10-K 1 d643263d10k.htm 10-K 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2018

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                  to                 

Commission file number 001-37747

 

 

MEDALLION FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

 

 

 

DELAWARE   04-3291176

(State of

Incorporation)

 

(IRS Employer

Identification No.)

437 MADISON AVENUE, 38th Floor, NEW YORK, NEW YORK 10022

(Address of principal executive offices) (Zip Code)

(212) 328-2100

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Stock, par value $0.01 per share   NASDAQ Global Select Market

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    YES  ☐    NO  ☒

Indicated by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    YES  ☐    NO  ☒

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  ☒    NO  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files).    YES  ☒    NO  ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ☒

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer      Accelerated filer  
Non accelerated filer      Smaller reporting company  
Emerging growth company       

If an emerging growth company, indicate by checkmark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    YES  ☐    NO  ☒

The aggregate market value of the voting common equity held by non-affiliates of the registrant, computed by reference to the last reported price at which the stock was sold on June 29, 2018, was $111,869,794.

The number of outstanding shares of registrant’s common stock, par value $0.01, as of March 11, 2019 was 24,433,178.

 

 

 


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DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Definitive Proxy Statement for its 2019 Annual Meeting of Shareholders, which Definitive Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the registrant’s fiscal year-end of December 31, 2018, are incorporated by reference into Part III of this Form 10-K.

MEDALLION FINANCIAL CORP.

2018 FORM 10-K ANNUAL REPORT

TABLE OF CONTENTS

 

         Page  

PART I

     3  

ITEM 1.

  OUR BUSINESS      3  

ITEM 1A.

  RISK FACTORS      18  

ITEM 1B.

  UNRESOLVED STAFF COMMENTS      36  

ITEM 2.

  PROPERTIES      36  

ITEM 3.

  LEGAL PROCEEDINGS      36  

ITEM 4.

  MINE SAFETY DISCLOSURES      36  

PART II

     37  

ITEM 5.

  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES      37  

ITEM 6.

  SELECTED FINANCIAL DATA      38  

ITEM 7.

  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS      41  

ITEM 7A.

  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK      70  

ITEM 8.

  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA      71  

ITEM 9.

  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE      71  

ITEM 9A.

  CONTROLS AND PROCEDURES      71  

ITEM 9B.

  OTHER INFORMATION      75  

PART III

     75  

ITEM 10.

  DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE      75  

ITEM 11.

  EXECUTIVE COMPENSATION      75  

ITEM 12.

  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS      75  

ITEM 13.

  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE      75  

ITEM 14.

  PRINCIPAL ACCOUNTANT FEES AND SERVICES      75  

PART IV

     75  

ITEM 15.

  EXHIBITS AND FINANCIAL STATEMENT SCHEDULES      75  

ITEM 16.

  FORM 10-K SUMMARY      81  

SIGNATURES

     82  

CERTIFICATIONS

The following discussion should be read in conjunction with our financial statements and the notes to those statements and other financial information appearing elsewhere in this report.

This report contains forward-looking statements relating to future events and future performance applicable to us within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including, without limitation, statements regarding our expectations, beliefs, intentions,

 

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or future strategies that are signified by the words expects, anticipates, intends, believes, or similar language. In connection with certain forward-looking statements contained in this Form 10-K and those that may be made in the future by or on behalf of the Company, the Company notes that there are various factors that could cause actual results to differ materially from those set forth in any such forward-looking statements. The forward-looking statements contained in this Form 10-K were prepared by management and are qualified by, and subject to, significant business, economic, competitive, regulatory, and other uncertainties and contingencies, all of which are difficult or impossible to predict, and many of which are beyond control of the Company. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any forward-looking statements. The statements have not been audited by, examined by, compiled by, or subjected to agreed-upon procedures by independent accountants, and no third-party has independently verified or reviewed such statements. Readers of this Form 10-K should consider these facts in evaluating the information contained herein. In addition, the business and operations of the Company are subject to substantial risks which increase the uncertainty inherent in the forward-looking statements contained in this Form 10-K. The inclusion of the forward-looking statements contained in this Form 10-K should not be regarded as a representation by the Company or any other person that the forward-looking statements contained in this Form 10-K will be achieved. In light of the foregoing, readers of this Form 10-K are cautioned not to place undue reliance on the forward-looking statements contained herein. You should consider these risks and those described under Risk Factors below and others that are detailed in this Form 10-K and other documents that the Company files from time to time with the Securities and Exchange Commission, including quarterly reports on Form 10-Q and any current reports on Form  8-K.

PART I

 

ITEM 1.

OUR BUSINESS

We, Medallion Financial Corp. or the Company, are a finance company, organized as a Delaware corporation, that includes Medallion Bank, our primary operating subsidiary. Effective April 2, 2018, following authorization by our shareholders, we withdrew our previous election to be regulated as a business development company, or BDC, under the Investment Company Act of 1940, as amended, or the 1940 Act. Prior to such time, we were a closed-end, non-diversified management investment company that had elected to be treated as a BDC under the 1940 Act.

As a result of this change in status, commencing with the three months ended June 30, 2018:

 

   

we consolidated the results of Medallion Bank and our other subsidiaries in our financial statements, which, as an investment company, we were previously precluded from doing; and

 

   

with the consolidation of Medallion Bank, given its significance to our overall financial results, we now report as a bank holding company for accounting purposes under Article 9 and Guide 3 of Regulation S-X; but we are not a bank holding company for regulatory purposes.

In accordance with FASB Accounting Standards Codification (ASC) Topic 946 – Financial Services – Investment Companies, we made this change to our financial reporting prospectively, and did not restate or revise periods prior to our change in status to a non-investment company effective April 2, 2018. Accordingly, in this report we refer to both accounting in accordance with US generally accepted accounting principles (GAAP) applicable to bank holding companies (Bank Holding Company Accounting), which applies commencing April 2, 2018, and to that applicable to investment companies under the 1940 Act (Investment Company Accounting), which applies to prior periods.

 

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We historically have had a leading position in originating, acquiring, and servicing loans that finance taxicab medallions and various types of commercial businesses. Recently, our strategic growth has been through Medallion Bank which originates consumer loans for the purchase of recreational vehicles, boats, and trailers and to finance small-scale home improvements. 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 16% (19% if there had been no loan sales during 2016, 2017, and 2018). In January 2017, we announced our plans to transform our overall strategy. We are transitioning away from medallion lending and placing our strategic focus on our growing consumer finance portfolio. Total assets under management and management of our wholly-owned subsidiaries, which includes our managed net investment portfolio, as well as assets serviced for third party investors and unconsolidated subsidiaries, were $1,522,000,000 as of December 31, 2018, and were $1,593,000,000 as of December 31, 2017, and have grown at a compound annual growth rate of 9% from $215,000,000 at the end of 1996. Since our initial public offering in 1996, we have paid/declared distributions in excess of $263,060,000, or $14.66 per share.

We conduct our business through various wholly-owned subsidiaries, including:

 

   

Medallion Bank, or the Bank, an FDIC-insured industrial bank that originates consumer loans, raises deposits and conducts other banking activity and has a separate board of directors with a majority of independent directors;

 

   

Medallion Funding LLC, or Medallion Funding, a Small Business Investment Company, or SBIC, our primary taxicab medallion lending company;

 

   

Medallion Capital, Inc., or Medallion Capital, an SBIC which conducts a mezzanine financing business;

 

   

Freshstart Venture Capital Corp., or Freshstart, an SBIC which originates and services taxicab medallion and commercial loans; and

 

   

Medallion Servicing Corp., or MSC, which provides loan services to the Bank.

Our other consolidated subsidiaries are comprised of Medallion Fine Art, Inc., Medallion Taxi Media, Inc., CDI-LP Holdings, Inc., Medallion Motorsports, LLC, and RPAC Racing, LLC, or RPAC. In addition, we make both marketable and nonmarketable equity investments, primarily as a function of our mezzanine lending business.

Our Market

We provide loans to individuals and small to mid-size businesses, through our subsidiaries, in four segments:

 

   

loans that finance consumer purchases of recreational vehicles, boats, and trailers;

 

   

loans that finance consumer small scale home improvements;

 

   

loans that finance commercial businesses; and

 

   

loans that finance taxicab medallions.

The following chart shows the details of our loans receivable as of December 31, 2018:

 

(Dollars in thousands)

   Loans      Allowance for Loan Loss      Net Loans Receivable  

Recreation

   $ 587,038      $ 6,856      $ 580,182  

Home improvement

     183,155        1,796        181,359  

Commercial

     64,083        —          64,083  

Medallion

     183,606        27,743        155,863  
  

 

 

    

 

 

    

 

 

 

Total

   $ 1,017,882      $ 36,395      $ 981,487  
  

 

 

    

 

 

    

 

 

 

 

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Consumer Loans

Consumer loans are originated by the Bank and consist of loans for the purchase of recreational vehicles, boats and trailers (recreation lending) and to finance home improvements such as replacement windows and roofs (home improvement lending). Combined consumer loans outstanding were $761,541,000 at December 31, 2018 and comprised 77% of our net loans receivable compared to $683,502,000 comprising 49% of our $1,380,054,000 managed net investment portfolio as of December 31, 2017. The managed net investment portfolio was all investments held by our consolidated and unconsolidated subsidiaries. We believe that the consumer loan portfolio is of acceptable credit quality given the high interest rates earned on the loans, which compensate for the higher degree of credit risk in the loan portfolio.

Recreation Lending. Recreation lending is a high-growth business focused on originating prime and non-prime recreation loans. The segment is a significant source of income, accounting for 71.0% of our interest income for the nine months ended December 31, 2018. All of our recreation loans are serviced by a third-party loan servicer, and we have used the same loan servicer since the business’s inception.

Through the Bank, we maintain non-exclusive relationships with more than 2,800 dealers and financial service providers (FSPs), not all of which are active at any one time. FSPs are entities that provide finance and insurance (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 to the Bank. We receive approximately half of our loan volume from dealers and the other half from FSPs. A dedicated sales team working from the Bank’s Salt Lake City headquarters manages our relationships with dealers and FSPs. Approximately 4% of recreation lending’s new loan originations for the nine months ended December 31, 2018 were from our top ten dealer relationships and an additional 24% were from our top three FSP relationships.

The recreation lending portfolio consists of thousands of geographically distributed loans with an average loan size of approximately $13,500 as of December 31, 2018. The loans are fixed rate loans with an average loan term at origination of approximately 10 years. The weighted average remaining term of our loans outstanding at December 31, 2018 is 8.5 years. The size, geographic dispersion, source variety and collateral variety of the loans reduce risk to the Company.

Home Improvement Lending. Through the Bank, we work directly with contractors and an FSP to offer flexible customer financing for window, siding and roof replacement, swimming pool installation and solar system installation, and other home improvement projects. Our core product is a standard installment loan, which features affordable monthly payments and competitive interest rates for prime credit customers at no cost to the contractor. We also offer a variety of promotional loan options to help contractors close a challenging sale. Promotional loan options include same-as-cash, no interest and deferred payment features, which allow borrowers to reduce the total cost of financing or start repayments when it is most convenient.

Home improvement lending operates in a manner similar to recreation lending, with a few key differences. Through the Bank, we maintain a smaller number of non-exclusive relationships; the Bank currently has relationships with approximately 600 contractors. Most of our home improvement-financed sales take place in the borrower’s home instead of a store, with the contractor presenting the borrower with a bid that includes a financing option.

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., information technology and extended operating hours) and additional support for the salesperson throughout the financing process. The Bank’s contractor relationships are managed by a remote sales team with employees located in the geographical regions served. Approximately 59% of home improvement lending’s new loan originations for the nine months ended December 31, 2018 were from our top ten contractors and our FSP relationship.

 

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We offer only fixed rate home improvement loans with an average loan term at origination of approximately 12 years. The weighted average remaining term of our loans outstanding is 10.2 years as of December 31, 2018. The average size of the loans in our home improvement portfolio is approximately $14,100, and geographic dispersion, source variety and collateral variety of home improvement loans reduce risk to the Company.

Commercial Loans

Commercial loans finance either the purchase of the equipment and related assets necessary to open a new business or the purchase or improvement of an existing business. From the inception of the commercial loan business in 1987 through December 31, 2018, we have originated more than $970,572,000 of commercial loans. Commercial loans of $64,083,000 comprised 7% of our net loans receivable as of December 31, 2018, compared to managed commercial loans of $91,783,000, or 7%, of our $1,380,054,000 net investment portfolio as of December 31, 2017. We have worked to increase our commercial loan activity in recent years, primarily because of the attractive higher yielding nature of most of this business. The increase since 1996 has been primarily driven by internal growth through the origination of additional commercial loans. We focus our marketing efforts on the manufacturing, professional, scientific, and technical services and other services. The majority of our commercial borrowers are located in the New York metropolitan area and the Midwest. We plan to continue expanding our commercial loan activities by developing a more diverse borrower base, with a wider geographic area of coverage, and by expanding targeted industries.

Mainly through our subsidiary Medallion Capital, we originate both senior and subordinated loans nationwide to businesses in a variety of industries, including manufacturing and various service providers, more than 51% of which are located in the Midwest and Northeast regions, with the rest scattered across the country. These commercial loans are primarily secured by a second position on all assets of the businesses and generally range in amount from $1,000,000 to $5,000,000 at origination. As a component of most of the transactions, a portion of the investment is an equity or partnership stake, and occasionally, we also receive warrants to purchase an equity interest in the borrowers or some other form of success fee or profit participation.

Commercial loans are generally secured by equipment, accounts receivable, real estate, or other assets, and have interest rates averaging 806 basis points over the prevailing prime rate at the end of 2018, up from 735 basis points over prime at the end of 2017.

Medallion Loans

Taxi medallion loans of $155,863,000 comprised 16% of our net loans receivable as of December 31, 2018, compared to managed taxi medallion loans of $388,001,000, or 28%, of our $1,380,054,000 managed net investment portfolio as of December 31, 2017. Including loans to unaffiliated investors and unconsolidated subsidiaries, the total amount of medallion loans under our management was $323,786,000 as of December 31, 2018, compared to $414,350,000 as of December 31, 2017. Since 1979, we have originated approximately $3,631,000,000 in medallion loans in New York City, Chicago, Boston, Newark, Cambridge, and other cities within the United States. In addition, our management has a long history of owning, managing, and financing taxicab fleets, taxicab medallions, and corporate car services, dating back to 1956.

Medallion loans collateralized by New York City taxicab medallions and related assets comprised 87% and 73% (81% on a managed basis) of the medallion loan portfolio as of December 31, 2018 and 2017. Based on taxi medallion values published by the New York City Taxi and Limousine Commission, or TLC, and our cash flow analysis, we estimate that the total value of all of New York City taxicab medallions and related assets such as the vehicle, taximeter, and roof lights exceeded $2.7 billion as of December 31, 2018. We estimate that the total value of all taxicab medallions and related assets in our major US markets exceeded $3.1 billion as of December 31, 2018.

While medallion loans do become delinquent or in default, all of our medallion loans are secured by the medallion and enhanced with personal guarantees of the owners, shareholders or equity members. When a

 

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borrower defaults on a loan, we have the ability to restructure the underlying loan or repossess the medallion collateralizing that loan and sell it in the market or through a foreclosure auction and pursue the personal guarantees, all of which we have done. Given the current market conditions, we have recorded an allowance for loan losses against performing and nonperforming loans to mitigate potential future losses.

The New York City Market. A New York City taxicab medallion is the only permitted license to operate a taxicab and accept street hails in New York City, except as discussed below. As reported by the TLC, individual (owner-driver) medallions and corporate medallions sold for a wide variety of prices during the year. Our analysis of transaction activity combined with cash flow analysis of owners and operators supported our estimated value of $181,000, net of liquidation costs, as of December 31, 2018. The number of taxicab medallions is limited by law to 13,630 medallions outstanding as of December 31, 2018. A New York State law permits cars for hire to pick up street hails in the boroughs outside Manhattan. Pursuant to such law, the TLC began issuing Street Hail Livery licenses in June 2013.

A prospective medallion owner must qualify under the medallion ownership standards set and enforced by the TLC. These standards prohibit individuals with criminal records from owning medallions, require that the funds used to purchase medallions be derived from legitimate sources, and mandate that taxicab vehicles and meters meet TLC specifications. In addition, before the TLC will approve a medallion transfer, the TLC requires a letter from the seller’s insurer stating that there are no outstanding claims for personal injuries in excess of insurance coverage. After the transfer is approved, the owner’s taxicab is subject to quarterly TLC inspections.

Most New York City medallion transfers are handled through approximately 20 medallion brokers licensed by the TLC. In addition to brokering medallions, these brokers also arrange for TLC documentation insurance, vehicles, meters, and financing. We have excellent relations with many of the most active brokers, and regularly receive referrals from them.

The Newark Market. We estimate that Newark medallions sold for approximately $147,000, net, as of December 31, 2018. The number of Newark medallions has been limited to 600 since 1950 by local law. We estimate that the total value of all Newark medallions and related assets is over $91,800,000 as of December 31, 2018.

The Chicago Market. We estimate that Chicago medallions sold for approximately $27,000, net, as of December 31, 2018. Pursuant to a municipal ordinance, the number of outstanding medallions is capped at 6,995 as of December 31, 2018. We estimate that the total value of all Chicago medallions and related assets is over $230,835,000 as of December 31, 2018.

Other Markets. We estimated that Boston and Cambridge medallions sold for approximately $43,000 and $22,000, net, as of December 31, 2018. These other markets make up 0.4% of our total medallion loans receivable.

Our Strategy

Our core philosophy has been “In niches there are riches.” We try to identify markets that are profitable and where we can be an industry leader. Key elements of our strategy include:

Capitalize on our relationships with brokers and dealers. We are committed to establishing, building, and maintaining our relationships with our brokers and dealers. Our marketing efforts are focused on building relationships with dealers in the consumer markets as we work directly with dealerships, contractors and FSPs to offer quality financing for their customers, including those with past credit challenges. We believe that our relationships with dealers and brokers provide us with, in addition to potential investment opportunities, other significant benefits, including an additional layer of due diligence and additional monitoring capabilities. We have assembled a management team that has developed an extensive network of dealer and broker relationships

 

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in our target markets over the last 50 years. We believe that our management team’s relationships with these dealers and brokers have and will continue to provide us with significant investment opportunities. In 2018, 100% of our consumer loans were generated by brokers and dealers, and there were few originations in the medallion or commercial lending space.

Focus on niche industries and our expertise in these niche fields. We specialize in providing consumer loans for the purchase of recreational vehicles (RVs), boats and trailers, and to finance home improvements through contractors and suppliers in the home improvement sector. We believe our focus on these niche areas provides us with an opportunity to realize favorable returns, with less competition.

Employ disciplined underwriting policies and maintain rigorous portfolio monitoring. We have an extensive loan underwriting and monitoring process. We conduct a thorough analysis of each potential loan portfolio and its prospects, competitive position, financial performance, and industry dynamics. We stress the importance of credit and risk analysis in our underwriting process. We believe that our continued adherence to this disciplined process will permit us to continue to generate a stable, diversified and increasing revenue stream of current income from our earning assets to enable us to make distributions to our shareholders.

Leverage the skills of our experienced management team. Our management team is led by our Chief Executive Officer, Mr. Alvin Murstein, and our President, Mr. Andrew M. Murstein. Alvin Murstein has over 60 years of experience in the ownership, management, and financing of taxicab medallions and other commercial businesses, and Andrew M. Murstein is the third generation in his family to participate in the business and has over 30 years of experience in the ownership, management, and financing of taxicab medallions and other commercial businesses. The other members of our management team including Medallion Bank have broad investment backgrounds, with prior experience in banking and non-bank consumer lending, at specialty finance companies, middle market commercial banks, and other financial services companies. We believe that the experience and contacts of our management team will continue to allow us to effectively implement the key aspects of our business strategy.

Perform Strategic Acquisitions. In addition to increasing market share in existing lending markets and identifying new niches, we seek to acquire medallion financing businesses and related portfolios and specialty finance companies that make secured loans to small businesses which have experienced historically low loan losses similar to our own. Since our initial public offering in May 1996, we have acquired eight specialty finance companies, five loan portfolios, and three taxicab rooftop advertising companies.

 

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Loan/Investment Activity

The following table sets forth the components of loan/investment activity in the consolidated/managed investment portfolio for the years indicated.

 

     Year ended December 31,  

(Dollars in thousands)

   2018      2017      2016  

Net investments at beginning of year

   $ 1,380,054      $ 1,517,592      $ 1,501,555  

Loans/investments originated (1)

     428,510        475,465        738,238  

Repayments of loans/investments (1)

     (261,383      (270,133      (655,071

Consumer loans sold to third parties

     (100,920      (221,447      (97,511

Net realized losses on loans/investments (2)

     (42,305      (79,264      (34,888

Provision for loan losses

     (59,008      —          —    

Net increase in unrealized appreciation (depreciation) (3)

     29,864        6,390        79,650  

Transfers to loans in process of foreclosure

     (53,756      (44,968      (10,941

Investment transfers excluded from loans in process of foreclosure (4)

     (262,064      —          —    

Deconsolidation of Trust III (5)

     (71,409      —          —    

Amortization of origination costs

     (3,950      (3,581      (3,440

Other, net

     (2,146      —          —    
  

 

 

    

 

 

    

 

 

 

Net increase (decrease) in loans/investments

     (398,567      (137,538      16,037  
  

 

 

    

 

 

    

 

 

 

Net loans receivable/investments at end of year

   $ 981,487      $ 1,380,054      $ 1,517,592  
  

 

 

    

 

 

    

 

 

 

 

(1)

Includes refinancings.

(2)

Excludes net realized losses of $7,736 and $5,875 for the years ended December 31, 2017 and 2016 related to investments other than securities and other assets.

(3)

Excludes net unrealized depreciation of $1,915 for the three months ended March 31, 2018 and $2,076 and $28,372 for the years ended December 31, 2017 and 2016 related to investments other than securities and other assets.

(4)

Represents portfolio investments transferred to other asset categories and excluded from net loans receivable.

(5)

Represents the Trust III gross loans of $53,546 and loans in process of foreclosure that had been transferred to other assets of $17,863 as a result of the Company no longer considered the primary beneficiary of, and thus not consolidating, Trust III.

Loan/Investment Characteristics

Consumer Loans. Consumer loans generally require equal monthly payments covering accrued interest and amortization of principal over a negotiated term, generally around ten to twelve years. Interest rates offered are fixed. Borrowers may prepay consumer loans without any prepayment penalty. In general, Medallion Bank has established relationships with dealers, FSPs, and contractors in the industry, who are the sources for consumer loan volumes. The loans are made up of recreation loans and home improvement loans which were 76% and 24% of total consumer loans at December 31, 2018.

Our recreation loans are secured primarily by RVs, boats and trailers with a small proportion of loans secured by other collateral such as autos, motorcycles and boat motors. These loans, which together make up our largest and most profitable loan portfolio, have a weighted average yield of 16.88% at December 31, 2018. Our home improvement loans are secured by the personal property installed, and the security interest for a majority of these loans is perfected with a UCC fixture filing. As of December 31, 2018, these loans had a weighted average yield of 9.20%.

 

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Commercial Loans. We have typically originated commercial loans in principal amounts generally ranging from under $1,000,000 to $5,000,000, and occasionally have originated loans in excess of that amount. These loans are generally retained and typically have maturities ranging from three to ten years and require monthly payments ranging from full amortization over the loan term to fully deferred interest and principal at maturity, with multiple payment options in between. Substantially all loans may be prepaid, and in the first five years, a fee will be owed to us. The term of, and interest rate charged on, certain of our outstanding loans are subject to the regulations of the Small Business Administration, or the SBA. Under SBA regulations, the maximum rate of interest permitted on loans originated by us is 19%; however, terms and interest rates are subject to market competition for all loans. Unlike medallion loans, for which competition and market conditions preclude us from charging the maximum rate of interest permitted under SBA regulations, we are able to charge the maximum rate on certain commercial loans.

Medallion Loans. Our medallion loan portfolio consists of mostly fixed-rate loans, collateralized by first security interests in taxicab medallions and related assets (vehicles, meters, and the like). We estimate that the weighted average loan-to-value ratio of all of the medallion loans was 220% as of December 31, 2018, compared to 131% as of December 31, 2017. These ratios do not factor in the reserve on these loans of $27,743,000 as of December 31, 2018 and the unrealized depreciation on managed loans of $62,723,000 as of December 31, 2017. In addition, we have recourse against a vast majority of the owners of the taxicab medallions and related assets through personal guarantees.

Medallion loans generally require equal monthly payments covering accrued interest and amortization of principal over a five to twenty-five year schedule, subject to a balloon payment of all outstanding principal at maturity. Historically, we have originated loans with one-to-five year maturities where interest rates are adjusted and a new maturity period set.

Historically, we have retained the medallion loans we originate; however, from time to time, we participate or sell shares of some loans or portfolios to interested third party financial institutions. In these cases, we retain the borrower relationships and service the sold loans.

Marketing, Origination, and Loan Approval Process

We employ 78 personnel to originate, manage, service and collect on the consumer, commercial, and medallion loans. Each loan application is individually reviewed through analysis of a number of factors, including loan-to-value ratios, a review of the borrower’s credit history, public records, personal interviews, trade references, personal inspection of the premises, and approval from the TLC, SBA, or other regulatory body, if applicable. Each medallion and commercial loan applicant is required to provide personal or corporate tax returns, premises leases, and/or property deeds. The Company’s senior management establishes loan origination criteria. Loans that conform to such criteria may be processed by a loan officer with the proper credit authority, and non-conforming loans (other than those by the Bank) must be approved by the Company’s Chief Executive Officer, President, and/or the Chief Credit Officer and the Investment Oversight Committee of the Company’s Board of Directors. Loan criteria for loans originated with the Bank is established by the Bank’s board of directors and senior management. The Bank’s policies identify specific approval authorities for its recreation, home improvement, medallion and real estate loans. Policy exceptions are reported to the Bank’s board of directors. Both medallion and commercial loans are sourced from brokers with extensive networks of applicants, and commercial loans are also referred by contacts with banks, attorneys, and accounting firms. Consumer loans are primarily sourced through relationships which have been established with recreational vehicle and boat dealers, and home improvement contractors throughout our market area.

Sources of Funds

We have historically funded our lending operations primarily through credit facilities with bank syndicates and, to a lesser degree, through equity or debt offerings or private placements, and fixed-rate, senior secured

 

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notes and long-term subordinated debentures issued to or guaranteed by the SBA. Since the inception of Medallion Bank, substantially all of Medallion Bank’s funding has been provided by FDIC insured brokered certificates of deposit. The determination of funding sources is established by our management, based upon an analysis of the respective financial and other costs and burdens associated with funding sources. Our funding strategy and interest rate risk management strategy is to have the proper structuring of debt to minimize both rate and maturity risk, while maximizing returns with the lowest cost of funding over an intermediate period of time.

The table below summarizes our sources of available funds and amounts outstanding under credit facilities and their respective end of period weighted average interest rates at December 31, 2018. See Note 7 to the consolidated financial statements for additional information about each credit facility.

 

(Dollars in  thousands)

   Total  

Cash and cash equivalents

   $ 57,713  

Bank loans

     59,615  

Average interest rate

     4.55

Maturity

     3/19-12/23  

Preferred securities

     33,000  

Average interest rate

     4.86

Maturity

     9/37  

Retail notes

     33,625  

Average interest rate

     9.00

Maturity

     4/21  

SBA debentures and borrowings

     83,099  

Amounts undisbursed

     3,000  

Amounts outstanding

     80,099  

Average interest rate

     3.40

Maturity

     3/19-9/28  

Brokered CDs & other funds borrowed

     848,040  

Average interest rate

     2.14

Maturity

     1/19-07/23  

Other borrowings

     7,649  

Average interest rate

     2.00

Maturity

     12/19-3/20  
  

 

 

 

Total cash

   $ 57,713  
  

 

 

 

Total debt outstanding

   $ 1,062,028  
  

 

 

 

We fund our fixed-rate loans with variable-rate credit lines and bank debt, and with fixed-rate SBA debentures and borrowings. The mismatch between maturities and interest-rate sensitivities of these balance sheet items results in interest rate risk. We seek to manage our exposure to increases in market rates of interest to an acceptable level by:

 

   

Originating adjustable rate loans; and

 

   

Incurring fixed-rate debt.

Nevertheless, we accept varying degrees of interest rate risk depending on market conditions. For additional discussion of our funding sources and asset liability management strategy, see Asset/Liability Management on page 65.

Competition

Banks, credit unions, and finance companies, some of which are SBICs, compete with us in originating medallion, commercial, and consumer loans. Many of these competitors have greater resources than we do and

 

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certain competitors are subject to less restrictive regulations than us. As a result, we cannot assure you that we will be able to identify and complete the financing transactions that will permit us to compete successfully.

Employees

As of December 31, 2018 we employed 177 persons, including 75 at our Medallion Bank subsidiary. We believe that relations with our employees are good.

MATERIAL U.S. FEDERAL INCOME TAX CONSIDERATIONS

For our tax years ended December 31, 2018 and 2017, we have been taxed as a corporation and must pay corporate-level federal and state income taxes on our taxable income. Because we were taxed as a corporation under Subchapter C of the Internal Revenue Code (the Code) for the tax year ended December 31, 2018 and 2017, we are able to carry forward any net operating losses incurred to succeeding years. In addition, distributions will generally be taxable to our shareholders to the extent of our current and accumulated earnings and profits for U.S. federal tax purposes. Distributions in excess of our current and accumulated earnings and profits would be treated first as a return of capital to the extent of a shareholder’s tax basis, and any remaining distributions would be treated as a capital gain. Subject to certain limitations under the Code, corporate distributees would be eligible for the dividends received deduction.

On December 22, 2017, the U.S. Government signed into law the “Tax Cuts and Jobs Act” which, starting in 2018, reduced the Company’s corporate statutory income tax rate from 35% to 21%, but eliminated or increased certain permanent differences.

REGULATION

Exemption from the 1940 Act

In order to maintain our status as a non-investment company, we operate so as to fall outside the definition of an “investment company” or within an applicable exception. We expect to continue to fall within the exception from the definition of an “investment company” provided under Section 3(c)(6) of the 1940 Act as a company primarily engaged, directly or through majority-owned subsidiaries, in the business of, among other things, (i) banking, (ii) purchasing and otherwise acquiring notes, drafts, acceptances, open accounts receivable, and other obligations representing part or all of the sales price of merchandise, insurance and services, and (iii) making loans to manufacturers, wholesalers, and retailers of, and to prospective purchasers of, specified merchandise, insurance, and services. We monitor our continued compliance with this exception, which we have met since April 2, 2018, and were compliant as of December 31, 2018.

Regulation of Medallion Bank as an Industrial Bank

In May 2002, we formed Medallion Bank, which received approval from the FDIC for federal deposit insurance in October 2003. Medallion Bank, a Utah-chartered industrial bank, is a depository institution subject to regulatory oversight and examination for safety and soundness by both the FDIC and the Utah Department of Financial Institutions. Medallion Bank is examined annually by the FDIC and the Utah Department of Financial Institutions. Numerous other federal and state laws and regulations govern almost all aspects of Medallion Bank’s operations and, to some degree, our operations and those of our non-bank subsidiaries as institution-affiliated parties. Under its banking charter, Medallion Bank is empowered to make consumer and commercial loans, and may accept all FDIC-insured deposits other than demand deposits (checking accounts). Medallion Bank provides stable and low-cost bank deposit funding for our key lending business activities conducted through Medallion Bank.

In addition, the FDIC has regulatory authority to prohibit Medallion Bank from engaging in any unsafe or unsound practice in conducting its business.

 

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Medallion Bank is subject to risk-based and leverage capital standards issued by the federal banking regulators. These standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banking organizations, to account for off-balance sheet exposure, to minimize disincentives for holding liquid assets, and to achieve greater consistency in evaluating the capital adequacy of major banks throughout the world. Under the risk-based capital standards, assets and off-balance sheet items are assigned to broad risk categories, each with designated weights, and the resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.

In July 2013, the Federal Reserve, the FDIC, and the Office of the Comptroller of the Currency adopted the U.S. Basel III capital rules, which implement many aspects of the Basel Committee on Banking Supervision’s Basel III capital framework and are aimed at increasing both the quantity and quality of regulatory capital. The requirements in the U.S. Basel III capital rules began to phase in on January 1, 2015, for many covered banking organizations, including Medallion Bank. Most requirements in the U.S. Basel III capital rules were fully phased in by January 1, 2019. Because Medallion Bank was already subject to a capital maintenance agreement with the FDIC that required it to hold capital in excess of the then applicable capital requirements, we do not believe that the U.S. Basel III capital rules will have a material impact on Medallion Bank’s business.

Under the U.S. Basel III capital rules, Medallion Bank is subject to the following minimum capital ratios:

 

   

a new Common Equity Tier 1 risk-based capital ratio of 4.5%;

 

   

a Tier 1 risk-based capital ratio of 6%;

 

   

a Total risk-based capital ratio of 8%; and

 

   

a Tier 1 leverage ratio of 4%.

In addition, Medallion Bank is subject to a Common Equity Tier 1 capital conservation buffer on top of the minimum risk-based capital ratios. The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and increased by 0.625% each subsequent January 1 until January 1, 2019. Including the buffer, as of January 1, 2019, Medallion Bank is be required to maintain the following minimum capital ratios: a Common Equity Tier 1 risk-based capital ratio of greater than 7.0%, a Tier 1 risk-based capital ratio of greater than 8.5% and a total risk-based capital ratio of greater than 10.5%. The new and highest form of capital, Common Equity Tier 1 capital, consists solely of common stock (plus related surplus), retained earnings, accumulated other comprehensive income, and limited amounts of qualifying minority interests that are in the form of common stock. For Medallion Bank to pay a dividend, they would need to comply with these capital requirements.

The U.S. Basel III capital rules retain or modify certain deductions from and adjustments to regulatory capital and also provide for new ones. In addition, the U.S. Basel III capital rules provide for limited recognition in Common Equity Tier 1 capital, and deduction from Common Equity Tier 1 capital above certain thresholds, of three categories of assets: (i) deferred tax assets arising from temporary differences that cannot be realized through net operating loss carrybacks (net of related valuation allowances and of deferred tax liabilities), (ii) mortgage servicing assets (net of associated deferred tax liabilities) and (iii) investments in more than 10% of the issued and outstanding common stock of unconsolidated financial institutions (net of associated deferred tax liabilities).

For purposes of calculating the denominator of the three risk-based capital ratios, the assets of covered banking organizations are given risk weights that, under the U.S. Basel III capital rules, range from 0% to 1,250%, depending on the nature of the asset. Direct obligations of the U.S. Treasury or obligations unconditionally guaranteed by the U.S. government have a 0% risk weight, while general obligation claims on states or other political subdivisions of the United States are assigned a 20% risk weight, except for municipal or state revenue bonds, which have a 50% risk weight. Most first-lien residential mortgage exposures that are prudently underwritten and performing according to their original terms carry a 50% risk weight, with a 100%

 

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risk weight for other residential mortgage exposures. In addition, certain off-balance sheet items are assigned credit conversion factors to convert them to asset equivalent amounts to which an appropriate risk weight is applied. For example, the unused portion of unconditionally cancellable commitments is assigned a 0% conversion factor, while self-liquidating, transaction-related contingent items with an original maturity of one year or less and the amount of a commitment with an initial maturity of one year or less that is not unconditionally cancellable by the covered banking organization are converted at 20%. Transaction-related contingencies such as bid bonds and standby letters of credit backing nonfinancial obligations, as well as the amount of a commitment with an original maturity of more than one year that is not unconditionally cancellable, have a 50% conversion factor. General guarantees and standby letters of credit backing financial obligations are given a 100% conversion factor.

In addition, pursuant to provisions of the FDIC Improvement Act of 1991, or FDICIA, and related regulations with respect to prompt corrective action, FDIC-insured institutions such as Medallion Bank may only accept brokered deposits without FDIC permission if they meet specified capital standards, and are subject to restrictions with respect to the interest they may pay on deposits unless they are well capitalized. The U.S. Basel III capital rules revised the capital threshold to be well capitalized. Effective January 1, 2015, in order to qualify as well capitalized, an insured depository institution must maintain a Common Equity Tier 1 risk-based capital ratio of at least 6.5%, a Tier 1 risk-based capital ratio of at least 8.0%, a total risk-based capital ratio of at least 10.0%, and a Tier 1 leverage ratio of at least 5.0%, and the bank must not be under any order or directive from the appropriate regulatory agency to meet and maintain a specific capital level.

Pursuant to a capital maintenance agreement with the FDIC, we and Medallion Bank have agreed that the capital levels of Medallion Bank will at all times meet or exceed the levels required for Medallion Bank to be considered well-capitalized under the FDIC rules and regulations, that Medallion Bank’s Tier 1 capital to total assets leverage ratio will be maintained at not less than 15%, and that Medallion Bank will maintain an adequate allowance for loan and lease losses. As of December 31, 2018, Medallion Bank was in compliance with the above rules and tests.

Medallion Bank is also subject to certain federal laws that restrict and control its ability to extend credit and provide or receive services between affiliates. Sections 23A and 23B of the Federal Reserve Act and Regulation W promulgated thereunder limit the transfer of funds by a depository institution to certain of its affiliates, including us, in the form of loans, extensions of credit, investments, or purchases of assets. Sections 23A and 23B and Regulation W also require generally that the depository institution’s transactions with its affiliates be on terms no less favorable to Medallion Bank than comparable transactions with unrelated third parties.

The USA Patriot Act and the International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001, or the Patriot Act, is intended to detect and prosecute terrorism and international money laundering. The Patriot Act establishes new standards for verifying customer identification incidental to the opening of new accounts. Medallion Bank has undertaken appropriate measures to comply with the Patriot Act and associated regulations. Other provisions of the Patriot Act provide for special information sharing procedures governing communications with the government and other financial institutions with respect to suspected terrorists and money laundering activity, and enhancements to suspicious activity reporting, including electronic filing of suspicious activity reports over a secure filing network. The compliance programs required by the Patriot Act are intended to supplement pre-existing compliance requirements that apply to financial institutions under the Bank Secrecy Act and the Office of Foreign Assets Control, or OFAC, regulations to which Medallion Bank is also subject. The Bank Secrecy Act requires all financial institutions, including banks, to, among other things, establish a risk-based system of internal controls reasonably designed to prevent money laundering and the financing of terrorism. The Bank Secrecy Act includes a variety of record-keeping and reporting requirements (such as cash and suspicious activity reporting), as well as due diligence/know-your-customer documentation requirements. Medallion Bank has in place policies, procedures and internal controls in order to comply with Bank Secrecy Act and OFAC laws and regulations. Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications.

 

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Federal and state banking agencies require Medallion Bank to prepare annual reports on financial condition and to conduct an annual audit of financial affairs in compliance with minimum standards and procedures. Medallion Bank must undergo regular on-site examinations by the appropriate banking agency, which will examine for adherence to a range of legal and regulatory compliance responsibilities. A bank regulator conducting an examination has complete access to the books and records of the examined institution. The results of the examination are confidential. The cost of examinations may be assessed against the examined institution as the agency deems necessary or appropriate.

Regulation by the SBA

Medallion Funding, Medallion Capital, and Freshstart are each licensed by the SBA to operate as SBICs, under the Small Business Investment Act of 1958, as amended, or the SBIA. The SBIA authorizes the organization of SBICs as vehicles for providing equity capital, long term financing, and management assistance to small business concerns. Under the regulations promulgated by the SBA a “small business concern” is defined as a business that is independently owned and operated, which does not dominate its field of operation, and which (i) has a tangible net worth, together with any affiliates, of $19.5 million or less and average annual net income after U.S. federal income taxes for the preceding two fiscal years of $6.5 million or less (average annual net income is computed without the benefit of any carryover loss), or (ii) satisfies alternative criteria under the Federal government’s North American Classification System, or the NAICS, that assigns codes to the industry in which a small business is engaged and provides a small business size standard based either on the number of persons employed by the business or its gross revenues. In addition, at the end of each fiscal year, at least 25% of the total amount of loans made (after April 25, 1994) must be made in “smaller businesses” that have a net worth of $6.0 million or less, and average net income after federal income taxes for the preceding two years of $2.0 million or less. A business that meets the NAICS size standards also qualifies as a “smaller business” for purposes of meeting SBA’s size standard regulations.

Investments by SBICs must be in active, primarily domestic businesses. SBIC regulations preclude investment in the following types of businesses: (1) financial companies whose principal business activity is as a relender or reinvestor (that is, directly or indirectly, providing funds to others, purchasing debt obligations, factoring, or long term leasing of equipment with no provision for maintenance or repair); (2) many kinds of real estate projects; (3) single purpose projects that are not continuing businesses; (4) companies located outside the U.S. intending to use the proceeds of the investment outside of the U.S. or companies that are located in the U.S. that have more than 50% of their employees or tangible assets located outside of the U.S.; (5) businesses that are passive and do not carry on an active trade or business; (6) businesses that use 50% or more of the funds to buy goods or services from an associated supplier; and (7) certain “sin businesses” such as gambling and the like. Nonetheless, the regulations provide an exception to (1) above for an SBIC that provides Venture Capital Financing investments (represented by common or preferred stock, a limited partnership interest or a similar partnership interest) to a Disadvantaged Business that is a relender or reinvestor (except banks or savings and loans insured by agencies of the Federal Government, and agricultural credit companies), so long as, without SBA prior approval, total outstanding financings do not exceed the SBICs regulatory capital at the end of its fiscal year.

Under current SBA regulations, the maximum rate of interest that Medallion Funding, Medallion Capital and Freshstart may charge may not exceed the higher of (i) 19% or (ii) the sum of (a) the higher of (i) that company’s weighted average cost of qualified borrowings, as determined under SBA regulations, or (ii) the current SBA debenture rate, plus (b) 11%, rounded to the next lower eighth of one percent. As of December 31, 2018, the maximum rate of interest permitted on loans originated by Medallion Funding, Medallion Capital, and Freshstart was 19%. As of December 31, 2018, our outstanding medallion loans had a weighted average rate of interest 4.43% and our outstanding commercial loans had a weighted average rate of interest of 13.56%. Current SBA regulations also require that each loan originated by an SBIC has a term between one and 20 years.

In addition, SBICs are subject to periodic examination by the SBA, for which the SBA charges examination fees. SBICs are required to maintain certain minimum levels of capital and must maintain certain records and

 

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make them available for SBA examination. SBICs also are required to prepare valuations of their portfolio investments in accordance with prescribed valuation guidelines, to maintain certain minimum levels of capital, to file annual reports containing financial, management and other information and to file notices of certain material changes in their ownership and operations. We are examined by the SBA annually for compliance with applicable SBA regulations.

SBICs are precluded from making investments in a small business if it would give rise to a conflict of interest. Generally, a conflict of interest may arise if an associate of the SBIC has or makes an investment in the small business the SBIC is financing or serves as one of its officers or would otherwise benefit from the financing. A conflict of interest would also occur if an SBIC were to lend money to any of its officers, directors, and employees, or invest in any affiliates thereof. Joint investing with an associate (such as another fund controlled by affiliates of the general partner of the fund) may be made on identical terms or on terms that are fair to the SBIC. The SBA also prohibits, without prior SBA approval, a “change of control” or transfers which would result in any person (or group of persons acting in concert) owning 10% or more of any class of capital stock of an SBIC. A “change of control” is any event which would result in the transfer of the power, direct or indirect, to direct the management and policies of an SBIC, whether through ownership, contractual arrangements, or otherwise.

Under SBA regulations, without prior SBA approval, loans by licensees with outstanding SBA leverage to any single small business concern may not exceed 30% of an SBIC’s regulatory capital, as defined in the SBIA.

SBICs must invest idle funds that are not being used to make loans in investments permitted under SBA regulations. These permitted investments include direct obligations of, or obligations guaranteed as to principal and interest by, the government of the U.S. with a term of 15 months or less and deposits maturing in one year or less issued by an institution insured by the FDIC. These permitted investments must be maintained in (i) direct obligations of, or obligations guaranteed as to principal and interest by, the U.S., which mature within 15 months from the date of the investment; (ii) repurchase agreements with federally insured institutions with a maturity of seven days or less if the securities underlying the repurchase agreements are direct obligations of, or obligations guaranteed as to principal and interest by the U.S., and such securities must be maintained in a custodial account in a federally insured institution; (iii) mutual funds, securities, or other instruments that exclusively consist of, or represent pooled assets of, investments described in (i) or (ii) above; (iv) certificates of deposit with a maturity of one year or less, issued by a federally insured institution; (v) a deposit account in a federally insured institution, subject to withdrawal restriction of one year or less; (vi) a checking account in a federally insured institution; or (vii) a reasonable petty cash fund.

SBICs may purchase voting securities of small business concerns in accordance with SBA regulations. Although prior regulations prohibited an SBIC from controlling a small business concern except in limited circumstances, SBA regulations allow an SBIC to exercise control over a small business for a period of seven years from the date on which the SBIC initially acquires its control position. This control period may be extended for an additional period of time with the SBA’s prior written approval.

If an SBIC defaults in its payment obligations to SBA under its outstanding debentures, fails to comply with any terms of its securities, or violates any law or regulation applicable to it, the SBA has the right to accelerate the maturity of all amounts due under its debentures. Additionally, the SBA can bring suit for the appointment of a receiver for the SBIC and for its liquidation in the event a default on payment of a SBIC’s debentures or for serious regulatory violations.

Other

Because Medallion Bank is an “insured depository institution” within the meaning of the Federal Deposit Insurance Act and the Change in Bank Control Act and we are a “financial institution holding company” within the meaning of the Utah Financial Institutions Act, federal and Utah law and regulations prohibit any person or

 

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company from acquiring control of us and, indirectly, Medallion Bank, without, in most cases, prior written approval of the FDIC or the Commissioner of Utah Department of Financial Institutions, as applicable. Under the Change in Bank Control Act, control is conclusively presumed if, among other things, a person or company acquires 25% or more of any class of our voting stock. A rebuttable presumption of control arises if a person or company acquires 10% or more of any class of voting stock and is subject to a number of specified “control factors” as set forth in the applicable regulations. Although Medallion Bank is an “insured depository institution” within the meaning of the Federal Deposit Insurance Act and the Change in Bank Control Act, your investment in Medallion Financial Corp. is not insured or guaranteed by the FDIC, or any other agency, and is subject to loss. Under the Utah Financial Institutions Act, control is defined as the power to vote 20% or more of any class of our voting securities by an individual or to vote more than 10% of any class of our voting securities by a person other than an individual. Investors are responsible for ensuring that they do not, directly or indirectly, acquire shares of our common stock in excess of the amount which can be acquired without regulatory approval.

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

 

   

regulate credit granting activities, including establishing licensing requirements, if any, in various jurisdictions;

 

   

establish maximum interest rates, finance charges and other charges;

 

   

require disclosures to customers;

 

   

govern secured transactions;

 

   

set collection, foreclosure, repossession and claims handling procedures and other trade practices;

 

   

prohibit discrimination in the extension of credit and administration of loans; and

 

   

regulate the use and reporting of information related to a borrower’s credit experience and other data collection.

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

AVAILABLE INFORMATION

Our corporate website is located at www.medallion.com. We make copies of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to those reports filed with or furnished to the SEC pursuant to Section 13(a) or 15(d) of the Exchange Act available on or through our website free of charge as soon as reasonably practicable after we electronically file them with or furnish them to the SEC. Our SEC filings can be found in the For Investors section of our website, the address of which is http://www.medallion.com/investors.html, or on the SEC website at www.sec.gov. Our Code of Ethical Conduct and Insider Trading Policy can be located in the Corporate Governance section of our website at http://www.medallion.com/investors_corporate_governance.html. These documents, as well as our SEC filings, are available in print free of charge to any stockholder who requests a copy from our Secretary.

 

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ITEM 1A.

RISK FACTORS

Risks Relating to Our Business and Structure

Our business is heavily concentrated in consumer lending, which carries a high risk of loss and could be adversely affected by an economic downturn.

Our business is heavily concentrated in consumer lending. As a result, we are more susceptible to fluctuations and risks particular to consumer credit than a more diversified company. For example, our business is particularly sensitive to macroeconomic conditions that affect the U.S. economy, consumer spending and consumer credit. We are also more susceptible to the risks of increased regulations and legal and other regulatory actions that are targeted at consumer credit or the specific consumer credit products that we offer (including promotional financing). Our business concentration could have a material adverse effect on our results of operations.

By its nature, lending to consumers carries with it different risks and typically a higher risk of loss than commercial lending. Although the net interest margins are intended to be higher to compensate us for this increased risk, an economic downturn could result in higher loss rates and lower returns than expected, and could affect the profitability of our consumer loan portfolio. During periods of economic slowdown, such as the 2007-2009 recession, delinquencies, defaults, repossessions, and losses generally increase, and consumers are likely to reduce their discretionary spending in areas such as recreation and home improvement, which comprise a high proportion of our business. These periods may also be accompanied by increasing unemployment rates and declining values of consumer products securing outstanding accounts, which weaken collateral coverage and increase the amount of a loss in the event of default.

Additionally, higher gasoline prices, volatile real estate values and market conditions, reset of adjustable rate mortgages to higher interest rates, general availability of consumer credit, or other factors that impact consumer confidence or disposable income could increase loss frequency and decrease consumer demand for RVs, boats, trailers and other consumer products (including in connection with home improvement projects), as well as weaken collateral values on certain types of consumer products. Any decrease in consumer demand for those products could have a material adverse effect on our ability to originate new loans and, accordingly, on our business, financial condition, and results of operations.

Although declines in commodity prices, and more particularly gasoline prices, generally are financially beneficial to the individual consumer, such declines may also have a negative impact on unemployment rates in geographic areas that are highly dependent upon the oil and natural gas industry, which could adversely affect the credit quality of consumers in those areas.

Our balance sheet consists of a significant percentage of nonprime consumer loans, which are associated with higher than average delinquency rates. The actual rates of delinquencies, defaults, repossessions, and losses on these loans could be more dramatically affected by a general economic downturn. In addition, during an economic slowdown or recession, our servicing costs may increase without a corresponding increase in our net interest income.

Furthermore, our business is significantly affected by monetary and regulatory policies of the U.S. Federal Government and its agencies. Changes in any of these policies are influenced by macroeconomic conditions and other factors that are beyond our control and could have a material adverse effect on us through interest rate changes, costs of compliance with increased regulation, and other factors. Although market conditions have improved since the 2007-2009 recession, conditions remain challenging for financial institutions.

The process we use to estimate losses inherent in our credit exposure requires complex judgments, including forecasts of economic conditions and how those economic conditions might impair the ability of our borrowers to repay their loans. The degree of uncertainty concerning economic conditions may adversely affect the accuracy of our estimates, which may, in turn, impact the reliability of the process and the quality of our assets.

 

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Changes in the taxicab and for-hire vehicle industries have resulted in significantly increased competition and have had a material adverse effect on our business, financial condition, and operations.

There have been changes in the taxicab and for-hire vehicle industries that have resulted in significantly increased competition in all of our taxi medallion markets. Ridesharing applications, or ridesharing apps, utilized by for-hire vehicles were introduced in New York City in 2011 and continue to expand domestically and globally. Many of these for-hire vehicle operators operate outside of the regulatory regime with which we and our borrowers operate. As a result, there is an increased risk in competition because such operators are able to pass the cost savings of not having to comply with certain regulations to its passengers. Since 2017, New York State, New York City Council and the New York City Taxi and Limousine Commissions have made several changes to the medallion classes and regulations forcing greater transparency and equal regulation among transportation companies, including; eliminating the distinction between individual and corporate medallions, temporarily capping the number of ride-sharing licenses, minimum-wage regulations for for-hire vehicle (FHV) companies, and congestion pricing. Until the market fully stabilizes we will not be able to determine the ultimate impact of these changes. According to the TLC, between January 2018 and January 2019 approximately 15,500 new for-hire vehicle licenses were issued, increasing the total number of for-hire vehicles to approximately 120,608 as of January 25, 2019, a 14.8% increase from January 2018.

In addition, the New York State legislature enacted a law on December 21, 2011, which was amended on February 17, 2012, to permit cars for-hire to pick up street hails in boroughs outside of Manhattan. Pursuant to this law the TLC has issued approximately 8,300 Street Hail Livery licenses since June 2013, of which approximately 3,400 are active.

TLC annualized data through November 2018 has shown a 8.9% reduction in total New York City taxicab fares, compared to the annualized data of December 2017, and a 9.1% reduction in the total number of New York City taxicab trips. Such reductions in fare totals and taxicab trips are likely the result of a combination of ridesharing apps, Street Hail Livery licenses, and other forms of public transportation.

As of December 31, 2018, 8.6% of our medallion loan portfolio was 90 days or more past due. As discussed in further detail below, there have also been recent decreases in the values of our medallion loan collateral and our Chicago medallions purchased out of foreclosure. Increased competition from ridesharing apps and Street Hail Livery licenses has reduced our market share, the overall market for taxicab services, the supply of taxicab drivers, income from operating medallions, and the value of taxicab medallions. If these trends continue and intensify, there would be a further material increase to our loan to value ratios, loan delinquencies, and loan defaults resulting in a material adverse effect on our business, financial condition, and results of operations.

Decreases in the value of our medallion loan collateral and our Chicago medallions purchased out of foreclosure have had, and may continue to have, a material adverse effect on our business.

A significant portion of our loan revenue is derived from loans collateralized by New York City taxicab medallions. According to TLC data, over the past 20 years New York City taxicab medallions had appreciated in value from under $200,000 to $1,320,000 for corporate medallions and $1,050,000 for individual medallions in 2014. However, based on our evaluation of various sale transactions and cash flows of our underlying borrowers performance, we determined that a market value of $186,400, $181,000 net of liquidation costs, was appropriate, reflecting the median transactional activity for the quarter ended December 31, 2018.

We own 159 Chicago taxicab medallions that were purchased out of foreclosure in 2003. Additionally, a portion of our loan revenue is derived from loans collateralized by Chicago taxicab medallions. The Chicago medallions had appreciated in value from $50,000 in 2003 to approximately $370,000 in 2013. Since that time, however, there has been a decline in the value of Chicago taxicab medallions to approximately $28,000, $27,160 net of liquidation costs, as of December 31, 2018.

 

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Decreases in the value of our medallion loan collateral have resulted in an increase in the loan-to-value ratios of our medallion loans. We estimate that the weighted average loan-to-value ratio of our medallion loans was approximately 220% as of December 31, 2018. If taxicab medallion values continue to decline, there could be an increase in medallion loan delinquencies, foreclosures, and borrower bankruptcies. Our ability to recover on defaulted medallion loans by foreclosing on and selling the medallion collateral could be diminished, which could result in material losses on defaulted medallion loans which could have a material adverse effect on our business. Continued decreases in the value of our Chicago medallions purchased out of foreclosure could adversely affect our ability to dispose of such medallions at times when it may be advantageous for us to do so. If we are required to liquidate all or a portion of our medallions quickly, we could realize less than the value at which we had previously recorded such medallions.

Our financial condition, liquidity and results of operations depend on the credit performance of our loans.

As of December 31, 2018, more than half of our recreation loans are nonprime receivables with obligors who do not qualify for conventional consumer finance products as a result of, among other things, adverse credit history. While our underwriting guidelines are designed to confirm that, notwithstanding such factors, the obligor would be a reasonable credit risk, the receivables nonetheless are expected to experience higher default rates than a portfolio of obligations of prime obligors. The weakening of our underwriting guidelines for any reason, such as in response to the competitive environment, in an effort to originate higher yielding loans, a lack of discipline or diligence by our employees in underwriting and monitoring loans or our inability to adequately adapt policies and procedures to changes in economic or other conditions, may result in loan defaults and charge-offs that may necessitate increases to our allowance for loan losses, each of which could adversely affect our net income and financial condition. In the event of a default on a recreation loan, generally the most practical recovery method is repossession of the financed vehicle, although the collateral value of the vehicle usually does not fully cover the outstanding account balance and costs of recovery. Repossession sales that do not yield sufficient proceeds to repay the receivables in full typically result in losses on those receivables.

In addition, our prime portfolio has grown in proportion to our overall portfolio over the past several years. While prime portfolios typically have lower default rates than nonprime portfolios, we have less ability to make risk adjustments to the pricing of prime loans compared to nonprime loans. As a result, to the extent our prime portfolio continues to grow, a larger proportion of our business will consist of loans with respect to which we will have less flexibility to adjust pricing to absorb losses. As a result of these factors, we may sustain higher losses than anticipated in our prime portfolio. Additionally, if our prime loan losses are higher than expected then we may also be at risk with regards to our forecasted losses, which could impact our loss reserves and results of operations.

We are subject to certain financial covenants and other restrictions under our loan and credit arrangements, which could affect our ability to finance future operations or capital needs or to engage in other business activities.

Our loan and credit agreements contain financial covenants and other restrictions relating to borrowing base eligibility, tangible net worth, net income, leverage ratios, shareholders’ equity, and collateral values. Our ability to meet these financial covenants and restrictions could be affected by events beyond our control, such as a substantial decline in collateral values or a rise in borrower delinquencies. A breach of these covenants could result in an event of default under the applicable debt instrument. Such a default, if not cured or waived, may allow the creditors to accelerate the related debt and may result in the acceleration of any other debt that is subject to an applicable cross-acceleration or cross-default provision. Most of our credit facility debt is subject to cross default provisions. Certain other events can constitute an event of default. Furthermore, if we were unable to repay the amounts due and payable under our credit facilities, those lenders could proceed against the collateral granted to them to secure that indebtedness. In the event our lenders or holders of the related notes accelerate the repayment of our borrowings, we and our subsidiaries may not have sufficient assets to repay that

 

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indebtedness. We have regularly needed waivers and extensions and there can be no guarantee that we will be able to continue to get them if requested. Based on the foregoing factors, the operating and financial restrictions and covenants in our current credit agreements and any future financing agreements could adversely affect our ability to finance future operations or capital needs or to engage in other business activities.

Our business, financial condition and results of operations could be negatively impacted if we are unsuccessful in developing and maintaining our relationships with dealerships, contractors and FSPs.

We originate loans by working with third-party sellers of consumer products and not working directly with consumers. As a result, our ability to originate consumer loans depends on our relationships with dealerships, contractors and FSPs. Although we have relationships with various dealerships, contractors and FSPs, none of our relationships are exclusive and each may be terminated at any time. In particular, there is significant competition for the contractor and FSP relationships we depend on in connection with our home improvement lending business. The loss of any of these relationships, our failure to develop additional relationships, and circumstances in which our existing dealer, contractor, and FSP relationships generate decreased sales and loan volume all may have a material adverse effect on our business, financial condition and results of operations.

We borrow money, which magnifies the potential for gain or loss on amounts invested, and increases the risk of investing in us.

Borrowings, also known as leverage, magnify the potential for gain or loss on amounts invested, and therefore increase the risk associated with investing in us. We borrow from and issue senior debt securities to banks and other lenders, and through long-term subordinated SBA debentures. These creditors have fixed dollar claims on our assets that are superior to the claims of our shareholders. If the value of our assets increases, then leveraging would cause the net asset value to increase more sharply than it would have had we not leveraged. Conversely, if the value of our assets decreases, leveraging would cause net asset value to decline more sharply than it otherwise would have had we not leveraged. Similarly, any increase in our income in excess of interest payable on the borrowed funds would cause our net income to increase more than it would without the leverage, while any decrease in our income would cause net income to decline more sharply than it would have had we not borrowed. Such a decline could reduce the amount available for distribution payments.

As of December 31, 2018, we had $1,062,028,000 of outstanding indebtedness, with a weighted average borrowing cost of 2.67%.

Most of our borrowing relationships have maturity dates during 2019 through 2021. We have been in active and ongoing discussions with each of these lenders and have extended each of the facilities as they matured. Certain lenders have worked with us to extend and change the terms of the borrowing agreements. See Note 7 of our consolidated financial statements for a discussion of the current and new lending arrangements to date.

Failure to obtain an extension of our existing credit facilities or failure to obtain additional revolving credit facilities could have a material adverse effect on our results of operations and financial position.

We utilize secured revolving credit facilities and other facilities to fund our investments. We cannot guarantee that our credit facilities will continue to be available beyond their current maturity dates on reasonable terms or at all or that we will be able to otherwise obtain funds by selling assets or raising equity to make required payments on maturing indebtedness. Our revolving credit facilities have converted to term loans. Obtaining additional revolving credit facilities or other alternative sources of financing may be difficult and we cannot guarantee that we will be able to do so on terms favorable to us or at all. The availability of revolving credit facilities depends, in part, on factors outside of our control, including regulatory capital treatment for unfunded bank lines of credit, the financial strength and strategic objectives of the banks that participate in our credit facilities and the availability of bank liquidity in general. If the credit facilities are not renewed or extended by our lenders by their maturity dates, we will not be able to make further borrowings under the facilities after

 

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they mature and the outstanding principal balances under such facilities will be due and payable at maturity. If we are unable to refinance our indebtedness at maturity or meet our payment obligations, our financial condition would be adversely affected and our lenders may foreclose on the property securing such indebtedness. If we are unable to extend or replace these facilities or arrange new credit facilities or other types of interim financing, we may need to curtail or suspend loan origination and funding activities which could have a material adverse effect on our results of operations and financial position.

Our use of brokered deposits for our deposit-gathering activities may not be available when needed. The inability to accept and renew brokered deposits would have a material adverse effect on our business, financial condition, liquidity and results of operations.

We rely on the established brokered deposit market to originate deposits to fund our operations. Additionally, our business, strategy and prospects are dependent on our ability to accept and renew brokered deposits without limitation and, therefore, dependent on our ability to be “well-capitalized” under the FDIC’s regulatory framework.

Our brokered deposits consist of deposits raised through the brokered deposit market rather than through retail branches. Although we have developed contractual relationships with a diversified group of investment brokers, and the brokered deposit market is well developed and utilized by many banking institutions, conditions could change that might affect the availability of brokered deposits. In addition, our ability to rely on brokered deposits as a source of funding is subject to capitalization requirements set forth in the FDIC’s prompt corrective action framework. We may not accept or renew brokered deposits unless we are “well-capitalized” or we are “adequately capitalized” and we receive a waiver from the FDIC. A bank that is “adequately capitalized” and that accepts or renews brokered deposits under a waiver from the FDIC is subject to additional restrictions on the interest rates it may offer. See “Supervision and Regulation” for additional information.

If our capital levels fall below the “well-capitalized” level as defined by the FDIC our ability to raise brokered deposits would be materially impaired. If our capital levels fall below the “adequately capitalized” level as defined by the FDIC, we would be unable to raise brokered deposits. Any impairment or inability to raise brokered deposits would have a material adverse effect on our business, financial condition, liquidity and results of operations. Brokered deposits may also not be as stable as other types of deposits, and if we experience a period of sustained operating losses, the cost of attracting deposits from the brokered deposit market could increase significantly. Our ability to manage our growth to stay within the “well-capitalized” level is critical to our ability to retain open access to this funding source.

The issuance of debt securities or preferred stock and our borrowing money from banks or other financial institutions may affect holders of our common stock.

Our business may periodically require capital. We may issue debt securities or preferred stock, and/or borrow money from banks or other financial institutions, which we refer to collectively as senior securities. Any amounts that we use to service our debt or make payments on preferred stock will not be available for distributions to our common shareholders. It is likely that any senior securities we issue will be governed by an indenture or other instrument containing covenants restricting our operating flexibility. Additionally, some of these securities or other indebtedness may be rated by rating agencies, and in obtaining a rating for such securities and other indebtedness, we may be required to abide by operating and investment guidelines that further restrict operating and financial flexibility. We and, indirectly, our shareholders will bear the cost of issuing and servicing such securities and other indebtedness. Preferred stock or any convertible or exchangeable securities that we issue in the future may have rights, preferences, and privileges more favorable than those of our common stock, including separate voting rights, and could delay or prevent a transaction or a change in control to the detriment of the holders of our common stock.

If we raise additional funds by issuing more common stock or senior securities convertible into, or exchangeable for, our common stock, the percentage ownership of our shareholders at that time would decrease

 

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and they may experience dilution. Moreover, we can offer no assurance that we will be able to issue and sell additional equity securities in the future, on favorable terms or at all.

We are dependent upon our key investment personnel for our future success.

We depend on the diligence, skill, and network of business contacts of the investment professionals we employ for sourcing, evaluating, negotiating, structuring, and monitoring our investments. Our future success will also depend, to a significant extent, on the continued service and coordination of our senior management team, particularly, Alvin Murstein, our Chairman and Chief Executive Officer, Andrew M. Murstein, our President, Larry D. Hall, our Chief Financial Officer, Donald Poulton and his management team for Medallion Bank, and Alex Travis and his management team at Medallion Capital. The departure of Messrs. Murstein or Mr. Hall, or any other member of our senior management team, could have a material adverse effect on our business and financial results.

Changes in taxicab industry regulations that result in the issuance of additional medallions or increases in the expenses involved in operating a medallion would decrease the value of our medallion loan collateral and our Chicago medallions purchased out of foreclosure.

Every city in which we originate medallion loans, and most other major cities in the United States, limits the supply of taxicab medallions. This regulation results in supply restrictions that support the value of medallions. Actions that loosen these restrictions and result in the issuance of additional medallions into a market could decrease the value of medallions in that market. If this were to occur, the value of the collateral securing our then outstanding medallion loans in that market would be adversely affected. We are unable to forecast with any degree of certainty whether any other potential increases in the supply of medallions will occur.

In New York City, Chicago, Boston, and other markets where we originate medallion loans, taxicab fares are generally set by government agencies. Expenses associated with operating taxicabs are largely unregulated. As a result, the ability of taxicab operators to recoup increases in expenses is limited in the short term. Escalating expenses, such as rising gas prices and an increase in interest rates, can render taxicab operations less profitable, could cause borrowers to default on loans from us and would adversely affect the value of our collateral.

We operate in a highly regulated environment, and if we are found to be in violation of any of the federal, state, or local laws or regulations applicable to us, our business could suffer.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, was enacted in 2010. The Dodd-Frank Act significantly changed federal financial services regulation and affects, among other things, the lending, deposit, investment, trading, and operating activities of financial institutions and their holding companies. In addition to the statutory requirements under the Dodd-Frank Act, the legislation also delegated authority to U.S. banking, securities and derivatives regulators to impose additional restrictions through required rulemaking. The Dodd-Frank Act requires a company that owns an industrial bank to serve as a “source of strength” to the institution and is also subject to the “Volcker Rule.” Although these requirements have not materially impacted us, we cannot assure you that they will not in the future.

Other changes in the laws or regulations applicable to us more generally, may negatively impact the profitability of our business activities, require us to change certain of our business practices, materially affect our business model, limit the activities in which we may engage, affect retention of key personnel, require us to raise additional regulatory capital, increase the amount of liquid assets that we hold, or otherwise affect our funding profile or expose us to additional costs (including increased compliance costs). Any such changes may also require us to invest significant management attention and resources to make any necessary changes and may adversely affect our ability to conduct our business as previously conducted or our results of operations or financial condition.

 

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We are also subject to a wide range of federal, state, and local laws and regulations, such as local licensing requirements, and retail financing, debt collection, consumer protection, environmental, health and safety, creditor, wage-hour, anti-discrimination, whistleblower and other employment practices laws and regulations and we expect these costs to increase going forward. The violation of these or future requirements or laws and regulations could result in administrative, civil, or criminal sanctions against us, which may include fines, a cease and desist order against the subject operations or even revocation or suspension of our license to operate the subject business. As a result, we have incurred and will continue to incur capital and operating expenditures and other costs to comply with these requirements and laws and regulations.

Changes in laws, regulations, or policies may adversely affect our business.

The post-financial crisis era has been marked by an increase in regulation, regulatory intensity, and enforcement. We are unable to predict the ways in which this change in the regulatory environment could impact our business models or objectives. The laws and regulations governing our lending, servicing, and debt collection activities or the regulatory or enforcement environment at the federal level or in any of the states in which we operate may change at any time which may have an adverse effect on our business.

We expect, however, to see an increase over time in regulatory scrutiny and enforcement in the area of consumer financial products regulation, as a result of the establishment of the Consumer Financial Protection Bureau, or the CFPB, by the Dodd-Frank Act. The CFPB is responsible for interpreting and enforcing a broad range of consumer protection laws that govern the provision of deposit accounts and the making of loans, including the regulation of mortgage lending and servicing and automobile finance. While Medallion Bank’s size currently falls below the threshold that would give the CFPB direct authority over it, Medallion Bank’s existing bank supervisors may pursue similar policies and make similar information requests to those of the CFPB with respect to consumer financial products and other matters within the scope of the CFPB’s authority. We believe that the CFPB’s regulatory reforms, together with other provisions of the Dodd-Frank Act, and increased regulatory supervision, may increase our cost of doing business, impose new restrictions on the way in which we conduct our business, or add significant operational constraints that might impair our profitability.

We are unable to predict how these or any other future legislative proposals or programs will be administered or implemented or in what form, or whether any additional or similar changes to statutes or regulations, including the interpretation or implementation thereof, will occur in the future. Any such action could affect us in substantial and unpredictable ways and could have an adverse effect on our results of operations and financial condition.

Our inability to remain in compliance with regulatory requirements in a particular jurisdiction could have a material adverse effect on our operations in that market and on our reputation generally. No assurance can be given that applicable laws or regulations will not be amended or construed differently or that new laws and regulations will not be adopted, either of which could materially adversely affect our business, financial condition, or results of operations.

Federal and state law may discourage certain acquisitions of our common stock which could have a material adverse effect on our shareholders.

Because Medallion Bank is an “insured depository institution” within the meaning of the Federal Deposit Insurance Act and the Change in Bank Control Act and we are a “financial institution holding company” within the meaning of the Utah Financial Institutions Act, federal and Utah law and regulations prohibit any person or company from acquiring control of us and, indirectly Medallion Bank, without, in most cases, prior written approval of the FDIC or the Commissioner of the Utah Department of Financial Institutions, as applicable. Under the Change in Bank Control Act, control is conclusively presumed if, among other things, a person or company acquires 25% or more of any class of our voting stock. A rebuttable presumption of control arises if a person or company acquires 10% or more of any class of voting stock and is subject to a number of specified “control

 

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factors” as set forth in the applicable regulations. Under the Utah Financial Institutions Act, control is defined as the power to vote 20% or more of any class of our voting securities by an individual or to vote more than 10% of any class of our voting securities by a person other than an individual. Investors are responsible for ensuring that they do not, directly or indirectly, acquire shares of our common stock in excess of the amount which can be acquired without regulatory approval. These provisions could delay or prevent a third party from acquiring us, despite the possible benefit to our shareholders, or otherwise adversely affect the market price of our common stock. Although Medallion Bank is an “insured depository institution” within the meaning of the Federal Deposit Insurance Act and the Change in Bank Control Act, your investment in Medallion Financial Corp. is not insured or guaranteed by the FDIC, or any other agency, and is subject to loss.

The banking industry is highly regulated, and the regulatory framework, together with any future legislative or regulatory changes, may have a significant adverse effect on our operations.

The banking industry is extensively regulated and supervised under both federal and state laws and regulations that are intended primarily for the protection of depositors, customers, federal deposit insurance funds, and the banking system as a whole, not for the protection of our stockholders and creditors. We are subject to regulation and supervision by the FDIC and the Utah Department of Financial Institutions. The laws and regulations applicable to us govern a variety of matters, including permissible types, amounts, and terms of loans and investments we may make, the maximum interest rate that may be charged, the amount of reserves we must hold against deposits we take, the types of deposits we may accept, maintenance of adequate capital and liquidity, changes in the control of Medallion Bank and us, restrictions on dividends, and establishment of new offices. As long as we remain well-capitalized under federal regulatory standards, there are no restrictions on the rates we may pay on brokered deposits. We must obtain approval from our regulators before engaging in certain activities or acquisitions, and there is the risk that such approvals may not be obtained, either in a timely manner or at all. Our regulators also have the ability to compel us to take, or restrict us from taking, certain actions entirely, such as actions that our regulators deem to constitute an unsafe or unsound banking practice. Our failure to comply with any applicable laws or regulations, or regulatory policies and interpretations of such laws and regulations, could result in sanctions by regulatory agencies, civil money penalties, or damage to our reputation, all of which could have a material adverse effect our business, financial condition or results of operations.

Since the 2007-2009 recession, federal and state banking laws and regulations, as well as interpretations and implementations of these laws and regulations, have undergone substantial review and change. In particular, the Dodd-Frank Act drastically revised the laws and regulations under which we operate. Financial institutions generally have also been subjected to increased scrutiny from regulatory authorities. These changes and increased scrutiny have resulted and may continue to result in increased costs of doing business and may in the future result in decreased revenues and net income, reduce our ability to effectively compete to attract and retain customers, or make it less attractive for us to continue providing certain products and services. Any future changes in federal and state law and regulations, as well as the interpretations and implementations, or modifications or repeals, of such laws and regulations, could affect us in substantial and unpredictable ways, including those listed above or other ways that could have a material adverse effect on our business, financial condition or results of operations.

Our SBIC subsidiaries are licensed by the SBA, and are therefore subject to SBA regulations.

Our SBIC subsidiaries are licensed to operate as SBICs and are regulated by the SBA. The SBA also places certain limitations on the financing terms of investments by SBICs in portfolio companies and prohibits SBICs from providing funds for certain purposes or to businesses in a few prohibited industries. Compliance with SBA requirements may cause the SBIC subsidiaries to forego attractive investment opportunities that are not permitted under SBA regulations.

Further, SBA regulations require that a licensed SBIC be periodically examined and audited by the SBA to determine its compliance with the relevant SBA regulations. The SBA prohibits, without prior SBA approval, a

 

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“change of control” of an SBIC or transfers that would result in any person (or a group of persons acting in concert) owning 10% or more of a class of capital stock of an SBIC. If the SBIC subsidiaries fail to comply with applicable SBIC regulations, the SBA could, depending on the severity of the violation, limit or prohibit their use of debentures, declare outstanding debentures immediately due and payable, and/or limit them from making new investments. In addition, the SBA could revoke or suspend an SBIC license or bring a suit for the appointment of a receiver for the SBIC and for its liquidation for willful or repeated violation of, or willful or repeated failure to observe, any provision of the SBIA or any rule or regulation promulgated thereunder. Such actions by the SBA would, in turn, negatively affect us.

Non-compliance with the USA PATRIOT Act, the Bank Secrecy Act or other laws and regulations could result in fines or sanctions against us.

The USA PATRIOT Act of 2001 and the Bank Secrecy Act require financial institutions to design and implement programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury Department’s Office of Financial Crimes Enforcement Network (FinCEN). These rules require financial institutions to establish procedures for identifying and verifying the identity of customers and beneficial owners of certain legal entity customers seeking to open new financial accounts. Federal and state bank regulators also have focused on compliance with Bank Secrecy Act and anti-money laundering regulations. Failure to comply with these regulations could result in fines or sanctions, including restrictions on conducting acquisitions or expanding activities. During the last several years, a number of banking institutions have received large fines for non-compliance with these laws and regulations. Although we have policies and procedures designed to assist in compliance with the Bank Secrecy Act and other anti-money laundering laws and regulations, there can be no assurance that such policies or procedures will work effectively all of the time or protect us against liability for actions taken by our employees, agents, and intermediaries with respect to our business or any businesses that we may acquire. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us, which could have a material adverse effect on our business, financial condition or results of operations.

Regulations relating to privacy, information security and data protection could increase our costs, affect or limit how we collect and use personal information and adversely affect our business opportunities.

We are subject to various privacy, information security, and data protection laws, including requirements concerning security breach notification, and we could be negatively affected by these laws. For example, our business is subject to the Gramm-Leach-Bliley Act which, among other things: (i) imposes certain limitations on our ability to share nonpublic personal information about our customers with nonaffiliated third parties; (ii) requires that we provide certain disclosures to customers about our information collection, sharing and security practices and afford customers the right to “opt out” of any information sharing by us with nonaffiliated third parties (with certain exceptions); and (iii) requires that we develop, implement and maintain a written comprehensive information security program containing safeguards appropriate based on our size and complexity, the nature and scope of our activities, and the sensitivity of customer information we process, as well as plans for responding to data security breaches. Various state and federal banking regulators and states have also enacted data security breach notification requirements with varying levels of individual, consumer, regulatory or law enforcement notification in certain circumstances in the event of a security breach. Moreover, legislators and regulators in the United States are increasingly adopting or revising privacy, information security, and data protection laws that potentially could have a significant impact on our current and planned privacy, data protection, and information security-related practices, our collection, use, sharing, retention and safeguarding of consumer or employee information, and some of our current or planned business activities. This could also increase our costs of compliance and business operations and could reduce income from certain business initiatives. This includes increased privacy-related enforcement activity at the federal level, by the Federal Trade Commission, as well as at the state level.

 

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Compliance with current or future privacy, data protection, and information security laws (including those regarding security breach notification) affecting customer or employee data to which we are subject could result in higher compliance and technology costs and could restrict our ability to provide certain products and services, which could have a material adverse effect on our business, financial conditions or results of operations. Our failure to comply with privacy, data protection, and information security laws could result in potentially significant regulatory or governmental investigations or actions, litigation, fines, sanctions, and damage to our reputation, which could have a material adverse effect on our business, financial condition, or results of operations.

Having withdrawn our election to be regulated as a BDC, we must maintain an exception from registration under the 1940 Act which could limit our ability to take advantage of attractive investment opportunities, and the failure to maintain that exception could have material adverse consequences on our business.

A company that meets the definition of an “investment company” under the 1940 Act, in the absence of an exception or exemption, must either register with the SEC as an investment company or elect BDC status. Historically, the composition of the Company’s assets caused us to meet the definition of an “investment company,” and the Company made a corresponding election to be treated as a BDC. The Company has de-elected BDC status, and now operates so as to fall outside the definition of an “investment company” or within an applicable exception. The Company expects to fall within the exception from the definition of an “investment company” provided under Section 3(c)(6) of the 1940 Act as a company primarily engaged, directly or through majority-owned subsidiaries, in the business of, among other things, (i) banking, (ii) purchasing and otherwise acquiring notes, drafts, acceptances, open accounts receivable, and other obligations representing part or all of the sales price of merchandise, insurance and services, and (iii) making loans to manufacturers, wholesalers, and retailers of, and to prospective purchasers of, specified merchandise, insurance, and services. The Company is required to monitor its continued compliance with this exception, which could limit our ability to take advantage of attractive investment opportunities that would cause us to be out of compliance with its limitations and could have a material adverse effect on our business. For example, we could be limited in growing Medallion Capital, Inc., which is currently engaged in a business that generally does not qualify for the exception.

If the SEC or a court were to find that we were required, but failed, to register as an investment company in violation of the 1940 Act, we may have to cease business activities, we would breach representations and warranties and/or be in default as to certain of our contracts and obligations, civil or criminal actions could be brought against us, our contracts would be unenforceable unless a court were to require enforcement and a court could appoint a receiver to take control of us and liquidate our business, any or all of which could have a material adverse effect on our business.

We operate in a highly competitive market for investment opportunities.

We compete for loans/investments with other business development companies and other investment funds, as well as traditional financial services companies such as commercial banks and credit unions. Many of our competitors are substantially larger and have considerably greater financial, technical, and marketing resources than we do. For example, some competitors may have a lower cost of funds and access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments. These characteristics could allow our competitors to consider a wider variety of investments, establish more relationships, and offer better pricing and more flexible structuring than us. We may be unwilling to match our competitors’ pricing, terms, and structure of certain loans and investments opportunities due to potential risks, which may result in us earning less income than our competitors. If we are forced to match our competitors’ pricing, terms, and structure, we may not be able to achieve acceptable returns on our investments or may bear substantial risk of capital loss.

 

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We cannot assure you that the competitive pressures we face will not have a material adverse effect on our business, financial condition, and results of operations. Also, as a result of this competition, we may not be able to take advantage of attractive investment opportunities from time to time.

Changes in interest rates may affect our cost of capital and net interest income.

Because we borrow to fund our loans and investments, a portion of our income is dependent upon the difference between the interest rate at which we borrow funds and the interest rate at which we invest these funds. A portion of our investments, such as taxi medallion loans, will have fixed interest rates, while a portion of our borrowings will likely have floating interest rates. As a result, a significant change in market interest rates could have a material adverse effect on our net investment income. In periods of rising interest rates, our cost of funds could increase, which would reduce our net investment income. We may hedge against interest rate fluctuations by using standard hedging instruments, subject to applicable legal requirements. These activities may limit our ability to participate in the benefits of lower interest rates with respect to the hedged portfolio. Adverse developments resulting from changes in interest rates or hedging transactions could have a material adverse effect on our business, financial condition, and results of operations. Also, we will have to rely on our counterparties to perform their obligations under such hedges.

A decrease in prevailing interest rates may lead to more loan prepayments, which could adversely affect our business.

Our commercial borrowers generally have the right to prepay their loans upon payment of a fee ranging from 1% to 2% for standard loans, and for higher amounts, as negotiated, for larger more custom loan arrangements. A borrower is likely to exercise prepayment rights at a time when the interest rate payable on the borrower’s loan is high relative to prevailing interest rates. In a lower interest rate environment, we will have difficulty re-lending prepaid funds at comparable rates, which may reduce the net interest income that we receive. When this occurs, we will generally reinvest these proceeds in temporary investments, pending their future investment in new portfolio companies. These temporary investments will typically have substantially lower yields than the debt being prepaid, and we could experience significant delays in reinvesting these amounts. Any future investment in a new portfolio company may also be at lower yields than the debt that was repaid. As a result, our results of operations could be materially adversely affected if a substantial number of our portfolio companies elect to prepay amounts owed to us and we are not able to reinvest the proceeds for comparable yields in a timely fashion. Additionally, prepayments could negatively impact our return on equity, which could result in a decline in the market price of our common stock.

An increase in prevailing interest rates could adversely affect our business.

The majority of our loan portfolio is comprised of fixed-rate loans. An abrupt increase in market rates of interest may have an adverse impact on our earnings until we are able to originate new loans at higher prevailing interest rates.

We depend on cash flow from our subsidiaries to make distribution payments to our shareholders.

We are primarily a holding company, and we derive most of our operating income and cash flow from our subsidiaries. As a result, we rely heavily upon distributions from our subsidiaries to generate the funds necessary to make distribution payments to our shareholders. Funds are provided to us by our subsidiaries through dividends and payments on intercompany indebtedness, but we cannot assure you that our subsidiaries will be in a position to continue to make these dividend or debt payments. The Utah Department of Financial Institutions and FDIC have the authority to prohibit or to limit the payment of dividends by Medallion Bank. In addition, as a condition to receipt of FDIC insurance, Medallion Bank entered into a capital maintenance agreement with the FDIC requiring it to maintain a 15% Tier 1 leverage ratio (Tier 1 capital to average assets). As of December 31, 2018, Medallion Bank’s Tier 1 leverage ratio was 15.85%. We have not received dividends from Medallion Bank since 2016.

 

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Medallion Bank’s use of brokered deposit sources for its deposit-gathering activities may not be available when needed.

Medallion Bank relies on the established brokered deposit market to originate deposits to fund its operations. Medallion Bank’s brokered deposits consist of deposits raised through the brokered deposit market rather than through retail branches. While Medallion Bank has developed contractual relationships with a diversified group of investment brokers, and the brokered deposit market is well developed and utilized by many banking institutions, conditions could change that might affect the availability of deposits. Applicable statutes and regulations restrict the use of brokered deposits and the interest rates paid on such deposits for institutions that are less than “well-capitalized”. If the capital levels at Medallion Bank fall below the “well-capitalized” level as defined by the FDIC or the capital level currently required by the FDIC pursuant to its capital maintenance agreement, or if Medallion Bank experiences a period of sustained operating losses, the cost of attracting deposits from the brokered deposit market could increase significantly, and the ability of Medallion Bank to raise deposits from this source could be impaired. Brokered deposits may also not be as stable as other types of deposits. Medallion Bank’s ability to manage its growth to stay within the “well-capitalized” level, and the capital level currently required by the FDIC pursuant to its capital maintenance agreement, which is also considerably higher than the level required to be classified as “well-capitalized”, is critical to Medallion Bank’s retaining open access to this funding source.

Uncertainty relating to the reporting of collateral values for our loans may adversely affect the value of our portfolio.

Medallion loans are primarily collateral-based lending, whereby the collateral value exceeds the amount of the loan, providing sufficient excess collateral to protect us against losses. Despite our reliance on collateral values, medallions are income producing assets that generate cash flow which is utilized to repay our loans. We rely on the integrity of the collateral value benchmarks obtained by the applicable regulatory agencies and other third parties. If these benchmarks are artificially influenced by market participants we could suffer losses. We have experienced a significant downward movement in medallion collateral values which may continue, and has caused a negative impact on our valuation analysis and could result in further significant lower fair market value measurements of our portfolio.

We require an objective benchmark in determining the fair value of our portfolio. If the benchmarks that we currently use are deemed to be unreliable, we will need to use other intrinsic factors in determining the collateral values for our loans.

Our allowance for loan losses may prove to be insufficient to cover losses on our loans.

We maintain an allowance for loan losses (a reserve established through a provision for losses that decreases our earnings and that, accordingly, affects our financial condition) that we believe is appropriate to provide for incurred losses in our loan portfolio.

The process for establishing an allowance for loan losses is critical to our results of operations and financial condition, and requires complex models and judgments, including forecasts of economic conditions. Changes in economic conditions affecting borrowers, growth in our loan portfolio, changes in the credit characteristics of our loan portfolio, new information regarding our loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. We may underestimate our incurred losses and fail to maintain an allowance for loan losses sufficient to account for these losses. In cases where we modify a loan, if the modified loans do not perform as anticipated, we may be required to establish additional allowances on these loans.

We periodically review and update our methodology, models and the underlying assumptions, estimates and assessments we use to establish our allowance for loan losses to reflect our view of current conditions. Moreover,

 

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our regulators, as part of their supervisory function, periodically review the methodology, models and the underlying assumptions, estimates and assessments we use for calculating, and the adequacy of, our allowance for loan losses. Our regulators, based on their judgment, may conclude that we should modify our methodology, models or the underlying assumptions, estimates and assessments, increase our allowance for loan losses, and/or recognize further losses. We continue to review and evaluate our methodology, models and the underlying assumptions, estimates, and assessments we use and we will implement further enhancements or changes to them, as needed. We cannot assure you that our loan loss reserves will be sufficient to cover actual losses. Future increases in the allowance for loan losses or recognized losses (as a result of any review, update, regulatory guidance, changes in accounting standards or otherwise) will result in a decrease in net earnings and capital and could have a material adverse effect on our business, results of operations, and financial condition.

The lack of liquidity in our investments may adversely affect our business.

We generally make investments in private companies. Substantially all of these securities are subject to legal and other restrictions on resale or are otherwise less liquid than publicly traded securities. The illiquidity of our investments may make it difficult for us to sell such investments if the need arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we had previously recorded our investments. We may also face other restrictions on our ability to liquidate an investment in a portfolio company to the extent that we have material non-public information regarding such portfolio company.

In addition, the illiquidity of our loan portfolio and investments may adversely affect our ability to dispose of loans 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 the investments in the 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 rising interest rates, our cost of funds would increase, which would reduce our net operating income before net realized and unrealized gains. We use a combination of long-term and short-term borrowings and equity capital to finance our investing activities. Our long-term fixed-rate investments are financed primarily with short-term floating-rate debt, and to a lesser extent by term fixed-rate debt. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. Such techniques may include various interest rate hedging activities. 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 the line item “net income” as of December 31, 2018 by approximately $549,000 on an annualized basis, and the impact of such an immediate increase of 1% over a one year period would have been approximately ($1,012,000) at December 31, 2018. 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 increase in net assets resulting 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.

We may experience fluctuations in our quarterly results.

We could experience fluctuations in our quarterly operating results due to a number of factors, including our ability to originate loans that meet our investment criteria, the interest rate payable on the debt securities we acquire, the level of our expenses, variations in and the timing of the recognition of charge-offs and provision for loan losses, the degree to which we encounter competition in our markets, and general economic conditions. As a result of these factors, results for any period should not be relied upon as being indicative of performance in future periods.

 

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A reduction in demand for our products and failure by us to adapt to such reduction could adversely affect our business, financial condition and results of operations.

The demand for the products we offer may be reduced due to a variety of factors, such as demographic patterns, changes in customer preferences or financial conditions, regulatory restrictions that decrease customer access to particular products or the availability of competing products. If we fail to adapt to significant changes in our customers’ demand for, or access to, our products, our revenues could decrease and our operations could be adversely affected. Even if we do make changes to our product offerings to fulfill customer demand, customers may resist such changes or may reject such products. Moreover, the effect of any product change on the results of our business may not be fully ascertainable until the change has been in effect for some time, and, by that time, it may be too late to make further modifications to such product without causing further adverse effects to our business, results of operations and financial condition.

Security breaches and other disruptions could compromise our information and expose us to liability, which would cause our business and reputation to suffer.

In the ordinary course of our business, we collect and store sensitive data, including our proprietary business information and that of our customers and personally identifiable information of our customers and employees, in third-party data centers, and on our networks. The secure processing, maintenance, and transmission of this information is critical to our operations. Despite our security and business continuity measures, our information technology and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance or other disruptions or vulnerable to other disruptions as a result of system failures, operational events, employee error or incidents affecting our third-party service providers (or providers to those third-party service providers). Any such breach or disruption could compromise our networks and the information stored there could be accessed, publicly disclosed, lost, destroyed or stolen. Any such access, disclosure, destruction or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information and regulatory penalties, disrupt our operations and damage our reputation, which could adversely affect our business. In addition, we may also be required to incur significant costs in connection with any regulatory investigation or civil litigation resulting from a security breach or other information technology disruption that affects us.

Our operations could be interrupted if certain external vendors on which we rely experience difficulty, terminate their services or fail to comply with banking laws and regulations.

We depend to a significant extent on relationships with third parties that provide services, primarily information technology services critical to our operations. Currently, we obtain services from third parties that include information technology infrastructure and support, plus loan origination, loan servicing, and accounting systems and support. If any of our third-party service providers experience difficulties or terminate their services and we are unable to replace our service providers with other service providers, our operations could be interrupted. It may be difficult for us to replace some of our third-party vendors, particularly vendors providing our loan origination, loan servicing and accounting services, in a timely manner if they are unwilling or unable to provide us with these services in the future for any reason. If an interruption were to continue for a significant period of time, it could have a material adverse effect on our business, financial condition or results of operations. Even if we are able to replace these third parties, it may be at higher cost to us, which could have a material adverse effect on our business, financial condition or results of operations. In addition, if a third-party provider fails to provide the services we require, fails to meet contractual requirements, such as compliance with applicable laws and regulations, or suffers a cyber-attack or other security breach, our business could suffer economic and reputational harm that could have a material adverse effect on our business, financial condition or results of operations.

 

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Our use of third-party vendors and our other ongoing third-party business relationships are subject to increasing regulatory requirements and attention.

We regularly use third-party vendors as part of our business. We also have substantial ongoing business relationships with other third parties. These types of third-party relationships are subject to increasingly demanding regulatory requirements and attention by our federal and state bank regulators. Recent regulation requires us to enhance our due diligence, ongoing monitoring and control over our third-party vendors and other ongoing third-party business relationships. In certain cases, we may be required to renegotiate our agreements with these vendors to meet these enhanced requirements, which could increase our costs and potentially limit our competitiveness. We expect that our regulators will hold us responsible for deficiencies in our oversight and control of our third-party relationships and in the performance of the parties with which we have these relationships. As a result, if our regulators conclude that we have not exercised adequate oversight and control over our third-party vendors or other ongoing third-party business relationships or that such third parties have not performed appropriately, we could be subject to enforcement actions, including civil money penalties or other administrative or judicial penalties or fines as well as requirements for customer remediation, any of which could have a material adverse effect our business, financial condition or results of operations.

Our business depends on our ability to adapt to rapid technological change.

The financial services industry is continually undergoing rapid technological change with frequent introductions of new, technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to serve customers better and to reduce costs. Our future success depends, in part, upon our ability to address the needs of customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements than we do. We may not be able to effectively implement new, technology-driven products and services or be successful in marketing these products and services to our customers. In addition, the implementation of technological changes and upgrades to maintain current systems and integrate new ones may also cause service interruptions, transaction processing errors and system conversion delays and may cause us to fail to comply with applicable laws. Failure to successfully keep pace with technological change affecting the financial services industry and failure to avoid interruptions, errors and delays could have a material adverse effect on our business, financial condition or results of operations.

We expect that new technologies and business processes applicable to the banking industry will continue to emerge, and these new technologies and business processes may be better than those we currently use. Because the pace of technological change is high and our industry is intensely competitive, we may not be able to sustain our investment in new technology as critical systems and applications become obsolete or as better ones become available. A failure to maintain current technology and business processes could cause disruptions in our operations or cause our products and services to be less competitive, all of which could have a material adverse effect on our business, financial condition or results of operations.

We depend on the accuracy and completeness of information about customers.

In deciding whether to extend credit or enter into other transactions, and in evaluating and monitoring our loan portfolio on an ongoing basis, we may rely on information furnished by or on behalf of customers, including financial statements, credit reports and other financial information. We may also rely on representations of those customers or of other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate, incomplete, fraudulent or misleading financial statements, credit reports or other financial or business information, or the failure to receive such information on a timely basis, could result in loan losses, reputational damage or other effects that could have a material adverse effect on our business, financial condition or results of operations.

 

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Terrorist attacks, other acts of violence or war, and natural disasters may affect any market for our securities, impact the businesses in which we invest, and harm our operations and profitability.

Terrorist attacks and natural disasters may harm our results of operations and your investment. We cannot assure you that there will not be further terrorist attacks against the U.S. or U.S. businesses or major natural disasters hitting the United States. Such attacks or natural disasters in the U.S. or elsewhere may impact the businesses in which we directly or indirectly invest by undermining economic conditions in the United States. In addition, a substantial portion of our business is focused in the New York City metropolitan area, which suffered a terrorist attack in 2001 and has faced continued threats. Another terrorist attack in New York City or elsewhere could severely impact our results of operations. Losses resulting from terrorist attacks are generally uninsurable.

Our financial condition and results of operations will depend on our ability to manage growth effectively.

Our ability to achieve our loan and investment objective will depend on our ability to grow, which will depend, in turn, on our management team’s ability to identify, evaluate, and monitor, and our ability to finance and invest in, companies that meet our investment criteria.

Accomplishing this result on a cost-effective basis will be largely a function of our management team’s handling of the investment process, its ability to provide competent, attentive, and efficient services, and our access to financing on acceptable terms. In addition to monitoring the performance of our existing investments, members of our management team and our investment professionals may also be called upon to provide managerial assistance to our portfolio companies. These demands on their time may distract them or slow the rate of investment. In order to grow, we will need to hire, train, supervise, and manage new employees. However, we cannot assure you that any such employees will contribute to the success of our business. Any failure to manage our future growth effectively could have a material adverse effect on our business, financial condition, and results of operations.

Our ability to enter into transactions with our affiliates is restricted.

The SBA restricts the ability of SBICs to lend money to any of their officers, directors, and employees, or invest in any affiliates thereof.

Medallion Bank is subject to certain federal laws that restrict and control its ability to engage in transactions with its affiliates. Sections 23A and 23B of the Federal Reserve Act and applicable regulations restrict the transfer of funds by Medallion Bank to certain of its affiliates, including us, in the form of loans, extensions of credit, investments, or purchases of assets and restrict its ability to provide services to, or receive services from, its affiliates. Sections 23A and 23B also require generally that Medallion Bank’s transactions with its affiliates be on terms no less favorable to Medallion Bank than comparable transactions with unrelated third parties.

Current or former employee misconduct could expose us to significant legal liability and reputational harm.

We are vulnerable to reputational harm because we operate in an industry in which integrity and the confidence of the dealerships, contractors and FSPs that sell our consumer products are of critical importance. Our employees could engage, or our former directors, employees, or our controlling shareholder could have engaged, in misconduct that adversely affects our business. For example, if such a person were to engage, or previously engaged, in fraudulent, illegal or suspicious activities, we could be subject to regulatory sanctions and suffer serious harm to our reputation (as a consequence of the negative perception resulting from such activities), financial position, third-party relationships and ability to forge new relationships with third-party dealers or contractors. Our business often requires that we deal with confidential information. If our employees were to improperly use or disclose this information, or if former directors, employees, or our controlling shareholder

 

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previously improperly used or disclosed this information, even if inadvertently, we could suffer serious harm to our reputation, financial position and current and future business relationships. It is not always possible to deter employee misconduct, and the precautions we take to detect and prevent this activity may not always be effective. Misconduct by our employees or former directors, employees, or our controlling shareholder, or even unsubstantiated allegations of misconduct, could result in a material adverse effect on our business, financial condition or results of operations

Risks Relating to Our Loan Portfolios and Investments

Lending to small businesses involves a high degree of risk and is highly speculative.

Lending to small businesses involves a high degree of business and financial risk, which can result in substantial losses and should be considered speculative. Historically, our borrower base consists primarily of small business owners that may have limited resources and that are generally unable to obtain financing from traditional sources. There is generally no publicly available information about these small business owners, and we must rely on the diligence of our employees and agents to obtain information in connection with our credit decisions. In addition, these small businesses often do not have audited financial statements. Some smaller businesses have narrower product lines and market shares than their competition. Therefore, they may be more vulnerable to customer preferences, market conditions, or economic downturns, which may adversely affect the return on, or the recovery of, our investment in these businesses.

Our portfolio is and may continue to be concentrated in a limited number of portfolio companies, and industries and sectors, which will subject us to a risk of significant loss if any of these companies defaults on its obligations to us or by a downturn in the particular industry or sector.

Our portfolio is and may continue to be concentrated in a limited number of portfolio companies, and industries and sectors. In addition, taxicab companies that constitute separate issuers may have related management or guarantors and constitute larger business relationships to us. As of December 31, 2018, New York City taxi medallion loans represented approximately 87% of our taxi medallion loans, which in turn represented 16% of our net loan portfolio. We do not have fixed guidelines for diversification, and while we are not targeting any specific industries, our investments are, and could continue to be, concentrated in relatively few industries. As a result, the aggregate returns we realize may be adversely affected if a small number of loans perform poorly or if we need to write down the value of any one loan. If our larger borrowers were to significantly reduce their relationships with us and seek financing elsewhere, the size of our loan portfolio and operating results could decrease. In addition, larger business relationships may also impede our ability to immediately foreclose on a particular defaulted portfolio company as we may not want to impair an overall business relationship with either the portfolio company management or any related funding source. Additionally, a downturn in any particular industry or sector in which we are invested could also negatively impact the aggregate returns we realize.

If we are unable to continue to diversify geographically, our business may be further adversely affected if New York City experiences a sustained economic downturn.

Historically, a significant portion of our loan revenue is derived from medallion loans collateralized by New York City taxicab medallions. An economic downturn in New York City could lead to an additional increase in defaults on our medallion loans. We cannot assure you that we will be able to sufficiently diversify our operations geographically.

An economic downturn could result in additional commercial and consumer loan customers experiencing declines in business activities and/or personal resources, which could lead to difficulties in their servicing of their loans with us, and increasing the level of delinquencies, defaults, and loan losses in our commercial and consumer loan portfolios.

 

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Laws and regulations implemented in response to climate change could result in increased operating costs for our portfolio companies.

Congress and other governmental authorities have either considered or implemented various laws and regulations in response to climate change and the reduction of greenhouse gases. Existing environmental regulations could be revised or reinterpreted, new laws and regulations could be adopted, and future changes in environmental laws and regulations could occur, which could impose additional costs on the operation of our portfolio companies. For example, regulations to cut gasoline use and control greenhouse gas emissions from new cars could adversely affect our medallion portfolio companies. Our portfolio companies may have to make significant capital and other expenditures to comply with these laws and regulations. Changes in, or new, environmental restrictions may force our portfolio companies to incur significant expenses or expenses that may exceed their estimates. There can be no assurance that such companies would be able to recover all or any increased environmental costs from their customers or that their business, financial condition or results of operations would not be materially and adversely affected by such expenditures or any changes in environmental laws and regulations, in which case the value of these companies could be adversely affected.

Our portfolio companies may incur debt that ranks equally with, or senior to, our investments in such companies.

We invest in our portfolio companies primarily through senior secured loans, junior secured loans, and subordinated debt issued by small- to mid-sized companies. Our portfolio companies may have, or may be permitted to incur, other debt that ranks equally with, or senior to, the debt in which we invest. By their terms, such debt instruments may entitle the holders to receive payment of interest or principal on or before the dates on which we are entitled to receive payments with respect to the debt instruments in which we invest. Also, in the event of insolvency, liquidation, dissolution, reorganization, or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our investment in that portfolio company would typically be entitled to receive payment in full before we receive any distribution. After repaying such senior creditors, such portfolio company may not have any remaining assets to use for repaying its obligation to us. In the case of debt ranking equally with debt instruments in which we invest, we would have to share on an equal basis any distributions with other creditors holding such debt in the event of an insolvency, liquidation, dissolution, reorganization, or bankruptcy of the relevant portfolio company.

There may be circumstances where our debt investments could be subordinated to claims of other creditors or we could be subject to lender liability claims.

Even though we may have structured most of our investments as senior loans, if one of our portfolio companies were to go bankrupt, depending on the facts and circumstances, including the extent to which we actually provided managerial assistance to that portfolio company, a bankruptcy court might recharacterize our debt investment and subordinate all or a portion of our claim to that of other creditors. We may also be subject to lender liability claims for actions taken by us with respect to a borrower’s business or instances where we exercise control over the borrower. It is possible that we could become subject to a lender’s liability claim, including as a result of actions taken in rendering significant managerial assistance.

We may not control many of Medallion Capital’s portfolio companies.

We may not control many of Medallion Capital’s portfolio companies, even though we may have board representation or board observation rights. As a result, we are subject to the risk that a Medallion Capital portfolio company in which we invest may make business decisions with which we disagree, and the management of such company may take risks or otherwise act in ways that do not serve our interests as debt investors.

 

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We may not realize gains from our equity investments.

Certain investments that we have made in the past and may make in the future include warrants or other equity securities. In addition, we may from time to time make non-control, equity co-investments in companies in conjunction with private equity sponsors. Our goal is ultimately to realize gains upon our disposition of such equity interests. However, the equity interests we receive may not appreciate in value and, in fact, may decline in value. Accordingly, we may not be able to realize gains from our equity interests, and any gains that we do realize on the disposition of any equity interests may not be sufficient to offset any other losses we experience. We also may be unable to realize any value if a portfolio company does not have a liquidity event, such as a sale of the business, recapitalization, or public offering, which would allow us to sell the underlying equity interests.

 

ITEM 1B.

UNRESOLVED STAFF COMMENTS

None.

 

ITEM 2.

PROPERTIES

We lease office space in New York City for our corporate headquarters under a lease expiring in April 2027. We also lease office space for loan origination offices and subsidiary operations in Long Island City, New York, Newark, New Jersey and Chicago, Illinois, which, along with our New York City office, handles our medallion loan segment, and Minneapolis, Minnesota, which handles our commercial lending segment. Medallion Bank leases office space in Salt Lake City, Utah under a lease expiring in November 2023, which handles the recreation and home improvement lending segments, and Bothell, Washington, which handles our home improvement lending segment. We do not own any real property, other than foreclosed properties obtained as a result of lending relationships. We believe that our leased properties, taken as a whole, are in good operating condition and are suitable for our current business operations.

 

ITEM 3.

LEGAL PROCEEDINGS

We are currently involved in various legal proceedings incident to the ordinary course of our business, including collection matters with respect to certain loans. We intend to vigorously defend any outstanding claims and pursue our legal rights. In the opinion of our management and based upon the advice of legal counsel, other than as set forth in the following paragraph there is no proceeding pending, or to the knowledge of management threatened, which in the event of an adverse decision could result in a material adverse effect on our results of operations or financial condition.

On December 20, 2017, a stockholder derivative action was filed in the Supreme Court of the State of New York, County of New York (Shields v. Murstein, et al.). The complaint named us as a nominal defendant and purports to assert claims derivatively on our behalf against certain of our current directors, one of our former directors, and a former independent contractor for one of our subsidiaries. The complaint alleged that the director defendants breached their fiduciary duties with respect to certain alleged misconduct by the former independent contractor involving postings about us under an alleged pseudonym. On January 25, 2018, we and the director defendants filed a motion to dismiss the action. On June 27, 2018, a hearing was held on the motion. On November 26, 2018, the Court entered a decision granting the motion. On December 17, 2018, the Court entered an order dismissing the plaintiff’s complaint with prejudice. The time for the plaintiff to appeal the Court’s order has elapsed.

 

ITEM 4.

MINE SAFETY DISCLOSURES

Not applicable.

 

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PART II

 

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

STOCK PERFORMANCE GRAPH

The following graph commences as of December 31, 2013 and compares the Company’s Common Stock with the cumulative total return for the NASDAQ Composite Index and the Russell 2000 Index. Furthermore, the following graph assumes the investment of $100 on December 31, 2013 in each of the Company’s Common Stock, the stocks comprising the NASDAQ Composite Index and the Russell 2000 Index and assumes dividends are reinvested.

Cumulative Total Return

Based on Initial Investment of $100 on December 31, 2013

with dividends reinvested

 

 

LOGO

Our common stock is quoted on NASDAQ under the symbol “MFIN.” Our common stock commenced trading on May 23, 1996. As of March 11, 2019, there were approximately 324 holders of record of our common stock. On March 11, 2019, the last reported sale price of our common stock was $6.60 per share.

We are subject to federal and applicable state corporate income taxes on our taxable ordinary income and capital gains, and are not subject to the annual distribution requirements under Subchapter M of the Code. Thus, there can be no assurance that we will pay any cash distributions as we may retain our earnings in certain circumstances to facilitate the growth of our business, to finance our investments, to provide liquidity or for other corporate purposes. We have not paid dividends since 2016 and do not currently anticipate paying dividends. We may, however, re-evaluate paying dividends in the future depending on market conditions.

We have adopted a dividend reinvestment plan pursuant to which shareholders may elect to have distributions reinvested in additional shares of common stock. When we declare a distribution, all participants will have credited to their plan accounts the number of full and fractional shares (computed to three decimal places) that could be obtained with the cash, net of any applicable withholding taxes that would have been paid to them if they were not participants. The number of full and fractional shares is computed at the weighted average price of all shares of common stock purchased for plan participants within the 30 days after the distribution is declared plus brokerage commissions. The automatic reinvestment of distributions will not release plan participants of any income tax that may be payable on the distribution. Shareholders may terminate their participation in the dividend reinvestment plan by providing written notice to the Plan Agent at least 10 days before any given distribution payment date. Upon termination, we will issue to a shareholder both a certificate

 

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for the number of full shares of common stock owned and a check for any fractional shares, valued at the then current market price, less any applicable brokerage commissions and any other costs of sale. There are no additional fees or expenses for participation in the dividend reinvestment plan. Shareholders may obtain additional information about the dividend reinvestment plan by contacting the American Stock Transfer & Trust Company, LLC at 6201 15th Avenue, Brooklyn, NY, 11219.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

We did not repurchase any of our shares during the three months ended December 31, 2018. Accordingly, under our Stock Repurchase Program previously authorized by our Board of Directors, up to 22,874,509 shares remain authorized for repurchase under the program.

 

ITEM 6.

SELECTED FINANCIAL DATA

Summary Consolidated Financial Data

You should read the consolidated financial information below with the Consolidated Financial Statements and Notes thereto included in this report. As described therein, for the nine months ended December 31, 2018, the Company reported under Bank Holding Company Accounting.

 

(Dollars in thousands, except per share data)

   Nine Months Ended December 31, 2018  

Statement of operations

  

Net interest income

   $ 71,987  

Provision for loan losses

     59,008  

Non-interest income (expense), net

     (20,135
  

 

 

 

Net loss before taxes

     (7,156

Income tax provision

     (709

Less non-controlling interest

     2,307  
  

 

 

 

Net loss after taxes

     (10,172
  

 

 

 

Per share data

  

Net loss after taxes

     (0.42

Distributions per share

     0.00  
  

 

 

 

Weighted average common shares outstanding

  

Diluted

     24,234,633  
  

 

 

 

Balance sheet data

  

Net loans receivable

   $ 981,487  

Total assets

     1,381,846  

Total borrowings

     1,062,028  

Total liabilities

     1,091,642  

Total equity (3)

     290,204  
  

 

 

 

Selected financial ratios

  

Return on average assets (ROA)

     (0.90 %) 

Return on average equity (ROE)

     (4.62

Dividend payout ratio

     0.00  

Net interest margin

     8.19  

Other income ratio (1)

     1.88  

Total expense ratio (2)

     9.77  

Equity to assets (3)

     21.00  

Debt to equity (3)

     365.96  

Loans receivable to assets

     71.03  

Net charge-offs

     22,613  

Net charge-offs as a % of average loans receivable

     2.73

Allowance coverage ratio

     3.58  

 

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(1)

Other income ratio represents other income divided by average interest earning assets, and excludes the gain on the deconsolidation of Trust III of $25,325. See Note 23 for additional information.

(2)

Total expense ratio represents total expenses (interest expense, operating expenses, and income taxes) divided by average interest earning assets, and includes the goodwill impairment of $5,615.

(3)

Includes $27,596 related to non-controlling interest in consolidated subsidiaries.

You should read the consolidated financial information below with the Consolidated Financial Statements and Notes thereto included in this report. As described therein, for the three months ended March 31, 2018, and the years ended December 31, 2017, 2016, 2015 and 2014, the Company reported under Investment Company Accounting.

 

    Three Months
Ended March 31,
    Year Ended December 31,  

(Dollars in thousands, except per share data)

  2018     2017     2016     2015     2014  

Statement of operations

         

Investment income

  $ 4,033     $ 19,624     $ 25,088     $ 42,653     $ 41,068  

Interest expense

    3,551       13,770       12,638       9,422       8,543  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

    482       5,854       12,450       33,231       32,525  

Noninterest income

    60       107       408       319       509  

Operating expenses

    4,108       13,810       22,786       16,724       17,889  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income (loss) before income taxes

    (3,566     (7,849     (9,928     16,826       15,145  

Income tax benefit

    336       728       10,047       —         —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income (loss) after income taxes

    (3,230     (7,121     119       16,826       15,145  

Net realized gains (losses) on investments

    (34,745     (43,744     457       7,636       (5,607

Net change in unrealized appreciation on Medallion Bank and other controlled subsidiaries (1)

    29,115       9,483       130,121       16,830       15,643  

Net change in unrealized appreciation (depreciation) on investments (1)

    (1,915     8,222       (22,863     (2,295     6,412  

Net change in unrealized depreciation on investments other than securities

    (4,403     (2,060     (28,372     (9,621     (2,901

Income tax (provision) benefit

    304       35,498       (55,947     —         —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase (decrease) in net assets resulting from operations

  ($ 14,874   $ 278     $ 23,515     $ 29,376     $ 28,692  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Per share data

         

Net investment income (loss)

  ($ 0.15   ($ 0.33   ($ 0.41   $ 0.69     $ 0.60  

Income tax (provision) benefit

    0.03       1.51       (1.90     —         —    

Net realized gains (losses) on investments

    (1.44     (1.82     0.02       0.31       (0.22

Net change in unrealized appreciation on investments (1)

    0.94       0.65       3.26       0.2       0.76  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase (decrease) in net assets resulting from operations

  ($ 0.62   $ 0.01     $ 0.97     $ 1.20     $ 1.14  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Distributions declared per share

  $ 0.00     $ 0.00     $ 0.35     $ 1.00     $ 0.96  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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    Three Months
Ended March 31,
    Year Ended December 31,  

(Dollars in thousands, except per share data)

  2018     2017     2016     2015     2014  

Weighted average common shares outstanding

         

Basic

    24,154,879       23,919,994       24,123,888       24,315,427       24,850,496  

Diluted

    24,154,879       24,053,307       24,173,020       24,391,959       25,073,323  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance sheet data

         

Net investments

  $ 595,402     $ 610,135     $ 652,278     $ 606,959     $ 527,601  

Total assets

    616,710       635,522       689,377       689,050       632,287  

Total funds borrowed

    320,662       327,623       349,073       404,540       348,795  

Total liabilities

    344,273       348,363       403,281       410,962       357,617  

Total shareholders’ equity

    272,437       287,159       286,096       278,088       274,670  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Managed balance sheet data (2)

         

Net investments

  $ 1,386,136     $ 1,380,054     $ 1,517,592     $ 1,501,555     $ 1,310,685  

Total assets

    1,479,826       1,565,889       1,605,435       1,631,118       1,469,751  

Total funds borrowed

    1,167,888       1,234,371       1,257,515       1,313,436       1,156,735  

Total liabilities

    1,207,389       1,278,730       1,319,340       1,353,030       1,195,081  

Selected financial ratios and other data

         

Return on average assets (ROA) (3)

         

Net investment income (loss) after taxes

    (2.08 )%      (1.07 )%      0.02     2.59     2.51

Net increase in net assets resulting from operations

    (9.55     0.04       3.48       4.53       4.75  

Return on average equity (ROE) (4)

         

Net investment income (loss) after taxes

    (4.62     (2.49     0.04       6.08       5.48  

Net increase (decrease) in net assets resulting from operations

    (21.24     0.10       8.49       10.61       10.39  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average yield

    2.70     3.12     4.17     7.74     8.25

Weighted average cost of funds

    2.38       2.19       2.10       1.71       1.71  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest margin (5)

    0.32       0.93       2.07       6.03       6.54  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest income ratio (6)

    0.01       0.02       0.07       0.06       0.10  

Total expense ratio (7)

    1.16       (1.37     13.5       4.75       5.31  

Operating expense ratio (8)

    0.68       2.20       3.78       3.04       3.60  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

As a percentage of net investment portfolio

         

Medallion loans

    27     34     41     51     59

Commercial loans

    15       15       13       14       14  

Investment in Medallion Bank and other controlled subsidiaries

    56       49       45       26       26  

Equity investments

    2       2       1       1       1  

Investment securities

    —         —         —         8       —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Investments to assets (9)

    97     96     95     88     83

Equity to assets (10)

    44       45       42       40       43  

Debt to equity (11)

    118       114       122       145       127  

 

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(1)

Unrealized appreciation (depreciation) on investments represents the increase (decrease) for the year in the fair value of our investments, including the results of operations for Medallion Bank and other controlled subsidiaries, where applicable.

(2)

Includes the balances of wholly-owned, unconsolidated portfolio companies, primarily Medallion Bank.

(3)

ROA represents the net investment income after taxes or net increase in net assets resulting from operations, divided by average total assets, and includes the goodwill impairment of $5,099 in 2016. Excluding the impairment writeoff, the ratio was 0.77% in 2016.

(4)

ROE represents the net investment income after taxes or net increase in net assets resulting from operations, divided by average shareholders’ equity, and includes the goodwill impairment of $5,099 in 2016. Excluding the impairment writeoff, the ratio was 1.88% in 2016.

(5)

Net interest margin represents net interest income for the year divided by average interest earning assets, and included interest recoveries and bonuses of $0 for the three months ended March 31, 2018, $0 in 2017, $0 in 2016, $817 in 2015, and $4,160 in 2014, and also included dividends from Medallion Bank and other controlled subsidiaries of $28 for the three months ended March 31, 2018, $1,278 in 2017, $3,000 in 2016, $18,889 in 2015, and $15,000 in 2014. On a managed basis, combined with Medallion Bank, the net interest margin was 6.96% for the three months ended March 31, 2018 and 6.99%, 6.77%, 6.98%, and 7.09% for 2017, 2016, 2015, and 2014.

(6)

Noninterest income ratio represents noninterest income divided by average interest earning assets.

(7)

Total expense ratio represents total expenses (interest expense, operating expenses, and income taxes) divided by average interest earning assets, and includes the goodwill impairment of $5,099 in 2016. Excluding the impairment writeoff, the ratio was 12.65% in 2016.

(8)

Operating expense ratio represents operating expenses divided by average interest earning assets, and includes the goodwill impairment of $5,099 in 2016. Excluding the impairment writeoff, the ratio was 2.94% in 2016.

(9)

Represents net investments divided by total assets as of December 31.

(10)

Represents total shareholders’ equity divided by total assets as of December 31.

(11)

Represents total funds borrowed divided by total shareholders’ equity as of December 31.

 

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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, 2018, 2017, and 2016. 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. Additionally, more information about our business activities can be found in “Business.”

GENERAL

We are a finance company that has historically had a leading position in originating, acquiring, and servicing loans that finance taxicab medallions and various types of commercial businesses. Recently, our strategic growth has been through Medallion Bank, a wholly-owned subsidiary, which originates consumer loans for the purchase of RV’s, boats, motorcycles, and trailers, and to finance small-scale home improvements.

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 16% (19% if there had been no loan sales during 2016, 2017, and 2018). We are transitioning away from medallion lending and placing our strategic focus on our growing consumer finance business. As a result of our change in strategy, as of December 31, 2018, our consumer loans represented 77% of our loan portfolio, with medallion loans representing 16% and commercial loans representing 7%. Total assets under management and management of

 

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our unconsolidated wholly-owned subsidiaries (prior to April 2, 2018), which includes our managed net investment portfolio, as well as assets serviced for third party investors and unconsolidated subsidiaries, were $1,522,000,000 as of December 31, 2018, and were $1,593,000,000 as of December 31, 2017, and have grown at a compound annual growth rate of 9% 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 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.

On March 7, 2018, a majority of the Company’s shareholders authorized the Company’s Board of Directors to withdraw the Company’s election to be regulated as a BDC under the 1940 Act, and we withdrew such election effective April 2, 2018. At that point, we were no longer a BDC or subject to the provisions of the 1940 Act applicable to BDCs. Historically, the composition of the Company’s assets caused it to meet the definition of an “investment company,” and the Company made a corresponding election to be treated as a BDC. Now that the Company has de-elected BDC status, it operates so as to fall outside the definition of an “investment company” or within an applicable exception.

As a result of this change in status, commencing with the three months ended June 30, 2018:

 

   

we consolidated the results of Medallion Bank and our other subsidiaries in our financial statements, which, as an investment company, we were previously precluded from doing; and

 

   

with the consolidation of Medallion Bank, given its significance to our overall financial results, we now report as a bank holding company for accounting purposes under Article 9 and Guide 3 of Regulation S-X (but we are not a bank holding company for regulatory purposes).

As we made this change to our financial reporting prospectively, in this report we refer to both accounting in accordance with U.S. generally accepted accounting principles (GAAP) applicable to bank holding companies (Bank Holding Company Accounting), which applies commencing April 2, 2018, and to that applicable to investment companies under the 1940 Act (Investment Company Accounting), which applies to prior periods.

Our wholly-owned subsidiary, Medallion Bank, is a bank regulated by the FDIC and the Utah Department of Financial Institutions which originates 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. To take advantage of this low cost of funds, historically we have referred a portion of our taxicab medallion and commercial loans to Medallion Bank, which originated these loans, and have been serviced by MSC. However, at this time Medallion Bank is not originating any new taxi medallion loans and is working with MSC to service its existing portfolio. The FDIC restricts the amount of taxicab medallion loans that Medallion Bank may finance to three times Tier 1 capital, although it is less than one times Tier 1 capital as of December 31, 2018. MSC earns referral and servicing fees for these activities.

 

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The assets of Taxi Medallion Loan Trust III (Trust III) were not available to pay obligations of its affiliates or any other party. Trust III’s loans are serviced by Medallion Funding LLC (MFC). On November 8, 2018, a limited guaranty in favor of DZ Bank was terminated in exchange for a $1.4 million note, payable in quarterly installments over five years. As a result of such restructuring, effective as of such date, Trust III is no longer consolidated in our financial statements, and a gain of $25,325,000 was recorded in the 2018 fourth quarter reflecting the deconsolidation.

CRITICAL ACCOUNTING POLICIES

We follow financial accounting and reporting policies that are in accordance with U.S. generally accepted accounting principles (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: 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

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 loans and home improvement 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. Performing loans are recorded at book value and the general reserve maintained to absorb expected losses consistent with GAAP.

All medallion loans that reach 90 days or more delinquent require a specific allowance reserve for those loans, which is determined on an individual basis. The allowance is then recorded so the net value of the loan is either equal to the market or collateral value of the loan.

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

 

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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.

Medallion Loan Collateral Valuation

Due to the low volume of market transfer activity the taxi medallion collateral fair value is derived quarterly for each jurisdiction using recent market transfer activity, to the extent it is available, and a discounted cash flow model. Recent market transfers published by the jurisdiction are averaged to derive the transfer activity value. When analyzing transfer activity, management does not consider transaction outliers in the average calculation nor transactions which are confirmed through third-party sources as not arms-length. For the discounted cash flow model value, significant inputs include the discount rate, taxi fare/lease revenue and associated expenses such as vehicle costs, fuel, credit card processing fees, repair costs, and insurance premiums. A higher discount rate, lower taxi fare/lease revenue and higher associated expenses each produce a lower fair value. At period end, the transfer activity and discounted cash flow values create the fair value range. A weight is ascribed to each value in order to determine the final market value.

Average Balances and Rates (Bank Holding Company Accounting)

The following table shows the Company’s consolidated average balance sheets, interest income and expense, and the average interest earning/bearing assets and liabilities for nine months ended December 31, 2018.

 

     Nine Months Ended December 31, 2018  

(Dollars in thousands)

   Average Balance      Interest      Average Yield/Cost  

Interest-earning assets:

        

Interest-earning cash and cash equivalents

   $ 45,836      $ 508        1.47

Investment securities

     44,789        850        2.52  

Loans:

        

Recreation

     579,440        68,870        15.78  

Home improvement

     187,570        12,799        9.06  

Commercial loans

     78,501        7,459        12.61  

Medallion loans

     234,476        6,317        3.58  
  

 

 

    

 

 

    

Total loans

     1,079,987        95,445        11.73  
  

 

 

    

 

 

    

Total interest-earning assets

   $ 1,170,612      $ 96,803        10.98
  

 

 

    

 

 

    

 

 

 

Non-interest-earning assets

        

Cash

   $ 12,131        

Equity investments

     10,665        

Loan collateral in process of foreclosure (1)

     56,397        

Goodwill and intangible assets

     210,441        

Other assets

     37,542        
  

 

 

       

Total non-interest-earning assets

     327,176        
  

 

 

       

Total assets

   $ 1,497,788        
  

 

 

       

 

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     Nine Months Ended December 31, 2018  

(Dollars in thousands)

   Average Balance      Interest      Average Yield/Cost  

Interest-bearing liabilities

        

Deposits

   $ 891,588      $ 14,230        2.12

DZ loan

     67,935        2,126        4.15  

SBA debentures and borrowings

     79,157        2,300        3.86  

Notes payable to banks

     67,732        2,305        4.52  

Retail notes

     33,625        2,625        10.36  

Preferred securities

     33,000        1,111        4.47  

Other borrowings

     8,286        119        1.91  
  

 

 

    

 

 

    

Total interest-bearing liabilities

   $ 1,181,323      $ 24,816        2.79
  

 

 

    

 

 

    

 

 

 

Non-interest-bearing liabilities

        

Deferred tax liability

   $ 1,549        

Other liabilities

     22,743        
  

 

 

       

Total non-interest-bearing liabilities

     24,292        
  

 

 

       

Total liabilities

   $ 1,205,615        
  

 

 

       

Non-controlling interest

     27,318        

Total stockholders’ equity

     264,855        
  

 

 

       

Total liabilities and stockholders’ equity

   $ 1,497,788        
  

 

 

       

Net interest income

      $ 71,987     
     

 

 

    

Net interest margin

           8.19
        

 

 

 

 

(1)

Includes financed sales of this collateral to third parties reported separately from the loan portfolio, and that are conducted by the Bank of $3,134.

During the nine months, our net loans receivable had a yield of 11.73%, which was driven by the recreation loans partly offset by the medallion loan yield driven by the market and the overall decline in the balance. The recreation loans are consumer loans used in large part to purchase recreational vehicles, boats and trailers and the recreation loan portfolio produces the majority of our interest income. Of our debt, we use certificates of deposit to provide the funding for our consumer loans (recreation and home improvement) and a portion of our medallion loans. In addition, due to the restructuring of the DZ loan, the overall borrowings declined, but the rate increased due to current market conditions.

 

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Rate/Volume Analysis (Bank Holding Company Accounting)

The following table presents the change in interest income and expense due to changes in the average balances (volume) and average rates by calculated for the period indicated.

 

     Nine Months Ended December 31, 2018  

(Dollars in thousands)

   Increase (Decrease) In
Volume
     Increase
(Decrease) In Rate
     Net Change  

Interest-earning assets

        

Interest-earning cash and cash equivalents

   $ 142      $ 18      $ 160  

Investment securities

     30        12        42  

Loans

        

Recreation

     2,089        (1,427      662  

Home improvement

     28        160        188  

Commercial

     (153      314        161  

Medallion

     (962      (1,460      (2,422
  

 

 

    

 

 

    

 

 

 

Total loans receivable

   $ 1,002      ($ 2,413    ($ 1,411
  

 

 

    

 

 

    

 

 

 

Total interest-earning assets

   $ 1,174      ($ 2,383    ($ 1,209
  

 

 

    

 

 

    

 

 

 

Interest-bearing liabilities

        

Deposits

   $ 218      $ 1,203      $ 1,421  

DZ loan

     (679      (41      (720

SBA debentures and borrowings

     32        (2      30  

Notes payable to banks

     (190      108        (82

Retail notes

     —          (19      (19

Preferred securities

     —          79        79  

Other borrowings

     2        4        6  
  

 

 

    

 

 

    

 

 

 

Total interest-bearing liabilities

   ($ 617    $ 1,332      $ 715  
  

 

 

    

 

 

    

 

 

 

Net

   $ 1,791      ($ 3,715    ($ 1,924
  

 

 

    

 

 

    

 

 

 

Our interest expense is driven by the interest rates payable on our bank certificates of deposit, short-term credit facilities with banks, fixed-rate, long-term debentures issued to the SBA, and other short-term notes payable. Medallion Bank issues brokered bank certificates of deposit, which are our lowest borrowing costs. Medallion 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 7 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.

 

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We measure our borrowing costs as our aggregate interest expense for all of our interest-bearing liabilities divided by the average amount of such liabilities outstanding during the period. The following tables show the average borrowings and related borrowing costs for the years ended December 31, 2018, 2017 and 2016. Our average balances decreased during the current year, reflecting the contraction in the loan portfolios, mainly due to the deconsolidation of Trust III and the consumer loan sale in the third quarter of 2018. The increase in borrowing costs primarily reflected the repricing of term borrowings based upon the current market and increased deposit balances reflecting a lengthening of their maturity profile.

 

(Dollars in thousands)

   Interest
Expense
     Average
Balance
     Average
Borrowing
Costs
 

December 31, 2018 (1)

        

Deposits

   $ 14,230      $ 891,588        2.14

DZ loan

     2,928        81,256        3.60  

SBA debentures and borrowings

     3,049        79,016        3.86  

Notes payable to banks

     3,118        71,353        4.37  

Retail notes

     3,500        33,625        10.41  

Preferred securities

     1,423        33,000        4.31  

Other borrowings

     119        8,286        1.93  
  

 

 

    

 

 

    

Total borrowings

   $ 28,367      $ 1,198,124        2.37  
  

 

 

    

 

 

    

December 31, 2017

        

DZ loan

   $ 2,892      $ 102,894        2.81

Notes payable to banks

     3,164        84,219        3.76  

SBA debentures and borrowings

     3,099        80,284        3.86  

Preferred securities

     1,111        33,000        3.37  

Retail notes

     3,504        33,625        10.42  
  

 

 

    

 

 

    

Total

   $ 13,770      $ 334,022        4.12  
  

 

 

    

 

 

    

Medallion Bank borrowings

     13,869        913,072        1.52  
  

 

 

    

 

 

    

Total managed borrowings

   $ 27,639      $ 1,247,094        2.22  
  

 

 

    

 

 

    

December 31, 2016

        

DZ loan

   $ 2,670      $ 119,492        2.23

Notes payable to banks

     3,119        105,893        2.95  

SBA debentures

     3,134        79,175        3.96  

Preferred securities

     945        33,000        2.87  

Retail notes

     2,501        23,748        10.53  

Margin loans

     269        18,997        1.42  
  

 

 

    

 

 

    

Total

   $ 12,638      $ 380,305        3.32  
  

 

 

    

 

 

    

Medallion Bank borrowings

     11,762        924,235        1.27  
  

 

 

    

 

 

    

Total managed borrowings

   $ 24,400      $ 1,304,540        1.87  
  

 

 

    

 

 

    

 

(1)

Balance includes the nine months ended December 31, 2018 under Bank Holding Company Accounting and three months ended March 31, 2018 under Investment Company Accounting.

We will 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 SBIA and SBA regulations. We believe that financing operations primarily with short-term floating rate secured bank debt has generally decreased our interest expense, but has also increased our exposure to the risk of increases in market interest rates, which we mitigate with certain interest rate strategies. At December 31, 2018 short-term adjustable rate debt constituted 6% of total debt, and

 

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were 55% (15% on a managed basis which included borrowings of our consolidated and unconsolidated subsidiaries) and 59% (16% on a managed basis) as of December 31, 2017 and 2016.

Provision and Allowance for Loan Loss (Bank Holding Company Accounting)

The below is based upon activity beginning on April 2, 2018. During the nine months ended December 31, 2018, the New York medallion value slightly decreased to a net realizable value of $181,000, from $183,500 at March 31, 2018 and in the 2018 fourth quarter, the net realizable value of the other markets declined as loans continue to age over 120 days. The provision was slightly improved by the deconsolidation of Trust III in the 2018 fourth quarter, leading to a reversal of $8,161,000 of provision. The provision also included $5,708,000 of a general reserve, for the Company, for current and performing medallion loans under 90 days past due, as an additional buffer against future losses. This figure excludes the general reserve of $17,351,000 at the Bank, which was netted against loan balances at consolidation on April 2, 2018.

 

(Dollars in thousands)

   Nine Months
Ended
December 31,
2018
 

Allowance for loan losses – beginning balance (1)

   $ —  

Charge-offs

  

Recreation

     (12,697

Home improvement

     (1,562

Commercial

     —    

Medallion

     (14,277
  

 

 

 

Total charge-offs

     (28,536
  

 

 

 

Recoveries

  

Recreation

     4,437  

Home improvement

     905  

Commercial

     4  

Medallion

     577  
  

 

 

 

Total recoveries

     5,923  
  

 

 

 

Net charge-offs

     (22,613 )(2) 
  

 

 

 

Provision for loan losses (3)

     59,008 (4)  
  

 

 

 

Allowance for loan losses – ending balance

   $ 36,395  
  

 

 

 

 

(1)

Beginning balance for the nine months December 31, 2018 ended reflects the transition to Bank Holding Company Accounting by netting previously established unrealized depreciation against the gross loan balances resulting in a starting point of zero for this table.

(2)

As of December 31, 2018, cumulative charge-offs of loans and loans in process of foreclosure in the medallion portfolio were $215,789, representing collection opportunities for the Company.

(3)

Includes $5,708 of a general reserve, for the Company, for current and performing medallion loans under 90 days past due, as an additional buffer against future losses, representing 16% of the total allowance, and 4% of the loans in question. This figure excludes the general reserve for the Bank, which was netted against loan balances at consolidation on April 2, 2018.

(4)

Includes $8,161 of a reversal of provision for loan loss related to the deconsolidation of Trust III in the 2018 fourth quarter.

 

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The following table presents the allowance by segment as a percent of loans as of December 31, 2018 under Bank Holding Company Accounting.

 

(Dollars in thousands)

   Amount      Percentage
of
Allowance
    Allowance as a
Percent of Loan
Category
 

Recreation

   $ 6,856        19     1.17

Home improvement

     1,796        5       0.98  

Commercial

     —          —         0.00  

Medallion

     27,743        76       15.11  
  

 

 

    

 

 

   

Total

   $ 36,395        100     3.58
  

 

 

    

 

 

   

The following tables set forth the pre-tax changes in our unrealized appreciation (depreciation) on investments, for the three months ended March 31, 2018 and for the years ended December 31, 2017 and 2016 under Investment Company Accounting.

 

(Dollars in thousands)

  Medallion
Loans
    Commercial
Loans
    Investments
in
Subsidiaries
    Equity
Investments
    Investment
Securities
    Investments
Other Than
Securities
    Total  

Balance December 31, 2015

  $ (3,438   $ (2,239   $ 18,640     $ 2,582     $ (18   $ 28,956     $ 44,483  

Net change in unrealized

             

Appreciation on investments

    —         —         133,805       2,979       7       (28,372     108,419  

Depreciation on investments

    (28,028     318       305       —         5       —         (27,400

Reversal of unrealized appreciation (depreciation) related to realized

             

Gains on investments

    —         —         —         (1,627     —         —         (1,627

Losses on investments

    2,943       543       —         —         12       —         3,498  

Other

    —         —         —         —         (6     —         (6
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance December 31, 2016

    (28,523     (1,378     152,750       3,934       —         584       127,367  

Net change in unrealized

             

Appreciation on investments

    —         —         6,170       2,060       —         (821     7,409  

Depreciation on investments

    (37,335     (410     —         (277     —         (1,253     (39,275

Reversal of unrealized appreciation (depreciation) related to realized

             

Gains on investments

    —         —         —         (3,082     —         —         (3,082

Losses on investments

    45,520       1,275       —         486       —         —         47,281  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance December 31, 2017

    (20,338     (513     158,920       3,121       —         (1,490     139,700  

Net change in unrealized

             

Appreciation on investments

    —         —         38,795       (998     —         —         37,797  

Depreciation on investments

    (38,170     18       —         —         —         (1,915     (40,067

Reversal of unrealized appreciation (depreciation) related to realized

             

Gains on investments

    —         —         —         —         —         —         —    

Losses on investments

    34,747       —         —         —           —         34,747  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance March 31, 2018

  ($ 23,761   ($ 495   $ 197,715     $ 2,123     $ —     ($ 3,405   $ 172,177  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Under both Bank Holding Company Accounting and Investment Company Accounting, we generally follow a practice of discontinuing the accrual of interest income on our loans that are in arrears as to payments for a

 

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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 and principal 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 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 the dates indicated.

 

     Bank Holding Company
Accounting
    Investment Company Accounting  
     December 31, 2018     December 31, 2017     December 31, 2016  

(Dollars in  thousands)

   Amount      (1)     Amount      (1)     Amount      (1)  

Recreation

   $ 4,020        0.4     N/A        N/A       N/A        N/A  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Home improvement

     135        0.0       N/A        N/A       N/A        N/A  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Commercial

     279        0.0       749        0.2       2,124        0.6  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Medallion

     15,720        1.6       59,701        18.7       71,976        18.9  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total loans 90 days or more past due

   $ 20,154        2.0   $ 60,450        18.9   $ 74,100        19.5
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total Medallion Bank loans (2)

     N/A        N/A     $ 16,115        1.8   $ 42,269        4.2
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total managed loans 90 days or more past due

     N/A        N/A     $ 76,565        6.2   $ 116,369        8.4
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1)

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

(2)

Includes medallion and consumer loans held at Medallion Bank.

 

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The following table presents the credit-related information for the investment portfolios as of the dates shown under Investment Company Accounting.

 

(Dollars in  thousands)

   December 31, 2017     December 31, 2016  

Total loans

    

Medallion loans

   $ 208,279     $ 266,816  

Commercial loans

     90,188       83,634  
  

 

 

   

 

 

 

Total loans

     298,467       350,450  

Investments in Medallion Bank and other controlled subsidiaries

     302,147       293,360  

Equity investments (1)

     9,521       8,468  

Investment securities

     —         —    
  

 

 

   

 

 

 

Net investments

   $ 610,135     $ 652,278  
  

 

 

   

 

 

 

Net investments in Medallion Bank and other controlled subsidiaries

   $ 908,297     $ 1,001,940  

Managed net investments

   $ 1,380,054     $ 1,517,592  
  

 

 

   

 

 

 

Unrealized appreciation (depreciation) on investments

    

Medallion loans

   ($ 20,338   ($ 28,523

Commercial loans

     (513     (1,378
  

 

 

   

 

 

 

Total loans

     (20,851     (29,901

Investments in Medallion Bank and other controlled subsidiaries

     158,920       152,750  

Equity investments

     3,121       3,934  

Investment securities

     —         —    
  

 

 

   

 

 

 

Total unrealized appreciation on investments

   $ 141,190     $ 126,783  
  

 

 

   

 

 

 

Net unrealized depreciation on investments at Medallion Bank and other controlled subsidiaries

   ($ 63,785   ($ 55,616

Managed total unrealized appreciation (depreciation) on investments

   $ 77,405     $ 71,167  
  

 

 

   

 

 

 

Unrealized appreciation (depreciation) as a % of balances outstanding (2)

    

Medallion loans

     (8.90 %)      (9.67 %) 

Commercial loans

     (0.57     (1.62

Total loans

     (6.53     (7.87

Investments in Medallion Bank and other controlled subsidiaries

     110.96       108.63  

Equity investments

     48.77       86.77  

Investment securities

     —         —    

Net investments

     30.11       24.13  
  

 

 

   

 

 

 

Net investments at Medallion Bank and other controlled subsidiaries

     (6.64 %)      (5.32 %) 

Managed net investments

     5.99     4.96
  

 

 

   

 

 

 

 

(1)

Represents common stock, warrants, preferred stock, and limited partnership interests held as investments.

(2)

Unlike other lending institutions, we were not permitted to establish reserves for loan losses. Instead, the valuation of our portfolio was adjusted quarterly to reflect estimates of the current realizable value of the investment portfolio. These percentages represent the discount or premium that investments were carried on the books at, relative to their par or gross value.

 

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The following table presents the gain/loss experience on the investment portfolio for the three months ended March 31, 2018 and for the years ended December 31, 2017 and 2016 under Investment Company Accounting.

 

(Dollars in thousands)

   March 31,
2018
    December 31,
2017
    December 31,
2016
 

Realized gains (losses) on loans and equity investments

      

Medallion loans

   ($ 34,747   ($ 49,609   ($ 2,938

Commercial loans (1)

     2       (1,412     1,284  
  

 

 

   

 

 

   

 

 

 

Total loans

     (34,745     (51,021     (1,654

Investments in Medallion Bank and other controlled subsidiaries

     —         —         214  

Equity investments

     —         7,277       1,884  

Investment securities

     —         —         13  
  

 

 

   

 

 

   

 

 

 

Total realized gains (losses) on loans and equity investments

   ($ 34,745   ($ 43,744   $ 457  
  

 

 

   

 

 

   

 

 

 

Net realized losses on investments at

Medallion Bank and other controlled subsidiaries

   ($ 23,073     (43,256     (35,341
  

 

 

   

 

 

   

 

 

 

Total managed realized gains (losses) on loans and equity investments

   ($ 57,818   ($ 87,000   ($ 34,884
  

 

 

   

 

 

   

 

 

 

Realized gains (losses) as a % of average balances outstanding

      

Medallion loans

     (65.74 %)      (17.76 %)      (0.97 %) 

Commercial loans

     0.01       (1.71     1.49  

Total loans

     (45.96     (14.10     (0.42

Investments in Medallion Bank and other controlled subsidiaries

     —         —         0.14  

Equity investments

     —         119.20       41.15  

Investment securities

     —         —         0.01  

Net investments

     (30.89     (8.50     0.08  
  

 

 

   

 

 

   

 

 

 

Net investments at Medallion Bank and other controlled subsidiaries

     (9.66 %)      (4.19 %)      (3.33 %) 

Managed net investments

     (18.22 %)      (6.19 %)      (2.34 %) 
  

 

 

   

 

 

   

 

 

 

 

(1)

Includes $2,056 of gain recognized on the sale of the asset based lending portfolio in 2016.

 

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The following table sets forth the pre-tax changes in our unrealized and realized gains and losses in the investment portfolio, for the three months ended March 31, 2018 and years ended December 31, 2017 and 2016 under Investment Company Accounting.

 

(Dollars in thousands)

   March 31,
2018
     December 31,
2017
     December 31,
2016
 

Net change in unrealized appreciation (depreciation) on investments

        

Unrealized appreciation

   ($ 998    $ 2,060      $ 2,986  

Unrealized depreciation

     (38,152      (38,022      (27,705

Net unrealized appreciation on investments in Medallion Bank and other controlled subsidiaries

     29,115        9,483        130,121  

Realized gains

     —          (3,082      (1,627

Realized losses

     34,747        47,281        3,498  

Net unrealized losses on investments other than securities and other assets

     (1,915      (2,075      (28,387
  

 

 

    

 

 

    

 

 

 

Total

   $ 22,797      $ 15,645      $ 78,886  
  

 

 

    

 

 

    

 

 

 

Net realized gains (losses) on investments

        

Realized gains

   $ —      $ 3,082      $ —  

Realized losses

     (34,747      (47,281      (3,486

Other gains

     —          4,684        4,140  

Direct recoveries (charge-offs)

     2        (4,229      (197
  

 

 

    

 

 

    

 

 

 

Total

   ($ 34,745    ($ 43,744    $ 457  
  

 

 

    

 

 

    

 

 

 

SEGMENT RESULTS

We manage our financial results under four operating segments and report like a bank holding company. The segments are recreation lending, home improvement lending, commercial lending, and medallion lending. We also show results for two non-operating segments; RPAC and corporate and other investments. Prior to April 2, 2018, we operated as one segment. All results are for the nine months ended December 31, 2018.

Recreation Lending

The recreation lending segment is a high-growth prime and non-prime consumer finance business which is a significant source of income for us, accounting for 71% of our interest income for the nine months ended December 31, 2018. In September 2018, we sold of $55,979,000 of recreation loans for a gain of $3,093,000, included in non-interest income (expense). Recreation loans are secured primarily by RVs and boats, with RV loans making up 59% of the portfolio and boat loans making up 18% of the portfolio at the end of the period. Recreation loans are made to borrowers residing in all fifty states, with the highest concentrations in Texas, California, and Florida, at 18%, 11%, and 10% of loans outstanding, respectively, and with no other states over 10%.

 

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The following table presents as of and for the nine months ended December 31, 2018.

 

(Dollars in thousands)

   Recreation  

Selected Earnings Data

  

Total interest income

   $ 68,870  

Total interest expense

     6,986  
  

 

 

 

Net interest income

     61,884  

Provision for loan losses

     15,118  
  

 

 

 

Net interest income after loss provision

     46,766  

Total non-interest income (expense)

     (14,242
  

 

 

 

Net income before taxes

     32,524  

Income tax (provision)

     (8,579
  

 

 

 

Net income

   $ 23,945  
  

 

 

 

Balance Sheet Data

  

Total loans, gross

   $ 587,038  

Total loan allowance

     6,856  
  

 

 

 

Total loans, net

     580,182  

Total assets

     590,746  

Total borrowings

     434,527  
  

 

 

 

Selected Financial Ratios

  

Return on average assets

     5.48

Return on average equity

     22.60  

Interest yield

     15.78  

Net interest margin

     14.18  

Reserve coverage

     1.17  

Delinquency status (1)

     0.69  

Charge-off%

     1.89  
  

 

 

 

 

(1)

Loans 90 days or more past due.

Home Improvement Lending

The home improvement lending segment works with contractors and financial service providers to finance residential home improvements and is concentrated in swimming pools, solar panels, roofs, and windows at 31%, 16%, 15%, and 11% of total loans outstanding, with no other collateral types over 10%. Home improvement loans are made to borrowers residing in all fifty states, with the highest concentrations in Texas, Florida, Ohio, and California at 15%, 11%, 9%, and 9% of loans outstanding, respectively, and with no other states over 10%. In September 2018, we sold $44,909,000 of home improvement loans for a gain of $2,079,000, included in non-interest income (expense).

 

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The following table presents as of and for the nine months ended December 31, 2018.

 

(Dollars in thousands)

   Home
Improvement
 

Selected Earnings Data

  

Total interest income

   $ 12,799  

Total interest expense

     2,290  
  

 

 

 

Net interest income

     10,509  

Provision for loan losses

     2,453  
  

 

 

 

Net interest income after loss provision

     8,056  

Total non-interest income (expense)

     (3,093
  

 

 

 

Net income before taxes

     4,963  

Income tax (provision)

     (1,319
  

 

 

 

Net income

   $ 3,644  
  

 

 

 

Balance Sheet Data

  

Total loans, gross

   $ 183,155  

Total loan allowance

     1,796  
  

 

 

 

Total loans, net

     181,359  

Total assets

     188,892  

Total borrowings

     143,815  
  

 

 

 

Selected Financial Ratios

  

Return on average assets

     2.56

Return on average equity

     11.30  

Interest yield

     9.06  

Net interest margin

     7.44  

Reserve coverage

     0.98  

Delinquency status (1)

     0.07  

Charge-off%

     0.46  
  

 

 

 

 

(1)

Loans 90 days or more past due.

Commercial Lending

We originate both senior and subordinated loans nationwide to businesses in a variety of industries, more than 51% of which are located in the Midwest and Northeast regions, 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 $1,000,000 to $5,000,000 at origination, and typically included an equity component as part of the financing. The commercial lending business has concentrations in manufacturing; professional, scientific, and technical services; and transportation and warehousing; and wholesale trade making up 48%, 14%, 9% and 9% of total business.

 

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The following table presents as of and for the nine months ended December 31, 2018.

 

(Dollars in thousands)

   Commercial  

Selected Earnings Data

  

Total interest income

   $ 7,459  

Total interest expense

     2,037  
  

 

 

 

Net interest income

     5,422  

Provision for loan losses

     —    
  

 

 

 

Net interest income after loss provision

     5,422  

Total non-interest income (expense)

     (1,917
  

 

 

 

Net income before taxes

     3,505  

Income tax (provision)

     (808
  

 

 

 

Net income

   $ 2,697  
  

 

 

 

Balance Sheet Data

  

Total loans, gross

   $ 64,083  

Total loan allowance

     —    
  

 

 

 

Total loans, net

     64,083  

Total assets

     90,264  

Total borrowings

     51,266  
  

 

 

 

Selected Financial Ratios

  

Return on average assets

     3.59

Return on average equity

     7.52  

Interest yield

     12.61  

Net interest margin

     9.17  

Reserve coverage

     0.00  

Delinquency status (1)

     0.44  

Charge-off%

     0.00  
  

 

 

 

 

(1)

Loans 90 days or more past due.

 

Geographic Concentrations

   Total Gross Loans      % of Market  

Colorado

   $ 6,900        11

Minnesota

     6,503        10

Illinois

     5,467        9

Delaware

     5,460        9

California

     4,983        8

Other (1)

     34,770        53
  

 

 

    

 

 

 

Total

   $ 64,083        100
  

 

 

    

 

 

 

 

(1)

Includes 12 other states with none greater than 7%.

Medallion Lending

The medallion lending segment operates mainly in the New York, Newark, and Chicago markets. We have a long history of owning, managing, and financing taxicab fleets, taxicab medallions, and corporate car services. For the nine months ended December 31, 2018, we have seen a leveling off in the medallion values of the New York market, while in the other markets there has been a decline in values. Additionally, we have also continued to see a decline in interest income due to loans aging greater than 90 days and being placed on nonaccrual. During the 2018 fourth quarter,

 

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we deconsolidated Trust III which led to a gain of $25,325,000. Additionally, we continued removing underperforming loans from the portfolio by transferring to loan collateral in process of foreclosure, or charge-offs. All the loans are secured by the medallions and enhanced by personal guarantees of the shareholders and owners.

The following table presents as of and for the nine months ended December 31, 2018.

 

(Dollars in thousands)

   Medallion  

Selected Earnings Data

  

Total interest income

   $ 6,317  

Total interest expense

     10,125  
  

 

 

 

Net interest loss

     (3,808

Provision for loan losses

     41,437  
  

 

 

 

Net interest loss after loss provision

     (45,245

Total non-interest income (expense)

     9,742  
  

 

 

 

Net loss before taxes

     (35,503

Income tax benefit

     7,938  
  

 

 

 

Net loss

   $ (27,565
  

 

 

 

Balance Sheet Data

  

Total loans, gross

   $ 183,606  

Total loan allowance

     27,743  
  

 

 

 

Total loans, net

     155,863  

Total assets

     273,501  

Total borrowings

     294,465  
  

 

 

 

Selected Financial Ratios

  

Return on average assets

     (10.13 %) 

Return on average equity

     NM  

Interest yield

     3.58  

Net interest margin

     (2.16

Reserve coverage

     15.11  

Delinquency status (1)

     8.89  

Charge-off%

     7.76  
  

 

 

 

 

(1)

Loans 90 days or more past due.

 

Geographic

Concentration

   Total Gross
Loans
     % of Market  

New York City

   $ 160,313        87

Newark

     18,455        10  

Chicago

     4,021        2  

All Other

     817        1  
  

 

 

    

 

 

 

Total

   $ 183,606        100
  

 

 

    

 

 

 

RPAC

We are the majority owner and managing member of RPAC Racing, LLC, a performance and marketing company for NASCAR. Revenues are mainly earned through sponsorships and race winning activity over the nine month race season (February through November) during the year.

 

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The following table presents as of and for the nine months ended December 31, 2018.

 

(Dollars in thousands)

   RPAC  

Selected Earnings Data

  

Sponsorship, race winnings, and other income

   $ 14,368  

Race and other expenses

     18,597  

Interest expense

     121  
  

 

 

 

Total expenses

     18,718  

Net loss before taxes

     (4,350

Income tax benefit

     1,108  
  

 

 

 

Net loss

   ($ 3,242
  

 

 

 

Balance Sheet Data

  

Total assets

   $ 29,925  

Total borrowings

     7,649  
  

 

 

 

Selected Financial Ratios

  

Return on average assets

     (11.69 %) 

Return on average equity

     NM  
  

 

 

 

Corporate and Other Investments

This non-operating segment relates to our equity and investment securities as well as other assets, liabilities, revenues, and expenses not allocated to the other main operating segments. This activity also includes the elimination of all intercompany activity amongst the entities.

The following table presents as of and for the nine months ended December 31, 2018.

 

(Dollars in thousands)

   Corporate and
Other
 

Selected Earnings Data

  

Interest income

   $ 1,358  

Interest expense

     3,257  
  

 

 

 

Net interest loss

     (1,899

Total non-interest income (expense), net

     (6,396
  

 

 

 

Net loss before taxes

     (8,295

Income tax benefit

     951  
  

 

 

 

Net loss

   ($ 7,344
  

 

 

 

Balance Sheet Data

  

Total assets

   $ 208,522  

Total borrowings

     130,306  
  

 

 

 

Selected Financial Ratios

  

Return on average assets

     (4.13 %) 

Return on average equity

     (13.18
  

 

 

 

Trends in Investment Portfolio under Investment Company Accounting

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

 

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medallion loans, commercial loans, equity investments, and investment securities, and also presents the portfolio information for Medallion Bank, at the dates indicated.

 

     December 31, 2017      December 31, 2016  

(Dollars in  thousands)

   Interest
Rate (1)
    Investment
Balances
     Interest
Rate (1)
    Investment
Balances
 

Medallion loans

         

New York

     4.23   $ 167,226        3.67   $ 202,469  

Newark

     5.34       21,935        5.27       23,267  

Chicago

     4.74       19,436        4.45       38,091  

Boston

     4.51       18,564        4.52       25,857  

Cambridge

     4.55       773        4.47       4,401  

Other

     7.95       482        7.26       965  
    

 

 

      

 

 

 

Total medallion loans

     4.41       228,416        4.01       295,050  
  

 

 

      

 

 

   

Deferred loan acquisition costs

       201          289  

Unrealized depreciation on loans

       (20,338        (28,523
    

 

 

      

 

 

 

Net medallion loans

     $ 208,279        $ 266,816  
    

 

 

      

 

 

 

Commercial loans

         

Secured mezzanine

     12.09   $ 88,334        13.47   $ 76,469  

Other secured commercial

     9.39       2,477        9.33       8,657  
    

 

 

      

 

 

 

Total commercial loans

     12.02       90,811        13.05       85,126  
  

 

 

      

 

 

   

Deferred loan acquisition income

       (110        (114

Unrealized depreciation on loans

       (513        (1,378
    

 

 

      

 

 

 

Net commercial loans

     $ 90,188        $ 83,634  
    

 

 

      

 

 

 

Investment in Medallion Bank and other controlled subsidiaries

     0.83   $ 143,227        2.13   $ 140,610  

Unrealized appreciation on subsidiary investments

       158,920          152,750  
    

 

 

      

 

 

 

Investment in Medallion Bank and other controlled subsidiaries, net

     $ 302,147        $ 293,360  
    

 

 

      

 

 

 

Equity investments

     0.00   $ 6,400        0.00   $ 4,534  
  

 

 

      

 

 

   

Unrealized appreciation on equities

       3,121          3,934  
    

 

 

      

 

 

 

Net equity investments

     $ 9,521        $ 8,468  
    

 

 

      

 

 

 

Investment securities

     —     $ —          $ —  
  

 

 

      

 

 

   

Unrealized depreciation on investment securities

       —            —    
    

 

 

      

 

 

 

Net investment securities

     $ —        $ —  
    

 

 

      

 

 

 

Investments at cost (2)

     4.73   $ 468,854        4.94   $ 525,320  
  

 

 

      

 

 

   

Deferred loan acquisition costs

       91          175  

Unrealized appreciation on controlled subsidiaries, equity investments, and investment securities

       162,041          156,684  

Unrealized depreciation on loans

       (20,851        (29,901
    

 

 

      

 

 

 

Net investments

     $ 610,135        $ 652,278  
    

 

 

      

 

 

 

 

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     December 31, 2017      December 31, 2016  

(Dollars in  thousands)

   Interest
Rate (1)
    Investment
Balances
     Interest
Rate (1)
    Investment
Balances
 

Medallion Bank investments

         

Consumer loans

     15.02   $ 693,289        14.27   $ 708,524  

Medallion loans

     4.30       222,252        3.75       296,436  

Commercial loans

     2.28       1,598        3.40       2,567  

Investment securities

     2.40       43,582        2.27       37,420  
    

 

 

      

 

 

 

Medallion Bank investments at cost (2)

     11.94       960,721        10.83       1,044,947  
  

 

 

      

 

 

   

Deferred loan acquisition costs

       11,097          12,371  

Unrealized depreciation on investment securities

       (368        (797

Premiums paid on purchased securities

       265          238  

Unrealized depreciation on loans

       (63,417        (54,819
    

 

 

      

 

 

 

Medallion Bank net investments

     $ 908,298        $ 1,001,940  
    

 

 

      

 

 

 

 

(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 10.89% and 9.74%, at December 31, 2017 and 2016.

PORTFOLIO SUMMARY (Investment Company Accounting)

Total Portfolio Yield

The weighted average yield (which is calculated by dividing the aggregate yield of each investment in the portfolio by the aggregate portfolio balance and does not include expenses and sales load for any offering) of the total managed portfolio under Investment Company Accounting at March 31, 2018 was 10.96%, an increase of 35 basis points from 10.61% at December 31, 2017 and an increase of 146 basis points from 9.50% at December 31, 2016.

Medallion Loan Portfolio

Our managed medallion loans of $318,864,000 comprised 23% of the net managed portfolio of $1,386,136,000 at March 31, 2018, compared to 28% of the net managed portfolio of $1,380,054,000 at December 31, 2017 and 35% the net managed portfolio of $1,517,592,000 at December 31, 2016. The medallion loan portfolio decreased by $69,137,000 or 18% on a managed basis from December 31, 2017 to March 31, 2018 primarily reflecting increased realized and unrealized losses and net amortization of loan principal, especially in the New York, Boston, and Chicago markets.

The weighted average yield of the managed medallion loan portfolio at March 31, 2018 was 4.42%, an increase of 6 basis points from 4.36% at December 31, 2017, and an increase of 48 basis points from 3.88% at December 31, 2016. The fluctuation in yield primarily reflected the repricing of the existing portfolio to current market interest rates. At March 31, 2018, 15% of the managed medallion loan portfolio represented loans outside New York, compared to 19% and 24% at December 31, 2017 and 2016.

Commercial Loan Portfolio

Our commercial loans represented 7%, 7% and 6% of the net managed investment portfolio as of March 31, 2018 and December 31, 2017 and 2016. Commercial loans increased by $4,986,000 or 5% on a managed basis from December 31, 2017 to March 31, 2018 primarily reflecting the growth in the mezzanine loan portfolio.

The weighted average yield of the managed commercial loan portfolio at March 31, 2018 was 11.76%, a decrease of 9 basis points from 11.85% at December 31, 2017, and a decrease of 100 basis points from 12.76% at December 31, 2016. The decreases primarily reflected the recent lower rates on certain of the mezzanine loans.

 

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Consumer Loan Portfolio

Medallion Bank originates fixed rate consumer loans secured by recreational vehicles, boats, trailers, and home improvements located in all 50 states. Our managed consumer loans, represented 52%, 49% and 46% of the managed net investment portfolio as of March 31, 2018 and December 31, 2017 and 2016.

The weighted average gross yield of the managed consumer loan portfolio was 14.86% at March 31, 2018, compared to 15.02% at December 31, 2017 and 14.27% at December 31, 2016. The change in yield primarily reflects the changes in the loans originated.

Investment in Medallion Bank and Other Controlled Subsidiaries

As an investment company prior to April 2, 2018, our investment in Medallion Bank was previously subject to quarterly assessments of fair value. We conducted a thorough valuation analysis, and determined 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. Because of these restrictions and other factors, our Board of Directors had previously determined that Medallion Bank had little value beyond its recorded book value. As a result of this valuation process, we had previously 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. In the 2015 second quarter, we first became aware of external interest in Medallion Bank and its portfolio assets at values in excess of their book value. Expression of interest in Medallion Bank from both investment bankers and interested parties has continued. We incorporated these new factors in the Medallion Bank’s fair value analysis and the Board of Directors determined that Medallion Bank had a fair value in excess of book value. In addition, in the 2016 third quarter there was a court ruling involving a marketplace lender that we believe heightens the interest of marketplace lenders to acquire or merge with Utah industrial banks. We also engaged a valuation specialist to assist the Board of Directors in its determination of Medallion Bank’s fair value, and this appreciation of $15,500,000 was thereby recorded in 2015, and additional appreciation of $128,918,000 was recorded in 2016, $7,849,000 was recorded in 2017, and $39,826,000 was recorded in the first quarter of 2018.

Consolidated Results of Operations

For the Nine Months Ended December 31, 2018 under Bank Holding Company Accounting

Net loss attributable to shareholders was $10,172,000 or $0.42 per diluted common share for the nine months ended December 31, 2018.

Total interest income was $96,803,000 in for the nine months. The yield on interest earning assets was 10.98% for the nine months. Average interest earning assets were $1,170,612,000 for the nine months.

Loans before allowance for loan losses were $1,017,882,000 as of December 31, 2018, and were comprised of recreation ($587,038,000), home improvement ($183,155,000), medallion ($183,606,000) and commercial ($64,083,000) loans. The Company had an allowance for loan losses as of the end of the year 2018 of $36,395,000, which was attributable to the medallion (76%), recreation (19%), and home improvement (5%) loan portfolios. Loans declined from $1,095,780,000 at April 2, 2018 primarily due to the deconsolidation of Trust III of $53,545,740 in medallion loans, along with continued charge-offs, reserve increases, and principal repayments. These decreases were partially offset by net loan originations in which a majority related to the recreation segment. The provision for loan losses was $59,008,000 for the nine months ended December 31, 2018, reflecting losses throughout the entire loan portfolio and included a non-specific general reserve for medallion loans of $5,708,000. See Note 4 for additional information on loans and the allowance for loan losses.

Interest expense was $24,816,000 for the nine months and the cost of borrowed funds was 2.79%. Average debt outstanding was $1,181,323,000. See page 47 for a table which shows average balances and cost of funds for our funding sources.

 

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Net interest income was $71,987,000 and the net interest margin was 8.19% for the nine months ended.

Noninterest income, which is mainly comprised of sponsorship and race winnings at RPAC, late charges, write-downs of loan collateral, impairment of equity investments and other miscellaneous income, was $41,946,000 for the nine months. The activity also included the gain on the deconsolidation of Trust III of $25,325,000.

Operating expenses were $62,081,000 for the nine months. Salaries and benefits expense was $19,357,000 for the period, professional fees were $8,609,000, primarily reflecting legal costs for a variety of corporate and investment-related matters, race team costs were $7,121,000, loan servicing costs were $3,470,000, primarily reflecting the cost of servicing the recreation and home improvement consumer loans, and occupancy and other operating expenses were $17,909,000. In addition, impairment on goodwill of $5,615,000 was recorded in the nine months.

Total income tax expense was $709,000 for the nine months. See Note 8 for more information.

Loan collateral in process of foreclosure was $49,495,000 at December 31, 2018, an increase from $21,749,000 at April 2, 2018. The increase primarily reflected the re-classification of $31,099,000 from nonperforming loans shown as investments in the 2018 first quarter and the net increase in loans that reached 120 days past due and were charged down to collateral value and reclassified to loans in process of foreclosure, partially offset by the deconsolidation of Trust III, the writedowns of collateral values and the cash received in settlement of these assets.

Goodwill and intangible assets were $204,785,000 at December 31, 2018, which arose as a result of election to no longer report as a BDC as of April 2, 2018 and was in connection with the consolidation of Medallion Bank and RPAC. See Note 2 for further information regarding goodwill and intangible assets.

2018 First Quarter under Investment Company Accounting

Net decrease in net assets resulting from operations was $14,874,000 or $0.62 per diluted common share in the 2018 first quarter primarily reflecting an increase in net realized/unrealized losses on the investment portfolio, increased operating expenses and higher income taxes. Net investment loss after income taxes was $3,230,000 or $0.13 per share in the 2018 quarter.

Investment income was $4,033,000 in the 2018 first quarter and included $1,643,000 of interest reversals related to nonaccrual loans in 2018. The yield on the investment portfolio was 2.69% in the 2018 quarter.

Interest expense was $3,551,000 in the 2018 first quarter. The increase in interest expense was primarily due to increased borrowing costs. The cost of borrowed funds was 4.44% in 2018 reflecting the continuing increase in market interest rates. Average debt outstanding was $324,322,000 for the 2018 quarter primarily reflecting decreased borrowings required to fund the contracting loan portfolio.

Net interest income was $482,000 and the net interest margin was 0.32% for the 2018 quarter.

Noninterest income, which is comprised of prepayment fees, servicing fee income, late charges, and other miscellaneous income, was $60,000 in the 2018 quarter primarily reflecting the reversal of a previously earned management fee due from a portfolio company in the prior year quarter.

Operating expenses were $4,108,000 in the 2018 first quarter. Salaries and benefits expense was $2,349,000 in the 2018 quarter primarily due to executive and employee bonus accrual. Professional fees were $723,000 in 2018 primarily reflecting higher legal expenses for a variety of corporate and investment-related matters. Occupancy and other operating expenses of $1,036,000 in 2018 primarily reflecting higher road or miscellaneous taxes, collection costs related to the medallion loan portfolio and directors’ fees.

 

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Total income tax benefit was $640,000 in 2018, and was comprised of three components, a $336,000 benefit related to the net investment loss, an $8,426,000 benefit related to realized losses, and a provision of $8,122,000 related to net unrealized gains on investments.

Net change in unrealized appreciation (depreciation) on investments before income tax was appreciation of $22,797,000 in the 2018 first quarter. Net change in unrealized appreciation other than the portion related to Medallion Bank and the other controlled subsidiaries, was depreciation of $6,318,000 in 2018, resulting in decreased depreciation of $2,205,000 and related almost entirely to the medallion portfolio. Unrealized appreciation (depreciation) arises when we make valuation adjustments to the investment portfolio. When investments are sold or written off, any resulting realized gain (loss) is grossed up to reflect previously recorded unrealized components. As a result, movement between periods can appear distorted. The current quarter activity resulted from net appreciation on Medallion Bank and other controlled subsidiaries of $29,115,000 and by reversals of unrealized depreciation on loans which were charged-off of $34,747,000, offset by unrealized depreciation on loans and other investments of $40,067,000 mainly due to the continuing declining values of the medallions.

Our net realized losses on investments before taxes were $34,745,000 in the 2018 quarter. The 2018 activity reflected the realized losses in the loan portfolio.

Our net realized/unrealized loss on investments before income taxes was $11,948,000 in the 2018 first quarter reflecting the above.

For the Years Ended December 31, 2017 and 2016 under Investment Company Accounting

Net increase in net assets resulting from operations was $278,000 or $0.01 per diluted common share in 2017, down $23,237,000 or 99% from $23,515,000 or $0.97 per share in 2016, primarily reflecting an increase in net realized/unrealized losses on the investment portfolio and lower net interest income, partially offset by an increased income tax benefit and lower operating expenses. Net investment loss after income taxes was $7,121,000 or $0.30 per share in 2017, down $7,240,000 from income of $119,000 or less than $0.01 in 2016.

Investment income was $19,624,000 in 2017, down $5,464,000 or 22% from $25,088,000 a year ago, and included in 2017 and 2016 were $1,278,000 and $3,000,000 in dividends from Medallion Bank and other controlled subsidiaries. The decrease was also due to $5,514,000 of interest forgone in 2017, compared to $2,634,000 in 2016. The yield on the investment portfolio was 3.12% in 2017, down 25% from was 4.17% in 2016. Excluding the dividends, the 2017 yield was down 20% to 2.92% from 3.67% in 2016, reflecting the above. Average investments outstanding were $629,089,000 in 2017, up 4% from $602,349,000 in the prior year primarily reflecting growth in the commercial portfolio and subsidiary investments.

Medallion loans were $208,279,000 at year end, down $58,537,000 or 22% from $266,816,000 a year ago, representing 34% of the investment portfolio, compared to 41% a year ago, and were yielding 4.41% compared to 4.01% a year ago. The decrease in outstandings was primarily concentrated in the New York and Chicago markets, although all markets declined, and was primarily attributable to realized losses recognized and net amortization of loan principal. The managed medallion portfolio, which includes loans at Medallion Bank and those serviced for third parties, was $414,350,000 at year end, down $139,089,000 or 25% from $553,439,000 a year ago, reflecting the above, and realized losses taken and principal amortization at Medallion Bank. The commercial loan portfolio was $90,188,000 at year end, compared to $83,634,000 a year ago, an increase of $6,554,000 or 8%, and represented 15% of the investment portfolio compared to 13% a year ago. The increase was primarily attributable to increases in the secured mezzanine portfolio, partially offset by decreases in other secured commercial loans. Commercial loans yielded 12.02% at year end, down 8% from 13.05% a year ago, reflecting lower yields on certain recent loans. The net managed commercial loan portfolio, which includes loans at Medallion Bank and those serviced for or by third parties, was $92,530,000 at year end, up $4,686,000 or 5% from $87,844,000 a year ago, reflecting the above. Investments in Medallion Bank and other controlled

 

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subsidiaries were $302,147,000 at year end, up $8,787,000 or 3% from $293,360,000 a year ago, primarily reflecting the appreciation and equity in the earnings of Medallion Bank other portfolio company investments, capital contributions made, dividends paid, portfolio sales, and the net valuation adjustment, and which represented 49% of the investment portfolio at the end of 2017 and 45% in the prior year, and which yielded 0.83% at year end, compared to 2.13% a year ago, primarily reflecting reduced dividends from Medallion Bank. Equity investments were $9,521,000 at year end, up $1,053,000 or 12% from $8,468,000 a year ago, primarily reflecting increase in investments held, and which represented 2% of the investment portfolio at the end of 2017 and 1% in the prior year, and had a dividend yield of 0% in both years.

Interest expense was $13,770,000 in 2017, up $1,132,000 or 9% from $12,638,000 in 2016. The increase in interest expense was primarily due to increased borrowing costs on floating rate borrowings. The cost of borrowed funds was 4.12% in 2017, compared to 3.32% a year ago, an increase of 24%, reflecting the recent increases in market interest rates. Average debt outstanding was $334,022,000 in 2017, compared to $380,305,000 a year ago, down 12%, primarily reflecting decreased borrowings required to fund the contracting medallion loan portfolio. See page 47 for a table that shows average balances and cost of funds for our funding sources.

Net interest income was $5,854,000 and the net interest margin was 0.93% in 2017, down $6,596,000 or 53% from $12,450,000 a year ago, which represented a net interest margin of 2.07%, all reflecting the items discussed above.

Noninterest income, which is comprised of prepayment fees, management fees, servicing fee income, late charges, and other miscellaneous income was $107,000 in 2017, down $301,000 or 74% from $408,000 a year ago, primarily reflecting lower management and other fees generated from the portfolios.

Operating expenses were $13,810,000 in 2017, down $8,976,000 or 39% from $22,786,000 in 2016 which included a $5,099,000 goodwill write off. Salaries and benefits expense was $7,508,000 in the year, down $4,262,000 or 36% from $11,770,000 in 2016 primarily due to a reduction in bonus costs recorded in the current period and lower salary expenses due to the sale of its asset-based lending division in the prior year. Professional fees were $2,619,000 in 2017, up $272,000 or 12% from $2,347,000 a year ago, primarily reflecting higher legal and other professional fee expenses for a variety of corporate and investment-related matters. Occupancy expense was $1,069,000 in 2017, up $103,000 or 11% from $966,000 in 2016, primarily reflecting annual increases in rent expense at various locations. Other operating expenses of $2,614,000 in 2017 were down $10,000 from $2,604,000 a year ago reflecting decreased travel and entertainment expenses, directors’ fees, miscellaneous taxes and reduced expense reimbursements, partially offset by increases in collection and other expenses.

Total income tax benefit was $36,226,000 in 2017 compared to income tax expense of $45,900,000 in 2016, a change of $82,126,000. Total taxes were comprised of three components, a $728,000 benefit related net investment loss compared to $10,047,000 in 2016, benefits related to realized losses and unrealized appreciation on investments of $15,955,000 and $19,543,000, compared to provisions of $384,000 and $55,563,000 in 2016. The tax benefit recorded in 2017 reflected the $17,279,000 for adjustment to implement the change in U.S. tax law rates on the net tax liabilities. See Note 8 for more information.

Net change in unrealized appreciation on investments was $15,645,000 in 2017, compared to $78,886,000 in 2016, a decrease in appreciation of $63,241,000. Net change in unrealized appreciation other than the portion related to Medallion Bank and the other controlled subsidiaries, was appreciation of $6,162,000 in 2017 compared to a depreciation of $51,235,000 in 2016, resulting in increased appreciation of $57,397,000 in 2017. Unrealized appreciation (depreciation) arises when we make valuation adjustments to the investment portfolio. When investments are sold or written off, any resulting realized gain (loss) is grossed up to reflect previously recorded unrealized components. As a result, movement between periods can appear distorted. The 2017 activity resulted from a net appreciation on Medallion Bank and other controlled subsidiaries of $9,483,000, reversals of

 

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unrealized depreciation associated with charged-off loans of $46,795,000, partially offset by unrealized depreciation on loans of $37,745,000, the reversal of unrealized appreciation on investments that were exited with a realized gain of $3,082,000, unrealized depreciation on investments other than securities and other assets of $2,075,000, and net unrealized appreciation on equity investments of $2,269,000. The 2016 activity resulted from net appreciation on Medallion Bank and other controlled subsidiaries of $130,121,000 and by reversals of unrealized depreciation associated with charged-off loans of $3,486,000, partially offset by unrealized depreciation on loans of $27,710,000, investments other than securities of $28,372,000, and net unrealized appreciation on investment securities of $1,367,000. The net appreciation on Medallion Bank and other controlled subsidiaries described above is net of the dividends declared by them to us of $1,278,000 in 2017 and $3,000,000 in 2016.

Our net realized losses on investments were $43,744,000 in 2017 compared to gains of $457,000 in 2016, an increase in realized losses of $44,201,000 in 2017. The 2017 activity reflected the reversals described in the unrealized paragraph above, other gain on the liquidation of other investment securities of $4,684,000, and net loan charge-offs of $4,715,000, inclusive of losses on equity investments. The 2016 activity reflected the reversals described in the unrealized paragraph above, and other net loan charge-offs of $224,000, partially offset by gains of $2,111,000 from the sale of investment securities and $2,057,000 from the sale of the asset-based lending portfolio.

Our net realized/unrealized gains on investments were $7,399,000 in 2017, compared to $23,396,000 in 2016, a decrease of $15,997,000 or 68% of net gains in the year, reflecting the above.

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 medallion, commercial, and consumer loans, and investment securities) reprice on a different basis over time in comparison to our interest-bearing liabilities (consisting primarily of credit facilities with banks and other lenders, bank certificates of deposit, and SBA debentures).

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

The effect of changes in interest rates is mitigated by regular turnover of the portfolio. Based on past experience, we anticipate that approximately 40% of the taxicab medallion portfolio will mature or be prepaid each year. We believe that the average life of our loan portfolio varies to some extent as a function of changes in interest rates. Borrowers are more likely to exercise prepayment rights in a decreasing interest rate environment because the interest rate payable on the borrower’s loan is high relative to prevailing interest rates. Conversely, borrowers are less likely to prepay in a rising interest rate environment. However, borrowers may prepay for a variety of other reasons, such as to monetize increases in the underlying collateral values, particularly in the medallion loan portfolio.

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. We had outstanding SBA debentures of $80,099,000 with a weighted

 

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average interest rate of 3.40%, constituting 7% of our total indebtedness, and retail notes of $33,625,000, with a weighted average interest rate of 9.00%, constituting 3% of total indebtedness as of December 31, 2018. Also, as of December 31, 2018, certain of the certificates of deposit were for terms of up to 55 months, further mitigating the immediate impact of changes in market interest rates.

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

The following table presents our interest rate sensitivity gap at December 31, 2018. 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.

 

December 31, 2018 Cumulative Rate Gap (1)

 

(Dollars in thousands)

  Less Than 1
Year
    More Than
1 and Less
Than 2
Years
    More
Than 2
and Less
Than 3
Years
    More
Than 3
and Less
Than 4
Years
    More
Than 4
and Less
Than 5
Years
    More Than
5 and Less
Than 6
Years
    Thereafter     Total  

Earning assets

               

Floating-rate

  $ 33,995     $ —     $ —     $ —     $ —     $ —     $ —     $ 33,995  

Adjustable rate

    41,145       16,796       9,312       6,603       15,187       270       2,388       91,701  

Fixed-rate

    80,454       33,557       45,051       54,741       65,073       50,541       643,030       972,447  

Cash

    23,718       —         —         —         —         —         —         23,718  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total earning assets

  $ 179,312     $ 50,353     $ 54,363     $ 61,344     $ 80,260     $ 50,811     $ 645,418     $ 1,121,861  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest bearing liabilities

               

Deposits

  $ 325,890     $ 191,054     $ 158,846     $ 136,508     $ 35,742     $ —     $ —     $ 848,040  

Notes payable to banks

    50,995       —         7,220       —         1,400     —         —         59,615  

SBA debentures and borrowings

    1,250       29,099       8,500       —         5,000       5,000       31,250       80,099  

Retail notes

    —         —         33,625       —         —         —         —         33,625  

Preferred securities

    33,000       —         —         —         —         —         —         33,000  

Other borrowings

    500       7,149       —         —         —         —         —         7,649  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

  $ 411,635     $ 227,302     $ 208,191     $ 136,508     $ 42,142     $ 5,000     $ 31,250     $ 1,062,028  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest rate gap

  ($ 232,323   ($ 176,949   ($ 153,828   ($ 75,164   $ 38,118     $ 45,811     $ 614,168     $ 59,833  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cumulative interest rate gap (2)

  ($ 232,323   ($ 409,272   ($ 563,100   ($ 638,264   ($ 600,146   ($ 554,335   $ 59,833       —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

December 31, 2017 (3)

  ($ 172,208   ($ 324,049   ($ 361,494   ($ 425,785   ($ 411,672   ($ 379,286   $ 168,501       —    

December 31, 2016 (3)

  ($ 160,931   ($ 229,981   ($ 304,974   ($ 301,658   ($ 334,577   ($ 301,596   $ 219,452       —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

The ratio of the cumulative one year gap to total interest rate sensitive assets was (21%), as of December 31, 2018.

(2)

Adjusted for the medallion loan 40% prepayment assumption results in a cumulative one year negative interest rate gap and related ratio of $210,284 or 19% at December 31, 2018.

(3)

Represents the cumulative rate gap on a combined basis with Medallion Bank for the years noted.

Our interest rate sensitive assets were $1,121,861,000 and interest rate sensitive liabilities were $1,062,028,000 at December 31, 2018. The one-year cumulative interest rate gap was a negative $232,323,000 or 21% of interest rate sensitive assets. However, using our estimated 40% prepayment/refinancing rate for medallion loans to adjust the interest rate gap resulted in a negative gap of $210,284,000 or 19% at December 31, 2018. We seek to manage interest rate risk by originating adjustable-rate loans, by incurring fixed-rate indebtedness, by evaluating appropriate derivatives, pursuing securitization opportunities, and by other options consistent with managing interest rate risk.

 

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Liquidity and Capital Resources

Our sources of liquidity are with a variety of local and regional banking institutions, 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, the disposition of other assets of the Company, and dividends from Medallion Bank, although we have not received any since 2016 and are subject to compliance with regulatory ratios, and Medallion Capital. Additionally, there were $3,000,000 of unfunded commitments from the SBA as of December 31, 2018.

Additionally, Medallion Bank has access to independent sources of funds for our business originated there, primarily through brokered certificates of deposit. Medallion Bank has $45,000,000 available under Fed Funds lines with several commercial banks. In addition, Medallion Bank can retain earnings in its business to fund future growth.

The components of our debt were as follows at December 31, 2018. See Note 7 to the consolidated financial statements for details of the contractual terms of our borrowings.

 

(Dollars in  thousands)

   Balance      Percentage     Rate (1)  

Deposits

   $ 848,040        80     2.14

SBA debentures and borrowings

     80,099        7       3.40  

Notes payable to banks

     59,615        6       4.55  

Retail notes

     33,625        3       9.00  

Preferred securities

     33,000        3       4.86  

Other borrowings

     7,649        1       2.00  
  

 

 

    

 

 

   

Total outstanding debt

   $ 1,062,028        100     2.67
  

 

 

    

 

 

   

 

 

 

 

(1)

Weighted average contractual rate as of December 31, 2018.

Our contractual obligations expire on or mature at various dates through September 2037. The following table shows all contractual obligations at December 31, 2018.

 

    Payments due by period  

(Dollars in  thousands)

  Less than 1 year     1 – 2 years     2 – 3 years     3 – 4 years     4 – 5 years     More than 5 years     Total  

Deposits

  $ 325,890     $ 191,054     $ 158,846     $ 136,508     $ 35,742     $ —     $ 848,040  

SBA debentures and borrowings

    3,226       25,873       8,500       —         5,000       37,500       80,099  

Notes payable to banks

    51,452       458     7,145       280       280     —         59,615  

Retail notes

    —         —         33,625       —         —         —         33,625  

Preferred securities

    —         —         —         —         —         33,000       33,000  

Other borrowings

    500       7,149       —         —         —         —         7,649  

Operating lease obligations

    2,357       2,380       2,278       2,216     2,136     6,048       17,415  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 383,425     $ 226,914     $ 210,394     $ 139,004     $ 43,158     $ 76,548     $ 1,079,443  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Most of our borrowing relationships have maturity dates during 2019 through 2021. We have been in active and ongoing discussions with each of these lenders and have extended each of the facilities as they matured. The lenders have worked with us to extend and change the terms of the borrowing agreements. We have arranged for changes to the terms of the notes and payment and borrowing base calculations which we anticipate will facilitate our operations for the foreseeable future.

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

 

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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 investing activities. Our long-term fixed-rate investments are financed primarily with short-term floating-rate debt, and to a lesser extent by term 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 the line item net income as of December 31, 2018 by $549,000 on an annualized basis, and the impact of such an immediate increase of 1% over a one year period would have been ($1,012,000) at December 31, 2018. 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.

We continue to work with investment banking firms and other financial intermediaries to investigate the viability of a number of 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, 2018. See Note 7 to the consolidated financial statements for additional information about each credit facility.

 

    Bank Holding Company Accounting     Managed  

(Dollars in  thousands)

  The Company     MFC     MCI     FSVC     MB     RPAC and
Other
    December 31,
2018
    December 31, 2017  

Cash

  $ 1,110     $ 1,118     $ 20,230     $ 693     $ 33,895     $ 667 (1)     $ 57,713     $ 122,923  

Bank loans

    38,870       20,745       —         —         —         —         59,615       81,450  

Average interest rate

    5.09     3.53     —         —         —         —         4.55     3.94

Maturity

    3/19-7/19       6/19-12/23       —         —         —         —         3/19-12/23       10/16-11/18  

Preferred securities

    33,000       —         —         —         —         —         33,000       33,000  

Average interest rate

    4.86     —         —         —         —         —         4.86     3.63

Maturity

    9/37       —         —         —         —         —         9/37       9/37  

Retail notes

    33,625       —         —         —         —         —         33,625       33,625  

Average interest rate

    9.00               9.00     9.00

Maturity

    4/21                 4/21       4/21  

DZ loan

    —         —         —         —         —         —         —         99,984  

Average interest rate

    —         —         —         —         —         —         —         3.02

Maturity

    —         —         —         —         —         —         —         3/18  

SBA debentures and borrowings

    —         —         54,000       29,099       —         —         83,099       85,064  

Amounts undisbursed

    —         —         3,000       —         —         —         3,000       5,500  

Amounts outstanding

    —         —         51,000       29,099       —         —         80,099       79,564  

Average interest rate

    —         —         3.48     3.25     —         —         3.40     3.39

Maturity

    —         —         3/21-3/29       2/20       —         —         2/20-3/29       2/20-3/27  

Brokered CDs & other funds borrowed

            848,040       —         848,040       906,748  

Average interest rate

    —         —         —         —         2.14     —         2.14     1.51

Maturity

    —         —         —         —         01/19-07/23       —         1/19-07/23       1/18-10/22  

Other borrowings

    —         —         —         —         —         7,649       7,649       —    

Average interest rate

    —         —         —         —         —         2.00     2.00     —  

Maturity

    —         —         —         —         —         12/19-3/20       12/19-3/20       —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total cash

  $ 1,110     $ 1,118     $ 20,230     $ 693     $ 33,895     $ 667     $ 57,713     $ 122,923  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total debt outstanding

  $ 105,495     $ 20,745     $ 51,000     $ 29,099     $ 848,040     $ 7,649     $ 1,062,028     $ 1,234,371  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Includes $90,000 of cash related to consolidated subsidiaries other than RPAC.

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

We also generate liquidity through deposits generated at Medallion Bank, borrowing arrangements with other banks, and through the issuance of SBA debentures, as well as from cash flow from operations. In addition, we may choose to participate a greater portion of our loan portfolio to third parties. We are actively seeking additional sources of liquidity, however, given current market conditions, we cannot assure you that we will be able to secure additional liquidity on terms favorable to us or at all. If that occurs, we may decline to underwrite lower yielding loans in order to conserve capital until credit conditions in the market become more favorable; or we may be required to dispose of assets when we would not otherwise do so, and at prices which may be below the net book value of such assets in order for us to repay indebtedness on a timely basis.

Recently Issued Accounting Standards

In August 2018, the FASB issued ASU 2018-13 Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value. The objective of this update is to modify the disclosure requirements as it relates to the fair value of assets and liabilities. The amendments in this update are

 

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effective for annual periods beginning after December 15, 2019, and interim periods within those fiscal years. We do not believe this update will have a material impact on our financial condition.

In January 2017, the FASB issued ASU 2017-04, “Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” The objective of this update is to simplify the subsequent measurement of goodwill, by eliminating step 2 from the goodwill impairment test. The amendments in this update are effective for annual periods beginning after December 15, 2019, and interim periods within those fiscal years. We do not believe this update will have a material impact on our financial condition.

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The main objective of this new standard is to provide financial statement users with more decision-useful information about the expected credit losses on financial assets and other commitments to extend credit held by a reporting entity at each reporting date. The aftermath of the global economic crisis and the delayed recognition of credit losses associated with loans (and other financial instruments) was identified as a weakness in the application of existing accounting standards. Specifically, because the existing “incurred” loss model delays recognition until it is probable a credit loss was incurred, the FASB explored alternatives that would use more forward-looking information. Under the FASB’s new standard, the concepts used by entities to account for credit losses on financial instruments will fundamentally change. The existing “probable” and “incurred” loss recognition threshold is removed. Loss estimates are based upon lifetime “expected” credit losses. The use of past and current events must now be supplemented with “reasonable and supportable” expectations about the future to determine the amount of credit loss. The collective changes to the recognition and measurement accounting standards for financial instruments and their anticipated impact on the allowance for credit losses modeling have been universally referred to as the CECL (current expected credit loss) model. ASU 2016-13 applies to all entities and is effective for fiscal years beginning after December 15, 2019 for public entities and is effective for fiscal years beginning after December 15, 2020 for all other entities, with early adoption permitted. We are assessing the impact the update will have on our financial statements and expects the update to have a significant impact on how we will account for estimated credit losses on our loans.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). ASU 2016-02 requires the recognition of lease assets and lease liabilities by lessees for leases classified as operating under GAAP. ASU 2016-02 applies to all entities and is effective for fiscal years beginning after December 15, 2018 for public entities. We have assessed the impact the update will have on our financial condition and determined that effective January 1, 2019 a right-of-use asset and a lease liability each of $13,997,000 would be recorded, and accrued/amortized over the remaining lease life terms. See Note 12 for additional information.

 

ITEM 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our business activities contain elements of risk. We consider the principal types of risk to be fluctuations in interest rates and portfolio valuations. We consider the management of risk essential to conducting our businesses. Accordingly, our risk management systems and procedures are designed to identify and analyze our risks, to set appropriate policies and limits, and to continually monitor these risks and limits by means of reliable administrative and information systems and other policies and programs.

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 investing activities. Our long-term fixed-rate investments are financed primarily with short-term floating-rate debt, and to a lesser extent

 

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by term 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 the line item net income as of December 31, 2018 by $549,000 on an annualized basis, and the impact of such an immediate increase of 1% over a one year period would have been ($1,012,000) at December 31, 2018. 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.

 

ITEM 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Reference is made to the financial statements set forth under Item 15 (A) (1) in this Annual Report on Form 10-K, which financial statements are incorporated herein by reference in response to this Item 8.

 

ITEM 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

 

ITEM 9A.

CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

As required by Rule 13a-15(b) under the Exchange Act, our management, including our Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of our disclosure controls and procedures as of the end of the fiscal year covered by this annual report. As a result of this evaluation, we have concluded that our disclosure controls and procedures were effective as of December 31, 2018.

Changes in Internal Control over Financial Reporting

As required by Rule 13a-15(d) under the Exchange Act, our management, including our Chief Executive Officer and Chief Financial Officer, have evaluated our internal control over financial reporting to determine whether any changes occurred during the 2018 fourth quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, and have concluded that there have been no changes that occurred during the 2018 fourth quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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Management’s Annual Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) and 15d-15(f) promulgated under the Exchange Act as a process designed by, or under the supervision of, our principal executive and principal financial officers and effected by our Board of Directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles, and includes those policies and procedures that:

 

   

Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;

 

   

Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and

 

   

Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2018. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework (2013). Based on its assessment and those criteria, management believes that we maintained effective internal control over financial reporting as of December 31, 2018.

We believe that the consolidated financial statements included in this report fairly represent our consolidated financial position and consolidated results of operations for all periods presented.

Our Independent Registered Public Accounting Firm, Mazars USA LLP, has audited and issued a report on management’s assessment of our internal control over financial reporting. The report of Mazars USA LLP appears below.

 

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Report of Independent Registered Public Accounting Firm

To the Stockholders and Board of Directors of Medallion Financial Corp.

Opinion on Internal Control over Financial Reporting

We have audited Medallion Financial Corp. and subsidiaries’ (the “Company”) internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control – Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control – Integrated Framework: (2013) issued by COSO.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of Medallion Financial Corp. and subsidiaries (the “Company”) as of December 31, 2018 and 2017, including the consolidated summary schedule of investments, as of December 31, 2017, and the related consolidated statements of operations, other comprehensive income (loss), changes in stockholders’ equity and changes in net assets, and cash flows for each of the three years in the three-year period ended December 31, 2018, and the related notes and schedules listed in the index to the financial statements and in Item 15(A)3 as Exhibit 99.1, and selected financial ratios and other data (see note 16) for each of the four years in the four-year period ended December 31, 2017 of the Company, and our report dated March 13, 2019 expressed an unqualified opinion.

Basis for Opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

Definition and Limitations of Internal Control over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

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Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.

/s/ Mazars USA LLP

New York, New York

March 13, 2019

 

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ITEM 9B.

OTHER INFORMATION

None.

PART III

 

ITEM 10.

DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Incorporated by reference from our Definitive Proxy Statement expected to be filed by April 30, 2019 for our fiscal year 2019 Annual Meeting of Shareholders under the captions “Our Directors and Executive Officers,” “Corporate Governance,” and “Section 16(a) Beneficial Ownership Reporting Compliance.”

 

ITEM 11.

EXECUTIVE COMPENSATION

Incorporated by reference from our Definitive Proxy Statement expected to be filed by April 30, 2019 for our fiscal year 2019 Annual Meeting of Shareholders under the caption “Executive Compensation” and “Compensation Committee Interlocks and Insider Participation.”

 

ITEM 12.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Incorporated by reference from our Definitive Proxy Statement expected to be filed by April 30, 2019 for our fiscal year 2019 Annual Meeting of Shareholders under the captions “Stock Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information.”

 

ITEM 13.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

Incorporated by reference from our Definitive Proxy Statement expected to be filed by April 30, 2019 for our fiscal year 2019 Annual Meeting of Shareholders under the captions “Certain Relationships and Related Party Transactions”, “Our Directors and Executive Officers,” and “Corporate Governance.”

 

ITEM 14.

PRINCIPAL ACCOUNTANT FEES AND SERVICES

Incorporated by reference from our Definitive Proxy Statement expected to be filed by April 30, 2019 for our fiscal year 2019 Annual Meeting of Shareholders under the caption “Principal Accountant Fees and Services.”

PART IV

 

ITEM 15.

EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(A) 1. FINANCIAL STATEMENTS

The consolidated financial statements of Medallion Financial Corp. and the Report of Independent Public Accountants thereon are included as set forth on the Index to Financial Statements on F-1.

2. FINANCIAL STATEMENT SCHEDULES

See Index to Financial Statements on F-1.

 

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3. EXHIBITS

 

Number  

Description

    3.1(a)   Restated Medallion Financial Corp. Certificate of Incorporation. Filed as Exhibit 3.1 to the Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (File No. 0-27812) and incorporated by reference herein.
    3.1(b)   Amendment to Restated Certificate of Incorporation. Filed as Exhibit 3.1.1 to the Quarterly Report on Form  10-Q for the quarterly period ended June 30, 1998 (File No. 0-27812) and incorporated by reference herein.
    3.2   Amended and Restated By-Laws of Medallion Financial Corp. (filed as Exhibit 3.1 to the Current Report on Form 8-K filed on April 27, 2018 (File No. 001-37747) and incorporated by reference herein).
    4.1   Fixed/Floating Rate Junior Subordinated Note, dated June  7, 2007, by Medallion Financial Corp., in favor of Medallion Financing Trust I. Filed as Exhibit 4.1 to the Current Report on Form 8-K filed on June 11, 2007 (File No.  814-00188) and incorporated by reference herein.
    4.2   Indenture, dated April  15, 2016, between Medallion Financial Corp. and Wilmington Trust, National Association. Filed as Exhibit d.6 to the Registration Statement on Form N-2 filed on April 15, 2016 (File No. 333-206692) and incorporated by reference herein.
    4.3   First Supplemental Indenture, dated April  15, 2016, between Medallion Financial Corp. and Wilmington Trust, National Association. Filed as Exhibit d.7 to the Registration Statement on Form N-2 filed on April 15, 2016 (File No. 333-206692) and incorporated by reference herein.
    4.4   Note, effective March  1, 2017, by