The information contained in this section should be read in conjunction with the Consolidated Financial Statements and Notes thereto for the years ended December 31, 2008, 2007, and 2006. 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 18.

CRITICAL ACCOUNTING POLICIES

The SEC has recently issued cautionary advice regarding disclosure about critical accounting policies. The SEC defines critical accounting policies as those that are both most important to the portrayal of a company's financial condition and results, and that require management's most difficult, subjective, or complex judgments, often as a result of the need to make estimates about matters that are inherently uncertain and may change materially in subsequent periods. The preparation of our consolidated financial statements requires estimates and assumptions that affect amounts reported and disclosed in the financial statements and related notes. Significant estimates made by us include valuation of loans, evaluation of the recoverability of accounts receivable and income tax assets, and the assessment of litigation and other contingencies. The matters that give rise to such provisions are inherently uncertain and may require complex and subjective judgments. Although we believe that estimates and assumptions used in determining the recorded amounts of net assets and liabilities at December 31, 2008 are reasonable, actual results could differ materially from the estimated amounts recorded in our financial statements.

Change in reporting entity

Since Medallion Bank commenced operations in December 2003, we had historically consolidated Medallion Bank's financial statements with those of our own. Although Medallion Bank is not an investment company, and SEC rules generally do not permit investment companies such as ours to consolidate the financial statements of non-investment companies, such as Medallion Bank, we had sought and obtained a letter from the SEC in March 2004 permitting such consolidation. We believed that consolidating Medallion Bank provided a more complete and accurate representation of our full scope of operations, and our complete financial position and results of operations.

During August 2006, we filed a registration statement on Form N-2 which the SEC staff reviewed and on which they provided comments, including those relating to the consolidation of the accounts of Medallion Bank which have evolved since 2004. Based on discussion with the SEC staff, we determined during the 2006 fourth quarter to voluntarily not consolidate Medallion Bank and present Medallion Bank as a portfolio company. We determined that this change represents a change in the reporting entity as described in SFAS No. 154, "Accounting Changes and Error Corrections." Accordingly we retrospectively applied this change to the financial statements of all prior periods presented, including previously issued interim periods presented, included in our 2006 Form 10-K. The effect of this retrospective application was to present our financial position and results of operations as if Medallion Bank had not been consolidated for all periods presented and to present Medallion Bank as an unconsolidated portfolio investment. Although this created changes in the reported levels of assets, liabilities, revenues, and expenses, our net increase in net assets resulting from operations, shareholders' equity, and the related amounts per common share were unchanged.

GENERAL

We are a specialty finance company that has a leading position in originating, acquiring, and servicing loans that finance taxicab medallions and various types of commercial businesses. A wholly-owned portfolio company of ours, Medallion Bank, also originates consumer loans for the purchase of recreational vehicles, boats, motorcycles, and trailers. Since 1996, the year in which we became a public company, we have increased our taxicab medallion loan portfolio at a compound annual growth rate of 10%, and our commercial loan portfolio at a compound annual growth rate of 7% (12% and 13% on a managed basis when combined with Medallion Bank). Since Medallion Bank acquired a consumer loan portfolio and began originating consumer loans in 2004, it has increased its consumer loan portfolio at a compound annual growth rate of 18%. Total assets under our management, which includes assets serviced for third party investors and managed by unconsolidated portfolio companies, were $1,075,509,000 as of December 31, 2008 and $1,017,433,000 at December 31, 2007, and have grown at a compound annual growth rate of 14% from $215,000,000 at the end of 1996.

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, such as revolving bank facilities, bank certificates of deposit issued to customers, debentures issued to and guaranteed by the SBA, and bank term debt. Net interest income fluctuates with changes in the yield on our loan portfolio and changes in the cost of borrowed funds, as well as changes in the amount of interest-bearing 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 on a different basis than our interest-bearing liabilities.

We also provide debt, mezzanine, and equity investment capital to companies in a variety of industries, consistent with our investment objectives. These investments may be venture capital style investments which may not be fully collateralized. Medallion Capital's investments are typically in the form of secured debt instruments with fixed interest rates accompanied by 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.

We are a closed-end, non-diversified management investment company under the 1940 Act. We have elected to be treated as a business development company under the 1940 Act. We have also elected to be treated for federal income tax purposes as a RIC under Subchapter M of the Code. As a RIC, we generally do not have to pay corporate-level federal income taxes on any net ordinary income or capital gains that we distribute to our shareholders as dividends if we meet certain source-of-income and asset diversification requirements. Medallion Bank is not a RIC and must pay corporate-level federal income taxes.

Our wholly-owned portfolio company, Medallion Bank, is a bank regulated by the FDIC and the Utah Department of Financial Institutions which originates taxicab medallion, commercial, and consumer loans, raises deposits, and conducts other banking activities. Medallion Bank generally provides us with our lowest cost of funds which it raises through bank certificates of deposits issued to its customers. To take advantage of this low cost of funds, we refer a portion of our taxicab medallion and commercial loans to Medallion Bank, which then originates these loans, which are serviced by us. We earn referral and servicing fees for these activities.

Realized gains or losses on investments are recognized when the investments are sold or written off. The realized gains or losses represent the difference between the proceeds received from the disposition of portfolio assets, if any, and the cost of such portfolio assets. In addition, changes in unrealized appreciation or depreciation of investments are recorded and represent the net change in the estimated fair values of the portfolio assets at the end of the period as compared with their estimated fair values at the beginning of the period. Generally, realized gains (losses) on investments and changes in unrealized appreciation (depreciation) on investments are inversely related. When an appreciated asset is sold to realize a gain, a decrease in the previously recorded unrealized appreciation occurs. Conversely, when a loss previously recorded as unrealized depreciation is realized by the sale or other disposition of a depreciated portfolio asset, the reclassification of the loss from unrealized to realized causes a decrease in net unrealized depreciation and an increase in realized loss.

Our investment in Medallion Bank, as a wholly owned portfolio investment, is also subject to quarterly assessments of fair value. We conduct a thorough valuation analysis as described previously, and determine whether any factors give rise to a valuation different than recorded book value, including various regulatory restrictions that were established at Medallion Bank's inception, by the FDIC and State of Utah, and also by additional marketplace restrictions, such as the ability to transfer industrial bank charters. As a result of this valuation process, we used Medallion Bank's actual results of operations as the best estimate of changes in fair value, and recorded the results as a component of unrealized appreciation (depreciation) on investments, although changes in these restrictions and other applicable factors could change these conclusions in the future.

The credit markets are undergoing a crisis which has disrupted a wide range of traditional financing sources. The crisis has made it increasingly difficult and significantly more expensive through higher credit spreads for finance companies to obtain and renew financing. Continued turmoil in the credit markets could limit our access to funds and restrict us from continuing our current operating strategy or implementing new operating strategies. If funds are available to us, we anticipate that our cost of funds will increase as we obtain new financing.

The credit crisis has also caused many financial institutions to record significant write-downs, mostly on their residential mortgage related assets and structured investment vehicles and due to unsound lending practices. We are not involved in these types of transactions and always understand the importance of proper underwriting. Nonetheless, the judgments used by management in applying the critical accounting policies discussed herein may be affected by a further and prolonged deterioration in the economic environment, which may result in changes to future financial results. Subsequent evaluations of our loan portfolio and other investments, in light of the factors then prevailing, may result in changes to the fair value of the investments, including a decrease in the fair value. In addition, the fair value of investments in our portfolio may be negatively impacted by illiquidity or dislocation in marketplaces resulting in depressed market prices.

Trends in Investment Portfolio

Our investment income is driven by the principal amount of and yields on our
investment portfolio. To identify trends in the balances and yields, the
following table illustrates our investments at fair value, grouped by medallion
loans, commercial loans, equity investments, and investment securities, and also
presents the portfolio information for Medallion Bank, at the dates indicated.



                                                December 31, 2008             December 31, 2007             December 31, 2006
                                            Interest      Investment      Interest      Investment      Interest      Investment
(Dollars in thousands)                      Rate (1)       Balances       Rate (1)       Balances       Rate (1)       Balances
Medallion loans
New York                                        6.04 %   $    304,306         6.91 %   $    399,955         6.74 %   $    340,110
Boston                                          7.54           31,283         8.44           32,446         8.12           32,787
Chicago                                         7.15           28,172         7.43           33,008         6.88           31,077
Newark                                          8.17           27,809         8.40           22,058         8.32           10,233
Cambridge                                       7.59            4,387         8.41            5,174         7.93            8,184
Other                                           7.40            6,584         7.58            5,481         7.55            5,586

Total medallion loans                           6.42          402,541         7.13          498,122         6.93          427,977

Deferred loan acquisition costs                                   423                           798                           729
Unrealized depreciation on loans                                   -                            (37 )                        (457 )

Net medallion loans                                      $    402,964                  $    498,883                  $    428,249

Commercial loans
Secured mezzanine                              14.23 %   $     65,475        14.19 %   $     59,152        13.78 %   $     53,732
Asset based                                     5.29           13,552         8.91           19,870        10.28           18,668
Other secured commercial                        8.34           15,870         9.05           19,256         9.59           18,504

Total commercial loans                         11.97           94,897        12.12           98,278        12.21           90,904

Deferred loan acquisition (income) costs                         (171 )                         (64 )                         (98 )
Unrealized depreciation on loans                               (5,115 )                      (6,432 )                      (2,599 )

Net commercial loans                                     $     89,611                  $     91,782                  $     88,207

Investment in Medallion Bank and other
controlled subsidiaries, net                    8.22 %   $     74,750        13.79 %   $     57,501         0.00 %   $     50,448

Equity investments                              4.33 %   $      2,835         4.70 %   $      2,138         2.23 %   $     13,955

Unrealized appreciation on equities                               437                         2,742                         2,113

Net equity investments                                   $      3,272                  $      4,880                  $     16,068

Investment securities                             -  %   $         -            -  %   $         -          5.09 %   $      9,961

Unrealized depreciation on investment
securities                                                         -                             -                             -

Net investment securities                                $         -                   $         -                   $      9,961

Investments at cost                             7.56 %   $    575,023         8.45 %   $    656,039         7.01 %   $    593,245

Deferred loan acquisition costs                                   252                           734                           631
Unrealized appreciation on equities                               437                         2,742                         2,113
Unrealized depreciation on loans                               (5,115 )                      (6,469 )                      (3,056 )

Net investments                                          $    570,597                  $    653,046                  $    592,933

Medallion Bank investments
Consumer loans                                 18.26 %   $    189,886        18.54 %   $    139,972        18.48 %   $    113,777
Medallion loans                                 6.46          122,581         6.72           87,891         6.65           94,176
Commercial loans                                5.64           87,800         9.14           88,785        10.35           60,929
Investment securities                           4.87           20,056         4.82           21,707         4.60           21,841

Medallion Bank investments at cost (2)         11.54          420,323        12.12          338,355        11.90          290,723

Deferred loan acquisition costs                                 5,994                         4,569                         3,155
Unrealized appreciation (depreciation) on
investment securities                                             (64 )                          39                          (402 )
Premiums paid on purchased securities                              96                            91                           245
Unrealized depreciation on loans                              (10,936 )                      (7,311 )                      (6,057 )

Medallion Bank net investments                           $    415,413                  $    335,743                  $    287,664

(1) Represents the weighted average interest or dividend rate of the respective portfolio as of the date indicated.

(2) The weighted average interest rate for the entire managed loan portfolio (medallion, commercial, and consumer loans) was 9.44%, 9.57%, and 9.44% at December 31, 2008, 2007, and 2006.

PORTFOLIO SUMMARY

Total Portfolio Yield

The weighted average yield of the total portfolio at December 31, 2008 was 7.56% (7.47% for the loan portfolio), a decrease of 88 basis points from 8.44% at December 31, 2007, which was an increase of 143 basis points from 7.01% at December 31, 2006. The weighted average yield of the total managed portfolio at December 31, 2008 was 9.22% (9.44% for the loan portfolio), a decrease of 19 basis points from 9.41% at December 31, 2007, which was an increase of 37 basis points from 9.04% at December 31, 2006. The decrease from 2007 reflected the general market condition of falling interest rates, partially offset by changes in the portfolio composition towards higher yielding commercial and equity investments. The increase from 2006 primarily reflected the market increase in interest rates, partially offset by a higher proportion of lower-yielding medallion loans.

Medallion Loan Portfolio

Our medallion loans comprised 70% of the net portfolio of $570,597,000 at December 31, 2008, compared to 76% of $653,046,000 at December 31, 2007 and 72% of $592,933,000 at December 31, 2006. Our managed medallion loans of $525,372,000 comprised 57% of the net portfolio of $922,007,000 at December 31, 2008, compared to 63% of $934,955,000 at December 31, 2007 and 63% of $833,639,000 at December 31, 2006. The medallion loan portfolio decreased by $95,919,000 or 19% in 2008 ($61,126,000 or 10% on a managed basis), primarily reflecting decreases in New York, Chicago and Boston. The decrease in the New York market can be attributed to loan payoffs and the sale of participation interests to third parties. Total medallion loans serviced for third parties were $66,041,000, $4,443,000, and $5,783,000 at December 31, 2008, 2007, and 2006.

The weighted average yield of the medallion loan portfolio at December 31, 2008 was 6.42%, a decrease of 71 basis points from 7.13% at December 31, 2007, which was an increase of 20 basis points from 6.93% at December 31, 2006. The weighted average yield of the managed medallion loan portfolio at December 31, 2008 was 6.43%, a decrease of 64 basis points from 7.07% at December 31, 2007, which was an increase of 19 basis points from 6.88% at December 31, 2006. The change in yield primarily reflected the impact of changes in interest rates in the economy which rose from 2006 into 2007 and then fell sharply. At December 31, 2008, 24% of the medallion loan portfolio represented loans outside New York, compared to 20% and 21% at year-end 2007 and 2006. At December 31, 2008, 26% of the managed medallion loan portfolio represented loans outside New York, compared to 17% and 18% at year-end 2007 and 2006. We continue to focus our efforts on originating higher yielding medallion loans outside the New York market.

Commercial Loan Portfolio

Our commercial loans represented 16% of the net investment portfolio as of December 31, 2008, compared to 14% and 15% at December 31, 2007 and 2006, and were 19%, 19%, and 18% on a managed basis. Commercial loans decreased by $2,171,000 or 2% during 2008 (decreased by $3,404,000 or 2% on a managed basis), primarily reflecting loan participations sold. Net commercial loans serviced by third parties were $8,646,000 at December 31, 2008 and $12,643,000 at December 31, 2007, compared to loans serviced for third parties of $7,761,000 at December 31, 2006.

The weighted average yield of the commercial loan portfolio at December 31, 2008 was 11.97%, a decrease of 15 basis points from 12.12% at December 31, 2007, which was down 9 basis points from 12.21% at December 31, 2006. The weighted average yield of the managed commercial loan portfolio at December 31, 2008 was 8.93%, a decrease of 177 basis points from 10.70% at December 31, 2007, which was down 76 basis points from 11.46% at December 31, 2006. The decrease in the managed portfolio reflected the greater proportion of floating rate loans, compared to the owned portfolio with a larger concentration of high-yield, fixed rate loans. We continue to originate adjustable-rate and floating-rate loans tied to the prime rate. At December 31, 2008, variable-rate loans represented approximately 22% of the commercial portfolio, compared to 28% and 26% at December 31, 2007 and 2006, and were 59%, 57%, and 55% on a managed basis. Although this strategy initially produces a lower yield, we believe that this strategy mitigates interest rate risk by better matching our earning assets to their adjustable-rate funding sources.

Consumer loan portfolios

Our managed consumer loans, all of which are held in the portfolio managed by Medallion Bank, represented 20% of the managed net investment portfolio as of December 31, 2008, compared to 15% at December 31, 2007 and 13% at December 31, 2006. Medallion Bank started originating new adjustable rate consumer loans during the 2004 third quarter. Recreational vehicles, boats, and trailers located in all 50 states collateralize the loans. The portfolio is serviced by a third party subsidiary of a major commercial bank.

The weighted average gross yield of the managed consumer loan portfolio was 18.26% at December 31, 2008, compared to 18.54% and 18.48% at December 31, 2007 and 2006. Amortization of the portfolio purchase premium reduced the yield by an average of 0.25%, 0.51%, and 0.96% in 2008, 2007, and 2006. Adjustable rate loans represented approximately 89% of the managed consumer portfolio compared to 91% and 84% at December 31, 2007 and 2006.

Delinquency and Loan Loss Experience

We generally follow a practice of discontinuing the accrual of interest income on our loans that are in arrears as to interest payments for a period of 90 days or more. We deliver a default notice and begin foreclosure and liquidation proceedings when management determines that pursuit of these remedies is the most appropriate course of action under the circumstances. A loan is considered to be delinquent if the borrower fails to make a payment on time; however, during the course of discussion on delinquent status, we may agree to modify the payment terms of the loan with a borrower that cannot make payments in accordance with the original loan agreement. For loan modifications, the loan will only be returned to accrual status if all past due interest payments are brought fully current. For credit that is collateral based, we evaluate the anticipated net residual value we would receive upon foreclosure of such loans, if necessary. There can be no assurance, however, that the collateral securing these loans will be adequate in the event of foreclosure. For credit that is cash flow-based, we assess our collateral position, and evaluate most of these relationships as ongoing businesses, expecting to locate and install a new operator to run the business and reduce the debt.

For the consumer 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 75% of 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 realized gain. Proceeds collected on charged off accounts are recorded as realized gains. All collection, repossession, and recovery efforts are handled on behalf of Medallion Bank by the servicer.

The following table shows the trend in loans 90 days or more past due as of December 31,

                                                      2008                2007               2006
(Dollars in thousands)                            Amount    %(1)     Amount    %(1)      Amount    %(1)
Medallion loans                                  $    765    0.2 %   $ 3,519    0.6 %   $  5,707    1.1 %

Commercial loans
Secured mezzanine                                   6,415    1.3       2,819    0.5        3,459    0.7
Asset-based receivable                                 -     0.0          -     0.0           -     0.0
Other secured commercial                              190    0.0       1,195    0.2        1,652    0.3

Total commercial loans                              6,605    1.3       4,014    0.7        5,111    1.0

Total loans 90 days or more past due             $  7,370    1.5 %   $ 7,533    1.3 %   $ 10,818    2.1 %

Total Medallion Bank loans                       $  4,345    1.1 %   $ 1,036    0.3 %   $    631    0.2 %

Total managed loans 90 days or more past due     $ 11,715    1.3 %   $ 8,569    0.9 %   $ 11,449    1.5 %

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

In general, collection efforts since the establishment of our collection department have substantially contributed to the sizable reduction in overall delinquencies of medallion and other secured commercial loans. Medallion delinquencies decreased as a result of a renegotiation and paydowns with a past due relationship. Delinquencies in secured mezzanine financing, mostly in recreational and consumer-discretionary services, increased over 2007 due to the current state of the economy. For the same reasons, Medallion Bank also experienced higher consumer delinquencies due to bankruptcies and job losses. We are actively working with each delinquent borrower to bring them current, and believe that any potential loss exposure is reflected in our mark-to-market estimates on each loan. Although there can be no assurances as to changes in the trend rate and further negative changes in the economy, management believes that any loss exposures are properly reflected in reported asset values.

We monitor delinquent loans for possible exposure to loss by analyzing various factors, including the value of the collateral securing the loan and the . . .