MEDALLION FINANCIAL CORP (MFIN) FY 2022 MD&A

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OBJECTIVE

The information contained in this section should be read in conjunction with the consolidated financial statements and the accompanying notes thereto for the years ended December 31, 2022, 2021, and 2020. 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 on page 19. Additionally, more information about our business activities can be found in “Business.”

GENERAL

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 December 31, 2022, our consumer loans represented 94% of our gross loan portfolio and commercial loans represented 5%. Total assets were $2.3 billion as of December 31, 2022 and $1.9 billion as of December 31, 2021.

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 customers, 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.

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 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 medallion assets, the Bank has not originated any new medallion loans since 2014 (and Medallion Financial Corp. has not originated any new 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.

COVID-19

In March 2020, in response to the COVID-19 pandemic, we adjusted the payment policies and procedures with our consumer and medallion businesses, and allowed borrowers to defer payments up to 180 days. As of December 31, 2022, no consumer or medallion loans remained on deferral related to COVID-19. For our medallion portfolio, we determined that anticipated payment activity on our medallion portfolio was impossible to quantify upon the end of the deferral moratorium, and therefore all medallion loans were deemed impaired, placed on nonaccrual status, and written down to each market’s net collateral value in 2020, with additional write-offs taken during 2021. There were no additional write-offs in 2022. We will continue to monitor our medallion portfolio and related assets, which may result in additional write-downs, charge-offs or impairments.

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In addition to modifying payment policies, we took steps to accommodate remote work, some of which is still in place today, and implemented several cost-cutting measures, such as reducing employee headcount at our parent company, Medallion Financial Corp., and closing satellite offices in Long Island City, New York; Chicago, Illinois; and Boston, Massachusetts.

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.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

We follow financial accounting and reporting policies that are in accordance with GAAP. Some of these significant accounting policies require management to make difficult, subjective or complex judgments. The policies noted below, however, are deemed to be our “critical accounting policies” under the definition given to this term by the SEC. According to the SEC, “critical accounting policies” mean those policies that are most important to the presentation of a company’s financial condition and results of operations, and require management’s most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

The judgments used by management in applying the critical accounting policies may be affected by deterioration in the economic environment, which may result in changes to future financial results. Specifically, subsequent evaluations of the loan portfolio, in light of the factors then prevailing, may result in significant changes to the allowance for loan losses in future periods, and the inability to collect on outstanding loans could result in increased loan losses.

Allowance for Loan Losses

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions, and excess concentration risks. In analyzing the adequacy of the allowance for loan losses, the Company uses historical delinquency and actual loss rates with a three-year look-back period for medallion loans and a one-year look-back period for recreation and home improvement loans and uses historical loss experience and other projections for commercial loans. The allowance is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and size of the loan portfolio, adverse situations that may affect the borrower’s 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 that are susceptible to significant revision as more information becomes available.

Our methodology to calculate the general reserve portion of the allowance includes the use of quantitative and qualitative factors. We initially determine an allowance based on quantitative loss factors for loans evaluated collectively for impairment. The quantitative loss factors are based primarily on historical loss rates, after considering loan type, historical loss and delinquency experience. The quantitative loss factors applied in the methodology are periodically re-evaluated and adjusted to reflect changes in historical loss levels or other risks. Qualitative loss factors are used to modify the reserve determined by the quantitative factors and are designed to account for losses that may not be included in the quantitative calculation according to management’s best judgment. If our qualitative loss factor rates were to increase 50 basis points, our recreation and home improvement general reserve would increase by $5.9 million and $3.1 million, respectively. Likewise, if our qualitative loss factor rates were to decrease 50 basis points, our recreation and home improvement general reserve would decrease by $5.9 million and $3.1 million, respectively. Performing loans are recorded at par and the general reserve maintained to absorb expected losses consistent with GAAP.

All medallion loans are deemed impaired and have a specific allowance for each loan, such that the underlying net loan has a value no greater than collateral value. The determination of taxi medallion collateral fair value is derived quarterly for each jurisdiction. For medallion loans, delinquent nonperforming loans are valued at collateral value for the most recent quarter. Collateral value for the medallion loans is generally determined utilizing factors deemed relevant under the circumstances of the market including but not limited to: actual transfers, pending transfers, median and average sales prices, discounted cash flows, market direction and sentiment, and general economic trends for the industry and economy. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. We deem a loan impaired when, based on current information and events, it is probable that we will be unable to collect the amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. We charge-off loans in the period that such loans are deemed uncollectible or when they reach 120 days delinquent regardless of whether the loan is a recreation, home improvement, or medallion loan.

The methodology used in the periodic review of reserve adequacy, which is performed at least quarterly, is designed to be responsive to changes in portfolio credit quality and inherent credit losses. The changes are reflected in both the pooled formula reserve and in specific reserves as the collectability of larger classified loans is regularly recalculated with new information as it becomes available. Management is primarily responsible for the overall adequacy of the allowance.

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We adopted the Current Expected Credit Loss accounting standard (Topic 326), otherwise known as CECL, effective January 1, 2023. We anticipate the adoption will increase our allowance for loan losses (allowance for credit losses under CECL) by $11.6 million for consumer loans and a $2.2 million increase with respect to our commercial loans. With the adoption of CECL, we expect that there will be earlier recognition of credit losses, including a near-term effect of larger loan loss provisions, compared to the previous incurred losses accounting standard.

Goodwill and Intangible Assets

Goodwill and intangible assets arose as a result of the excess of the fair value that was determined by an independent third party expert over the book value of several of our previously unconsolidated portfolio investment companies as of April 2, 2018. Goodwill is not amortized, but is subject to quarterly review by management to determine whether additional impairment testing is needed, and such testing is performed at least on an annual basis. The annual goodwill assessment is focused on the Bank goodwill of $150.8 million and intangible assets of $22.0 million, both of which utilized a step zero qualitative impairment analysis based on historical and projected financial data. The Bank-related intangible assets are amortized over their approximate useful life.

Deferred Taxes

Deferred taxes reflect the impact of temporary differences between the carrying amount of assets and liabilities and their tax basis and are stated at tax rates expected to be in effect when taxes are actually paid or recovered. Deferred tax assets are recognized subject to management’s judgment that it is more like than not that it will be recognized. In addition, a valuation allowance is recorded when it is deemed that some or all of the deferred tax assets will not be realized due to the temporary differences.

Average Balances and Rates

The following table shows our consolidated average balance sheets, interest income and expense, and the average interest earning/bearing assets and liabilities, and which reflect the average yield on assets and average costs on liabilities as of and for the years ended December 31, 2022, 2021, and 2020.

(1)
Includes financed sales of this collateral to third parties reported separately from the loan portfolio, and that are conducted by the Bank of $7.5 million, $7.4 million, and $3.5 million as of December 31, 2022, 2021, and 2020.

(2)
Excludes deferred financing costs of $7.0 million and $7.1 million as of December 31, 2022 and 2021.

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For the year ended December 31, 2022, our net loans receivable yielded 11.77% (compared to 12.24% for the year ended December 31, 2021). The 47 basis point decrease from the prior year is attributable to the changing mix of our loans, mainly driven by the growth in the home improvement loans, which have a lower coupon than our recreation and commercial loans, as well as competitive pressures in the home improvement segment. Our debt, a significant component being certificates of deposit, funds our growing lending business. Our average interest cost during the year decreased 11 basis points from the prior year, primarily the result of the changing composition, with certificates of deposit comprising a larger percentage of our debt at the end of 2022 as compared to the prior year. Despite the rising costs associated with our certificates of deposit issued during 2022, these borrowings carry a much lower cost of funds than our other funding sources.

Rate/Volume Analysis

The following table presents the change in interest income and expense due to changes in the average balances (volume) and average rates, calculated for the years ended December 31, 2022, 2021, and 2020.

For the year ended December 31, 2022, interest income increased primarily due to the increased volume of our recreation and home improvement loan portfolios, even as the average yield decreased on these portfolios. In 2022, we increased rates on newly issued recreation and home improvement loans; however, the effects of these increases have been mitigated as maturing and pre-paid loans had interest rates comparable to or exceeding these increased rates. Despite a decrease in our average borrowing cost, interest expense increased for 2022 driven by the overall increase in our borrowings. The portion of our borrowings represented by deposits, our lowest cost of funds, accounted for a greater percentage of our total borrowings in 2022 compared to 2021 and caused a decrease in our average cost of borrowings, despite a slight increase in costs of those deposits.

Our interest expense is driven by the interest rates payable on our bank certificates of deposit, fixed-rate, long-term private notes, fixed-rate, long-term debentures issued to the SBA, preferred securities, and have historically included short-term credit facilities with banks and other short-term notes payable. The Bank issues brokered bank certificates of deposit, which are our lowest borrowing costs. The Bank is able to bid on these deposits at a wide variety of maturity levels which allows for improved interest rate management strategies.

Our cost of funds is primarily driven by the rates paid on our various debt instruments and their relative mix, 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 continue to seek SBA funding through Medallion Capital 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 2020, we obtained a $25.0 million commitment from the SBA. As of December 31, 2022 and 2021, adjustable rate debt constituted 2% of total debt.

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Loans

Loans are reported at the principal amount outstanding, inclusive of deferred loan acquisition costs, which primarily includes deferred fees paid to loan originators, which are amortized to interest income over the life of the loan. For the years ended December 31, 2022 and 2021, there was continued growth in the recreation and home improvement segments, as well as, and to a lesser extent, in the commercial segment.

The following table presents the approximate maturities and sensitivity to change in interest rates for our loans as of December 31, 2022.

(1)
Excludes strategic partnership loans.

(2)
Excludes deferred costs.

(3)
As of December 31, 2022, there were no floating-rate loans.

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Provision and Allowance for Loan Loss

Our methodology to calculate the general reserve portion of the allowance includes the use of quantitative and qualitative factors. We initially determine an allowance based on quantitative loss factors for loans evaluated collectively for impairment. The quantitative loss factors are based primarily on historical loss rates, after considering loan type, historical loss and delinquency experience. The quantitative loss factors applied in the methodology are periodically reevaluated and adjusted to reflect changes in historical loss levels or other risks. Qualitative loss factors are used to modify the reserve determined by the quantitative factors and are designed to account for losses that may not be included in the quantitative calculation according to management’s best judgment. If our qualitative loss factor rates were to increase 50 basis points, our recreation and home improvement general reserve would increase by $5.9 million and $3.1 million, respectively. Likewise, if our qualitative loss factor rates were to decrease 50 basis points, our recreation and home improvement general reserve would decrease by $5.9 million and $3.1 million, respectively. Performing loans are recorded at book value and the general reserve is maintained to absorb expected losses consistent with GAAP.

We continued to utilize a value of $79,500 for New York City taxi medallions in determining loan loss allowances for medallion loans, during the year ended December 31, 2022, despite reported transfer prices exceeding that level at various points during the year, as we continue to deem the entire medallion portfolio as impaired.

The following table sets forth the activity in the allowance for loan losses for December 31, 2022 and 2021.

(1)
As of December 31, 2022, cumulative net charge-offs of loans and loan collateral in process of foreclosure in the medallion portfolio were $244.2 million, some of which may represent collection opportunities for us.

(2)
As of December 31, 2022, there was no allowance for loan loss and net charge-offs related to the strategic partnership loans.

Allowance for loan losses by type as of December 31, 2022 and 2021 follows:

As of December 31, 2022, the overall allowance for loan losses increased from December 31, 2021, mainly due to the growth of the loan portfolio, specifically the recreation and home improvement loans, as well as a higher allowance coverage ratio related to both recreation and home improvement loans, a result of the increased net charge-offs in 2022, compared to 2021. For recreation and home improvement loans, as of December 31, 2021 the presented allowances exclude $4.2 million and $0.5 million of loan loss allowances which had been netted within loans as a result of the consolidation of Medallion Bank, which was fully amortized in 2022.

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

(1)
Percentages are calculated against the total or managed loan portfolio, as appropriate.

(*) Less than 0.1%.

For the recreation loan portfolio, the process to repossess the collateral is started at 60 days past due. If the collateral is not located and the account reaches 120 days delinquent, the account is charged-off to realized losses. If the collateral is repossessed, a realized loss is recorded to write the collateral down to its net realizable value, and the collateral is sent to auction. When the collateral is sold, the net auction proceeds are applied to the account, and any remaining balance is written off as a realized loss, and any excess proceeds are recorded as a recovery. Proceeds collected on charged-off accounts are recorded as recoveries. All collection, repossession, and recovery efforts are handled on behalf of the Bank by the servicer. We estimate that the weighted average loan-to-value ratio of our medallion loans was approximately 339%, 295%, and 327%, for the years ended December 31, 2022, 2021, and 2020.

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 table shows the activity of loan collateral in process of foreclosure for the twelve months ended December 31, 2022 and 2021.

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SEGMENT RESULTS

We manage our financial results under four operating segments; recreation lending, home improvement lending, commercial lending, and 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 71%, 74%, and 76% of our interest income for the years ended December 31, 2022, 2021, and 2020.

We maintain relationships with approximately 3,100 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 48% of recreation lending’s new loan originations for the year ended December 31, 2022. 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 $18,000 as of December 31, 2022. The loans are fixed rate with an average term at origination of 11.3 years. The weighted average maturity of our loans outstanding as of December 31, 2022 is 9.6 years.

The loans are secured primarily by RVs, boats, and trailers, with RV loans making up 58% of the portfolio, boat loans making up 19% of the portfolio, and trailer loans 14% as of December 31, 2022, compared to 60%, 19% and 9% as of December 31, 2021. Recreation loans are made to borrowers residing nationwide, with the highest concentrations in Texas and Florida, at 16% and 11% of loans outstanding with no other states over 10%. As of December 31, 2022, 2021, and 2020, the weighted average FICO scores of our recreation loans outstanding were 671, 668, and 658. The weighted average FICO scores at the time of origination for the loans funded in the years ended December 31, 2022, 2021, and 2020 were 676, 684, and 680.

The following table presents selected financial data and ratios as of and for the years ended December 31, 2022, 2021, and 2020.

(1)
Loans 90 days or more past due.

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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 37%, 23%, and 12% of total loans outstanding as of December 31, 2022, as compared to 30%, 26%, and 13% as of December 31, 2021, with no other collateral types over 10%. Home improvement loans are made to borrowers residing nationwide, with the highest concentrations in Texas and Florida at 10% and 10% of loans outstanding December 31, 2022, with no other states over 10%. As of December 31, 2022, 2021, and 2020, the weighted average FICO scores of our home improvement loans outstanding were 753, 754, and 758. The weighted average FICO scores at the time of origination for the loans funded in the years ended December 31, 2022, 2021, and 2020 were 758, 759, and 759.

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. Our top ten contractors and FSP relationships were responsible for 62% of home improvement lending’s new loan originations for the year ended December 31, 2022. 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.

During the year ended December 31, 2022, the home improvement lending segment continued to grow with the net portfolio increasing 43% from the prior year. Reserve coverage rates increased 14 basis points from a year ago. The interest yield decreased from the prior year period, as did the net interest margin, which also reflected higher rates on borrowings and certificates of deposit issued in the current year as compared to the prior year.

The following table presents selected financial data and ratios as of and for the years ended December 31, 2022, 2021, and 2020.

(1)
Loans 90 days or more past due.

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Commercial Lending

We originate both senior and subordinated loans nationwide to businesses in a variety of industries, more than 44% of which are located in the Midwest region, with the rest scattered across the country. These mezzanine loans are primarily secured by a second position on all assets of the businesses and generally range in amount from $2.0 million to $5.0 million at origination, and typically include an equity component as part of the financing. The commercial lending business has concentrations in manufacturing and wholesale trade, making up 52% and 15% of the outstanding loans as of December 31, 2022.

During the year ended December 31, 2022, the commercial portfolio grew to $92.9 million, representing $28.2 million of new loan originations, offset by payoffs and charge-offs. Additionally, reserve rates increased, reflecting specific reserves on aged investments.

The following table presents selected financial data and ratios as of and for the years ended December 31, 2022, 2021, and 2020. 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.

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

(2)
Loans 90 days or more past due.

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

(1)
Includes nine other states, which were all under 10% as of December 31, 2022 and 10 other states, which were all under 10% as of December 31, 2021.

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Medallion Lending

The medallion lending segment operates mainly in the New York City, Newark, and Chicago markets. We have a long history of owning, managing, and financing taxi fleets, taxi medallions, and corporate car services. We continue to not recognize interest income with all loans being placed on nonaccrual as of the third quarter 2020, and 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.

The following table presents selected financial data and ratios as of and for the years ended December 31, 2022, 2021, and 2020.

(1)
Loans 90 days or more past due.

(*) Less than 1%.

(*) Less than 1%.

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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 not 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. Strategic partnership loans were $0.6 million in net loans as of December 31, 2022, compared to $0.1 million as of December 31, 2021. This segment also reflects the gains (losses) on the dispositions of certain non-core assets.

The following table presents selected financial data and ratios as of and for the years ended December 31, 2022, 2021, and 2020.

Summary Consolidated Financial Ratios

The following table presents selected financial data and ratios as of and for the years ended December 31, 2022, 2021, and 2020.

(1)
Other income ratio represents other income divided by average interest earning assets.

(2)
Total expense ratio represents total expenses (interest expense, operating expenses, and income taxes) divided by average interest earning assets.

(3)
Includes $68.8 million, $68.8 million, and $73.2 million related to non-controlling interests in consolidated subsidiaries as of December 31, 2022, 2021, and 2020.

(4)
Excludes deferred financing costs of $7.0 million, $7.1 million, and $5.8 million as of December 31, 2022, 2021, and 2020.

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Consolidated Results of Operations

For the Year Ended December 31, 2022 Compared to the Year Ended December 31, 2021

Net income attributable to shareholders was $43.8 million, or $1.83 per share, for the year ended December 31, 2022, compared to $54.1 million, or $2.17 per share, for the year ended December 31, 2021.

Total interest income was $196.6 million for the year ended December 31, 2022, compared to $159.0 million for the year ended December 31, 2021. The increase in interest income reflects continued growth in the recreation and home improvement lending segments, and to a lesser extent, growth in our commercial lending segment. The yield on interest earning assets was 11.06% for the year ended December 31, 2022, compared to 11.51% for the year ended December 31, 2021, reflecting the growth of our home improvement lending segment, the loans of which have a lower coupon associated with the higher credit quality, as compared to our other lending segments which carry a higher coupon. Average interest earning assets were $1.8 billion for the year ended December 31, 2022, an increase from $1.4 billion for the year ended December 31, 2021, due to continued demand for both recreation and home improvement loans in 2022. In 2022, loan originations were $983.9 million, up from $747.4 million in 2021, with $513.1 million and $392.5 million of the 2022 originations attributable to the recreation and home improvement loans.

Loans before allowance for loan losses were $1.9 billion as of December 31, 2022, comprised of recreation ($1.2 billion), home improvement ($0.6 billion), commercial ($92.9 million), medallion ($13.6 million), and strategic partnership (less than $0.6 million) loans. We had an allowance for loan losses as of December 31, 2022 of $63.8 million, which was attributable to the recreation (66%), home improvement (18%), medallion (15%), and commercial (1%) loan portfolios. As of December 31, 2021, loans before allowance for loan losses were $1.5 billion, comprised of recreation ($1.0 billion), home improvement ($0.4 billion), commercial ($76.7 million), medallion ($14.0 million), and strategic partnership ($0.1 million) loans. We had an allowance for loan losses as of December 31, 2021 of $50.2 million, which was attributable to recreation (64%), medallion (19%), and home improvement (15%) loans. The loan loss allowance increased during the year, primarily due to the growth in the loan portfolio, as well as due to increases in the rate at which we provision for loans, specifically our recreation and home improvement loans, with the allowance rate for these portfolios increasing 18 basis points and 13 basis points, respectively. These increases represent the increased charge-off exposure incurred in 2022 as compared to the prior year.

Loans increased $0.4 billion, or 29%, from $1.5 billion as of December 31, 2021 to $1.9 billion as of December 31, 2022 as a result of $1.0 billion of loan originations, offset primarily by principal payments, and to a lesser extent charge-offs and transfers to loan collateral in process of foreclosure. The provision for loan losses was $30.1 million for the year ended December 31, 2022, compared to $4.6 million for the year ended December 31, 2021. The increase from the prior year is attributable to the growth in the loan portfolio, with new loans requiring an initial allowance be recorded upon issuance, an increase in net charge-offs during the year, as well as an increase in our allowance rate for our loans, particularly recreation and home improvement loans where our allowance coverage rates increased 18 basis point and 13 basis points, respectively. See Note 4 of the accompanying consolidated financial statements for additional information on loans and allowance for loan losses.

Interest expense was $36.2 million for the year ended December 31, 2022, compared to $31.1 million for the year ended December 31, 2021. The increase from the prior year is attributable to the increase in our borrowings, primarily the increase in our certificates of deposit, despite our average cost of borrowing for the year decreasing 11 basis points from the prior year. The average cost of borrowed funds was 2.17% for the year ended December 31, 2022, compared to 2.28% for the year ended December 31, 2021, the decrease mainly driven by the changing mix of our borrowings, with certificates of deposit, our lowest cost of funding, continuing to be a larger portion of our borrowings when compared to prior years. The average cost of the certificates of deposit was 1.57% during the year ended December 31, 2022, compared to 1.55% for the year ended December 31, 2022, with the increase reflecting the increased costs associated with newly issued deposits in the current year when compared to the maturing deposits. We expect our average cost of funds to increase from these levels in this current inflationary environment as we continue to rely upon the issuance of new certificates of deposit to fund our growing lending business. Average debt outstanding was $1.7 billion for the year ended December 31, 2022, up from $1.4 billion for the year ended December 31, 2021, as we issued additional certificates of deposit fund our loan growth. See page 37 for tables that show average balances and cost of funds for our funding sources.

Net interest income was $160.4 million for the year ended December 31, 2022, compared to $127.8 million for the year ended December 31, 2021. Net interest margin was 9.05% for the year ended December 31, 2022, compared to 9.25%, for the year ended December 31, 2021, reflecting the above. With the rates we charge on loans and our cost of funds both increasing due to inflation, we expect our net interest margin to continue to tighten in 2023.

Net other income, which is comprised primarily of gains on the sale of loans and medallion, gains (losses) on equity investments, prepayment fees, servicing fee income, late charges, write-downs of loan collateral, and sponsorship and race winnings in the previous year, was $9.5 million for the year ended December 31, 2022, compared to $31.6 million for the year ended December 31, 2021. The decrease was mainly due to the absence of non-recurring gains such as disposal of equity investments and the extinguishment of debt, as well as the absence of sponsorship and race winnings in the current year resulting from the disposition of our ownership in RPAC in December 2021.

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Operating expenses were $72.1 million for year ended December 31, 2022, down from $72.9 million for year ended December 31, 2021. Salaries and benefits were $31.1 million for the year ended December 31, 2022, down from $31.6 million for the year ended December 31, 2021, with the change mainly attributable to the absence of RPAC related salaries, offset by the increased number of employees at the Bank tied to the overall growth in our assets. Professional fees were $13.1 million for the year ended December 31, 2022, compared to $5.3 million for the year ended December 31, 2021, primarily reflective of higher legal and professional costs for a variety of corporate matters inclusive of the SEC litigation.

Total income tax expense was $18.0 million for the year ended December 31, 2022, compared to $24.2 million for the year ended December 31, 2021, for which $1.8 million of tax expense was recorded in 2021 related to a valuation allowance with respect to certain tax assets which we believe will not be realized.

Loan collateral in process of foreclosure was $21.8 million at December 31, 2022, a decline from $37.4 million at December 31, 2021. The decrease primarily reflects cash payments received and structured settlements during the year.

For the Year Ended December 31, 2021 Compared to the Year Ended December 31, 2020

For a comparison of the Company’s results of operations for the year ended December 31, 2021 to the year ended December 31, 2020, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the Securities and Exchange Commission on March 14, 2022.

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 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, privately placed notes, SBA debentures and borrowings, and preferred securities).

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 portfolios. We believe that the average life of our loan portfolios 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.

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The following table presents our interest rate sensitivity gap at December 31, 2022. 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 have not reflected an assumed annual prepayment rate for such assets in this table.

(1)
The ratio of the cumulative one-year gap to total interest rate sensitive assets was (18%), (14%), and (27%) as of December 31, 2022, 2021, and 2020.

(2)
Excludes federal funds sold and investment securities.

Our interest rate sensitive assets were $2.1 billion and interest rate sensitive liabilities were $1.8 billion at December 31, 2022. The one-year cumulative interest rate gap was a negative $367.8 million or 18% of interest rate sensitive assets. We actively monitor the level of exposure with the goal that movements in interest rates not adversely and unexpectedly negatively affect future earnings. We use net interest income sensitivity analysis as our primary metric to measure and manage the interest rate sensitivities of our loan and investment securities portfolios.

LIBOR is set to terminate on June 30, 2023. We do not have lendings tied to LIBOR and do not expect an impact on our loans. We have borrowings, our trust preferred securities that bear a variable rate of interest of 90 day LIBOR (4.77% at December 31, 2022) plus 2.13%. For these borrowings, the Secured Overnight Financing Rate (SOFR) adjusted by a relevant spread adjustment of approximately 43 basis points will replace LIBOR upon its termination. We do not expect this change to have a material impact on our borrowings.

Liquidity and Capital Resources

Our sources of liquidity include brokered certificates of deposit, unfunded commitments to sell debentures to the SBA, loan amortization and prepayments, private 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. Additionally, the Bank has up to $75.0 million available under Fed Funds lines with several commercial banks, and as of December 31, 2022, we had unfunded commitments from the SBA of $4.8 million.

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.

The net proceeds from the December 2020, February 2021, March 2021 and April 2021 private placements were used for general corporate purposes, including repayment of outstanding debts, 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.

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 expected to be three-month Secured Overnight Financing Rate, or SOFR) plus a spread of 6.46% per annum.

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In March 2019, we completed a private placement to certain institutional investors of $30.0 million aggregate principal amount of 8.25% unsecured notes due 2024, with interest payable semiannually. A follow-on offering of these notes in the 2019 third quarter raised an additional $6.0 million.

The table below presents the components of our debt were as of December 31, 2022, exclusive of deferred financing costs of $7.0 million. See Note 4 to the consolidated financial statements for details of the contractual terms of our borrowings.

(1)
Weighted average contractual rate as of December 31, 2022.

(2)
Balance includes $1.3 million of strategic partner reserve deposits as of December 31, 2022.

Our contractual obligations expire on or mature at various dates through September 2037. The following table shows all contractual obligations at December 31, 2022.

(1)
Total debt is exclusive of deferred financing costs of $7.0 million.

(2)
Balance excludes $1.3 million of strategic partner reserve deposits as of December 31, 2022.

Approximately $977 million of our borrowings have maturity dates during the next two years, a vast majority of which are brokered certificates of deposit.

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 loans and 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 December 31, 2022 by $1.2 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 $1.4 million at December 31, 2022. 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.

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The following table illustrates sources of available funds for us and each of our subsidiaries, and amounts outstanding under credit facilities and their respective end of period weighted average interest rates at December 31, 2022. See Note 5 to the consolidated financial statements for additional information about each credit facility.