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TAXI > SEC Filings for TAXI > Form 10-Q on 7-Nov-2012All Recent SEC Filings

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Form 10-Q for MEDALLION FINANCIAL CORP


7-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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, trailers and to finance small scale home improvement. 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 5%, and our commercial loan portfolio at a compound annual growth rate of 2% (10% and 7% 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 13%. Total assets under our management and the management of our unconsolidated wholly-owned subsidiaries, which includes assets serviced for third party investors, were $1,176,796,000 as of September 30, 2012, and $1,141,806,000 and $1,113,595,000 as of December 31, 2011 and September 30, 2011, and have grown at a compound annual growth rate of 11% 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, 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 US federal and state income taxes.

Our wholly-owned portfolio company, Medallion Bank, is a Utah industrial 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 deposit 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. However, the FDIC restricts the amount of taxicab medallion loans that Medallion Bank may finance to three times Tier 1 capital, or $343,827,000 as of September 30, 2012. We earn referral fees for these activities. In December 2010, all of these servicing activities were assigned to MSC. As a non-investment company, Medallion Bank is not consolidated with the Company.

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 on 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, 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 regulatory restrictions, such as the current moratorium imposed by the Dodd-Frank Act on the acquisition of control of an industrial bank by a "commercial firm" (a company whose gross revenues are primarily derived from non-financial activities) before July 2013. Because of these restrictions and other factors, our Board of Directors has determined that Medallion Bank has little value beyond its

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recorded book value. 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 have recently experienced 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, 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.

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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.



                                                  September 30, 2012                     June 30, 2012                      March 31, 2012                     December 31, 2011                   September 30, 2011
                                             Interest          Investment         Interest         Investment         Interest         Investment         Interest         Investment         Interest          Investment
(Dollars in thousands)                       Rate (1)           Balances          Rate (1)          Balances          Rate (1)          Balances          Rate (1)          Balances          Rate (1)           Balances
Medallion loans
New York                                           4.16 %     $    202,076             4.43 %     $    201,452             4.52 %     $    214,858             4.66 %     $    227,426              5.20 %     $    229,008
Chicago                                            5.30             39,811             5.45             35,355             5.51             33,217             5.79             34,200              6.45             29,149
Newark                                             6.94             16,836             7.11             16,625             7.20             16,848             7.38             17,693              7.49             17,766
Boston                                             6.10             14,239             6.14             14,895             6.49             15,097             6.56             16,955              6.64             16,916
Cambridge                                          6.44              5,753             6.51              6,048             6.57              6,433             6.62              6,179              6.67              6,297
Other                                              6.72              2,951             6.74              3,021             6.46              4,186             6.54              4,318              6.76              4,373

Total medallion loans                              4.66            281,666             4.89            277,396             4.97            290,639             5.11            306,771              5.59            303,509

Deferred loan acquisition costs                                        220                                 360                                 386                                 396                                  434
Unrealized depreciation on loans                                        -                                   -                                   -                                   -                                    -

Net medallion loans                                           $    281,886                        $    277,756                        $    291,025                        $    307,167                         $    303,943

Commercial loans
Secured mezzanine                                 13.39 %     $     52,059            13.54 %     $     53,649            13.61 %     $     53,577            14.04 %     $     51,622             14.24 %     $     57,578
Asset based                                        5.73              9,138             5.71              7,123             5.65              9,024             5.77              9,388              5.62              8,070
Other secured commercial                           8.36              7,844             8.32              8,120             8.25              8,156             8.06              7,539              8.35              9,251

Total commercial loans                            11.80             69,041            12.11             68,892            11.98             70,757            12.25             68,549             12.58             74,899

Deferred loan acquisition income                                       (67 )                               (52 )                              (113 )                               (92 )                               (112 )
Unrealized depreciation on loans                                   (12,209 )                           (14,560 )                           (14,533 )                           (14,298 )                            (15,767 )

Net commercial loans                                          $     56,765                        $     54,280                        $     56,111                        $     54,159                         $     59,020

Investment in Medallion Bank and other
controlled subsidiaries, net                       9.46 %     $     95,167             8.99 %     $     89,035             7.37 %     $     88,207             6.40 %     $     85,932              4.69 %     $     85,264

Equity investments                                 1.76 %     $      4,375             1.64 %     $      4,575             1.46 %     $      4,581             2.26 %     $      3,472              2.13 %     $      3,471

Unrealized appreciation (depreciation)
on equities                                                            827                                 825                                 943                               1,105                                1,284

Net equity investments                                        $      5,202                        $      5,400                        $      5,524                        $      4,577                         $      4,755

Investment securities                                -  %     $         -                -  %     $         -                -  %     $         -                -  %     $         -                 -  %     $         -

Investments at cost (2)                            6.74 %     $    450,249             6.81 %     $    439,898             6.49 %     $    454,184             6.38 %     $    464,724              6.52 %     $    467,143

Deferred loan acquisition (income) costs                               153                                 308                                 273                                 304                                  322
Unrealized appreciation (depreciation)
on equities                                                            827                                 825                                 943                               1,105                                1,284
Unrealized depreciation on loans                                   (12,209 )                           (14,560 )                           (14,533 )                           (14,298 )                            (15,767 )

Net investments                                               $    439,020                        $    426,471                        $    440,867                        $    451,835                         $    452,982

Medallion Bank investments
Medallion loans                                    4.39 %     $    328,705             4.53 %     $    313,164             4.65 %     $    297,421             4.79 %     $    294,214              5.22 %     $    277,328
Consumer loans                                    17.11            256,396            17.39            232,884            17.68            204,393            17.73            199,843             17.77            204,819
Commercial loans                                   5.01             73,903             5.05             75,451             4.98             79,749             4.97             76,606              4.98             75,383
Investment securities                              2.54             21,638             2.72             20,680             2.58             24,044             2.51             25,419              3.21             21,660

Medallion Bank investments at cost                 9.19            680,642             9.20            642,179             9.01            605,607             9.06            596,082              9.55            579,190

Deferred loan acquisition costs                                      7,004                               6,417                               5,749                               5,597                                5,744
Unrealized appreciation on investment
securities                                                           1,032                                 896                                 769                                 714                                  851
Premiums paid on purchased securities                                  389                                 315                                 356                                 403                                  222
Unrealized depreciation on loans                                   (14,905 )                           (14,766 )                           (14,480 )                           (14,576 )                            (14,741 )

Medallion Bank net investments                                $    674,162                        $    635,041                        $    598,001                        $    588,220                         $    571,266

(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 8.25%, 8.31%, 8.15%, 8.18%, and 8.70% at September 30, 2012, June 30, 2012, March 31, 2012, December 31, 2011, and September 30, 2011.

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Investment Activity

The following table sets forth the components of investment activity in the
investment portfolio for the periods indicated.



                                               Three Months Ended September 30,              Nine Months Ended September 30,
(Dollars in thousands)                           2012                    2011                  2012                   2011
Net investments at beginning of period      $       426,471         $       465,425       $       451,835        $       483,516
Investments originated (1)                           79,329                  28,026               146,643                131,677
Repayments of investments (1)                       (69,649 )               (41,530 )            (165,843 )             (166,576 )
Net realized gains (losses) on
investments (2)                                      (2,546 )                   686                (2,281 )                1,270
Net increase in unrealized appreciation
(3)                                                   5,468                     395                 8,793                  3,077
(Amortization) accretion of origination
costs                                                   (53 )                   (20 )                (127 )                   18

Net increase (decrease) in investments               12,549                 (12,443 )             (12,815 )              (30,534 )

Net investments at end of period            $       439,020         $       452,982       $       439,020        $       452,982

(1) Includes refinancings.

(2) Excludes net realized losses of $74 for the quarter and nine months ended September 30, 2012, related to foreclosed properties, which are carried in other assets on the consolidated balance sheet.

(3) Excludes net unrealized appreciation of $2,426 and $6,815 for the quarter and nine months ended September 30, 2012, and $2,378 and $3,487 for the comparable 2011 periods, related to foreclosed properties, which are carried in other assets on the consolidated balance sheet.

PORTFOLIO SUMMARY

Total Portfolio Yield

The weighted average yield of the total portfolio at September 30, 2012 was 6.74% (6.07% for the loan portfolio), an increase of 36 basis points from 6.38% at December 31, 2011, and an increase of 22 basis points from 6.52% at September 30, 2011. The weighted average yield of the total managed portfolio at September 30, 2012 was 8.07% (8.25% for the loan portfolio), an increase of 7 basis points from 8.00% at December 31, 2011, and a decrease of 41 basis points from 8.48% at September 30, 2011. The changes in 2012 reflected changes in the portfolio mix.

Medallion Loan Portfolio

Our medallion loans comprised 64% of the net portfolio of $439,020,000 at September 30, 2012, compared to 68% of the net portfolio of $451,835,000 at December 31, 2011, and 67% of $452,982,000 at September 30, 2011. Our managed medallion loans of $609,688,000 comprised 60% of the net managed portfolio of $1,022,149,000 at September 30, 2012, compared to 63% of the net managed portfolio of $956,626,000 at December 31, 2011, and 62% of $942,355,000 at September 30, 2011. The medallion loan portfolio decreased by $25,281,000 or 8% in 2012 (an increase of $9,021,000 or 2% on a managed basis), primarily reflecting the movement of loans to Medallion Bank. Total medallion loans serviced for third parties were $67,558,000, $75,866,000, and $84,673,000 at September 30, 2012, December 31, 2011, and September 30, 2011.

The weighted average yield of the medallion loan portfolio at September 30, 2012 was 4.66%, a decrease of 45 basis points from 5.11% at December 31, 2011, and a decrease of 93 basis points from 5.59% at September 30, 2011. The weighted average yield of the managed medallion loan portfolio at September 30, 2012 was 4.52%, a decrease of 44 basis points from 4.96% at December 31, 2011, and a decrease of 89 basis points from 5.41% at September 30, 2011. The decrease in yield primarily reflected the impact of falling interest rates in the economy and the effects of borrower refinancings. At September 30, 2012, 28% of the medallion loan portfolio represented loans outside New York, compared to 26% at December 31, 2011, and 25% at September 30, 2011. At September 30, 2012, 22% of the managed medallion loan portfolio represented loans outside New York, compared to 22% at December 31, 2011 and September 30, 2011. We continue to focus our efforts on originating higher yielding medallion loans outside the New York market.

Commercial Loan Portfolio

Our commercial loans represented 13%, 12%, and 13% of the net investment portfolio as of September 30, 2012, December 31, 2011, and September 30, 2011, and were 13%, 13%, and 14% on a managed basis. Commercial loans increased by $2,606,000 or 5% during 2012 (decreased $36,000 or less than 1% on a managed basis), primarily reflecting increases in the secured mezzanine portfolio, and on a managed basis, decreases in the asset-based portfolio. Net commercial loans serviced by third parties were $13,231,000 at September 30, 2012, $14,298,000 at December 31, 2011, and $14,029,000 at September 30, 2011.

The weighted average yield of the commercial loan portfolio at September 30, 2012 was 11.80%, a decrease of 45 basis points from 12.25% at December 31, 2011, and a decrease of 78 basis points from 12.58% at September 30, 2011. The weighted average yield of the managed commercial loan portfolio at September 30, 2012 was 8.29%, a decrease of 12 basis points from 8.41% at December 31, 2011,

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and a decrease of 48 basis points from 8.77% at September 30, 2011. The fluctuations primarily reflect changes in the portfolio mix and changes in the rates earned. We continue to originate adjustable-rate and floating-rate loans tied to the prime rate to help mitigate our interest rate risk in a rising interest rate environment. At September 30, 2012, variable-rate loans represented approximately 14% of the commercial portfolio, compared to 14% and 12% at December 31, 2011 and September 30, 2011, and were 56%, 57%, and 54% 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 Portfolio

Our managed consumer loans, all of which are held in the portfolio managed by Medallion Bank, represented 24%, 20%, and 21% of the managed net investment portfolio as of September 30, 2012, December 31, 2011, and September 30, 2011. Medallion Bank originates adjustable and fixed rate consumer loans secured by recreational vehicles, boats, motorcycles, trailers, and home improvements. located in all 50 states. 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 17.11% at September 30, 2012, compared to 17.73% and 17.77% at December 31, 2011 and September 30, 2011. Adjustable rate loans represented 78%, 80%, and 80% of the managed consumer portfolio at September 30, 2012, December 31, 2011, and September 30, 2011.

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 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 third party servicer.

The following table shows the trend in loans 90 days or more past due.

                                                 September 30, 2012           June 30, 2012           March 31, 2012           December 31, 2011           September 30, 2011
(Dollars in thousands)                           Amount          %(1)        Amount      %(1)        Amount       %(1)         Amount         %(1)          Amount         %(1)
Medallion loans                                $       216         0.1 %    $    580       0.2 %    $      47       0.0 %    $        35        0.0 %    $        495        0.1 %

. . .
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