor demand for financing services that facilitate an in-home transaction (e.g., digital tools, including mobile applications for phone or tablet, support for E-SIGN compliant electronic signatures, and extended operating hours), and additional resources for the salesperson throughout the financing process. We currently maintain relationships with approximately 1,100 contractors and FSPs. Our top ten contractors and FSP relationships were responsible for 61% of home improvement lending’s new loan originations for both the three and nine months ended September 30, 2023. The percentage of new loan originations by the top ten contractor and FSP relationships is a measure of concentration, which management uses to determine whether to undertake diversification efforts, and which provides investors with information about origination concentration.

The home improvement loan portfolio consists of thousands of geographically distributed loans with an average loan size approximately $20,000 as of September 30, 2023. The loans are fixed rate with an average term at origination of 13.6 years. The weighted average maturity of our loans outstanding as of September 30, 2023 is 12.4 years.

During the nine months ended September 30, 2023, the home improvement portfolio grew 19.8% from $626.4 million to $750.5 million, with reserve coverage rates increasing 54 basis points from a year ago reflecting an increase in reserves due to the adoption of CECL and rising loss rates. The average interest rate increased 83 basis points to 9.38% from the prior year.

The following table presents certain financial data and ratios as of and for the three and nine months ended September 30, 2023 and 2022.

(Dollars in thousands)

(1) Loans 90 days or more past due.

Commercial Lending

We originate both senior and subordinated loans nationwide to businesses in a variety of industries, with California, Minnesota, Illinois, and Texas each having 25%, 14%, 11%, and 10% of the segment portfolio, and no other states having a concentration greater than 10%. These mezzanine loans are primarily secured by a second position on all assets of the businesses and generally range in amount from $2,000,000 to $5,000,000 at origination, and typically include an equity component as part of the financing. The commercial lending business has concentrations in manufacturing, wholesale trade, construction, and administrative and support services making up 43%, 16%, 15%, and 10%, of the loans outstanding as of September 30, 2023.

During the nine months ended September 30, 2023, we originated $16.7 million of loans, compared to $28.2 million in originations in the 2022 period. As of September 30, 2023, commercial loans totaled $100.3 million, reflecting the originations generated during 2023.

The following table presents certain financial data and ratios as of and for the three and nine months ended September 30, 2023 and 2022. The commercial segment encompasses the mezzanine lending business, and the other legacy commercial loans (immaterial to total) have been allocated to corporate and other investments.

(Dollars in thousands)

(1) Ratio is based off of total commercial balances and relates solely to the legacy commercial loan balances.

(2) Loans 90 days or more past due.

(3) Ratio is based on total commercial lending balances and relates to the total loan business.

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Taxi Medallion Lending

The taxi medallion lending segment operates primarily in New York City, and to a lesser extent in Newark, Chicago and other markets. During the three and nine months ended September 30, 2023, taxi medallion values remained consistent in the New York City market. We continued to not recognize interest income with all loans being placed on nonaccrual as of the third quarter 2020 (except for settled loans with interest being paid in excess of the loan balance), and by transferring underperforming loans from the portfolio to loan collateral in process of foreclosure with charge-offs to collateral value, once loans become more than 120 days past due. All the loans are secured by taxi medallions and enhanced by personal guarantees of the shareholders and owners.

During the three and nine months ended September 30, 2023, we collected $5.7 million and $29.6 million related to taxi medallion and related assets, which resulted in net recoveries and gains of $3.2 million and $18.4 million in the respective periods. The amount of cash collected as well as recoveries recorded vary greatly from period to period due to a wide variety of circumstances surrounding each of the underlying assets, and while we continue to focus on collection and recovery efforts, including the $9.4 million collected in October 2023, it is unlikely that there will be other future collections at the levels experienced in the current periods.

The following table presents certain financial data and ratios as of and for the three and nine months ended September 30, 2023 and 2022.

(Dollars in thousands)

(1) Loans 90 days or more past due.

(*) Less than 1%.

(*) Less than 1%.

Corporate and Other Investments

This non-operating segment relates to our equity and investment securities as well as our legacy commercial business, and other assets, liabilities, revenues, and expenses, which are not specifically allocated to the operating segments. Commencing with the 2020 second quarter, the Bank began issuing loans related to the new strategic partnership business, which is currently included within this segment. The associated activities of the strategic partnership business are currently limited to originating loans or other receivables facilitated by our strategic partners and selling those loans or receivables to our strategic partners or other third parties, without recourse, within a specified time after origination, such as three business days. Strategic partnerships represent $1.8 million in net loans as of September 30, 2023, compared to $0.8 million as of September 30, 2022, with originations of $36.5 million and $96.6 million during the three and nine months ended September 30, 2023 and $19.4 million and $34.3 million during the three and nine months ended September 30, 2022.

The following table presents certain financial data and ratios as of and for the three and nine months ended September 30, 2023 and 2022.

(Dollars in thousands)

SUMMARY CONSOLIDATED FINANCIAL DATA

The table below presents our selected financial data for the three and nine months ended September 30, 2023 and 2022.

(Dollars in thousands)

(1) Includes $68.8 million related to non-controlling interests in consolidated subsidiaries as of September 30, 2023 and 2022.

(2) Excludes deferred financing costs of $8.2 million and $7.4 million as of September 30, 2023 and 2022.

CONSOLIDATED RESULTS OF OPERATIONS

Three and Nine Months Ended September 30, 2023 Compared to the Three and Nine Months Ended September 30, 2022

Net income attributable to shareholders was $11.2 million and $40.8 million, or $0.48 and $1.77 per diluted share, for the three and nine months ended September 30, 2023, compared to $7.6 million and $30.8 million, or $0.32 and $1.26 per diluted share, for the three and nine months ended September 30, 2022.

Total interest income was $65.9 million and $183.5 for the three and nine months ended September 30, 2023 compared to $51.7 million and $142.1 million for the three and nine months ended September 30, 2022. The increase in interest income reflects the continued growth in our recreation and home improvement segments and an increased weighted average interest rate on the loan portfolio. The yield on interest earning assets, before allowance, was 11.28% and 11.10% for the three and nine months ended September 30, 2023, compared to 10.61% and 10.69% for the three and nine months ended September 30, 2022. The increase reflects higher interest rates on new originations in our recreation, home improvement and commercial segments, with the yield anticipated to continue to increase as older loans with lower rates amortize and newer originations at the higher current rates become a larger portion of our portfolio.

Loans before allowance for credit losses were $2.2 billion as of September 30, 2023, comprised of recreation ($1.3 billion), home improvement ($750.5 million), commercial ($100.3 million), taxi medallion ($3.9 million), and strategic partnership loans ($1.8 million). We had an allowance for credit losses as of September 30, 2023 of $79.1 million, which was attributable to the recreation (72%), home improvement (22%), commercial (4%), and taxi medallion (2%) loans, and included the impact of our CECL adoption on January 1, 2023, which resulted in an increase in allowance of $13.7 million.

Loans increased $286.1 million, or 15%, from December 31, 2022 as a result of $791.0 million of loan originations, offset by principal payments, and to a lesser extent charge-offs, transfers to loan collateral in process of foreclosure and net charge-offs. The provision for credit losses were $14.5 million and $27.0 million for the three and nine months ended September 30, 2023, compared to $10.0 million and $21.0 million in the three and nine months ended September 30, 2022. The provision for credit loss in the three and nine months ended September 30, 2023 included $5.3 million and $12.4 million of charge-offs with respect to the taxi medallion lending segment, reflecting continued recovery efforts with the impaired taxi medallion portfolio, while net charge offs in the recreation and home improvement segments increased to more normal levels from the historically low levels experienced in the prior year periods. Recoveries in the taxi medallion lending segment are closely tied to our collection efforts and fluctuate significantly from quarter to quarter. Collections for the three and nine months ended September 30, 2023, including $5.7 million and $29.6 million in the taxi medallion loan portfolio, were substantially higher than normal, which we do not expect to occur on a recurring basis.

Interest expense was $17.1 million and $44.4 million for the three and nine months ended September 30, 2023, compared to $9.7 million and $25.3 million for the three and nine months ended September 30, 2022, reflecting both higher average borrowings and higher average borrowing costs during the three and nine months ended September 30, 2023, both of which we expect to further increase in the current inflationary environment. The average cost of borrowed funds was 3.28% and 3.02% for the three and nine months ended September 30, 2023, compared to 2.20% and 2.09% for the three and nine months ended September 30, 2022. The increase of 108 and 93 basis points from the prior year periods is attributable to the increased cost of newly issued certificates of deposit used both to fund our growth and to replace older maturing vintages with lower rates. As we replace upcoming maturities with new issues, we expect our cost of funds to further increase. In addition, we expect our interest expense to increase as a result of our refinancing of our senior notes. Average debt outstanding was $2.1 billion and $2.0 billion for the three and nine months ended September 30, 2023, up from $1.7 billion for both the three and nine months ended September 30, 2022, as we have issued additional certificates of deposits to fund our loan growth. See page 39 for tables that show average balances and cost of funds for our funding sources.

Net interest income was $48.8 million and $139.1 million for the three and nine months ended September 30, 2023, compared to $42.0 million and $116.9 million for the three and nine months ended September 30, 2022. The net interest margin before the impact of the allowance for credit losses was 8.35% and 8.42% for the three and nine months ended September 30, 2023, compared to 8.63% and 8.79% for the three and nine months ended September 30, 2022, reflecting the above as well as a greater composition in our home improvement loan portfolio, which has a lower net interest margin as compared to our recreation loan portfolio. With the rates we charge on loans and our cost of funds both increasing due to inflation, our net interest margin has tightened, and we expect that trend to continue to some degree. However, despite such tightening of our net interest margin, our net interest still increased as a result of a higher volume of originations.

Net other income, which is comprised primarily of gains on the sale of loans and taxi medallions, gain (losses) on equity investments, prepayment fees, servicing fee income, late charges, and write-downs of loan collateral was $4.3 million and $8.3 million for the three and nine months ended September 30, 2023, primarily due to collections on the taxi medallion loans which generated gains of $1.4 million and $4.6 million for the three and nine months ended September 30, 2023, compared to $0.2 million of losses and $5.1 million of income for the three and nine months ended September 30, 2022, which included $0.5 million and $5.1 million of gains on the disposition of taxi medallion and related assets.

Operating expenses were $19.1 million and $56.5 million for the three and nine months ended September 30, 2023, compared to $19.4 million and $56.3 million for the three and nine months ended September 30, 2022. Salaries and benefits were $9.6 million and $27.8 million for the three and nine months ended September 30, 2023, compared to $8.4 million and $23.7 million for the three and nine months ended September 30, 2022, primarily reflecting a greater head count at our operating subsidiaries, Medallion Bank and Medallion Capital, and the increased cost of managing our businesses as they grow. Professional fees were $1.1 million and $4.2 million for the three and nine months ended September 30, 2023, down from $3.7 million and $12.1 million for the three and nine months ended September 30, 2022, primarily reflecting lower legal and professional costs during the quarter for a variety of corporate matters, with costs in the prior year period being elevated due to the SEC litigation. These elevated costs incurred gave rise to an approximate $6.5 million liability as a result of the collection of insurance coverage with respect to those costs. The Company anticipates recognizing the benefit of this liability, offsetting future costs, through the remainder of this matter.

Total income tax expense was $6.7 million and $18.6 million for the three and nine months ended September 30, 2023, compared to $3.2 million and $12.9 million for the three and nine months ended September 30, 2022, and included a $1.1 million valuation allowance in the 2023 periods related to certain deferred tax assets.

Loan collateral in process of foreclosure was $15.9 million at September 30, 2023, a decline from $21.8 million at December 31, 2022. The decrease primarily reflects cash payments received and structured settlements during the period.

ASSET/LIABILITY MANAGEMENT

Interest Rate Sensitivity

We, like other financial institutions, are subject to interest rate risk to the extent that our interest-earning assets (consisting of consumer, commercial, and taxi medallion loans, and investment securities) reprice on a different basis over time in comparison to our interest-bearing liabilities (consisting primarily of bank certificates of deposit, SBA debentures and borrowings, historically credit facilities, and borrowings from banks and other lenders).

Having interest-bearing liabilities that mature or reprice more frequently on average than assets may be beneficial in times of declining interest rates, although such an asset/liability structure may result in declining net earnings during periods of rising interest rates. Abrupt increases in market rates of interest may have an adverse impact on our earnings until we are able to originate new loans at the higher prevailing interest rates. Conversely, having interest-earning assets that mature or reprice more frequently on average than liabilities may be beneficial in times of rising interest rates, although this asset/liability structure may result in declining net earnings during periods of falling interest rates. This mismatch between maturities and interest rate sensitivities of our interest-earning assets and interest-bearing liabilities results in interest rate risk.

The effect of changes in interest rates is mitigated by regular turnover of the portfolio. We believe that the average life of our loan portfolio varies to some extent as a function of changes in interest rates. Borrowers are more likely to exercise prepayment rights in a decreasing interest rate environment because the interest rate payable on the borrower’s loan is high relative to prevailing interest rates. Conversely, borrowers are less likely to prepay in a rising interest rate environment. However, borrowers may prepay for a variety of other reasons, such as to monetize increases in the underlying collateral values. In addition, we manage our exposure to increases in market rates of interest by incurring fixed-rate indebtedness, such as ten year subordinated SBA debentures, and by setting repricing intervals on certificates of deposit, for terms of up to five years.

A relative measure of interest rate risk can be derived from our interest rate sensitivity gap. The interest rate sensitivity gap represents the difference between interest-earning assets and interest-bearing liabilities, which mature and/or reprice within specified intervals of time. The gap is considered to be positive when repriceable assets exceed repriceable liabilities, and negative when repriceable liabilities exceed repriceable assets. A relative measure of interest rate sensitivity is provided by the cumulative difference between interest sensitive assets and interest sensitive liabilities for a given time interval expressed as a percentage of total assets.

The following table presents our interest rate sensitivity gap at September 30, 2023. The principal amounts of interest earning assets are assigned to the time frames in which such principal amounts are contractually obligated to be repriced. We do not reflect any prepayment assumptions in preparing the analysis, despite historical average life experience being significantly shorter than contractual terms.

September 30, 2023 Cumulative Rate Gap (1)

(Dollars in thousands)

(1) The ratio of the cumulative one-year gap to total interest rate sensitive assets was (20%) as of September 30, 2023, and was (18%) as of December 31, 2022.

(2) Excludes federal funds sold and investment securities.

Our interest rate sensitive assets were $2.4 billion and interest rate sensitive liabilities were $2.1 billion at September 30, 2023. The one-year cumulative interest rate gap was a negative $475.5 million or 20% of interest rate sensitive assets. We seek to manage interest rate risk by incurring fixed-rate indebtedness, by evaluating appropriate derivatives, pursuing securitization opportunities, entering into borrowing arrangements with terms that align with the anticipated life of our assets, and using other options consistent with managing interest rate risk.

LIBOR terminated on June 30, 2023. We did not have loans tied to LIBOR. Our trust preferred securities bore a variable rate of interest of 90-day LIBOR plus 2.13% until June 30, 2023. For these borrowings, the 90-day Secured Overnight Financing Rate adjusted by a relevant spread adjustment of approximately 26 basis points has replaced the previous LIBOR-based rate.

Liquidity and Capital Resources

Our sources of liquidity include brokered certificates of deposit and other borrowings at Medallion Bank, unfunded commitments to sell debentures to the SBA, loan amortization and prepayments, private and public issuances of debt securities, participations or sales of loans to third parties, issuances of preferred securities at our subsidiaries, and the disposition of our other assets.

In September 2023, we completed a private placement to certain institutional investors of $39.0 million aggregate principal amount of 9.25% unsecured senior notes due September 2028, with interest payable semiannually.

In April 2023, the Bank began to originate retail savings deposits through a third-party service provider and, as of September 30, 2023, the Bank had $18.0 million in retail savings deposit balances.

In March 2023, the Bank established a discount window line of credit at the Federal Reserve. As of September 30, 2023, the Bank had approximately $37.0 million in investment securities pledged as collateral to the Federal Reserve. The current advance rate on the pledged securities is 100% of fair value, for a total of approximately $37.0 million in secured borrowing capacity, none of which was utilized as of September 30, 2023.

The Bank has borrowings arrangements with several commercial banks. These agreements are accommodations that can be terminated at any time, for any reason, and allow the Bank to borrow up to $75.0 million. As of September 30, 2023, $10.0 million was outstanding on these lines, with $65.0 million available.

In February 2021, we completed a private placement to certain institutional investors of $25.0 million aggregate principal amount of 7.25% unsecured senior notes due February 2026, with interest payable semiannually. Follow-on offerings of these notes in March and April 2021 raised an additional $3.3 million and $3.0 million.

In December 2020, we completed a private placement to certain institutional investors of $33.6 million aggregate principal amount of 7.50% unsecured senior notes due December 2027, with interest payable semiannually. Follow-on offerings of these notes in February and March 2021 raised an additional $8.5 million. In April 2021, we raised an additional $11.7 million in a follow-on offering, and repaid substantially all of our remaining bank borrowings.

In December 2019, the Bank closed an initial public offering of 1,840,000 shares of its Fixed-to-Floating Rate Non-Cumulative Perpetual Preferred Stock, Series F, with a $46.0 million aggregate liquidation amount, yielding net proceeds of $42.5 million, which were recorded in the Bank’s shareholders’ equity. Dividends are payable quarterly from the date of issuance to, but excluding April 1, 2025, at a rate of 8% per annum, and from and including April 1, 2025, at a floating rate equal to a benchmark rate (which is based on the Secured Overnight Financing Rate, or SOFR, and is expected to be three-month Term SOFR) plus a spread of 6.46% per annum.

The net proceeds from the December 2020, February 2021, March 2021, April 2021, and September 2023 private placements were used for general corporate purposes, including repayment of outstanding debt, including repayment of our 9.00% retail notes at maturity in April 2021 and to pay down other borrowings, including some borrowings at a discount, and to repurchase and cancel $33.0 million of our 8.25% notes due in March 2024.

The table below presents the components of our debt and preferred securities as of September 30, 2023, exclusive of deferred financing costs of September 30, 2023. See Note 5 to the consolidated financial statements for details of the contractual terms of our borrowings.

(Dollars in thousands)

(1) Weighted average contractual rate as of September 30, 2023.

(2) Balance includes $1.5 million of strategic partner reserve deposits as of September 30, 2023.

(*) Less than 1%.

Our contractual obligations expire on or mature at various dates through September 2037. The following table shows our contractual obligations at September 30, 2023.

(Dollars in thousands)

(1) Total debt is exclusive of deferred financing costs of $8.2 million as of September 30, 2023.

(2) Balance excludes $1.5 million of strategic partner reserve deposits as of September 30, 2023.

Approximately $1.3 billion of our borrowings have maturity dates during the next two years, a majority of which are brokered CDs that have no right of voluntary withdrawal.

In addition, the illiquidity of portions of our loan portfolio and investments may adversely affect our ability to dispose of them at times when it may be advantageous for us to liquidate such portfolio or investments. In addition, if we were required to liquidate some or all of our portfolio, the proceeds of such liquidation may be significantly less than the current value of such investments. Because we borrow money to make loans and investments, our net operating income is dependent upon the difference between the rate at which we borrow funds and the rate at which we invest these funds. As a result, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our interest income. In periods of sharply rising interest rates, our cost of funds would increase, which would reduce our net interest income.

We use a combination of long-term and short-term borrowings and equity capital to finance our lending and investing activities. Our long-term fixed-rate investments are financed primarily with fixed-rate debt. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. We have analyzed the potential impact of changes in interest rates on net interest income. Assuming that the balance sheet were to remain constant and no actions were taken to alter the existing interest rate sensitivity a hypothetical immediate 1% increase in interest rates would result in an increase to net income as of September 30, 2023 by $2.5 million on an annualized basis, and the impact of such an immediate increase of 1% over a one year period would have been a reduction in net income by $1.1 million at September 30, 2023. Although management believes that this measure is indicative of our sensitivity to interest rate changes, it does not adjust for potential changes in credit quality, size, and composition of the assets on the balance sheet, and other business developments that could affect net income from operations in a particular quarter or for the year taken as a whole. Accordingly, no assurances can be given that actual results would not differ materially from the potential outcome simulated by these estimates.

From time to time, we work with investment banking firms and other financial intermediaries to investigate the viability of several other financing options which include, among others, the sale or spinoff of certain assets or divisions, the development of a securitization conduit program, and other independent financing for certain subsidiaries or asset classes. These financing options would also provide additional sources of funds for both external expansion and continuation of internal growth.

The following table illustrates sources of available funds for us and each of our subsidiaries, and amounts outstanding under preferred securities and borrowings and their respective end of period weighted average interest rates at September 30, 2023. See Note 5 to the consolidated financial statements for additional information about each borrowing.

(Dollars in thousands)

(1) Cash resides in the applicable SBIC and is generally not available for corporate use.

(2) Includes deposits of $1.5 million related to the strategic partnership business and $8.2 million related to listing services.

Loan amortization, prepayments, and sales also provide a source of funding for us. Prepayments on loans are influenced significantly by general interest rates, taxi medallion loan market values, economic conditions, and competition.

We also generate liquidity through deposits generated at the Bank, the offering of privately placed notes, through the issuance of SBA debentures, and through our preferred securities, and have utilized borrowing arrangements with other banks in the past, as well as from cash flow from operations. In addition, we may choose to participate a greater portion of our loan portfolio to third parties. We regularly seek additional sources of liquidity; however, given current market conditions, there can be no assurance that we will be able to secure additional liquidity on terms favorable to us or at all. If that occurs, we may decline to underwrite lower yielding loans in order to conserve capital until credit conditions in the market become more favorable; or we may be required to dispose of assets when we would not otherwise do so, and at prices which may be below the net book value of such assets in order for us to repay indebtedness on a timely basis.

Dividends and Stock Repurchases

Beginning in March 2022, the Company's board of directors reinstated our quarterly dividend. A dividend of $0.08 per share was paid in August 2023. On October 24, 2023, the board of directors authorized and increased the quarterly dividend to $0.10 per share, with a dividend payable on November 30, 2023. We may, however, re-evaluate the dividend policy in the future depending on market conditions. There can be no assurance that we will continue to pay any cash distributions, as we may retain our earnings to facilitate the growth of our business, to finance our investments, to provide liquidity, or for other corporate purposes.

On April 29, 2022, our board of directors authorized a new stock repurchase program, pursuant to which we were authorized to repurchase up to $35 million of our shares, which was increased to $40 million on August 10, 2022. Such new repurchase program replaced the previous one, which was terminated. The Company did not repurchase shares of common stock during the nine months ended September 30, 2023. Accordingly, as of September 30, 2023, up to $19,998,012 of shares remained authorized for repurchase under our stock repurchase program.

There has been no material change in disclosure regarding quantitative and qualitative disclosures about market risk since we filed our Annual Report on Form 10-K for the year ended December 31, 2022.

Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures pursuant to Rules 13a—15(e) and 15d – 15(e) under the Securities Exchange Act of 1934, and have concluded that they are effective as of September 30, 2023 to provide reasonable assurance that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized, and reported within the time periods specified in the SEC rules and forms and (ii) accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.

Changes in Internal Control over Financial Reporting

As required by Rule 13a-15(d) under the Exchange Act, our management, including our Chief Executive Officer and Chief Financial Officer, have evaluated our internal control over financial reporting to determine whether any changes occurred during the 2023 third quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, and have concluded that there have been no changes that occurred during the 2023 third quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes in our risk factors from those disclosed in Part 1, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, which was filed with the Securities and Exchange Commission on March 10, 2023.