UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2019
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
Trading Symbols
Name of each exchange
on which registered
Common Stock, par value $0.01 per share
9.000% Senior Notes due 2021
MFIN
MFINL
NASDAQ Global Select Market
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 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 check mark 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 Exchange Act). YES ☐ NO ☒
The number of outstanding shares of registrant’s Common Stock, par value $0.01, as of October 30, 2019 was 24,609,203.
TABLE OF CONTENTS
Page
PART I – FINANCIAL INFORMATION
3
ITEM 1. FINANCIAL STATEMENTS
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
46
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
74
ITEM 4. CONTROLS AND PROCEDURES
PART II—OTHER INFORMATION
75
ITEM 1. LEGAL PROCEEDINGS
ITEM 1A. RISK FACTORS
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ITEM 6. EXHIBITS
76
SIGNATURES
77
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, 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-Q 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-Q 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-Q 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-Q. The inclusion of the forward-looking statements contained in this Form 10-Q should not be regarded as a representation by the Company or any other person that the forward-looking statements contained in this Form 10-Q will be achieved. In light of the foregoing, readers of this Form 10-Q 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 in the Company’s Annual Report on Form 10-K and others that are detailed in the other reports that the Company files from time to time with the Securities and Exchange Commission.
Page 2 of 77
BASIS OF PREPARATION
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, or ASC, Topic 946 – Financial Services – Investment Company, we made this change to our financial reporting prospectively, and have not restated or revised 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, or GAAP, applicable to bank holding companies, or Bank Holding Company Accounting, which applies commencing April 2, 2018, and to that applicable to investment companies under the 1940 Act, or Investment Company Accounting, which applies to prior periods.
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 17% (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 have transitioned away from medallion lending and have placed our strategic focus on our growing consumer finance portfolio. Total assets under management, which includes our portfolio, as well as assets serviced for third party investors, were $1,649,000,000 as of September 30, 2019, and were $1,522,000,000 as of December 31, 2018, 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 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 activities, 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., 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 consolidated balance sheet as of September 30, 2019, and the related consolidated statements of operations, consolidated statements of other comprehensive income/(loss), consolidated statements of stockholders’ equity and cash flows for the quarter and nine months then ended included in Item 1 have been prepared by us, without audit, pursuant to the rules and regulations of the SEC. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the US have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the accompanying consolidated financial statements include all adjustments, which are of a normal and recurring nature, necessary to present fairly our consolidated financial position and results of operations. The results of operations for the quarter and nine months ended September 30, 2019 may not be indicative of future performance. These financial statements should be read in conjunction with the financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2018.
Page 3 of 77
CONSOLIDATED BALANCE SHEETS
UNAUDITED
(Dollars in thousands, except share and per share data)
September 30, 2019
December 31, 2018
Assets
Cash(1)
$
21,724
23,842
Federal funds sold
33,291
33,871
Equity investments
9,880
9,197
Investment securities
47,422
45,324
Loans
1,142,282
1,017,882
Allowance for losses
(43,113
)
(36,395
Net loans receivable
1,099,169
981,487
Accrued interest receivable
8,040
7,413
Property, equipment, and right-of-use lease asset, net
13,544
1,222
Loan collateral in process of foreclosure(2)
53,539
49,495
Goodwill
150,803
Intangible assets, net
52,898
53,982
Other assets
29,444
25,210
Total assets
1,519,754
1,381,846
Liabilities
Accounts payable and accrued expenses(3)
18,651
18,789
Accrued interest payable
3,511
3,852
Deposits
962,987
848,040
Short-term borrowings
42,503
55,178
Deferred tax liabilities and other tax payables
5,597
6,973
Operating lease liabilities
12,090
—
Long-term debt
181,625
158,810
Total liabilities
1,226,964
1,091,642
Commitments and contingencies(4)
Stockholders’ equity
Preferred stock (1,000,000 shares of $0.01 par value stock authorized-none outstanding)
Common stock (50,000,000 shares of $0.01 par value stock authorized- 27,560,539
shares at September 30, 2019 and 27,385,600 shares at December 31, 2018 issued)
276
274
Additional paid in capital
275,143
274,292
Treasury stock (2,951,243 shares at September 30, 2019 and December 31, 2018)
(24,919
Accumulated other comprehensive income (loss)
1,240
(82
Retained earnings
11,746
13,043
Total stockholders’ equity
263,486
262,608
Non-controlling interest in consolidated subsidiaries
29,304
27,596
Total equity
292,790
290,204
Total liabilities and equity
Number of shares outstanding
24,609,296
24,434,357
Book value per share
10.71
10.75
(1)
Includes restricted cash of $2,970 as of September 30, 2019.
(2)
Includes financed sales of this collateral to third parties that are reported separately from the loan portfolio, and that are conducted by the Bank of $6,091 as of September 30, 2019 and $3,134 as of December 31, 2018.
(3)
Includes the short-term portion of lease liabilities of $1,820 as of September 30, 2019. Refer to Note 8 for more details.
(4)
Refer to Note 14 for details.
The accompanying notes should be read in conjunction with these consolidated financial statements.
Page 4 of 77
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Bank Holding
Company Accounting
Company
Accounting
Combined(1)
For the Three Months Ended September 30, 2019
For the Nine Months Ended September 30, 2019
For the Three Months Ended September 30, 2018
For the Nine Months Ended September 30, 2018
Interest and fees on loans
34,081
94,833
32,692
64,718
Interest and dividends on investment securities
521
1,756
430
1,032
Medallion lease income
38
109
30
100
Interest income on investments
3,287
Dividend income from controlled subsidiaries
28
Interest income from affiliated investments
654
Interest income from controlled subsidiaries
10
Total interest income(2)/total investment income(2)
34,640
96,698
33,152
69,829
Interest on deposits
6,003
16,409
5,064
9,264
Interest on short-term borrowings
730
2,616
1,698
3,557
Interest on long-term debt
2,492
6,743
2,125
3,991
Interest expense
3,551
Total interest expense(3)
9,225
25,768
8,887
20,363
Net interest income/net investment income
25,415
70,930
24,265
49,466
Provision for loan losses
8,337
36,851
18,205
48,781
Net interest income after provision for loan losses
17,078
34,079
6,060
685
Other income (loss)
Sponsorship and race winnings
7,940
16,008
5,371
10,599
Change in collateral value on in process of foreclosure
(113
(4,204
(1,265
(1,361
Gain on the extinguishment of debt
4,145
Gain on sale of loans
5,488
Impairment of equity investments
(388
(862
Other income
1,047
1,471
235
515
Total other income, net
8,874
17,420
9,441
14,379
Other expenses
Salaries and employee benefits
6,795
18,457
5,999
13,987
Race team related expenses
2,663
7,211
2,876
5,416
Professional fees
2,277
5,961
3,951
6,920
Collection costs
4,589
1,381
2,218
Loan servicing fees
1,364
3,851
1,185
2,313
Rent expense
592
1,769
615
1,449
Regulatory fees
252
1,147
563
1,145
Amortization of intangible assets
361
1,084
722
Travel, meals, and entertainment
300
770
313
1,122
Other expenses(4)
2,050
6,399
2,220
5,206
Total other expenses
18,352
51,238
19,464
40,498
Income (loss) before income taxes/net investment loss before taxes(5)
7,600
261
(3,963
(25,434
Income tax (provision) benefit
(165
1,926
117
4,474
Net income (loss) after taxes/net investment loss after taxes
7,435
2,187
(3,846
(20,960
Net realized losses on investments(6)
(34,745
Income tax benefit
8,426
Total net realized losses on investments
(26,319
Net change in unrealized appreciation on Medallion Bank and other
controlled subsidiaries
29,115
Net change in unrealized depreciation on investments other than securities
(1,915
Net change in unrealized depreciation on investments
(4,403
Income tax provision
(8,122
Net unrealized appreciation on investments
14,675
Net realized/unrealized losses on investments
(11,644
Net income (loss) after taxes/net decrease on net assets resulting from operations
(32,604
Less: income attributable to the noncontrolling interest
2,460
3,484
851
1,614
Total net income (loss) attributable to Medallion Financial
Corp./net decrease on net assets resulting from operations
4,975
(1,297
(4,697
(34,218
Basic net income (loss) per share
0.20
(0.05
(0.19
(1.41
Diluted net income (loss) per share
Distributions declared per share
Weighted average common shares outstanding
Basic
24,361,680
24,336,677
24,235,242
24,207,273
Diluted
24,607,167
Results include the six months ended September 30, 2018 under Bank Holding Company Accounting and the three months ended March 31, 2018 under Investment Company Accounting.
Page 5 of 77
Included in interest and investment income is $212 and $637 of paid in kind interest for the three and nine months ended September 30, 2019 and $450 and $1,428 for the comparable 2018 periods.
Average borrowings outstanding were $1,169,182 and $1,121,693, and the related average borrowing costs were 3.13% and 3.07% for the three and nine months ended September 30, 2019, and were $1,255,945 and $1,226,896, and 2.81% and 2.22% for the comparable 2018 periods.
See Note 12 for the components of other operating expenses as of March 31, 2018.
(5)
Includes $256 of net revenues received from Medallion Bank for the three months ended March 31, 2018, primarily for expense reimbursements. See Notes 6 and 15 for additional information.
(6)
There were no net losses on investment securities of affiliated issuers for the three months ended March 31, 2018.
Page 6 of 77
CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE INCOME/(LOSS)
(Dollars in thousands)
Net income (loss) after taxes/net decrease on net assets resulting
from operations
Other comprehensive income (loss), net of tax
95
1,322
(214
(469
Total comprehensive income (loss)
7,530
3,509
(4,060
(33,073
Less comprehensive income attributable to the noncontrolling
interest
Total comprehensive income (loss) attributable to Medallion
Financial Corp.
5,070
25
(4,911
(34,687
Page 7 of 77
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY AND CHANGES IN NET ASSETS
Bank Holding Company Accounting
Common
Stock
Shares
Preferred
Capital in
Excess of
Par
Treasury
Retained
Earnings
Accumulated
Other
Comprehensive
Income
Total
Stockholders’
Equity
Non-
controlling
Interest
Balance at December 31, 2018
27,385,600
(2,951,243
Net income
1,228
167
1,395
Distributions to non-
controlling interest
(592
Stock-based compensation
1
164
165
Issuance of restricted stock, net
163,098
Forfeiture of restricted stock, net
(1,699
Net change in unrealized gains
on investments, net of tax
669
Balance at March 31, 2019
27,546,999
275
274,456
14,271
587
264,670
27,171
291,841
Net (loss)
(7,500
857
(6,643
Distributions to non-controlling
340
4,751
(949
558
Balance at June 30, 2019
27,550,801
274,796
6,771
258,068
27,436
285,504
347
348
10,417
(679
Balance at September 30, 2019
27,560,539
Page 8 of 77
Bank Holding & Investment Company Accounting
Investment Company Accounting
Bank Holding &
Investment Company
Stock Shares
Undistributed
Net
Investment
Loss
Unrealized
Appreciation
on
Investments,
Net of Tax
Noncontrolling
Balance at December 31, 2017
27,294,327
273
273,716
(65,592
103,681
287,159
Net decrease in net assets resulting
(38,299
23,425
(14,874
Stock-based compensation expense
151
152
95,726
Balance at March 31, 2018
27,390,053
273,867
(103,891
127,106
272,437
Adoption of Bank Holding
103,891
(127,106
23,215
27,065
Balance at April 2, 2018
299,502
Net loss
(14,647
763
(13,884
Distributions to noncontrolling
145
13
Net change in unrealized losses on
investments, net of tax
(255
Balance at June 30, 2018
27,390,066
274,012
8,568
257,680
27,236
284,916
1,229
Balance at September 30, 2018
27,391,295
274,163
3,871
252,920
27,495
280,415
Page 9 of 77
CONSOLIDATED STATEMENTS OF CASH FLOWS
CASH FLOWS FROM OPERATING ACTIVITIES
Net income/net decrease in net assets resulting from operations
Adjustments to reconcile net loss/net decrease in net assets resulting from operations to net cash
provided by operating activities:
Paid-in-kind interest
(637
(1,428
Depreciation and amortization
6,014
2,995
(Decrease) increase in deferred and other tax liabilities
(1,375
8,676
Amortization of origination fees, net
3,753
2,192
Proceeds from the sale and principal payments on loan collateral in process
of foreclosure
12,714
Net change in loan collateral in process of foreclosure
9,126
3,258
Net realized losses on sale of investments
(1,810
(4,726
1,299
5,380
853
446
Gain on extinguishment of debt
(4,145
(Increase) decrease in accrued interest receivable
(627
486
Increase in other assets
(4,890
(7,173
Decrease in accounts payable and accrued expenses
(1,763
(675
Increase (decrease) in accrued interest payable
(341
41
Loans originated
(8,193
Proceeds from principal receipts, sales, and maturities of loans
13,279
Capital returned by Medallion Bank and other controlled subsidiaries, net
93
Net change in unrealized depreciation on investment other than securities
1,915
Increase in unrealized appreciation on Medallion Bank and other controlled subsidiaries
(29,115
Net realized losses on investments
34,745
Increase in other liabilities
3,159
Net cash provided by operating activities
57,209
41,532
CASH FLOWS FROM INVESTING ACTIVITIES
(374,642
(256,933
188,226
240,915
Purchases of investments
(6,849
(8,304
Proceeds from principal receipts, sales, and maturities of investments
5,902
2,475
Net cash used for investing activities
(187,363
(21,847
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from time deposits and funds borrowed
450,192
336,108
Repayments of time deposits and funds borrowed
(324,960
(253,497
Purchase of federal funds
4,000
8,000
Repayments of federal funds
(8,000
Distributions to noncontrolling interests
(1,776
(1,184
Payments of declared distributions
(65
Net cash provided by financing activities
127,456
81,362
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS AND
RESTRICTED CASH
(2,698
101,047
Cash and cash equivalents and restricted cash, beginning of period(2)
57,713
42,513
Cash and cash equivalents and restricted cash, end of period(3)
55,015
143,560
SUPPLEMENTAL INFORMATION
Cash paid during the period for interest
24,252
17,381
Cash paid during the period for income taxes
135
52
NON-CASH INVESTING
Loans transferred to loan collateral in process of foreclosure
25,884
19,472
The beginning balance for the nine months ended September 30, 2018 includes $29,923 of cash, cash equivalents and federal funds sold as a result of the consolidation of previously unconsolidated subsidiaries and excludes $100 of cash held by the Company on deposit with Medallion Bank.
Includes federal funds sold.
Page 10 of 77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2019
(1) ORGANIZATION OF MEDALLION FINANCIAL CORP. AND ITS SUBSIDIARIES
Medallion Financial Corp. (the Company) is a finance company organized as a Delaware corporation that reports as a bank holding company, but is not a bank holding company for regulatory purposes. The Company conducts its business through various wholly-owned subsidiaries including its primary operating company, Medallion Bank (the Bank), a Federal Deposit Insurance Corporation (FDIC) insured industrial bank that originates consumer loans, raises deposits, and conducts other banking activities. The Bank is subject to competition from other financial institutions and to the regulations of certain federal and state agencies, and undergoes examinations by those agencies. The Bank was initially formed for the primary purpose of originating commercial loans in three categories: 1) loans to finance the purchase of taxicab medallions, 2) asset-based commercial loans, and 3) SBA 7(a) loans. The loans are marketed and serviced by the Bank’s affiliates that have extensive prior experience in these asset groups. Subsequent to its formation, the Bank began originating consumer loans to finance the purchases of recreational vehicles (RVs), boats, and other related items, and to finance small scale home improvements. The Company also conducts business through Medallion Funding LLC (MFC), a Small Business Investment Company (SBIC), which originates and services taxicab medallion and commercial loans.
The Company also conducts business through its subsidiaries Medallion Capital, Inc. (MCI), an SBIC that conducts a mezzanine financing business, and Freshstart Venture Capital Corp. (FSVC), an SBIC that originated and services taxicab medallion and commercial loans. MFC, MCI, and FSVC, as SBICs, are regulated by the Small Business Administration (SBA). MCI and FSVC are financed in part by the SBA.
The Company has a controlling ownership stake in Medallion Motorsports, LLC, the primary owner of RPAC Racing, LLC (RPAC), a professional car racing team that competes in the Monster Energy NASCAR Cup Series and is also consolidated with the Company.
The Company formed a wholly-owned subsidiary, Medallion Servicing Corporation (MSC), to provide loan services to the Bank. The Company has assigned all of its loan servicing rights for the Bank, which consists of servicing taxi medallion loans originated by the Bank, to MSC, which bills and collects the related service fee income from the Bank, which is allocated and charged by the Company for MSC’s share of these servicing costs.
Taxi Medallion Loan Trust III (Trust III) was established for the purpose of owning medallion loans originated by MFC or others. Trust III is a variable interest entity (VIE), and MFC was the primary beneficiary. As a result, the Company consolidated Trust III in its financial results until the consummation of a restructuring in the 2018 fourth quarter. For a discussion of the restructuring, see Note 19. Trust III is a separate legal and corporate entity with its own creditors which, in any liquidation of Trust III, will be entitled to be satisfied out of Trust III’s assets prior to any value in Trust III becoming available to Trust III’s equity holders. The assets of Trust III are not available to pay obligations of its affiliates or any other party, and the assets of affiliates or any other party are not available to pay obligations of Trust III. Trust III’s loans are serviced by MFC.
The Company established a wholly-owned subsidiary, Medallion Financing Trust I (Fin Trust) for the purpose of issuing unsecured preferred securities to investors. Fin Trust is a separate legal and corporate entity with its own creditors who, in any liquidation of Fin Trust, will be entitled to be satisfied out of Fin Trust’s assets prior to any value in Fin Trust becoming available to Fin Trust’s equity holders. The assets of Fin Trust, aggregating $36,139,000 at September 30, 2019, are not available to pay obligations of its affiliates or any other party, and the assets of affiliates or any other party are not available to pay obligations of Fin Trust.
MFC, through several wholly-owned subsidiaries (together, Medallion Chicago), purchased $8,689,000 of City of Chicago taxicab medallions out of foreclosure, some of which are leased to fleet operators while being held for sale. The 159 medallions are carried at a net realizable value of $3,091,000 in other assets on the Company’s consolidated balance sheet at September 30, 2019, compared to a net realizable value of $4,305,000 and $5,535,000 at December 31, 2018 and September 30, 2018.
Page 11 of 77
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Change to Bank Holding Company Accounting
Effective April 2, 2018, the Company withdrew its previous election to be regulated as a business development company (BDC) under the Investment Company Act of 1940 (the 1940 Act). Prior to such time, the Company was a closed-end, non-diversified management investment company that had elected to be treated as a BDC under the 1940 Act. Accordingly, commencing with the three months ended June 30, 2018, the Company (which now consolidates the results of the Bank and its other subsidiaries) reports in accordance with Bank Holding Company Accounting; periods prior to such change in status are reported in accordance with Investment Company Accounting. Significant accounting policies that differ between such periods are described in more detail below.
Use of Estimates
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the US (GAAP) requires management to make estimates that affect the amounts reported in the consolidated financial statements and the accompanying notes. Accounting estimates and assumptions are those that management considers to be the most critical to an understanding of the consolidated financial statements because they inherently involve significant judgments and uncertainties. All of these estimates reflect management’s best judgment about current economic and market conditions and their effects based on information available as of the date of these consolidated financial statements. If such conditions change, it is reasonably possible that the judgments and estimates could change, which may result in future impairments of loans and loans in process of foreclosure, goodwill and intangible assets, and investments, among other effects.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and all of its wholly-owned and controlled subsidiaries commencing with the three months ended June 30, 2018. All significant intercompany transactions, balances, and profits (losses) have been eliminated in consolidation. As a result of the Company’s election to withdraw from being regulated as a BDC under the 1940 Act effective April 2, 2018, the Bank and various other Company subsidiaries that were not previously consolidated with the Company prior to the three months ended June 30, 2018, were now consolidated effective April 2, 2018. See Note 6 for the presentation of financial information for the Bank and other controlled subsidiaries for such prior periods.
The consolidated financial statements have been prepared in accordance with GAAP. The Company consolidates all entities it controls through a majority voting interest, a controlling interest through other contractual rights, or as being identified as the primary beneficiary of VIEs. The primary beneficiary is the party who has both (1) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance, and (2) an obligation to absorb losses of the entity or a right to receive benefits from the entity that could potentially be significant to the entity. For consolidated entities that are less than wholly owned, the third-party’s holding is recorded as non-controlling interest.
Cash and Cash Equivalents
The Company considers all highly liquid instruments with an original purchased maturity of three months or less to be cash equivalents. Cash balances are generally held in accounts at large national or regional banking organizations in amounts that exceed the federally insured limits. Cash includes $2,970,000 of an interest reserve associated with the private placements of debt in March and August 2019, which cannot be used for any other purpose until March 2022.
Fair Value of Assets and Liabilities
The Company follows FASB Accounting Standards Codification Topic 820, Fair Value Measurements and Disclosures (FASB ASC 820), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. FASB ASC 820 defines fair value as an exit price (i.e. a price that would be received to sell, as opposed to acquire, an asset or transfer a liability), and emphasizes that fair value is a market-based measurement. It establishes a fair value hierarchy that distinguishes between assumptions developed based on market data obtained from independent external sources and the reporting entity’s own assumptions. Further, it specifies that fair value measurement should consider adjustment for risk, such as the risk inherent in the valuation technique or its inputs. See also Notes 16 and 17 to the consolidated financial statements.
Page 12 of 77
Equity Investments
Equity investments of $9,880,000 and $9,197,000 at September 30, 2019 and December 31, 2018, comprised mainly of nonmarketable stock and stock warrants, are recorded at cost and are evaluated for impairment periodically. Prior to April 2, 2018, equity investments were recorded at fair value, represented as cost, plus or minus unrealized appreciation or depreciation. The fair value of investments that had no ready market were determined in good faith by the Board of Directors, based upon the financial condition and operating performance of the underlying investee companies as well as general market trends for businesses in the same industry.
Investment Securities (Bank Holding Company Accounting)
The Company follows FASB ASC Topic 320, Investments – Debt and Equity Securities (ASC 320), which requires that all applicable investments in equity securities with readily determinable fair values, and debt securities be classified as trading securities, available-for-sale securities, or held-to-maturity securities. Investment securities are purchased from time-to-time in the open market at prices that are greater or lesser than the par value of the investment. The resulting premium or discount is deferred and recognized on a level yield basis as an adjustment to the yield of the related investment. The net premium on investment securities totaled $236,000 at September 30, 2019 and $154,000 at December 31, 2018, and $21,000 and $46,000 was amortized to interest income for the three and nine months ended September 30, 2019, and $26,000 and $47,000 was amortized to interest income for the three and six months ended September 30, 2018. Refer to Note 3 for more details. ASC 320 further requires that held-to-maturity securities be reported at amortized cost and available-for-sale securities be reported at fair value, with unrealized gains and losses excluded from earnings at the date of the consolidated financial statements, and reported in accumulated other comprehensive income (loss) as a separate component of stockholders’ equity, net of the effect of income taxes, until they are sold. At the time of sale, any gains or losses, calculated by the specific identification method, will be recognized as a component of operating results and any amounts previously included in stockholders’ equity, which were recorded net of the income tax effect, will be reversed.
Other Investment Valuation (Investment Company Accounting)
Prior to April 2, 2018, under the 1940 Act, the Company’s investment in the Bank, as a wholly owned portfolio investment, was subject to quarterly assessments of fair value. The Company conducted a thorough valuation analysis, and also received an opinion regarding the valuation from an independent third party to assist the Board of Directors in its determination of the fair value of the Bank on at least an annual basis. The Company’s analysis included factors such as various regulatory restrictions that were established at the Bank’s inception, by the FDIC and State of Utah, and also by additional regulatory restrictions, such as the prior moratorium imposed by the Dodd-Frank Act on the acquisition of control of an industrial bank by a “commercial firm” (a company whose gross revenues are primarily derived from non-financial activities) which expired in July 2013 and the lack of any new charter issuances since the moratorium’s expiration. Because of these restrictions and other factors, the Company’s Board of Directors had previously determined that the Bank had little value beyond its recorded book value. As a result of this valuation process, the Company had previously used the 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, the Company first became aware of external interest in the Bank and its portfolio assets at values in excess of their book value. Expression of interest in the Bank from both investment bankers and interested parties continued. The Company incorporated these new factors in the Bank’s fair value analysis and the Board of Directors determined that the 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 the Company believes heightened the interest of marketplace lenders to acquire or merge with Utah industrial banks. The Company also engaged a valuation specialist to assist the Board of Directors in their determination of the 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. Refer to Note 6 for additional details.
The Company’s loans are currently reported at the principal amount outstanding, inclusive of deferred loan acquisition costs, which primarily includes deferred fees paid to loan originators, and which is amortized to interest income over the life of the loan. Effective April 2, 2018, the existing loan balances were adjusted to fair value in connection with the change in reporting, and balances, net of reserves and fees, became the opening balances.
Loan origination fees and certain direct origination costs are deferred and recognized as an adjustment to the yield of the related loans. At September 30, 2019 and December 31, 2018, net loan origination costs were $17,867,000 and $14,416,000. The majority of these loan origination costs were capitalized into the loan balances on April 2, 2018 in connection with the change in reporting status. Net amortization to income for the three months ended September 30, 2019 and 2018 was $1,364,000 and $1,147,000, and was $3,753,000 and $2,192,000 ($3,065,000 when combined with the Bank) for the comparable nine month period.
Page 13 of 77
Interest income is recorded on the accrual basis. Taxicab medallion and commercial loans are placed on nonaccrual status, and all uncollected accrued interest is reversed, when there is doubt as to the collectability of interest or principal, or if loans are 90 days or more past due, unless management has determined that they are both well-secured and in the process of collection. Interest income on nonaccrual loans is generally recognized when cash is received, unless a determination has been made to apply all cash receipts to principal. The consumer portfolio has different characteristics, typified by a larger number of lower dollar loans that have similar characteristics. A loan is considered to be impaired, or nonperforming, when based on current information and events, it is likely the Company will be unable to collect all amounts due according to the contractual terms of the original loan agreement. Management considers loans that are in bankruptcy status, but have not been charged-off, to be impaired. These loans are placed on nonaccrual, when they become 90 days past due, or earlier if they enter bankruptcy, and are charged-off in their entirety when deemed uncollectible, or when they become 120 days past due, whichever occurs first, at which time appropriate collection and recovery efforts against both the borrower and the underlying collateral are initiated. For the recreation 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. If the collateral is repossessed, a loss is recorded to write the collateral down to its fair value less selling costs, 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. Proceeds collected on charged-off accounts are recorded as a recovery. Total loans more than 90 days past due were $8,123,000 at September 30, 2019, or 0.73% of the total loan portfolio, compared to $20,154,000, or 2.03% at December 31, 2018.
In situations where, for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession for other than an insignificant period of time to the borrower that the Company would not otherwise consider, the related loan is classified as a trouble debt restructuring (“TDR”). The Company strives to identify borrowers in financial difficulty early and work with them to modify their loan to more affordable terms before it reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, term extensions, payment forbearance and other actions intended to minimize the economic loss to the Company and to avoid foreclosure or repossession of the collateral. For modifications where the Company forgives principal, the entire amount of such principal forgiveness is immediately charged off. Loans classified as TDRs are considered impaired loans. Beginning in fiscal year 2019, all consumer loans which are party to a bankruptcy are immediately classified as TDRs. The Company’s policy with regard to bankrupt loans is take an immediate 40% write down of the loan balance.
Loan collateral in process of foreclosure primarily includes taxicab medallion loans that have reached 120 days past due and have been charged-down to their net realizable value, in addition to consumer repossessed collateral in the process of being sold. The taxicab medallion loan component reflects that the collection activities on the loans have transitioned from working with the borrower, to the liquidation of the collateral securing the loans.
The Company had $30,295,000 and $40,500,000 of net loans and loans in process of foreclosure pledged as collateral under borrowing arrangements at September 30, 2019 and December 31, 2018.
The Company accounts for its sales of loans in accordance with FASB Accounting Standards Codification Topic 860, Transfers and Servicing (FASB ASC 860), which provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. In accordance with FASB ASC 860, the Company had elected the fair value measurement method for its servicing assets and liabilities. The principal portion of loans serviced for others by the Company and its affiliates was $125,818,000 at September 30, 2019 and $140,180,000 at December 31, 2018. The Company has evaluated the servicing aspect of its business in accordance with FASB ASC 860, which relates to servicing assets held by MFC (related to the remaining assets in Trust III) and determined that no material servicing asset or liability existed as of September 30, 2019 and December 31, 2018. The Company assigned its servicing rights of the Bank portfolio to MSC. The costs of servicing were allocated to MSC by the Company, and the servicing fee income was billed to and collected from the Bank by MSC.
Allowance for Loan Losses (Bank Holding Company Accounting)
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions, and excess concentration risks. In analyzing the adequacy of the allowance for loan losses, the Company uses historical delinquency and actual loss rates with a one year lookback period for consumer loans. For commercial loans deemed nonperforming, the historical loss experience and other projections are looked at, and for medallion loans, nonperforming loans are valued at the median sales price over the most recent quarter, and performing medallion loans are reserved utilizing historical loss ratios over a three-year lookback period. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. As a result, reserves of $4,608,000 were recorded by the Company as a general reserve on medallion loans as an additional buffer against future losses, not including the Bank’s general reserve of $17,351,000 which was netted against loan balances at consolidation on April 2, 2018. Subsequent to April 2, 2018, the Bank recorded general reserves of $6,032,000. Credit losses are deducted from the allowance and subsequent recoveries are added back to the allowance.
Page 14 of 77
Unrealized Appreciation (Depreciation) and Realized Gains (Losses) on Investments (Investment Company Accounting)
Prior to April 2, 2018, under Investment Company Accounting, the Company’s loans, net of participations and any unearned discount, were considered investment securities under the 1940 Act and recorded at fair value. As part of the fair value methodology, loans were valued at cost adjusted for any unrealized appreciation (depreciation). Since no ready market existed for these loans, the fair value was determined in good faith by the Board of Directors. In determining the fair value, the Board of Directors considered factors such as the financial condition of the borrower, the adequacy of the collateral, individual credit risks, cash flows of the borrower, market conditions for loans (e.g. values used by other lenders and any active bid/ask market), historical loss experience, and the relationships between current and projected market rates and portfolio rates of interest and maturities. Investments other than securities, which represent collateral received from defaulted borrowers, were valued similarly.
Under Investment Company Accounting, the Company recognized unrealized appreciation (depreciation) on investments as the amount by which the fair value estimated by the Company is greater (less) than the cost basis of the investment portfolio. Realized gains or losses on investments are generated through sales of investments, foreclosure on specific collateral, and writeoffs of loans or assets acquired in satisfaction of loans, net of recoveries. Refer to Note 5 for additional details.
Goodwill and Intangible Assets
The Company’s goodwill and intangible assets arose as a result of the excess of fair value over book value for several of the Company’s previously unconsolidated portfolio investment companies as of April 2, 2018. This fair value was brought forward under the Company’s new reporting, and was subject to a purchase price accounting allocation process conducted by an independent third party expert to arrive at the current categories and amounts. Goodwill is not amortized, but is subject to quarterly review by management to determine whether additional impairment testing is needed, said testing which is performed at least on an annual basis. Intangible assets are amortized over their useful life of approximately 20 years. As of September 30, 2019, December 31, 2018, and September 30, 2018, the Company had goodwill of $150,803,000, which all related to the Bank, and intangible assets of $52,898,000, $53,982,000 and $59,958,000, and the Company recognized $361,000 and $361,000 of amortization expense on the intangible assets for the three months ended September 30, 2019 and 2018, and $1,084,000 and $722,000 of amortization expense on the intangible assets for the nine months ended September 30, 2019 and 2018. Additionally, loan portfolio premiums of $12,387,000 were determined as of April 2, 2018, of which $6,161,000, $9,048,000, and $10,607,000 were outstanding at September 30, 2019, December 31, 2018, and September 30, 2018, and of which $713,000 and $1,780,000 were amortized to interest income for the three months ended September 30, 2019 and 2018, and of which $2,886,000 and $1,780,000 were amortized to interest income for the nine months ended September 30, 2019 and 2018. The Company engaged an expert to assess the goodwill and intangibles for impairment at December 31, 2018, who concluded there was no impairment on the Bank, and impairment on the RPAC intangible asset of $5,615,000, which was recorded in the 2018 fourth quarter.
The table below shows the details of the intangible assets as of the periods presented.
Brand-related intellectual property
20,350
21,176
Home improvement contractor relationships
6,383
6,641
Race organization
26,165
Total intangible assets
Fixed Assets
Fixed assets are carried at cost less accumulated depreciation and amortization, and are depreciated on a straight-line basis over their estimated useful lives of 3 to 10 years. Leasehold improvements are amortized on a straight-line basis over the shorter of the lease term or the estimated economic useful life of the improvement. Depreciation and amortization expense was $109,000 and $131,000 for the three months ended September 30, 2019 and 2018, and was $313,000 and $289,000 for the comparable nine months.
Deferred Costs
Deferred financing costs, included in other assets, represent costs associated with obtaining the Company’s borrowing facilities, and are amortized on a straight line basis over the lives of the related financing agreements and life of the respective pool. Amortization expense was $613,000 and $558,000 for the three months ended September 30, 2019 and 2018, and was $1,731,000 and $1,322,000 for the comparable nine months. In addition, the Company capitalizes certain costs for transactions in the process of completion (other than business combinations), including those for potential investments, and the sourcing of other financing alternatives. Upon completion or termination of the transaction, any accumulated amounts are amortized against income over an appropriate period, or written off. The amount on the Company’s balance sheet for all of these purposes was $5,589,000, $4,461,000, and $4,859,000 as of September 30, 2019, December 31, 2018, and September 30, 2018.
Page 15 of 77
Income Taxes
Income taxes are accounted for using the asset and liability approach in accordance with FASB ASC Topic 740, Income Taxes (ASC 740). Deferred tax assets and liabilities reflect the impact of temporary differences between the carrying amount of assets and liabilities and their tax basis and are stated at tax rates expected to be in effect when taxes are actually paid or recovered. Deferred tax assets are also recorded for net operating losses, capital losses and any tax credit carryforwards. A valuation allowance is provided against a deferred tax asset when it is more likely than not that some or all of the deferred tax assets will not be realized. All available evidence, both positive and negative, is considered to determine whether a valuation allowance for deferred tax assets is needed. Items considered in determining our valuation allowance include expectations of future earnings of the appropriate tax character, recent historical financial results, tax planning strategies, the length of statutory carryforward periods and the expected timing of the reversal of temporary differences. Under ASC 740, forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence, such as cumulative losses in recent years. The Company recognizes tax benefits of uncertain tax positions only when the position is more likely than not to be sustained assuming examination by tax authorities. The Company records income tax related interest and penalties, if applicable, within current income tax expense.
Sponsorship and Race Winnings
The Company accounts for sponsorship and race winnings revenue under FASB ASC Topic 606, Revenue from Contracts with Customers. Sponsorship revenue is recognized when the Company’s performance obligations are completed in according with the contract terms of the sponsorship contract. Race winnings revenue is recognized after each race during the season based upon terms provided by NASCAR and the placement of the driver.
Earnings (Loss) Per Share (EPS)
Basic earnings (loss) per share are computed by dividing net income (loss)/net increase (decrease) in net assets resulting from operations available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution that could occur if option contracts to issue common stock were exercised, or if restricted stock vests, and has been computed after giving consideration to the weighted average dilutive effect of the Company’s stock options and restricted stock. The Company uses the treasury stock method to calculate diluted EPS, which is a method of recognizing the use of proceeds that could be obtained upon exercise of options and warrants, including unvested compensation expense related to the shares, in computing diluted EPS. It assumes that any proceeds would be used to purchase common stock at the average market price during the period. The table below shows the calculation of basic and diluted EPS.
Three Months Ended September 30,
Nine Months Ended September 30,
2019
2018
Net income (loss)/net decrease in net assets resulting from operations
available to common stockholders
Weighted average common shares outstanding applicable to
basic EPS
Effect of dilutive stock options
16,543
Effect of restricted stock grants
228,944
Adjusted weighted average common shares outstanding
applicable to diluted EPS
Basic income (loss) per share
Diluted income (loss) per share
Potentially dilutive common shares excluded from the above calculations aggregated 468,055 and 115,000 shares as of September 30, 2019 and 2018.
Stock Compensation
The Company follows FASB ASC Topic 718 (ASC 718), Compensation – Stock Compensation, for its equity incentive, stock option, and restricted stock plans, and accordingly, the Company recognizes the expense of these grants as required. Stock-based employee compensation costs pertaining to stock options are reflected in net increase in net income/net assets resulting from operations for any new grants using the fair values established by usage of the Black-Scholes option pricing model, expensed over the vesting period of the underlying option. Stock-based employee compensation costs pertaining to restricted stock are reflected in net income/net increase net assets resulting from operations for any new grants using the grant date fair value of the shares granted, expensed over the vesting period of the underlying stock.
Page 16 of 77
During the nine months ended September 30, 2019 and 2018, the Company issued 178,266 and 101,010 of restricted shares of stock-based compensation awards, 375,481 and 39,000 shares of stock options, and 26,040 and no restricted stock units and recognized $348,000 and $853,000, or $0.01 and $0.03 per share, for the 2019 third quarter and nine months, and $151,000 and $466,000, or $0.01 and $0.02, per share, for each of the comparable 2018 periods, of non-cash stock-based compensation expense related to the grants. As of September 30, 2019, the total remaining unrecognized compensation cost related to unvested stock options and restricted stock was $1,663,000, which is expected to be recognized over the next 14 quarters (see Note 10).
Regulatory Capital
The Bank is subject to various regulatory capital requirements administered by the FDIC and the Utah Department of Financial Institutions. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classifications are also subject to qualitative judgments by the bank regulators about components, risk weightings, and other factors.
FDIC-insured banks, including the Bank, are subject to certain federal laws, which impose various legal limitations on the extent to which banks may finance or otherwise supply funds to certain of their affiliates. In particular, the Bank is subject to certain restrictions on any extensions of credit to, or other covered transactions, such as certain purchases of assets, with the Company or its affiliates.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios as defined in the regulations (set forth in the table below). Additionally, as conditions of granting the Bank’s application for federal deposit insurance, the FDIC ordered that the Tier 1 leverage capital to total assets ratio, as defined, be not less than 15%, which could preclude its ability to pay dividends to the Company, and that an adequate allowance for loan losses be maintained. As of September 30, 2019, the Bank’s Tier 1 leverage ratio was 15.91%. The Bank’s actual capital amounts and ratios, and the regulatory minimum ratios are presented in the following table.
Regulatory
Minimum
Well-
Capitalized
Common equity Tier 1 capital
153,580
141,608
Tier 1 capital
179,883
167,911
Total capital
194,436
180,917
Average assets
1,130,642
1,059,461
Risk-weighted assets
1,120,179
993,374
Leverage ratio(1)
4.0
%
5.0
15.9
15.8
Common equity Tier 1 capital ratio(2)
7.0
6.5
13.7
14.3
Tier 1 capital ratio(3)
8.5
8.0
16.1
16.9
Total capital ratio(3)
10.5
10.0
17.4
18.2
Calculated by dividing Tier 1 capital by average assets.
Calculated by subtracting preferred stock or non-controlling interest from Tier 1 capital and dividing by risk-weighted assets.
Calculated by dividing Tier 1 or total capital by risk-weighted assets.
In addition, the 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, the Bank is 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%. Since the FDIC’s new capital rule has been fully phased in, the minimum capital requirements plus the capital conservation buffer exceed the Prompt Corrective Action well-capitalized thresholds.
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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 they relate to the fair value of assets and liabilities. The amendments in this update are effective for annual periods beginning after December 15, 2019, and interim periods within those fiscal years. The Company does not believe this update will have a material impact on its 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. The Company does not believe this update will have a material impact on its 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. 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, with early adoption permitted. In October 2019, the FASB voted to defer implementation of the standard for smaller reporting companies, such as the Company, to fiscal years beginning after December 15, 2022. The Company is assessing the impact the update will have on its financial statements, and expects the update to have an impact on the Company’s accounting for estimated credit losses on its loans.
(3) INVESTMENT SECURITIES (Bank Holding Company Accounting)
Fixed maturity securities available for sale as of September 30, 2019 and December 31, 2018 consisted of the following:
Amortized
Cost
Gross
Gains
Losses
Fair Value
Mortgage-backed securities, principally obligations of US
federal agencies
34,431
569
34,935
State and municipalities
12,279
262
(54
12,487
46,710
831
(119
Amortized Cost
Mortgage-backed securities, principally obligations of
US federal agencies
32,184
15
(742
31,457
14,239
35
(407
13,867
46,423
50
(1,149
The amortized cost and estimated market value of investment securities as of September 30, 2019 by contractual maturity are shown below. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Due in one year or less
Due after one year through five years
12,416
12,497
Due after five years through ten years
10,267
Due after ten years
23,992
24,473
Page 18 of 77
The following tables show information pertaining to securities with gross unrealized losses at September 30, 2019 and December 31, 2018, aggregated by investment category and length of time that individual securities have been in a continuous loss position.
Less than Twelve Months
Twelve Months and Over
Gross Unrealized
Mortgage-backed securities, principally obligations
of US federal agencies
(39
4,083
(26
5,075
(1
169
(53
2,770
(40
4,252
(79
7,845
4,616
(688
24,871
(78
5,429
(329
6,259
(132
10,045
(1,017
31,130
Unrealized losses on securities have not been recognized into income because the issuers’ bonds are of high credit quality, and the Company has the intent and ability to hold the securities for the foreseeable future. The fair value is expected to recover as the bonds approach the maturity date.
(4) LOANS AND ALLOWANCE FOR LOAN LOSSES (Bank Holding Company Accounting)
The following table shows the major classification of loans, inclusive of capitalized loan origination costs, at September 30, 2019 and December 31, 2018.
As of September 30, 2019
As of December 31, 2018
Amount
As a Percent of
Gross Loans
Recreation
706,393
62
587,038
58
Home improvement
230,726
20
183,155
18
Commercial
68,209
6
64,083
Medallion
136,954
12
183,606
Total gross loans
Allowance for loan losses
Total net loans
The following tables show the activity of the gross loans for the three and nine months ended September 30, 2019.
Three Months Ended September 30, 2019
Home
Improvement
Gross loans – June 30, 2019
668,540
209,549
64,442
145,944
1,088,475
Loan originations
82,662
42,641
4,750
130,053
Principal payments
(40,790
(20,729
(375
(4,013
(65,907
Charge-offs, net
(3,489
(51
(819
(1,535
(5,894
Transfer to loans in process of foreclosure, net
(3,429
(3,005
(6,434
2,899
(684
211
(437
1,989
Gross loans – September 30, 2019
Page 19 of 77
Nine Months Ended September 30, 2019
Gross loans – December 31, 2018
248,989
102,821
14,520
366,330
(113,680
(53,508
(9,789
(10,612
(187,589
(10,853
(295
(18,166
(30,133
(10,311
(15,573
(25,884
5,210
(1,447
214
(2,301
1,676
The following table sets forth the activity in the allowance for loan losses for the three and nine months ended September 30, 2019 and the three and six months ended September 30, 2018.
Six Months
Ended
September 30,
Allowance for loan losses – beginning
balance
40,670
21,425
36,395
Charge-offs
(5,444
(4,825
(16,366
(9,471
(568
(659
(1,655
(1,220
(2,378
(6,457
(20,408
(12,737
Total charge-offs
(9,209
(11,941
(39,248
(23,428
Recoveries
1,955
1,318
5,513
3,217
517
367
1,360
606
4
843
110
2,242
304
Total recoveries
3,315
1,795
9,115
4,131
Net charge-offs(2)
(10,146
(19,297
Allowance for loan losses – ending balance
43,113
29,484
Beginning balance 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 the six months ended September 30, 2018.
As of September 30, 2019, cumulative net charge-offs of loans and loans in process of foreclosure in the medallion portfolio were $242,889, representing collection opportunities for the Company.
Includes $4,608 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 11% of the total allowance, and 3.56% of the medallion loans under 90 days past due as of September 30, 2019. This figure excludes $17,351 of a general reserve on loans at the Bank, which was netted against loan balances at consolidation on April 2, 2018. Subsequent to April 2, 2018, the Bank recorded general reserves of $6,032.
Page 20 of 77
The following tables set forth the composition of the allowance for loan losses by type as of September 30, 2019 and December 31, 2018.
Percentage of
Allowance
Allowance as a
Percent of Loan
Category
15,927
37
2.25
2,235
5
0.97
0.00
24,951
18.22
3.77
6,856
19
1.17
1,796
0.98
27,743
15.11
3.58
The following table presents total nonaccrual loans and foregone interest, substantially all of which is in the medallion portfolio. The decline reflects the charge-offs of certain loans and their movement to loan collateral in process of foreclosure. The fluctuation in nonaccrual interest foregone is due to past due loans and market conditions.
September 30, 2018
Total nonaccrual loans
27,078
34,877
45,765
Interest foregone quarter to date
403
487
Amount of foregone interest applied
to principal in the quarter
166
350
Interest foregone year to date
915
1,153
to principal in the year
244
535
987
Interest foregone life to date
2,432
1,952
8,530
to principal life to date
655
1,214
3,412
Percentage of nonaccrual loans to gross loan
portfolio
2
The following tables present the performance status of loans as of September 30, 2019 and December 31, 2018.
Performing
Nonperforming
to Total
699,685
6,708
0.95
230,487
239
0.10
56,178
12,031
17.64
128,854
8,100
5.91
1,115,204
2.37
Page 21 of 77
581,250
5,788
0.99
183,018
137
0.07
60,249
3,834
5.98
158,488
25,118
13.68
983,005
3.43
For those loans aged 31-90 days, there is a possibility that their delinquency status will continue to deteriorate and they will subsequently be placed on nonaccrual status and be reserved for, and as such, deemed nonperforming.
The following tables provide additional information on attributes of the nonperforming loan portfolio as of September 30, 2019 and 2018, and December 31, 2018, all of which had an allowance recorded against the principal balance.
Recorded
Unpaid
Principal
Balance
Related
Average
Recognized
With an allowance recorded
256
6,687
6,921
366
243
245
12,126
9,616
36
6,827
321
8,660
3,160
13,418
27
11,279
39
Total nonperforming loans
with an allowance
27,733
3,420
29,964
217
25,272
728
Six Months Ended
204
180
5,494
106
4,496
231
178
119
3,929
5,403
5,814
7,047
5,838
(12
26,237
22,035
38,057
39,038
10,085
55,065
101
54,917
215
36,091
22,242
48,702
50,094
10,368
67,784
125
65,370
434
The following tables show the aging of all loans as of September 30, 2019 and December 31, 2018.
Days Past Due
31-60
61-90
91 +
Current
Total (1)
90 Days and
Accruing
20,615
4,431
31,817
651,122
682,939
687
280
228
1,195
232,804
233,999
67,933
31,062
3,188
36,006
96,541
132,547
52,364
8,807
8,123
69,294
1,048,400
1,117,694
Excludes loan premiums of $6,161 resulting from purchase price accounting and $18,427 of capitalized loan origination costs.
Page 22 of 77
Investment >
18,483
5,655
4,020
28,158
539,051
567,209
715
283
1,133
184,528
185,661
454
279
733
63,350
8,689
3,652
15,720
28,061
148,774
176,835
27,887
10,044
20,154
58,085
935,703
993,788
Excludes loan premiums of $9,047 resulting from purchase price accounting and $15,047 of capitalized loan origination costs.
The Company estimates that the weighted average loan-to-value ratio of the medallion loans was approximately 202%, 220%, and 224% as of September 30, 2019, December 31, 2018, and September 30, 2018.
The following table shows the troubled debt restructurings which the Company entered into during the three and nine months ended September 30, 2019.
Number of
Pre-
Modification
Post-
Medallion loans - 2019 three months
758
Recreation loans - 2019 three months
40
505
Medallion loans - 2019 nine months
4,041
Recreation loans - 2019 nine months
4,109
2,619
During the twelve months ended September 30, 2019, three medallion loans modified as troubled debt restructurings were in default and had an investment value of $812,000 as of September 30, 2019, net of a $365,000 allowance for loan losses, and 191 recreation loans modified as trouble debt restructurings were in default and had an investment value of $1,727,000 as of September 30, 2019, net of a $66,000 allowance for loan losses.
The following table shows the troubled debt restructurings which the Company entered into during the three and nine months ended September 30, 2018.
Medallion loans - 2018 three months
4,810
Medallion loans - 2018 nine months
17
7,505
During the twelve months ended September 30, 2018, three loans modified as troubled debt restructurings were in default and had an investment value of $1,305,000 as of September 30, 2018, net of a $773,000 allowance for loan losses.
The following tables show the activity of the loans in process of foreclosure, which relate only to the recreation and medallion loans, for the three and nine months ended September 30, 2019.
Loans in process of foreclosure – June 30, 2019
955
51,413
52,368
Transfer from loans, net
3,429
3,005
6,434
Sales
(1,604
(387
(1,991
Cash payments received
(1,556
Collateral valuation adjustments
(1,603
(1,716
Loans in process of foreclosure – September 30, 2019
1,177
52,362
Page 23 of 77
Loans in process of foreclosure – December 31, 2018
1,503
47,992
10,311
15,573
(5,715
(899
(6,614
(6,100
(4,922
(9,126
(5) UNREALIZED APPRECIATION (DEPRECIATION) AND REALIZED GAINS (LOSSES) ON INVESTMENTS (Investment Company Accounting)
The following table sets forth the pre-tax change in the Company’s unrealized appreciation (depreciation) on investments for the three months ended March 31, 2018.
Investments in
Subsidiaries
Investments
Than Securities
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
(40,067
Reversal of unrealized appreciation
(depreciation) related to realized
Gains on investments
Losses on investments
34,747
Balance March 31, 2018
(23,761
(495
197,715
2,123
(3,405
172,177
The table below summarizes pre-tax components of unrealized and realized gains and losses in the investment portfolio for the three months ended March 31, 2018 under Investment Company Accounting.
Three Months
March 31, 2018
Net change in unrealized appreciation (depreciation) on
investments
Unrealized appreciation
Unrealized depreciation
(38,152
Net unrealized appreciation on investments in Medallion
Bank and other controlled subsidiaries
Realized gains
Realized losses
Net unrealized losses on investments other than securities and
other assets
22,797
Net realized gains (losses) on investments
(34,747
Direct recoveries
Page 24 of 77
(6) INVESTMENTS IN MEDALLION BANK AND OTHER CONTROLLED SUBSIDIARIES (Investment Company Accounting)
The following note is included for informational purposes as it relates to the prior periods when the Company reported under Investment Company Accounting and as such, was not able to consolidate the Bank’s results.
The following table presents information derived from the Bank’s statement of comprehensive income and other valuation adjustments on other controlled subsidiaries for the three months ended March 31, 2018 under Investment Company Accounting.
Statement of comprehensive income
Investment income
26,880
3,615
Net interest income
23,265
Noninterest income
Operating expenses
7,158
Net investment income before income taxes
16,126
3,321
Net investment income after income taxes
19,447
Net realized/unrealized losses of Medallion Bank
(28,539
Net decrease in net assets resulting from operations of
Medallion Bank
(9,092
Unrealized appreciation on Medallion Bank(1)
39,092
Net realized/unrealized losses on controlled subsidiaries
other than Medallion Bank
(885
Net increase in net assets resulting from operations of
Medallion Bank and other controlled subsidiaries
Unrealized depreciation on the Bank reflects the adjustment to the investment carrying amount to reflect the dividends declared to the US Treasury, and the fair value adjustments to the carrying amount of the Bank.
(7) FUNDS BORROWED
The outstanding balances of funds borrowed were as follows:
Payments Due for the Twelve Months Ending September 30,
2020
2021
2022
2023
2024
Thereafter
Rate (1)
348,385
182,587
225,560
112,413
94,042
SBA debentures and
borrowings
23,093
8,500
5,000
32,500
74,093
80,099
3.41
Retail and privately placed
notes
33,625
36,000
69,625
8.61
Notes payable to banks
7,652
27,370
70
35,652
59,615
4.25
Preferred securities
33,000
4.24
Other borrowings
11,758
7,649
2.09
390,888
252,082
225,840
117,693
135,112
65,500
1,187,115
1,062,028
2.91
Weighted average contractual rate as of September 30, 2019.
Page 25 of 77
(A) DEPOSITS
Deposits are raised through the use of investment brokerage firms who package deposits qualifying for FDIC insurance into pools that are sold to the Bank. The rates paid on the deposits are highly competitive with market rates paid by other financial institutions. Additionally, a brokerage fee is paid, depending on the maturity of the deposits, which averages less than 0.15%. Interest on the deposits is accrued daily and paid monthly, quarterly, semiannually, or at maturity. All time deposits are in denominations of less than $250,000 and have been originated through certificates of deposit broker relationships. The table presents time deposits of $100,000 or more by their maturity:
Three months or less
84,392
Over three months through six months
66,100
Over six months through one year
197,893
Over one year
614,602
Total deposits
(B) DZ LOAN
In December 2008, Trust III entered into the DZ loan agreement with DZ Bank, to provide up to $200,000,000 of financing through a commercial paper conduit to acquire medallion loans from MFC (DZ loan). The line, which currently terminates on November 15, 2019, is under negotiation to be extended.
Borrowings under Trust III’s DZ loan are collateralized by Trust III’s assets. MFC is the servicer of the loans owned by Trust III. In addition, if certain financial tests are not met, MFC can be replaced as the servicer. See Note 19 for more information about Trust III and the DZ loan.
(C) SBA DEBENTURES AND BORROWINGS
Over the years, the SBA has approved commitments for MCI and FSVC, typically for a four and half year term and a 1% fee, which was paid. During 2017, the SBA restructured FSVC’s debentures with SBA totaling $33,485,000 in principal into a new loan by the SBA to FSVC in the principal amount of $34,024,756 (the SBA Loan). In connection with the SBA Loan, FSVC executed a Note (the SBA Note), with an effective date of March 1, 2017, in favor of SBA, in the principal amount of $34,024,756. The SBA Loan bears interest at a rate of 3.25% per annum, required a minimum of $5,000,000 of principal and interest to be paid on or before February 1, 2018 (which was paid) and a minimum of $7,600,000 of principal and interest to be paid on or before March 27, 2019 (which was paid), and all remaining unpaid principal and interest on or before February 1, 2020, the final maturity date. The SBA Loan agreement contains covenants and events of defaults, including, without limitation, payment defaults, breaches of representations and warranties and covenants defaults. As of September 30, 2019, $172,485,000 of commitments had been fully utilized, there were $3,000,000 of commitments available, and $74,093,000 was outstanding, including $23,093,000 under the SBA Note.
(D) NOTES PAYABLE TO BANKS
The Company and its subsidiaries have entered into note agreements with a variety of local and regional banking institutions over the years. The notes are typically secured by various assets of the underlying borrower.
Page 26 of 77
The table below summarizes the key attributes of the Company’s various borrowing arrangements with these lenders as of September 30, 2019.
Borrower
# of
Lenders/
Notes
Note
Dates
Maturity
Type
Amounts
Outstanding
at September 30,
Payment
Rate at
Rate
Index(1)
Medallion Financial
Corp.
5/5
4/11 - 8/14
9/20 - 3/21
Term loans
and demand
notes secured
by pledged
loans(2)
23,231
only(3)
4.63
Various(3)
Medallion Chicago
2/23
11/11 - 12/11
2/21
secured by
owned
Chicago
medallions(4)
18,449
11,231
$134 of
principal &
paid
monthly
3.50
N/A
Medallion Funding
1/1
11/18
12/23
1,400
1,190
$70
quarterly
4.00
43,080
At September 30, 2019, 30 day LIBOR was 2.02%, 360 day LIBOR was 2.03%, and the prime rate was 5.00%.
One note has an interest rate of Prime, one note has an interest rate of Prime plus 0.50%, one note has a fixed interest rate of 3.75%, one note has an interest rate of LIBOR plus 3.75%, and the other interest rates on these borrowings are LIBOR plus 2%.
Various agreements call for remittance of all principal received on pledged loans subject to minimum monthly payments ranging from $12 to $81.
Guaranteed by the Company.
In March 2019, the Company used some of the proceeds of the privately placed notes to pay off one of the notes payable to banks at a 50% discount, resulting in a gain on debt extinguishment of $4,145,000 in the 2019 first quarter.
In November 2018, MFC entered into a note to the benefit of DZ Bank for $1,400,000 at a 4.00% interest rate due December 2023, as part of the restructuring of the DZ loan. See Note 19 for more information.
On July 6, 2019, the Company paid $10,819,000 at maturity in satisfaction of all its outstanding obligations under one of its credit facilities. In connection with this payment, the Company obtained a waiver from one of its other lenders, with a term note of $3,096,000, of certain resulting repayment and other obligation, which waiver expires on December 1, 2019.
(E) RETAIL AND PRIVATELY PLACED NOTES
In March 2019, the Company completed a private placement to certain institutional investors of $30,000,000 aggregate principal amount of 8.25% unsecured senior notes due 2024, with interest payable semiannually. The Company used the net proceeds from the offering for general corporate purposes, including repaying certain borrowings under its notes payable to banks at a discount which led to a gain of $4,145,000 in the 2019 first quarter. In August 2019, the private placement was reopened and an additional $6,000,000 of notes was issued to certain institutional investors.
In April 2016, the Company issued a total of $33,625,000 aggregate principal amount of 9.00% unsecured notes due 2021, with interest payable quarterly in arrears. The Company used the net proceeds from the offering of approximately $31,786,000 to make loans and other investments in portfolio companies and for general corporate purposes, including repaying borrowings under its DZ loan in the ordinary course of business.
Page 27 of 77
(F) PREFERRED SECURITIES
In June 2007, the Company issued and sold $36,083,000 aggregate principal amount of unsecured junior subordinated notes to Fin Trust which, in turn, sold $35,000,000 of preferred securities to Merrill Lynch International and issued 1,083 shares of common stock to the Company. The notes bear a variable rate of interest of 90 day LIBOR (2.09% at September 30, 2019) plus 2.13%. The notes mature in September 2037 and are prepayable at par. Interest is payable quarterly in arrears. The terms of the preferred securities and the notes are substantially identical. In December 2007, $2,000,000 of the preferred securities were repurchased from a third party investor. At September 30, 2019, $33,000,000 was outstanding on the preferred securities.
(G) OTHER BORROWINGS
In November and December 2017, RPAC amended the terms of various promissory notes with affiliate Richard Petty (refer to Note 15 for more details). At December 31, 2018, the total outstanding on these notes was $7,149,000 at a 2.00% annual interest rate compounded monthly and due March 31, 2020. As of September 30, 2019, $7,258,000 was outstanding on these notes. Additionally, RPAC has a short term promissory note to an unrelated party for $500,000 due on December 31, 2019.
In September 2019, the Company issued federal funds of $4,000,000 at a 2.25% interest rate, which funds were repaid in October 2019.
(H) COVENANT COMPLIANCE
Certain of our debt agreements contain restrictions that require the Company and its subsidiaries to maintain certain financial ratios, including debt to equity and minimum net worth, which in the event of noncompliance could preclude their ability to pay dividends to the Company.
(8) LEASES
The Company has leased premises that expire at various dates through November 30, 2027 that are operating leases. The Company has implemented ASC Topic 842 under a modified retrospective approach in which no adjustments have been made to the prior year balances.
The following table presents the operating lease costs and additional information for the three and nine months ended September 30, 2019.
Operating lease costs
531
1,593
Other information
Cash paid for amounts included in the measurement of lease
liabilities:
Operating cash flows from operating leases
556
1,680
Right-of-use asset obtained in exchange for lease liability
29
The following table presents the breakout of the operating leases as of September 30, 2019.
Operating lease right-of-use assets
12,559
Other current liabilities
1,820
Total operating lease liabilities
13,910
Weighted average remaining lease term
3.7 years
Weighted average discount rate
Page 28 of 77
At September 30, 2019, maturities of the lease liabilities were as follows.
Remainder of 2019
600
2,397
2,295
2,228
2,136
6,042
Total lease payments
15,698
Less imputed interest
1,788
(9) INCOME TAXES
The Company is subject to federal and applicable state corporate income taxes on its taxable ordinary income and capital gains. As a corporation taxed under Subchapter C of the Internal Revenue Code, the Company is able, and intends, to file a consolidated federal income tax return with corporate subsidiaries, in which it holds 80% or more of the outstanding equity interest measured by both vote and fair value.
The following table sets forth the significant components of our deferred and other tax assets and liabilities as of September 30, 2019 and December 31, 2018.
Goodwill and other intangibles
(44,315
(45,272
19,529
25,790
Net operating loss carryforwards(1)
21,166
11,132
Accrued expenses, compensation, and other assets
1,932
1,844
Unrealized gains on other investments
(4,737
(2,024
Total deferred tax liability
(6,425
(8,530
Valuation allowance
(462
Deferred tax liability, net
(6,887
(8,785
Taxes receivable
1,290
1,812
Net deferred and other tax liabilities
(5,597
(6,973
As of September 30, 2019, the Company and its subsidiaries had an estimated $87,433 of net operating loss carryforwards, $1,712 of which expire at various dates between December 31, 2026 and December 31, 2035, which had a net asset value of $20,704 as of September 30, 2019.
The components of our tax (provision) benefit for the three and nine months ended September 30, 2019 and 2018 were as follows.
Federal
(230
(9,353
(1,099
(3,040
State
(661
(2,318
(1,620
(1,078
Deferred
(887
9,100
1,311
8,128
1,613
2,688
3,334
768
Net (provision) benefit for income taxes
4,778
Page 29 of 77
The following table presents a reconciliation of statutory federal income tax (provision) benefit to consolidated actual income tax (provision) benefit reported in net loss/net decrease in net assets for the three and nine months ended September 30, 2019 and 2018.
Statutory Federal income tax (provision) benefit at 21%
(1,616
877
(332
8,106
State and local income taxes, net of federal income
tax benefit
(547
(107
994
Revaluation of net operating losses
876
380
Appreciation of Medallion Bank
(1,974
Utilization of carry forwards
(247
(910
Change in state income tax accruals
Change in effective state income tax rate
608
916
(1,358
Income attributable to non-controlling interest
451
Non deductible expenses
(215
(403
63
(191
24
323
Total income tax (provision) benefit
On December 22, 2017, the US 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.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which temporary differences become deductible pursuant to ASC 740. The Company considers the reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. The Company’s evaluation of the realizability of deferred tax assets must consider both positive and negative evidence. The weight given to the potential effects of positive and negative evidence is based on the extent to which it can be objectively verified. Based upon these considerations, the Company determined the necessary valuation allowance as of September 30, 2019.
The Company has filed tax returns in many states. Federal, New York State, New York City, and Utah tax filings of the Company for the tax years 2016 through the present are the more significant filings that are open for examination.
(10) STOCK OPTIONS AND RESTRICTED STOCK
The Company’s Board of Directors approved the 2018 Equity Incentive Plan (2018 Plan), which was approved by the Company’s stockholders on June 15, 2018. The terms of 2018 Plan provide for grants of a variety of different type of stock awards to the Company’s employees and non-employee directors, including options, restricted stock, stock appreciation rights, etc. A total of 1,500,253 shares of the Company’s common stock are issuable under the 2018 Plan, and 882,219 remained issuable as of September 30, 2019. Awards under the 2018 Plan are subject to certain limitations as set forth in the 2018 Plan, which will terminate when all shares of common stock authorized for delivery have been delivered and the forfeiture restrictions on all awards have lapsed, or by action of the Board of Directors pursuant to the 2018 Plan, whichever occurs first.
The Company’s Board of Directors approved the 2015 Employee Restricted Stock Plan (2015 Restricted Stock Plan) on February 13, 2015, which was approved by the Company’s shareholders on June 5, 2015. The 2015 Restricted Stock Plan became effective upon the Company’s receipt of exemptive relief from the SEC on March 1, 2016. The terms of 2015 Restricted Stock Plan provided for grants of restricted stock awards to the Company’s employees. A grant of restricted stock is a grant of shares of the Company’s common stock which, at the time of issuance, is subject to certain forfeiture provisions, and thus is restricted as to transferability until such forfeiture restrictions have lapsed. A total of 700,000 shares of the Company’s common stock were issuable under the 2015 Restricted Stock Plan, and 241,919 remained issuable as of June 15, 2018. Effective June 15, 2018, the 2018 Plan was approved, and these remaining shares were rolled into the 2018 Plan. Awards under the 2015 Restricted Stock Plan are subject to certain limitations as set forth in the 2015 Restricted Stock Plan. The 2015 Restricted Stock Plan will terminate when all shares of common stock authorized for delivery under the 2015 Restricted Stock Plan have been delivered and the forfeiture restrictions on all awards have lapsed, or by action of the Board of Directors pursuant to the 2015 Restricted Stock Plan, whichever occurs first.
Page 30 of 77
The Company had a stock option plan (2006 Stock Option Plan) available to grant both incentive and nonqualified stock options to employees. The 2006 Stock Option Plan, which was approved by the Board of Directors on February 15, 2006 and shareholders on June 16, 2006, provided for the issuance of a maximum of 800,000 shares of common stock of the Company. No additional shares are available for issuance under the 2006 Stock Option Plan. The 2006 Stock Option Plan was administered by the Compensation Committee of the Board of Directors. The option price per share could not be less than the current market value of the Company’s common stock on the date the option was granted. The term and vesting periods of the options were determined by the Compensation Committee, provided that the maximum term of an option could not exceed a period of ten years.
The Company’s Board of Directors approved the 2015 Non-Employee Director Stock Option Plan (2015 Director Plan) on March 12, 2015, which was approved by the Company’s shareholders on June 5, 2015, and on which exemptive relief to implement the 2015 Director Plan was received from the SEC on February 29, 2016. A total of 300,000 shares of the Company’s common stock were issuable under the 2015 Director Plan, and 258,334 remained issuable as of June 15, 2018. Effective June 15, 2018, the 2018 Plan was approved, and these remaining shares were rolled into the 2018 Plan. Under the 2015 Director Plan, unless otherwise determined by a committee of the Board of Directors comprised of directors who are not eligible for grants under the 2015 Director Plan, the Company granted options to purchase 12,000 shares of the Company’s common stock to a non-employee director upon election to the Board of Directors, with an adjustment for directors who were elected to serve less than a full term. The option price per share could not be less than the current market value of the Company’s common stock on the date the option was granted. Options granted under the 2015 Director Plan are exercisable annually, as defined in the 2015 Director Plan. The term of the options could not exceed ten years.
The Company’s Board of Directors approved the First Amended and Restated 2006 Director Plan (the Amended Director Plan) on April 16, 2009, which was approved by the Company’s shareholders on June 5, 2009, and on which exemptive relief to implement the Amended Director Plan was received from the SEC on July 17, 2012. A total of 200,000 shares of the Company’s common stock were issuable under the Amended Director Plan. No additional shares are available for issuance under the Amended Director Plan. Under the Amended Director Plan, unless otherwise determined by a committee of the Board of Directors comprised of directors who are not eligible for grants under the Amended Director Plan, the Company would grant options to purchase 9,000 shares of the Company’s common stock to an Eligible Director upon election to the Board of Directors, with an adjustment for directors who were elected to serve less than a full term. The option price per share could not be less than the current market value of the Company’s common stock on the date the option was granted. Options granted under the Amended Director Plan are exercisable annually, as defined in the Amended Director Plan. The term of the options could not exceed ten years.
Additional shares are only available for future issuance under the 2018 Plan. At September 30, 2019, 497,721 options on the Company’s common stock were outstanding under the Company’s plans, of which 81,667 options were exercisable, and there were 247,616 unvested shares of the Company’s common stock outstanding under the Company’s restricted stock plans.
The fair value of each restricted stock grant is determined on the date of grant by the closing market price of the Company’s common stock on the grant date. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The weighted average fair value of options granted was $2.98 per share and $1.06 per share for the nine months ended September 30, 2019 and 2018. The following assumption categories are used to determine the value of any option grants.
Risk free interest rate
2.39
2.82
Expected dividend yield
0.79
4.86
Expected life of option in years(1)
6.25
6.00
Expected volatility(2)
48.45
30.00
Expected life is calculated using the simplified method.
We determine our expected volatility based on our historical volatility.
Page 31 of 77
The following table presents the activity for the stock option programs for the 2019 quarters and the 2018 full year.
Options
Exercise
Price Per
Share
Weighted
Exercise Price
Outstanding at December 31, 2017
320,626
2.14-13.84
8.78
Granted
39,000
5.27-5.58
5.46
Cancelled
(214,960
9.22-9.24
9.22
Exercised(1)
Outstanding at December 31, 2018
144,666
2.06-13.84
7.23
374,377
5.21-6.55
6.48
(18,000
7.49-9.38
8.44
Outstanding at March 31, 2019
501,043
6.63
1,104
6.55
(3,433
6.55-7.49
7.10
Outstanding at June 30, 2019
498,714
6.62
(993
Outstanding at September 30, 2019(2)
497,721
Options exercisable at September 30, 2019(2)
81,667
8.35
The aggregate intrinsic value, which represents the difference between the price of the Company’s common stock at the exercise date and the related exercise price of the underlying options, was $0 for each of the 2019 and 2018 three and nine months ended September 30.
The aggregate intrinsic value, which represents the difference between the price of the Company’s common stock at September 30, 2019 and the related exercise price of the underlying options, was $180,000 for outstanding options and $78,000 for exercisable options as of September 30, 2019. The remaining contractual life was 8.81 years for outstanding options and 5.95 years for exercisable options at September 30, 2019.
The following table presents the activity for the restricted stock programs for the 2019 quarters and the 2018 full year.
Grant
408,582
2.06-10.38
3.45
101,010
3.93-5.27
4.41
(9,737
3.93-9.08
4.66
Vested(1)
(308,940
3.35
190,915
2.14-5.27
4.06
3.93-3.95
3.94
(101,832
3.93-4.39
4.07
250,482
2.14-6.55
5.68
6.55-7.03
6.98
3.95-6.55
6.40
(16,406
2.06-7.03
237,878
5.86
4.80
5.90
247,616
5.82
The aggregate fair value of the restricted stock vested was $0 and $736,000 for the three and nine months ended September 30, 2019, and was $32,000 and $1,241,000 for the comparable 2018 periods.
Page 32 of 77
The aggregate fair value of the restricted stock was $1,585,000 as of September 30, 2019. The remaining vesting period was 2.67 years at September 30, 2019.
In addition, during the 2019 third quarter, the Company granted and has outstanding, 26,040 restricted stock units that vest in one year with a grant price of $4.80. These units have the option of deferring vesting until a future date if the employee makes a formal election under the guidelines of IRC Section 409A.
The following table presents the activity for the unvested options outstanding under the plans for the 2019 quarters.
Price
Per Share
62,777
2.14-7.10
4.59
Vested
437,154
6.21
(1,433
(16,000
2.22-7.10
5.12
420,825
(3,778
2.61
Outstanding at September 30, 2019
416,054
6.28
The intrinsic value of the options vested was $8,000 and $34,000 for the three and nine months ended September 30, 2019.
(11) SEGMENT REPORTING (Bank Holding Company Accounting)
Under Bank Holding Company Accounting, the Company has six business segments, which include four lending and two non-operating segments, which are reflective of how Company management makes decisions about its business and operations.
Prior to April 2, 2018, the Company had one business segment, its lending and investing operations. This segment originated and serviced medallion, secured commercial, and consumer loans, and invested in both marketable and nonmarketable securities.
The four lending segments reflect the main types of lending performed at the Company, which are recreation, home improvement, commercial, and medallion. The recreation and home improvement lending segments are conducted by the Bank in all fifty states, with the highest concentrations in Texas, Florida, and California at 16%, 10%, and 10% of loans outstanding and with no other states over 10% as of September 30, 2019. The recreation lending segment is a consumer finance business that works with third-party dealers and financial service providers for the purpose of financing RVs, boats, and other consumer recreational equipment, of which RVs, boats, and trailers make up 62%, 18%, and 12% of the segment portfolio as of September 30, 2019. The home improvement lending segment works with contractors and financial service providers to finance residential home improvements concentrated in swimming pools, roofs, solar panels, and windows, at 25%, 20%, 13%, and 13% of total home improvement loans outstanding, and with no other product lines over 10% as of September 30, 2019. The commercial lending segment focuses on enterprise wide industries, including manufacturing services, and various other industries, in which 57% of these loans are made in the Midwest. The medallion lending segment arose in connection with the financing of the taxicab medallions, taxicabs, and related assets, of which 88% were in New York City as of September 30, 2019.
In addition, our non-operating segments include RPAC, which is a race car team, and our corporate and other investments segment which includes items not allocated to our operating segments such as investment securities, equity investments, intercompany eliminations, and other corporate elements.
As part of the segment reporting, capital ratios for all operating segments have been normalized at 20%, which approximates the percentage of consolidated total equity divided by total assets, with the net adjustment applied to corporate and other investments for the three and nine months ended September 30, 2019. In addition, beginning in fiscal year 2019, the commercial segment exclusively represents the mezzanine lending business, and the legacy commercial loan business (immaterial to total) has been re-allocated to corporate and other investments for all periods presented.
Page 33 of 77
The following tables present segment data as of September 30, 2019 and for the three and nine months then ended, and as of September 30, 2018, and for the three and six months then ended.
Consumer Lending
Lending
RPAC
and
Consolidated
Total interest income
26,147
5,184
1,842
975
492
Total interest expense
3,578
1,309
741
1,935
47
1,615
Net interest income (loss)
22,569
3,875
1,101
(960
(47
(1,123
6,744
(629
364
1,858
after loss provision
15,825
4,504
737
(2,818
(2,663
Other income (expense)
(6,181
(2,000
(2,762
(1,784
(2,591
(14,755
Net income (loss) before taxes
9,644
2,504
1,300
(5,580
3,446
(3,714
Income tax benefit (provision)
(2,497
(648
(314
1,345
(831
2,780
Net income (loss)
7,147
1,856
986
(4,235
2,615
(934
Balance Sheet Data
Total loans, net
690,466
228,491
64,646
112,003
3,563
702,541
239,991
87,486
226,868
33,134
229,734
Total funds borrowed
559,995
190,871
69,658
180,040
7,758
178,793
Selected Financial Ratios
Return on average assets
4.14
3.22
4.49
(7.26
)%
31.13
(1.54
1.31
Return on average equity
20.69
16.09
22.45
(36.30
NM
(7.81
6.81
Interest yield
15.35
9.46
11.09
3.30
11.87
Net interest margin
13.25
7.07
(3.25
8.71
Reserve coverage
Delinquency status(2)
0.69
0.11
0.40
2.41
0.73
Charge-off ratio
2.05
0.09
4.93
5.20
2.17
Ratio is based on total commercial lending balances, and relates solely to the legacy commercial loan business.
Loans 90 days or more past due.
Ratio is based on total commercial lending balances, and relates to the total loan business.
Page 34 of 77
72,996
14,187
5,359
2,482
1,674
9,541
3,252
2,108
5,435
5,313
63,455
10,935
3,251
(2,953
(3,639
19,925
15,374
455
43,530
10,202
2,887
(18,327
(4,094
(7,211
Other (expense)
(17,501
(5,356
(532
(8,106
(5,298
(5,822
(42,615
26,029
4,846
2,355
(26,433
3,380
(9,916
(6,741
(1,255
6,375
(815
4,930
19,288
3,591
1,787
(20,058
2,565
(4,986
4.01
2.50
2.69
(10.82
10.76
(2.90
(0.12
17.42
11.34
13.43
(54.12
(11.52
(0.60
15.45
9.44
11.59
11.68
7.27
7.03
(2.97
8.57
2.30
1.77
18.29
3.92
Page 35 of 77
Three Months Ended September 30, 2018
24,001
3,968
2,370
2,126
2,306
709
500
3,672
1,660
21,695
3,259
1,870
(1,546
(973
4,423
598
(75
13,259
Net interest income (loss) after loss
provision
17,272
2,661
1,945
(14,805
Sponsorship and race winning
(2,876
(3,160
400
(945
(4,077
(1,887
(2,849
(12,518
14,112
3,061
1,000
(18,882
568
(3,822
(3,979
(863
(232
4,371
927
10,133
2,198
(14,511
461
(2,895
Balance Sheet Data as of
572,995
168,781
77,886
235,827
4,572
1,060,061
582,610
175,333
88,035
369,763
36,237
319,429
1,571,407
431,868
132,914
53,323
399,750
7,614
239,605
1,265,074
580,182
181,359
59,973
155,863
4,110
590,746
188,892
90,264
273,501
29,925
208,518
434,527
143,815
51,266
294,465
130,306
Selected Financial Ratios as of
6.80
4.57
(15.23
4.94
(4.29
(1.19
27.77
19.99
7.47
42.83
(15.05
(6.59
15.87
8.10
12.33
14.34
6.65
9.73
(2.48
7.94
0.50
0.51
0.13
9.81
2.71
0.55
1.29
3.19
1.34
10.35
3.69
Page 36 of 77
Six Months Ended September 30, 2018
46,133
8,605
4,587
5,315
1,156
65,796
4,442
1,448
985
7,045
81
2,811
16,812
41,691
7,157
3,602
(1,730
(81
48,984
9,133
1,475
38,073
32,558
5,682
3,502
(39,803
203
(5,416
(8,680
(1,285
(6,888
(4,124
(4,390
(27,254
23,878
4,397
(46,691
978
(6,045
(21,868
(6,141
(1,159
(368
10,528
(150
1,428
4,138
17,737
3,238
1,247
(36,163
828
(4,617
(17,730
6.14
3.42
2.81
(18.49
4.46
(3.55
(2.51
25.84
15.22
6.05
38.67
(11.16
(13.34
15.88
8.94
13.48
4.03
10.91
14.35
7.44
10.58
(1.31
8.17
3.26
1.27
9.66
3.53
(12) OTHER OPERATING EXPENSES (Investment Company Accounting)
The major components of other operating expenses were as follows:
For the Three
Months Ended
Directors’ fees
89
Miscellaneous taxes
120
Computer expenses
23
161
Total other operating expenses
467
Page 37 of 77
(13) SELECTED FINANCIAL RATIOS AND OTHER DATA (Investment Company Accounting)
The following table provides selected financial ratios and other data for the three months ended March 31, 2018 under Investment Company Accounting.
(Dollars in thousands, except per share data)
Net share data
Net asset value at the beginning of the period
11.80
Net investment loss
(0.15
0.03
(1.44
Net change in unrealized appreciation on investments
0.94
Net decrease in net assets resulting from operations
(0.62
Issuance of common stock
(0.03
Repurchase of common stock
Net investment income
Return of capital
Net realized gains on investments
Total distributions
Total decrease in net asset value
(0.65
Net asset value at the end of the period(1)
11.15
Per share market value at beginning of period
Per share market value at end of period
4.65
Total return(2)
(129
Ratios/supplemental data
Total shareholders’ equity (net assets)
Average net assets
284,021
Total expense ratio(3) (4)
10.02
Operating expenses to average net assets(4)
5.87
Net investment loss after income taxes to average net assets(4)
(4.61
Includes $0 of undistributed net investment income per share and $0 of undistributed net realized gains per share as of March 31, 2018.
Total return is calculated by dividing the change in market value of a share of common stock during the period, assuming the reinvestment of distributions on the payment date, by the per share market value at the beginning of the period.
Total expense ratio represents total expenses (interest expense, operating expenses, and income taxes) divided by average net assets.
MSC has assumed certain of the Company’s servicing obligations, and as a result, servicing fee income of $1,290, and operating expenses of $1,150, which formerly were the Company’s, were MSC’s for the three months ended March 31, 2018. Excluding the impact of the MSC amounts, the total expense ratio, operating expense ratio, and net investment income ratio would have been 11.75%, 7.51%, and (4.49%) in the March 31, 2018 quarter.
(14) COMMITMENTS AND CONTINGENCIES
(A) EMPLOYMENT AGREEMENTS
The Company has employment agreements with certain key officers for either a two- or five-year term. Annually, the contracts with a five-year term will renew for new five-year terms unless prior to the end of the first year, either the Company or the executive provides notice to the other party of its intention not to extend the employment period beyond the current five-year term. Annually, the contracts with a two-year term will renew for new two-year terms unless prior to the term either the Company or the executive provides notice to the other party of its intention not to extend the employment period beyond the current one-year term. In the event of a change in control, as defined, during the employment period, the agreements provide for severance compensation to the executive in an amount equal to the balance of the salary, bonus, and value of fringe benefits which the executive would be entitled to receive for the remainder of the employment period.
Page 38 of 77
Employment agreements expire at various dates through 2024, with future minimum payments under these agreements of approximately $6,061,000.
(B) OTHER COMMITMENTS
Except as described in the following paragraph, the Company had no commitments to extend credit or make investments outstanding at September 30, 2019. Generally, any commitments would be on the same terms as loans to or investments in existing borrowers or investees, and generally have fixed expiration dates. Since some commitments would be expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
The Company has commitments for leased premises that expire at various dates through November 30, 2027. At September 30, 2019, minimal rental commitments for non-cancelable leases were $15,698,000.
(C) LITIGATION
The Company and its subsidiaries become defendants to various legal proceedings arising from the normal course of business. In the opinion of management, based on the advice of legal counsel, 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 impact on the financial condition or results of operations of the Company.
(D) REGULATORY
In the ordinary course of business, the Company and its subsidiaries are subject to inquiries from certain regulators. During 2014, FSVC was examined by the SBA. The foregoing regulatory examination was resolved in January 2017 as a result of FSVC’s transfer to liquidation status and the restructure of the FSVC loan described in Note 7.
(15) RELATED PARTY TRANSACTIONS
Certain directors, officers and stockholders of the Company are also directors and officers of its main subsidiaries, MFC, MCI, FSVC, and the Bank, as well as other subsidiaries. Officer salaries are set by the Board of Directors of the Company.
Jeffrey Rudnick, the son of one of the Company’s directors, is an officer of LAX Group, LLC (LAX), one of the Company’s equity investments. Mr. Rudnick receives a salary from LAX of $171,000 per year, and certain equity from LAX consisting of 10% ownership in LAX Class B stock, vesting at 3.34% per year; 5% of any new equity raised from outside investors at a valuation of $1,500,000 or higher; and 10% of LAX’s profits as a year-end bonus. In addition, Mr. Rudnick provides consulting services to the Company directly for a monthly retainer of $4,200.
The Company’s subsidiary RPAC, has an agreement with minority shareholder Richard Petty, in which it makes an annual payment of $700,000 per year for services provided to the entity. In addition, RPAC has a note payable to a trust controlled by Mr. Petty of $7,258,000 that earns interest at an annual rate of 2% as of September 30, 2019.
In the 2019 second quarter, RPAC entered into a sponsorship agreement with Victory Junction, a 501(c)(3) public charity for which Richard Petty is a Board member, for $7,000,000 of sponsorship payments to RPAC during the remaining 2019 race car season, of which $5,200,000 was earned and received in 2019.
The Company and MSC serviced $308,346,000 of loans for the Bank at March 31, 2018. Under Investment Company Accounting, included in net investment income were amounts as described in the table below that were received from the Bank for services rendered in originating and servicing loans, and also for reimbursement of certain expenses incurred on their behalf.
The Company had assigned its servicing rights to the Bank portfolio to MSC, a wholly-owned entity that had been unconsolidated under Investment Company Accounting. The costs of servicing are allocated to MSC by the Company, and the servicing fee income is billed and collected from the Bank by MSC. As a result, in the three months ended March 31, 2018, $1,290,000 of servicing fee income was earned by MSC.
Page 39 of 77
The following table summarizes the net revenues received from the Bank not eliminated under Investment Company Accounting.
Reimbursement of operating expenses
250
Loan origination and servicing fees
Total other income
The Company had a loan to Medallion Fine Art, Inc. in the amount of $999,000 as of December 31, 2017, which was repaid in full during the 2018 first quarter. The loan bore interest at a rate of 12%, all of which was paid in kind. Additionally, the Company recognized $10,000 of interest income not eliminated for the three months ended March 31, 2018 with respect to this loan.
The Company and MCI have loans to RPAC which have been eliminated in consolidation since April 2, 2018. The loans bear interest at 2%, inclusive of cash and paid in kind interest. The Company and MCI recognized $0 of interest income for the three months ended March 31, 2018 with respect to these loans.
(16) FAIR VALUE OF FINANCIAL INSTRUMENTS
FASB ASC Topic 825, “Financial Instruments,” requires disclosure of fair value information about certain financial instruments, whether assets, liabilities, or off-balance-sheet commitments, if practicable. The following methods and assumptions were used to estimate the fair value of each class of financial instrument. Fair value estimates that were derived from broker quotes cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument.
(a) Cash—Book value equals fair value.
(b) Equity securities—The Company’s equity securities are recorded at cost less impairment, which approximated fair value.
(c) Investment securities—The Company’s investments are recorded at the estimated fair value of such investments.
(d) Loans receivable—The Company’s loans are recorded at book value which approximated fair value.
(e) Floating rate borrowings—Due to the short-term nature of these instruments, the carrying amount approximates fair value.
(f) Commitments to extend credit—The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and present creditworthiness of the counter parties. For fixed rate loan commitments, fair value also includes a consideration of the difference between the current levels of interest rates and the committed rates. At September 30, 2019 and December 31, 2018, the estimated fair value of these off-balance-sheet instruments was not material.
(g) Fixed rate borrowings—The fair value of the debentures payable to the SBA is estimated based on current market interest rates for similar debt.
Carrying Amount
Financial assets
Cash and federal funds sold(1)
Loans receivable
Accrued interest receivable(2)
Financial liabilities
Funds borrowed(3)
1,188,850
1,062,297
Accrued interest payable(2)
Categorized as level 1 within the fair value hierarchy. See Note 17.
Categorized as level 3 within the fair value hierarchy. See Note 17.
As of September 30, 2019 and December 31, 2018, publicly traded retail notes traded at a premium to par of $1,735 and $269.
Page 40 of 77
(17) FAIR VALUE OF ASSETS AND LIABILITIES
The Company follows the provisions of FASB ASC 820, which defines fair value, establishes a framework for measuring fair value, establishes a fair value hierarchy based on the quality of inputs used to measure fair value, and enhances disclosure requirements for fair value measurements.
In accordance with FASB ASC 820, the Company has categorized its assets and liabilities measured at fair value, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (level 1) and the lowest priority to unobservable inputs (level 3). Our assessment and classification of an investment within a level can change over time based upon maturity or liquidity of the investment and would be reflected at the beginning of the quarter in which the change occurred.
As required by FASB ASC 820, when the inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. For example, a level 3 fair value measurement may include inputs that are observable (levels 1 and 2) and unobservable (level 3). Therefore gains and losses for such assets and liabilities categorized within the level 3 table below may include changes in fair value that are attributable to both observable inputs (level 1 and 2) and unobservable inputs (level 3).
Assets and liabilities measured at fair value, recorded on the consolidated balance sheets, are categorized based on the inputs to the valuation techniques as follows:
Level 1. Assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market that the Company has the ability to access (examples include active exchange-traded equity securities, exchange-traded derivatives, most US government and agency securities, and certain other sovereign government obligations).
Level 2. Assets and liabilities whose values are based on quoted prices in markets that are not active or model inputs that are observable either directly or indirectly for substantially the full term of the asset or liability. Level 2 inputs include the following:
A)
Quoted prices for similar assets or liabilities in active markets (for example, restricted stock);
B)
Quoted price for identical or similar assets or liabilities in non-active markets (for example, corporate and municipal bonds, which trade infrequently);
C)
Pricing models whose inputs are observable for substantially the full term of the asset or liability (examples include most over-the-counter derivatives, including interest rate and currency swaps); and
D)
Pricing models whose inputs are derived principally from or corroborated by observable market data through correlation or other means for substantially the full term of the asset or liability (examples include certain residential and commercial mortgage-related assets, including loans, securities, and derivatives).
Level 3. Assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the assets or liability (examples include certain private equity investments, and certain residential and commercial mortgage-related assets, including loans, securities, and derivatives).
A review of fair value hierarchy classification is conducted on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification for certain assets or liabilities. Reclassifications impacting level 3 of the fair value hierarchy are reported as transfers in/out of the level 3 category as of the beginning of the quarter in which the reclassifications occur. The following paragraph describes the sensitivity of the various level 3 valuations to the factors that are relevant in their valuation analysis under Bank Holding Company Accounting (applicable as of June 30, 2018 and for the quarter then ended) and shows the table under Investment Company Accounting (applicable to prior periods).
Commencing with the quarter ended June 30, 2018, equity investments are recorded at cost and are evaluated for impairment periodically.
Page 41 of 77
The following table presents the Company’s fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis as of September 30, 2019 and December 31, 2018.
Level 1
Level 2
Level 3
Available for sale investment securities(1)
57,302
Total unrealized income of $1,322, net of tax, was included in accumulated other comprehensive income (loss) for the nine months ended September 30, 2019 related to these assets.
54,521
Total unrealized losses of $82, net of tax, was included in accumulated other comprehensive income (loss) for the nine months ended December 31, 2018 related to these assets.
The following tables provide a summary of changes in fair value of the Company’s level 3 assets and liabilities for the three and nine months ended September 30, 2019 and the three and six months ended September 30, 2018, under Bank Holding Company Accounting, and for the three months ended March 31, 2018 under Investment Company Accounting.
June 30, 2019
9,797
Gains included in earnings
414
Purchases, investments, and issuances
1,077
Sales, maturities, settlements, and distributions
(1,408
Amounts related to held assets(1)
Total realized and unrealized gains (losses) included in income for the period which relate to assets held as of September 30, 2019.
510
2,727
(2,554
(1,300
Page 42 of 77
June 30, 2018
10,773
Losses included in earnings
(400
631
(252
10,752
Total realized and unrealized gains (losses) included in income for the period which relate to assets held as of September 30, 2018.
9,458
(774
1,160
Transfers in(1)
1,377
Amounts related to held assets(2)
Represents the removal of RPAC investments eliminated in consolidation as well as the transfer of LAX from controlled subsidiaries during the 2018 second quarter.
in Medallion
Bank &
Controlled
Other Than
Securities
December 31, 2017
208,279
90,188
302,147
9,521
7,450
339
Gains (losses) included in earnings
(38,190
(8
29,143
7
7,252
462
935
Sales, maturities, settlements, and
distributions
(8,941
(3,812
(583
(5
161,155
93,620
331,169
5,535
(10
Total realized and unrealized gains (losses) included in income for the period, which relate to assets held as of March 31, 2018.
The following tables present the Company’s fair value hierarchy for those assets and liabilities measured at fair value on a non-recurring basis as of September 30, 2019 and December 31, 2018 under Bank Holding Company Accounting.
Impaired loans
Loan collateral in process of foreclosure
80,617
Page 43 of 77
84,372
Significant Unobservable Inputs
ASC Topic 820 requires disclosure of quantitative information about the significant unobservable inputs used in the valuation of assets and liabilities classified as Level 3 within the fair value hierarchy. The tables below are not intended to be all-inclusive, but rather to provide information on significant unobservable inputs and valuation techniques used by the Company.
The valuation techniques and significant unobservable inputs used in recurring level 3 fair value measurements of assets and liabilities as of September 30, 2019 and December 31, 2018 were as follows under Bank Holding Company Accounting.
at 9/30/19
Valuation Techniques
Unobservable Inputs
Range
(Weighted Average)
7,038
Investee financial analysis
Financial condition and
operating performance of the
borrower
Collateral support
1,387
Investee book value adjusted for market appreciation
investee
Precedent arm’s length offer
Business enterprise value
$6,014 – $7,214
Business enterprise
value/revenue multiples
0.96x – 4.44x
Discount for lack of
marketability
25%
1,455
Precedent market transaction
Offering price
$8.73/share
at 12/31/18
5,683
1,850
0.96x – 4.54x
209
Investee book value
Valuation indicated by investee
filings
(18) SMALL BUSINESS LENDING FUND PROGRAM (SBLF) AND TROUBLED ASSETS RELIEF PROGRAM (TARP)
On February 27, 2009 and December 22, 2009, the Bank issued, and the US Treasury purchased under the TARP Capital Purchase Program (the CPP) the Bank’s fixed rate non-cumulative Perpetual Preferred Stock, Series A, B, C, and D for an aggregate purchase price of $21,498,000 in cash. On July 21, 2011, the Bank issued, and the US Treasury purchased 26,303 shares of Senior Non-Cumulative Perpetual Preferred Stock, Series E (Series E) for an aggregate purchase price of $26,303,000 under the SBLF. The SBLF is a voluntary program intended to encourage small business lending by providing capital to qualified smaller banks at favorable rates. In connection with the issuance of the Series E, the Bank exited the CPP by redeeming the Series A, B, C, and D; and received approximately $4,000,000, net of dividends due on the repaid securities. the Bank pays a dividend rate of 9% on the Series E.
Page 44 of 77
(19) VARIABLE INTEREST ENTITIES
During the 2018 third quarter, the Company determined that Trust III was a VIE. Trust III had been consolidated as a subsidiary of MFC historically, although it should have been consolidated under the variable interest model, since MFC was its primary beneficiary until October 31, 2018. Trust III is a VIE since the key decision-making authority rests in the servicing agreement (where MFC is the servicer for Trust III) rather than in the voting rights of the equity interests and as a result the decision-making rights are considered a variable interest. This conclusion is supported by a qualitative assessment that Trust III does not have sufficient equity at risk. Since the inception of Trust III, MFC had also been party to a limited guaranty which was considered a variable interest because, pursuant to the guaranty, MFC absorbed variability as a result of the on-going performance of the loans in Trust III. As of October 31, 2018, the Company determined that MFC was no longer the primary beneficiary of Trust III and accordingly deconsolidated the VIE, leading to a net gain of $25,325,000 recorded as well as a new promissory note payable by MFC of $1,400,000 issued in settlement of the limited guaranty (see Note 7 for more details). In addition, the Company remains the servicer of the assets of Trust III for a fee.
(20) SUBSEQUENT EVENTS
We have evaluated subsequent events that have occurred through the date of financial statement issuance. As of such date, there were no subsequent events that required disclosure.
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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 recreational vehicles (RVs), 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 17% (19% if there had been no loan sales during 2016, 2017, and 2018). We have transitioned away from medallion lending and have placed our strategic focus on our growing consumer finance portfolio. As a result of our change in strategy, as of September 30, 2019, our consumer loans represented 84% of our net loan portfolio, with medallion loans representing 10% and commercial loans representing 6%. Total assets under management and management of 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 $1,649,000,000 as of September 30, 2019, and were $1,522,000,000 and $1,598,000,000 as of December 31, 2018 and September 30, 2018, 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 bank certificates of deposit issued to customers, debentures issued to and guaranteed by the SBA, privately placed notes, 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. Our investments are typically in the form of secured debt instruments with fixed interest rates accompanied by an equity stake or warrants to purchase an equity interest for a nominal exercise price (such warrants are included in equity investments on the consolidated balance sheets). Interest income is earned on the debt instruments.
Beginning in the current year, the Bank began the process to build-out a strategic partnership program with financial technology (Fintech) companies. Although no partnerships have been finalized, the Bank is actively exploring this opportunity with a number of Fintech companies with a plan to begin operations in 2020.
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 business development company (BDC) under the Investment Company Act of 1940, as amended (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.
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 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.
Our wholly-owned subsidiary, Medallion Bank, is a bank regulated by the FDIC and the Utah Department of Financial Institutions that 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 Medallion Servicing Corp. (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 September 30, 2019. MSC earns referral and servicing fees for these activities.
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The assets of Taxi Medallion Loan Trust III (Trust III) are 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.
Average Balances and Rates (Bank Holding Company Accounting)
The following tables show the Company’s consolidated average balance sheet, interest income and expense and the average interest earning/bearing assets and liabilities, and which reflect the average yield on assets and average costs on liabilities for the three months ended September 30, 2019 and 2018, and for the nine months ended September 30, 2019 and for the six months ended September 30, 2018.
Yield/Cost
Interest-earning assets
Interest-earning cash and cash equivalents
36,070
1.59
54,777
128
0.93
44,896
303
2.68
45,835
292
2.53
675,973
600,160
217,510
194,466
65,896
1,886
11.36
81,312
2,637
12.87
117,160
247,409
Total loans
1,076,539
34,192
12.60
1,123,347
32,732
11.56
Total interest-earning assets
1,157,505
1,223,959
Non-interest-earning assets
Cash
27,380
10,347
9,960
10,888
Loan collateral in process of foreclosure(1)
52,962
60,871
Goodwill and intangible assets
203,882
210,972
Deferred tax asset
1,243
50,026
40,148
Total non-interest-earning assets
344,210
334,469
1,501,715
1,558,428
Interest-bearing liabilities
947,521
2.51
936,724
2.14
DZ loan
96,585
1,001
4.11
SBA debentures and borrowings
75,073
78,786
769
3.87
38,259
436
4.52
69,629
762
4.34
Retail and privately placed notes
66,592
1,618
9.64
875
10.32
375
4.51
8,737
2.13
7,596
Total interest-bearing liabilities
1,169,182
3.13
1,255,945
Non-interest-bearing liabilities
Deferred tax liability
6,114
Other liabilities
36,760
19,586
Total non-interest-bearing liabilities
42,874
1,212,056
1,275,531
Non controlling interest
28,423
27,246
261,236
255,651
Total liabilities and stockholders' equity
Includes financed sales of this collateral to third parties reported separately from the loan portfolio, and that are conducted by Medallion Bank of $6,091 and $2,668 as of September 30, 2019 and 2018.
Page 47 of 77
During the quarter, our net loans receivable had a yield of 11.87% (compared to 10.75% in the prior year quarter), mainly driven by the increase in the average yield on home improvement loans and the greater proportion of higher yielding assets in the portfolio mix while all other yields have declined overall. The debt, mainly certificates of deposit, helps fund the growing consumer loan business and as the market rates have increased, there has been an overall increase in the average borrowing rate to 3.13% from 2.8% in the prior year quarter.
34,464
443
1.72
42,674
223
1.04
44,630
993
2.97
44,522
561
631,754
579,456
201,024
191,970
61,818
12.11
80,834
12.24
132,799
263,090
4,959
1,027,395
95,262
12.40
1,115,350
65,012
11.63
1,106,489
1,202,546
33,453
10,349
9,460
10,934
51,587
60,841
204,244
211,191
1,873
46,162
37,352
344,906
332,540
1,451,395
1,535,086
898,188
2.44
900,941
97,050
1,885
77,647
2,261
3.89
78,634
1,521
3.86
48,999
1,703
71,077
1,583
4.44
55,757
4,106
9.85
1,750
10.38
1,170
4.74
4.40
8,102
1.96
8,550
1.89
1,121,693
3.07
1,222,877
2.74
6,721
32,678
23,081
39,399
1,161,092
1,245,958
27,800
27,227
262,503
261,901
For the nine months ended September 30, 2019, our net loans receivable had a yield of 11.68%, up from 10.91% in the six months ended September 30, 2018, which was mainly driven by the higher proportion of the portfolio of the higher yielding recreation loans. The debt, mainly certificates of deposit that assist in funding the growing consumer business, has an average borrowing rate of 3.07%.
Page 48 of 77
Rate/Volume Analysis (Bank Holding Company Accounting)
The following tables present the change in interest income and expense due to changes in the average balances (volume) and average rates, calculated for the periods indicated.
Increase
(Decrease)
In Volume
in Rate
Change
(44
60
16
108
(35
73
(6
11
(15
8
2,933
(786
2,147
1,994
(201
1,793
549
667
1,216
202
(767
(565
(441
(310
(751
(184
(143
(1,084
(67
(1,151
(278
(381
1,957
(496
1,461
1,959
(1,533
426
1,907
(419
1,488
2,090
(1,583
507
881
939
363
508
871
(501
(500
(1,001
132
122
(36
9
(27
(357
31
(326
(42
(57
801
(58
743
(29
368
309
652
961
1,936
(787
1,149
1,781
(2,235
(454
Page 49 of 77
During the quarter, the increase in the interest earnings assets was mainly driven by the increase in volume in consumer loans as well as lower volume in the medallion portfolio. The debt change was driven by the increase in the cost of funds borrowed due to the market as well as the new debt issued. These increases in activity were partly offset by the de-consolidation of the DZ loan.
In Rate
(189
124
(68
32
138
45
6,096
(2,051
4,045
2,923
(1,103
1,065
418
1,483
407
(530
(123
(1,690
(628
281
(2,406
(972
(3,378
(429
(689
(1,118
3,065
(3,233
(168
2,937
(2,077
860
2,866
(2,971
(105
3,069
(2,132
937
(111
2,290
2,179
442
965
1,407
(1,106
(1,020
(2,126
(21
216
195
(59
(695
98
(597
51
(56
1,482
(19
57
61
(4
(382
1,336
954
316
1,282
1,598
3,248
(4,307
(1,059
2,753
(3,414
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.
Page 50 of 77
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 tables above and the following table shows the average borrowings and related borrowing costs for the three and nine months ended September 30, 2019 and 2018. Our average balances declined during the current quarter and nine months ended September 30, 2019, reflecting the contraction in the medallion loan portfolio, mainly due to the deconsolidation of Trust III in the 2018 fourth quarter, but partly offset by the increase of certificates of deposits as the consumer business continued to grow. The increase in borrowing costs primarily reflects the repricing of term borrowings based upon current market conditions, and the increase in deposit balances reflect the lengthening of their maturity profile.
Nine Months Ended
Expense
Borrowing
Costs
9,263
2,687
97,734
3.68
2,269
78,543
2,398
74,503
4.30
Retail notes
2,625
10.44
1,040
4.21
Total borrowings
1,226,896
2.22
We expect to continue to seek SBA funding through Medallion Capital, Inc. (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 September 30, 2019 and 2018, short-term adjustable rate debt constituted 5% and 13% of total debt.
The gross loans are reported at the principal amount outstanding, inclusive of deferred loan acquisition costs, which primarily includes deferred fees paid to loan originators, and which is amortized to interest income over the life of the loan. During the three and nine months ended September 30, 2019, there was continued growth in the consumer lending segments, which was partially offset by the various commercial loans settled during the period and payments received from borrowers.
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Provision and Allowance for Loan Loss (Bank Holding Company Accounting)
During the three months ended September 30, 2019, New York medallion values (representing approximately 88% of the medallion loan portfolio) remained constant at $169,500, along with the Chicago medallion values remaining at $19,500, while the values also remained consistent for three months ended September 30, 2018, more loans had continued to age over 90 or 120 days, and were reserved and charged-off down to their collateral value. The provision and allowance also included the general reserve of $4,608,000 for the Company, for current and performing medallion loans under 90 days past due, as an additional buffer against future losses as of September 30, 2019, whereas for the three months ended September 30, 2018 it included the general reserve of $4,897,000. This figure as of September 30, 2019 excludes the general reserve of $17,351,000 at Medallion Bank, much of which was netted against loan balances at consolidation on April 2, 2018. Subsequent to April 2, 2018, the Bank recorded general reserves of $6,032,000. In addition, during the three months ended September 30, 2019, the recreation loan portfolio saw a decline in the reserve percentage leading to the lower provision.
During the nine months ended September 30, 2019, the New York medallion values declined to a net realizable value of $169,500 from $181,000 at December 31, 2018. Overall loans continued to age over 90 and 120 days, at which point they are charged-off.
-
Beginning balance 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 the six months ended September 30, 2018.
Includes $4,608 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 11% of the total allowance, and 3.56% of the loans in question. As of September 30, 2019, this figure excludes $17,351 of a general reserve on loans at Medallion Bank, much of which was netted
Page 52 of 77
against loan balances at consolidation on April 2, 2018. Subsequent to April 2, 2018, the Bank recorded general reserves of $6,032.
The following tables set forth the allowance for loan losses by type as of September 30, 2019 and December 31, 2018.
Percentage
of Allowance
Allowance as
a Percent of
Loan Category
Home Improvement
The following table sets forth the pre-tax changes in our unrealized appreciation (depreciation) on investments for the three months ended March 31, 2018 under Investment Company Accounting.
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 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.
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The following table shows the trend in loans 90 days or more past due as of the dates indicated.
March 31, 2019
%(1)
0.4
3,613
0.3
3,282
3,164
0.0
156
175
731
0.1
710
421
3,746
3,954
1.6
10,301
1.0
Total loans 90 days or more
past due
0.7
8,255
0.8
2.0
14,061
1.3
Percentages are calculated against the total loan portfolio.
We estimate that the weighted average loan-to-value ratio of our medallion loans was approximately 202%, 220%, and 224% as of September 30, 2019, December 31, 2018, and September 30, 2018.
Recreation and medallion loans that reach 120 days past due are charged down to collateral value and reclassified to loans in process of foreclosure. The following tables show the activity of loans in process of foreclosure for the three and nine months ended September 30, 2019.
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The following table presents the credit-related information for the investment portfolios as of March 31, 2018 shown under Investment Company Accounting.
March 31,
Medallion loans
Commercial loans
254,775
Investments in Medallion Bank and other controlled
subsidiaries
Equity investments(1)
Net investments
595,402
Net investments in Medallion Bank and other controlled
918,904
Managed net investments
1,384,449
Unrealized appreciation (depreciation) on investments
(24,256
Total unrealized appreciation on investments
175,582
Net unrealized depreciation on investments at Medallion
(69,561
Managed total unrealized appreciation on investments
106,021
Unrealized appreciation (depreciation) as a % of balances
outstanding(2)
(12.86
(0.53
(8.70
148.15
28.95
41.83
Net investments at Medallion Bank and other controlled
(7.12
8.36
Represents common stock, warrants, preferred stock, and limited partnership interests held as investments.
Unlike other lending institutions, under Investment Company Accounting 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 under Investment Company Accounting.
Realized gains (losses) on loans and equity investments
Total realized losses on loans and equity investments
Net realized losses on investments at Medallion Bank and other
(23,073
Total managed realized losses on loans and equity
(57,818
Realized gains (losses) as a % of average balances
outstanding
(65.74
0.01
(45.96
(30.89
(9.66
(18.22
Page 56 of 77
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 under Investment Company Accounting.
Net unrealized appreciation on investments in Medallion Bank
and other controlled subsidiaries
Net unrealized losses on investments other than securities
and other assets
Other gains
Realized gains on investments other than securities and other
assets
SEGMENT RESULTS
We manage our financial results under four operating segments and report like a bank holding company. The operating 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 three months ended September 30, 2019 and 2018, and for the nine months ended September 30, 2019 and the six months ended September 30, 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 75% of our interest income for the three and nine months ended September 30, 2019. The loans are secured primarily by RVs, boats, and trailers, with RV loans making up 62% of the portfolio, boat loans making up 18% of the portfolio, and trailer loans 12%. Recreation loans are made to borrowers residing in all fifty states, with the highest concentrations in Texas, California, and Florida, at 17%, 10%, and 10% of loans outstanding, and with no other states over 10%. During the 2018 third quarter, there was a sale of $55,979,000 loans for a gain of $3,093,000.
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The following table presents certain financial data and ratios as of and for the three months ended September 30, 2019 and 2018, and the nine months ended September 30, 2019 and the six months ended September 30, 2018.
Nine Months
Selected Earnings Data
Net interest income after loss provision
Total non-interest (expense)
Net income before taxes
Total loans, gross
575,875
Total loan allowance
2,880
Delinquency status(1)
Charge-off %
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, roofs, solar panels, and windows at 25%, 20%, 13%, and 13% 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, Ohio, and Florida at 12%, 11%, and 10% of loans outstanding, and with no other states over 10%. During the 2018 third quarter, there was a sale of $44,909,000 loans for a gain of $2,079,000.
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Total non-interest income (expense)
169,642
861
Commercial Lending
We originate both senior and subordinated loans nationwide to businesses in a variety of industries, more than 57% of which are located in the Midwest 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 $2,000,000 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 and professional, scientific, and technical services, making up 58% and 14% of the total business.
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The following table presents certain financial data and ratios as of and for the three months ended September 30, 2019 and 2018, and for the nine months ended September 30, 2019 and the six months ended September 30, 2018. The commercial segment encompasses the mezzanine lending business, and the other legacy commercial loans (immaterial to total) have been re-allocated to corporate and other investments for all periods presented.
77,986
Reserve coverage(1)
Delinquency status(1) (2)
Charge-off %(3)
Ratio is based off of total commercial balances, and relates solely to the legacy commercial loan balances.
Geographic Concentrations (Dollars in thousands)
Total Gross
% of Market
Michigan
10,304
Minnesota
9,445
Illinois
5,349
North Carolina
5,250
California
4,985
New Jersey
4,909
Other(1)
24,404
Includes 9 other states with none greater than 7%.
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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. During the three months ended September 30, 2019, the medallion values for New York and Chicago remained at a constant market value of $169,500, net of liquidation costs in New York and a market value of $19,500, net of liquidation costs in Chicago. We continued to experience a decline in interest income due to loans aging greater than 90 days and being placed on nonaccrual and by removing underperforming loans from the portfolio by transferring them to loan collateral in process of foreclosure with charge-offs to collateral value, and work with borrowers to collect on the loans. Lastly, in the 2018 fourth quarter we de-consolidated Trust III, leading to an overall decline in medallion loans. All the loans are secured by the medallions and enhanced by personal guarantees of the stockholders and owners.
Net interest loss
Net interest loss after loss provision
Net loss before taxes
261,470
25,643
Geographic Concentration (dollars in thousands)
New York City
120,656
88
Newark
15,293
514
All Other
491
0
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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Sponsorship, race winnings, and other income
Race team and other expenses
4,447
4,763
12,509
9,540
Total expenses
4,494
4,803
12,628
9,621
Income tax (provision)
Corporate and Other Investments
This nonoperating segment relates to our equity and investment securities, as well as our legacy commercial business, other assets, liabilities, revenues, and expenses not allocated to the operating segments. This segment also reflects the elimination of all intercompany activity among the consolidated entities.
Total non interest (expense)
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SELECTED FINANCIAL DATA
Summary Consolidated Financial Data
As described herein, for the three and nine months ended September 30, 2019 and for the three and six months ended September 30, 2018, the Company reported under Bank Holding Company Accounting. For the three months ended March 31, 2018, the Company reported under Investment Company Accounting. You should read the consolidated financial information below with the consolidated financial statements and accompanying notes thereto included in this report.
Statement of operations
Non-interest (expense), net
(9,478
(33,818
Net income before income taxes
Less: income attributable to the non-controlling interest
Per share data
Net income (loss) per diluted share
Distributions per share
Balance sheet data
Total borrowings(1)
1,201,025
Total equity(2)
Selected financial ratios
Return on average assets (ROA)
Return on average equity (ROE)
Dividend payout ratio
Other income ratio(3)
3.04
2.10
Total expense ratio(4)
9.51
9.07
Equity to assets(2)
19.27
Debt to equity (1)
4.1x
Loans receivable to assets
72
Net charge-offs
Net charge-offs as a % of average loans receivable
Allowance coverage ratio
Includes $13,910 related to the operating lease liability.
Includes $29,304 related to non-controlling interest in consolidated subsidiaries.
Other income ratio represents other income divided by average interest earning assets, and includes the gain on extinguishment of debt of $4,145 for the nine months ended September 30, 2019.
Total expense ratio represents total expenses (interest expense, operating expenses, and income taxes) divided by average interest earning assets.
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(10,023
(22,071
Net loss before income taxes
(19,344
Net loss per diluted share
(0.80
24,233,029
Net loan receivable
1,290,992
Total equity(1)
Other income ratio(2)
3.06
Total expense ratio(3)
9.15
8.14
Equity to assets(1)
17.84
Debt to equity
4.5x
84
10,146
19,297
Net charge-offs as a % of average loan receivable
3.54
3.37
Includes $27,495 related to non-controlling interest in consolidated subsidiaries.
Other income ratio represents other income divided by average interest earning assets.
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4,033
482
4,108
Net investment loss before income taxes
(3,566
336
Net investment loss after income taxes
(3,230
Net change in unrealized appreciation on Medallion Bank and
other controlled subsidiaries(1)
Net change in unrealized depreciation on investments other
than securities
Net change in unrealized depreciation on investments(1)
Net change in unrealized appreciation on investments(1)
24,154,879
616,710
320,662
344,273
Total shareholders’ equity
Managed balance sheet data(2)
1,386,136
1,479,826
1,167,888
1,207,389
Selected financial ratios and other data
Return on average assets (ROA)(3)
Net investment loss after taxes
(2.08
(9.55
Return on average equity (ROE)(4)
(4.62
(21.24
Weighted average yield
2.70
Weighted average cost of funds
2.38
Net interest margin(5)
0.32
Non-interest income ratio(6)
Total expense ratio(7)
1.16
Operating expense ratio(8)
0.68
As a percentage of net investment portfolio
Investment in Medallion Bank and other controlled subsidiaries
56
Investments to assets(9)
97
Equity to assets(10)
44
Debt to equity(11)
118
Unrealized appreciation (depreciation) on investments represents the increase (decrease) for the period in the fair value of our investments, including the results of operations for Medallion Bank and other controlled subsidiaries, where applicable.
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Includes the balances of wholly owned, unconsolidated portfolio companies, primarily Medallion Bank.
ROA represents the net investment loss after taxes or net decrease in net assets resulting from operations, divided by average total assets.
ROE represents the net investment loss after taxes or net decrease in net assets resulting from operations, divided by average shareholders’ equity.
Net interest margin represents net interest income for the period divided by average interest earning assets, and included dividends from Medallion Bank and other controlled subsidiaries of $28 for the three months ended March 31, 2018. On a managed basis, combined with Medallion Bank, the net interest margin was 6.96% for the three months ended March 31, 2018.
Noninterest income ratio represents noninterest income divided by average interest earning assets.
(7)
(8)
Operating expense ratio represents operating expenses divided by average interest earning assets.
(9)
Represents net investments divided by total assets as of the date indicated.
(10)
Represents total shareholders’ equity divided by total assets as of the date indicated.
(11)
Represents total funds borrowed divided by total shareholders’ equity as of the date indicated.
Consolidated Results of Operations
2019 Third Quarter Compared to 2018 Third Quarter under Bank Holding Company Accounting
Net income attributable to stockholders was $4,975,000 or $0.20 per diluted common share in the 2019 third quarter compared to a net loss of $4,697,000 or $0.19 per diluted common share in the 2018 third quarter.
Total interest income for the 2019 third quarter was $34,640,000, compared to $33,152,000 in the 2018 third quarter. Interest income in the 2019 third quarter reflected continued growth in the higher yielding consumer lending segments, offset by contraction in the lower yielding medallion lending segment, as well as $713,000 of loan premium amortization compared to $1,780,000 in the prior year quarter. The yield on interest earning assets was 11.87% in the 2019 third quarter, an improvement from 10.75% in the 2018 third quarter. Average interest earning assets were $1,157,505,000 in the 2019 third quarter, a decline from $1,223,959,000 during the 2018 third quarter, mainly due to the deconsolidation of Trust III in the 2018 fourth quarter and the continued charge offs and paydowns of the medallion business, partially offset by the growth in the consumer portfolios.
Loans before allowance for loan losses were $1,142,282,000 as of September 30, 2019, and were comprised of recreation ($706,393,000), home improvement ($230,726,000), medallion ($136,954,000) and commercial ($68,209,000) loans. The Company had an allowance for loan losses as of the end of the 2019 third quarter of $43,113,000, which was attributable to medallion (58%), recreation (37%), and home improvement (5%) loans. Loans increased from $1,088,475,000 at June 30, 2019 primarily due to $130,053,000 of originations, primarily in the recreation and home improvement segments, offset by principal repayments, transfer to loans in process of foreclosure, and net charge offs. As of September 30, 2018, gross loans were $1,089,545,000 and were comprised of recreation ($575,875,000), home improvement ($169,642,000), medallion ($261,470,000) and commercial ($82,558,000) loans. The Company had an allowance for loan losses as of the end of the 2018 third quarter of $29,484,000, which was attributable to the medallion (87%), recreation (10%), and home improvement (3%) loan portfolios. The provision for loan losses was $8,337,000 in the 2019 third quarter compared to $18,205,000 in the 2018 third quarter. The improvement was reflective of a lower medallion loan portfolio, as well as medallion values remaining consistent in the current quarter for the New York and Chicago markets. The charge off ratios on the loan portfolio improved to 2.17% in the 2019 third quarter compared to 3.54% in the prior year quarter and the allowance coverage also improved. See Note 4 for additional information on loans and the allowance for loan losses.
Interest expense was $9,225,000 at the 2019 third quarter compared to $8,887,000 in the 2018 third quarter, and the cost of borrowed funds was 3.13% compared to 2.81%, the increase mainly driven by the issuance of new borrowings at higher rates and fluctuations in average floating rate borrowings. Average debt outstanding was $1,169,182,000 in the quarter, compared to $1,255,945,000 for the 2018 third quarter. See page 47 for a table which shows average balances and cost of funds for our funding sources.
Net interest income was $25,415,000 for the 2019 third quarter compared to $24,265,000 in the 2018 third quarter and the net interest margin was 8.71% compared to 7.94% reflecting the above.
Noninterest income, which is comprised of sponsorship and race winnings, prepayment fees, servicing fee income, late charges, write-downs of loan collateral, impairment of equity investments and other miscellaneous income, was $8,874,000 in the 2019 third quarter, compared to $9,441,000 in the 2018 third quarter. The change was driven by the improvement in the current quarter sponsorship and race winnings along with the $1,384,000 gain on warrants, whereas in the prior year quarter there, had been a $5,172,000 gain on the sale of consumer loans along with lower sponsorship and race winnings.
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Operating expenses were $18,352,000 in the 2019 third quarter, compared to $19,464,000 in the 2018 third quarter. Professional fees were $2,277,000 in the 2019 third quarter compared to $3,951,000 in the 2018 third quarter, primarily reflecting legal costs for a variety of corporate and investment-related matters, salaries and benefits expense were $6,795,000 in the 2019 third quarter compared to $5,999,000 in the 2018 third quarter, reflective of lower base salary and bonus expenses in the prior year, and collection costs were $1,698,000 compared to $1,381,000, primarily reflective of continued efforts with the medallion loan portfolio. The remaining expenses during the 2019 third quarter included race team costs of $2,663,000, loan servicing costs of $1,364,000, primarily reflecting the cost of servicing the recreation and home improvement consumer loans, and occupancy and other operating expenses of $3,555,000, all relatively in line, or slightly improved, compared the 2018 third quarter.
Total income tax provision was $165,000 in the 2019 third quarter compared to a benefit of $117,000 in the 2018 third quarter. The current quarter included benefits of $876,000 attributable to net operating loss revaluations and $608,000 related to changes in the current effective income tax rate. See Note 9 for more information.
Loan collateral in process of foreclosure was $53,539,000 as of September 30, 2019, an increase of $1,171,000 from June 30, 2019, reflecting $6,434,000 of transfers from loans partially offset by sales, cash payments, and valuation adjustments incurred during the 2019 third quarter. At September 30, 2018, the balance was $59,761,000.
Goodwill and intangible assets were $203,701,000 as of September 30, 2019, down from $204,785,000 as of December 31, 2018. See Note 2 for further information regarding goodwill and intangible assets.
2019 Nine Months Ended Compared to 2018 Six Months Ended under Bank Holding Company Accounting
Net loss attributable to stockholders was $1,297,000 or $0.05 per diluted common share for the nine months ended September 30, 2019 compared to $19,344,000 or $0.80 per diluted common share for the six months ended September 30, 2018.
Total interest income for the nine months ended September 30, 2019 was $96,698,000, compared to $65,796,000 for the six months ended September 30, 2018. Interest income for the nine months ended September 30, 2019 reflected continued growth in the higher yielding consumer lending segments, offset by contraction in the lower yielding medallion lending segment and $2,887,000 of loan premium amortization compared to $1,780,000 in the prior year six months. The yield on interest earning assets was 11.68% for the nine months ended September 30, 2019, an improvement from 10.91% for the six months ended September 30, 2018. Average interest earning assets were $1,106,489,000 for the nine months ended September 30, 2019, a decline from $1,202,546,000 during the six months ended September 30, 2018, mainly due to the deconsolidation of Trust III in the 2018 fourth quarter and the continued chargeoffs and paydowns of the medallion business partially offset by the growth in the consumer portfolios.
Loans before allowance for loan losses were $1,142,282,000 as of September 30, 2019 and were comprised of recreation ($706,393,000), home improvement ($230,726,000), medallion ($136,954,000) and commercial ($68,209,000) loans. The Company had an allowance for loan losses as of the end of the 2019 third quarter of $43,113,000, which was attributable to medallion (58%), recreation (37%), and home improvement (5%) loans. Loans increased from $1,017,882,000 at December 31, 2018 primarily due to $366,330,000 of originations, primarily in the recreation and home improvement segments, partially offset by principal repayments and charge-offs. As of September 30, 2018, the gross loans were $1,089,545,000 and were comprised of recreation ($575,875,000), home improvement ($169,642,000), medallion ($261,470,000) and commercial ($82,558,000) loans. The Company had an allowance for loan losses as of the end of the 2018 third quarter of $29,484,000, which was attributable to the medallion (87%), recreation (10%), and home improvement (3%) loan portfolios. The provision for loan losses was $36,851,000 for the nine months ended September 30, 2019 compared to $48,781,000 for the six months ended September 30, 2018. The improvement was reflective of a lower medallion loan portfolio along with minimal activity in the non-specific general reserve for the nine months ended September 30, 2019, whereas there had been the initial recording of the non-specific general reserve of $6,663,000 in the six months ended September 30, 2018. See Note 4 for additional information on loans and the allowance for loan losses.
Interest expense was $25,768,000 for the nine months ended September 30, 2019 compared to $16,812,000 for the six months ended September 30, 2018, and the cost of borrowed funds was 3.07% compared to 2.74%, mainly driven by the new borrowings issued during the current year and the change in the market. Average debt outstanding was $1,121,693,000 for the nine months ended September 30, 2019 compared to $1,222,877,000 for six months ended September 30, 2018. See page 47 for a table which shows average balances and cost of funds for our funding sources.
Net interest income was $70,930,000 for the nine months ended September 30, 2019, compared to $48,984,000 for the six months ended September 30, 2018 and the net interest margin was 8.57% compared to 8.17% reflecting the above.
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Noninterest income, which is comprised of sponsorship and race winnings, prepayment fees, servicing fee income, late charges, write-downs of loan collateral, impairment of equity investments and other miscellaneous income, was $8,874,000 for the nine months ended September 30, 2019 compared to $14,319,000 for the six months ended September 30, 2018. The nine months ended September 30, 2019 includes $16,008,000 of sponsorship and race winnings and the one-time gain of $4,145,000 on the settlement of debt which had been offset by the decline in the non-Metropolitan medallion value for both the loans in process of foreclosure and the owned Chicago medallions whereas in the six months ended September 30, 2018 there had been $10,599,000 of sponsorship and race winnings and a $5,172,000 gain on the sale of consumer loans partly offset by a lower decline in the medallion market value for the loans in process of foreclosure.
Operating expenses were $51,238,000 for the nine months ended September 30, 2019 compared to $36,390,000 for the six months ended September 30, 2018. Salaries and benefits expense were $18,457,000 in the 2019 nine months compared to $11,638,000 in the 2018 six months, and collection costs were $4,589,000 compared to $2,218,000, primarily reflective of continued efforts with the medallion loan portfolio. The remaining expenses during the nine months ended September 30, 2019 included professional fees of $5,961,000, primarily reflecting legal costs for a variety of corporate and investment-related matters, race team costs of $7,211,000, loan servicing costs of $3,851,000, primarily reflecting the cost of servicing the recreation and home improvement consumer loans, and occupancy and other operating expenses of $11,169,000.
Total income tax benefit was $1,926,000 in the nine months ended September 30, 2019 compared to $4,138,000 in the six months ended September 30, 2018. The current nine months included benefits of $380,000 attributable to net operating loss revaluations, $916,000 related to changes in the effective income tax rate, and $600,000 due to changes in state income tax accruals recouped in connection with a settled state exam. See Note 9 for more information.
Loan collateral in process of foreclosure was $53,539,000 as of September 30, 2019, an increase of $4,044,000 from December 31, 2018, reflecting $25,884,000 of transfers from loans offset by sales, cash payments and valuation adjustments incurred during the nine months ended September 30, 2019. At September 30, 2018, the balance was $59,761,000.
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 first 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 first 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 the 2018 first quarter reflecting the continuing increase in market interest rates. Average debt outstanding was $324,322,000 for the 2018 first 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 first quarter.
Noninterest income, which is comprised of prepayment fees, servicing fee income, late charges, and other miscellaneous income, was $60,000 in the 2018 first quarter primarily reflecting the reversal of a previously earned management fee due from a portfolio company in the 2017 first quarter.
Operating expenses were $4,108,000 in the 2018 first quarter. Salaries and benefits expense was $2,349,000 in the 2018 first quarter primarily due to executive and employee bonus accrual. Professional fees were $723,000 in the 2018 first quarter primarily reflecting higher legal expenses for a variety of corporate and investment-related matters. Occupancy and other operating expenses of $1,036,000 in the 2018 first quarter primarily reflecting higher road or miscellaneous taxes, collection costs related to the medallion loan portfolio and directors’ fees.
Total income tax benefit was $640,000 in the 2018 first quarter, and was comprised of three components: a $336,000 benefit related to the net investment loss, a $8,426,000 benefit related to realized losses, and a provision of $8,122,000 related to net unrealized gains on investments.
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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 the 2018 first quarter, resulting in decreased depreciation of $2,205,000 and related almost entirely to the medallion portfolio. Unrealized appreciation (depreciation) arose when we made valuation adjustments to the investment portfolio. When investments were sold or written off, any resulting realized gain (loss) was grossed up to reflect previously recorded unrealized components. As a result, movement between periods can appear distorted. The 2018 first 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 first quarter. The 2018 first quarter 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.
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 bank certificates of deposit, credit facilities and borrowings from banks and other lenders, 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 and borrowings of $74,093,000 with a weighted average interest rate of 3.41%, constituting 6% of our total indebtedness, $36,000,000 of private placement notes, with a weighted average interest rate of 8.25%, constituting 3% of 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 September 30, 2019. Also, as of September 30, 2019, certain of the certificates of deposit were for terms of up to 60 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.
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The following table presents our interest rate sensitivity gap at September 30, 2019. 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.
September 30, 2019 Cumulative Rate Gap(1)
Less Than 1
Year
More Than
1 and Less
Than 2
Years
2 and Less
Than 3
3 and Less
Than 4
4 and Less
Than 5
5 and Less
Than 6
Earning assets
Floating-rate
33,405
Adjustable rate
17,490
7,975
15,410
14,480
452
1,158
57,723
Fixed-rate
53,902
52,094
38,857
62,970
67,468
56,317
774,836
1,106,444
Total earning assets
126,521
60,069
54,267
77,450
67,920
57,075
775,994
1,219,296
Interest bearing liabilities
14,000
18,500
12,168
22,294
428,404
247,006
117,413
136,232
Interest rate gap
(301,883
(186,937
(171,293
(39,963
(68,312
43,075
757,494
32,181
Cumulative interest rate gap(2)
(488,820
(660,113
(700,076
(768,388
(725,313
(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
The ratio of the cumulative one year gap to total interest rate sensitive assets was (25%) as of September 30, 2019.
Adjusted for the medallion loan 40% prepayment assumption results in a cumulative one year negative interest rate gap and related ratio of ($266,036) or (22%) as of September 30, 2019.
Represents the cumulative rate gap on a combined basis with Medallion Bank for the year noted.
Our interest rate sensitive assets were $1,219,296,000 and interest rate sensitive liabilities were $1,187,115,000 at September 30, 2019. The one-year cumulative interest rate gap was a negative $301,883,000 or 25% 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 $266,036,000 or 22% at September 30, 2019. 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.
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 Capital and Medallion Bank, although we have not received any from Medallion Bank since 2016, and are subject to compliance with regulatory ratios. Additionally, we had $3,000,000 of unfunded commitments from the SBA as of September 30, 2019.
Additionally, Medallion Bank has access to independent sources of funds for our business originated there, primarily through brokered certificates of deposit. Medallion Bank has up to $45,000,000 available under Fed Funds lines with several commercial banks as of September 30, 2019, of which $4,000,000 had been drawn upon at September 30, 2019 and repaid in October 2019.
In March 2019, we completed a private placement to certain institutional investors of $30,000,000 aggregate principal amount of 8.25% unsecured notes due 2024, with interest payable semiannually. A follow-on offering of these notes in the 2019 third quarter raised an additional $6,000,000.
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The components of our debt were as follows at September 30, 2019. See Note 7 to the consolidated financial statements for details of the contractual terms of our borrowings.
Total outstanding debt
Our contractual obligations expire on or mature at various dates through September 2037. The following table shows our contractual obligations at September 30, 2019.
Payments due by period
Less than
1 year
1 – 2 years
2 – 3 years
3 – 4 years
4 – 5 years
More than
5 years
Operating lease obligations
2,391
2,315
2,257
2,175
1,872
4,688
393,279
254,397
228,097
119,868
136,984
70,188
1,202,813
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.
On July 16, 2019, we paid $10,819,000 at maturity in satisfaction of all our outstanding obligations under one of our credit facilities. In connection with this payment, we obtained a waiver from one of our other lenders, with a term note of $3,096,000, of certain resulting repayment and other obligations, which waiver expires on December 1, 2019.
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 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 net income as of September 30, 2019 by $767,000 on an annualized basis, and the impact of such an immediate increase of 1% over an one year period would have been ($1,106,000) at September 30, 2019. 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.
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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.
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 September 30, 2019. See Note 7 to the consolidated financial statements for additional information about each credit facility.
Financial
MB
MFC
MCI
FSVC
RPAC and
December 31,
3,981
33,305
661
14,864
371
1,833
Brokered CDs & other funds
borrowed
Average interest rate
10/19-9/24
1/19-07/23
9.00
4/21-3/24
4/21
54,000
77,093
83,099
Amounts undisbursed
3,000
Amounts outstanding
51,000
3.49
3.25
3.40
3/21-3/29
2/1/2020
2/20-3/29
Bank loans
12,421
3.55
4.55
9/20-3/21
2/21/12/23
9/20-12/23
3/19-12/23
9/37
2.00
10/14/19
12/19-3/20
10/19-3/20
Total cash
Total debt outstanding
125,856
966,987
Includes $2,970 of an interest reserve associated with the 2019 private placement, which can be used for no other purpose for three years.
Federal funds had been paid off as of October 1, 2019.
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.
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 they relate to the fair value of assets and liabilities. 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 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.
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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. 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, with early adoption permitted. In October 2019, the FASB voted to defer implementation of the standard for smaller reporting companies, such as us, for fiscal years beginning after December 15, 2022. We are assessing the impact the update will have on its financial statements, and expect the update to have an impact on our accounting for estimated credit losses on our loans.
Dividends
We have not paid dividends on our common stock since 2016 and do not currently anticipate paying dividends. We may, however, re-evaluate paying dividends in the future depending on market conditions.
Control Statutes
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 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.
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There has been no material change in disclosure regarding quantitative and qualitative disclosures about market risk since we filed our Annual Report on Form 10-K for the year ended December 31, 2018.
Evaluation of Disclosure Controls and Procedures
Under the direction of our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures pursuant to Rules 13a—15(e) and 15d – 15(e) under the Securities Exchange Act of 1934, and have concluded that they are effective as of September 30, 2019 to provide reasonable assurance that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and (ii) accumulated and communicated to the Company’s management, including its Chief Executive Office and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.
Changes in Internal Controls
There were no changes in our internal controls over financial reporting during the quarter ended September 30, 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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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, 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.
There have been no material changes in our risk factors from those disclosed in Part 1, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018, which was filed with the Securities and Exchange Commission on March 13, 2019.
We did not repurchase any of our shares during the three months ended September 30, 2019. Accordingly, under our Stock Repurchase Program previously authorized by our Board of Directors, up to $22,874,509 of shares remain authorized for repurchase under the program.
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EXHIBITS
Number
Description
10.1
Ninth Amendment of Lease Agreement, dated August 19, 2019, between Investment Property Group, LLC and Medallion Bank. Filed as Exhibit 10.1 to the Current Report on Form 8-K filed on August 21, 2019 (File No. 001-37747) and incorporated by reference herein.
31.1
Certification of Alvin Murstein pursuant to Rule 13a-14(a) and 15d-14(a) as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002. Filed herewith.
31.2
Certification of Larry D. Hall pursuant to Rule 13a-14(a) and 15d-14(a) as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002. Filed herewith.
32.1
Certification of Alvin Murstein pursuant to 18 USC. Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Filed herewith.
32.2
Certification of Larry D. Hall pursuant to 18 USC. Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Filed herewith.
101.INS
XBRL Instance
101.SCH
XBRL Taxonomy Extension Schema
101.CAL
XBRL Taxonomy Extension Calculation
101.DEF
XBRL Taxonomy Extension Definition
101.LAB
XBRL Taxonomy Extension Labels
101.PRE
XBRL Taxonomy Extension Presentation
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date:
November 1, 2019
By:
/s/ Alvin Murstein
Alvin Murstein
Chairman and Chief Executive Officer
/s/ Larry D. Hall
Larry D. Hall
Senior Vice President and
Chief Financial Officer
Signing on behalf of the registrant as principal financial and accounting officer.
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