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EX-32.2 - CERTIFICATION OF LARRY D. HALL PURSUANT TO SECTION 906 - MEDALLION FINANCIAL CORPdex322.htm
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EX-32.1 - CERTIFICATION OF ALVIN MURSTEIN PURSUANT TO SECTION 906 - MEDALLION FINANCIAL CORPdex321.htm
EX-31.2 - CERTIFICATION OF LARRY D. HALL PURSUANT TO SECTION 302 - MEDALLION FINANCIAL CORPdex312.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the Quarterly Period Ended September 30, 2010

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 814-00188

 

 

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)

 

 

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  x    NO  ¨

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the Registrant was required to submit and post such files).    YES  ¨    NO  ¨

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

Large Accelerated Filer  ¨        Accelerated Filer  x        Non Accelerated Filer  ¨        Smaller Reporting Company  ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES  ¨    NO  x

The number of outstanding shares of registrant’s Common Stock, par value $0.01, as of November 2, 2010 was 17,398,033.

 

 

 


Table of Contents

 

MEDALLION FINANCIAL CORP.

FORM 10-Q

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION

    3   

ITEM 1.

 

FINANCIAL STATEMENTS

    3   

ITEM 2.

 

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

    27   

ITEM 3.

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

    45   

ITEM 4.

 

CONTROLS AND PROCEDURES

    45   

PART II – OTHER INFORMATION

    45   

ITEM 1.

 

LEGAL PROCEEDINGS

    45   

ITEM 1A.

 

RISK FACTORS

    45   

ITEM 6.

 

EXHIBITS

    54   

SIGNATURES

    55   

CERTIFICATIONS

    56   

 

Page 2 of 59


Table of Contents

 

PART I – FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

BASIS OF PREPARATION

We, Medallion Financial Corp. or the Company, are a closed-end, non-diversified management investment company organized as a Delaware corporation. We have elected to be treated as a business development company (BDC) under the Investment Company Act of 1940, as amended, or the 1940 Act. We are a specialty finance company that has a leading position in originating, acquiring, and servicing loans that finance taxicab medallions and various types of commercial businesses. A wholly-owned portfolio company of ours, Medallion Bank, also originates consumer loans for the purchase of recreational vehicles, boats, motorcycles, and trailers. Since 1996, the year in which we became a public company, we have increased our taxicab medallion loan portfolio at a compound annual growth rate of 7%, and our commercial loan portfolio at a compound annual growth rate of 3% (11% and 9% on a managed basis when combined with Medallion Bank). Since Medallion Bank acquired a consumer loan portfolio and began originating consumer loans in 2004, it has increased its consumer loan portfolio at a compound annual growth rate of 13%. Total assets under our management, which includes assets serviced for third party investors and managed by Medallion Bank, were $1,059,666,000 as of September 30, 2010, and $1,039,840,000 and $1,036,883,000 as of December 31, 2009 and September 30, 2009, and have grown at a compound annual growth rate of 12% from $215,000,000 at the end of 1996. Since our initial public offering in 1996, we have paid dividends in excess of $152,105,000 or $9.70 per share.

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

 

   

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 and a regulated investment company, or RIC, which conducts a mezzanine financing business; and

 

   

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

We also conduct business through our asset-based lending division, Medallion Business Credit, an originator of loans to small businesses for the purpose of financing inventory and receivables, which prior to December 31, 2007, was a wholly-owned investment company subsidiary. On December 31, 2007, Medallion Business Credit was merged into us and ceased to exist as a separate legal entity.

In addition, we conduct business through a wholly-owned portfolio company, Medallion Bank, a bank regulated by the FDIC and the Utah Department of Financial Institutions which originates taxicab medallion, commercial, and consumer loans, raises deposits, and conducts other banking activities. Medallion Bank generally provides us with our lowest cost of funds which it raises through bank certificates of deposit issued to its customers. To take advantage of this low cost of funds, we refer a portion of our taxicab medallion and commercial loans to Medallion Bank, which then originates these loans, which are then serviced by us. We earn referral and servicing fees for these activities. As a non-investment company, Medallion Bank is not consolidated with the Company, which is an investment company under the 1940 Act.

The financial information is divided into two sections. The first section, Item 1, includes our unaudited consolidated financial statements including related footnotes. The second section, Item 2, consists of Management’s Discussion and Analysis of Financial Condition and Results of Operations for the three and nine months ended September 30, 2010.

Our consolidated balance sheet as of September 30, 2010, and the related consolidated statements of operations, changes in net assets, and cash flows for the three and nine months ended September 30, 2010 and 2009 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 three and nine months ended September 30, 2010 and 2009, or for any other interim period, 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 fiscal year ended December 31, 2009.

 

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MEDALLION FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

 

 

     Three Months Ended September 30,     Nine Months Ended September 30,  

(Dollars in thousands, except per share data)

   2010     2009     2010     2009  

Interest income on investments

   $ 8,219      $ 8,865      $ 24,170      $ 27,545   

Dividends and interest income on short-term
investments (1)

     1,029        1,036        3,082        3,113   

Medallion lease income

     305        295        891        886   
                                

Total investment income

     9,553        10,196        28,143        31,544   
                                

Total interest expense (2)

     3,838        4,174        11,093        13,056   
                                

Net interest income

     5,715        6,022        17,050        18,488   
                                

Total noninterest income

     1,340        963        3,287        2,427   
                                

Salaries and benefits

     2,722        2,857        8,529        8,846   

Professional fees

     451        467        1,729        1,546   

Occupancy expense

     352        308        1,032        882   

Other operating expenses (3)

     1,162        1,352        1,509        3,615   
                                

Total operating expenses

     4,687        4,984        12,799        14,889   
                                

Net investment income before income taxes (1) (4)

     2,368        2,001        7,538        6,026   

Income tax (provision) benefit

     —          —          —          —     
                                

Net investment income after income taxes

     2,368        2,001        7,538        6,026   
                                

Net realized gains (losses) on investments

     (186     486        (9,076     (1,404
                                

Net change in unrealized appreciation (depreciation) on investments

     (689     (841     (2,877     1,208   

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

     1,975        1,243        11,026        951   
                                

Net unrealized appreciation on investments

     1,286        402        8,149        2,159   
                                

Net realized/unrealized gains (losses) on investments

     1,100        888        (927     755   
                                

Net increase in net assets resulting from operations

   $ 3,468      $ 2,889      $ 6,611      $ 6,781   
                                

Net increase in net assets resulting from operations per common share

        

Basic

   $ 0.20      $ 0.16      $ 0.38      $ 0.39   

Diluted

     0.20        0.16        0.37        0.38   
                                

Dividends declared per share

   $ 0.15      $ 0.19      $ 0.45      $ 0.57   
                                

Weighted average common shares outstanding

        

Basic

     17,472,385        17,575,877        17,535,826        17,567,602   

Diluted

     17,579,269        17,708,892        17,659,628        17,683,571   

 

(1) Includes $1,000 and $3,000 of dividend income for the three and nine months ended September 30, 2010 and 2009 from Medallion Bank.
(2) Average borrowings outstanding were $371,412 and $366,346, and the related average borrowing costs were 4.10% and 4.05% for the 2010 third quarter and nine months, and were $399,175, $430,699, 4.15%, and 4.05% for the comparable 2009 periods.
(3) Includes $1,312 of expense reversals related to the costs of winding up the operations of the SPAC’s in the 2010 nine months that were reclassified to realized losses on investments, and $310 that was reversed as a result of favorable negotiations with the creditors of SPAC. See Notes 7 and 10 for additional information.
(4) Includes $1,181 and $2,965 of net revenues received from Medallion Bank for the three and nine months ended September 30, 2010, and $821 and $2,042 for the comparable 2009 periods, primarily for servicing fees, loan origination fees, and expense reimbursements. See Notes 3 and 10 for additional information.

 

The accompanying notes should be read in conjunction with these consolidated financial statements.

 

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MEDALLION FINANCIAL CORP.

CONSOLIDATED BALANCE SHEETS

 

 

(Dollars in thousands, except per share data)

   UNAUDITED
September 30, 2010
    December 31, 2009  

Assets

    

Medallion loans, at fair value

   $ 327,425      $ 321,915   

Commercial loans, at fair value (1)

     65,158        77,922   

Investment in Medallion Bank and other controlled subsidiaries, at fair value

     75,759        72,279   

Equity investments, at fair value

     3,588        3,017   

Investment securities, at fair value

     —          —     
                

Net investments ($264,921 at September 30, 2010 and $261,332 at December 31, 2009 pledged as collateral under borrowing arrangements)

     471,930        475,133   

Cash and cash equivalents ($0 at September 30, 2010 and December 31, 2009 restricted as to use by lender)

     21,525        33,401   

Accrued interest receivable

     1,613        1,661   

Fixed assets, net

     408        302   

Goodwill, net

     5,069        5,069   

Other assets, net

     41,060        39,608   
                

Total assets

   $ 541,605      $ 555,174   
                

Liabilities

    

Accounts payable and accrued expenses (2)

   $ 6,461      $ 7,468   

Accrued interest payable

     821        2,207   

Funds borrowed

     373,679        382,522   
                

Total liabilities

     380,961        392,197   
                

Commitments and contingencies

     —          —     

Shareholders’ equity (net assets)

    

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 – 18,990,119 shares at September 30, 2010 and December 31, 2009 issued)

     190        190   

Treasury stock at cost (1,592,086 shares at September 30, 2010 and 1,414,242 at December 31, 2009)

     (14,225     (13,012

Capital in excess of par value

     179,015        178,845   

Accumulated undistributed net investment loss

     (15,043     (9,665

Accumulated undistributed net realized gains on investments

     —          —     

Net unrealized appreciation on investments

     10,707        6,619   
                

Total shareholders’ equity (net assets)

     160,644        162,977   
                

Total liabilities and shareholders’ equity

   $ 541,605      $ 555,174   
                

Number of common shares outstanding

     17,398,033        17,575,877   

Net asset value per share

   $ 9.23      $ 9.27   

 

(1) Includes a $3,100 loan to an entity which is majority owned by one of our controlled subsidiaries.
(2) Includes $1,622 of costs related to the winding up of operations of the SPAC’s as of December 31, 2009. See Notes 7 and 10 for additional information.

 

The accompanying notes should be read in conjunction with these consolidated financial statements.

 

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MEDALLION FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS

(UNAUDITED)

 

 

     Three Months Ended September 30,     Nine Months Ended September 30,  

(Dollars in thousands, except per share data)

   2010     2009     2010     2009  

Net investment income after income taxes

   $ 2,368      $ 2,001      $ 7,538      $ 6,026   

Net realized gains (losses) on investments

     (186     486        (9,076     (1,404

Net unrealized appreciation on investments

     1,286        402        8,149        2,159   
                                

Net increase in net assets resulting from operations

     3,468        2,889        6,611        6,781   
                                

Investment income, net

     (2,628     (3,340     (7,901     (10,016

Realized gains from investment transactions, net

     —          —          —          —     
                                

Dividends and distributions to shareholders (1)

     (2,628     (3,340     (7,901     (10,016
                                

Stock options

     56        57        170        309   

Treasury stock acquired

     (842     —          (1,213     —     
                                

Capital share transactions

     (786     57        (1,043     309   
                                

Total increase (decrease) in net assets

     54        (394     (2,333     (2,926

Net assets at the beginning of the period

     160,590        172,414        162,977        174,946   
                                

Net assets at the end of the period (2)

   $ 160,644      $ 172,020      $ 160,644      $ 172,020   
                                

Capital share activity

        

Common stock issued, beginning of period

     18,990,119        18,990,119        18,990,119        18,963,466   

Exercise of stock options

     —          —          —          26,653   
                                

Common stock issued, end of period

     18,990,119        18,990,119        18,990,119        18,990,119   
                                

Treasury stock, beginning of period

     (1,466,966     (1,414,242     (1,414,242     (1,414,242

Treasury stock acquired

     (125,120     —          (177,844     —     
                                

Treasury stock, end of period

     (1,592,086     (1,414,242     (1,592,086     (1,414,242
                                

Common stock outstanding

     17,398,033        17,575,877        17,398,033        17,575,877   

 

(1) Dividends declared were $0.15 and $0.45 per share for 2010 third quarter and nine months, and were $0.19 and $0.57 for the comparable 2009 periods.
(2) Includes $2,347 of undistributed net investment income and $0 of undistributed net realized gains on investments at September 30, 2010.

 

The accompanying notes should be read in conjunction with these consolidated financial statements.

 

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MEDALLION FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

 

     Nine Months Ended September 30,  

(Dollars in thousands)

               2010                              2009               

CASH FLOWS FROM OPERATING ACTIVITIES

    

Net increase in net assets resulting from operations

   $ 6,611      $ 6,781   

Adjustments to reconcile net increase in net assets resulting from operations to net cash provided by operating activities:

    

Depreciation and amortization

     1,082        1,359   

Amortization (accretion) of origination costs

     (249     8   

Increase in net unrealized (appreciation) depreciation on investments

     2,877        (1,208

Increase in unrealized appreciation on Medallion Bank and other controlled subsidiaries

     (11,026     (951

Net realized losses on investments

     9,076        1,404   

Stock-based compensation expense

     170        179   

Decrease in accrued interest receivable

     47        325   

Increase in other assets, net

     (1,206     (825

Increase (decrease) in accounts payable and accrued expenses

     (1,006     267   

Decrease in accrued interest payable

     (1,385     (1,165
                

Net cash provided by operating activities

     4,991        6,174   
                

CASH FLOWS FROM INVESTING ACTIVITIES

    

Investments originated

     (138,852     (130,167

Proceeds from principal receipts, sales, and maturities of investments

     140,906        196,709   

Investments in Medallion Bank and other controlled subsidiaries, net

     (711     (1,843

Capital expenditures

     (252     (105
                

Net cash provided by investing activities

     1,091        64,594   
                

CASH FLOWS FROM FINANCING ACTIVITIES

    

Proceeds from funds borrowed

     114,550        239,741   

Repayments of funds borrowed

     (123,394     (303,111

Proceeds from exercise of stock options

     —          130   

Purchase of treasury stock at cost

     (1,213     —     

Payments of declared dividends

     (7,901     (10,016
                

Net cash used for financing activities

     (17,958     (73,256
                

NET DECREASE IN CASH AND CASH EQUIVALENTS

     (11,876     (2,488

Cash and cash equivalents, beginning of period

     33,401        32,075   
                

Cash and cash equivalents, end of period

   $ 21,525      $ 29,587   
                

SUPPLEMENTAL INFORMATION

    

Cash paid during the period for interest

   $ 11,542      $ 13,061   

Cash paid during the period for income taxes

     —          —     

Non-cash investing activities – net transfer to (from) other assets

     —          480   

 

The accompanying notes should be read in conjunction with these consolidated financial statements.

 

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MEDALLION FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2010

(1) ORGANIZATION OF MEDALLION FINANCIAL CORP. AND ITS SUBSIDIARIES

We, Medallion Financial Corp. (the Company), are a closed-end management investment company organized as a Delaware corporation. The Company has elected to be regulated as a business development company (BDC) under the Investment Company Act of 1940, as amended (the 1940 Act). The Company conducts its business through various wholly-owned subsidiaries including its primary operating company, Medallion Funding LLC (MFC), a Small Business Investment Company (SBIC) which originates and services taxicab medallion and commercial loans.

On March 26, 2009, the Company formed a new wholly-owned New York limited liability company subsidiary, Medallion Funding LLC. On February 26, 2010, Medallion Funding Corp. merged into Medallion Funding LLC and following the merger, Medallion Funding LLC was the surviving entity and the successor-in-interest to Medallion Funding Corp.’s business. There is no business or operational change resulting from this corporate restructuring. For federal and state tax purposes, Medallion Funding LLC will be treated as a disregarded entity. Medallion Funding LLC will not independently file any tax return, but will be subsumed in the tax return of the Company. Medallion Funding LLC will maintain its status as an SBIC.

The Company also conducts business through Medallion Capital, Inc. (MCI), an SBIC which conducts a mezzanine financing business, and Freshstart Venture Capital Corp. (FSVC), an SBIC which originates 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 also conducts business through our asset-based lending division, Medallion Business Credit (MBC), an originator of loans to small businesses for the purpose of financing inventory and receivables.

In December 2008, MFC established a wholly-owned subsidiary, Taxi Medallion Loan Trust III (Trust III), for the purpose of owning medallion loans originated by MFC or others. Trust III is a separate legal and corporate entity with its own creditors who, 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, aggregating $212,303,000 at September 30, 2010, 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.

In June 2007, 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 $36,167,000 at September 30, 2010, 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.

In December 2006, MFC established a wholly-owned subsidiary, Taxi Medallion Loan Trust II (Trust II), for the purpose of owning medallion loans originated by MFC or others. Trust II was a separate legal and corporate entity with its own creditors who, in any liquidation of Trust II, would have been entitled to be satisfied out of Trust II’s assets prior to any value in Trust II becoming available to Trust II’s equity holders. In 2010, Trust II ceased operations and its assets were reduced to $0.

In December 2006, September 2006, and previously in June 2003, MFC through several wholly-owned and newly formed subsidiaries which, along with an existing subsidiary (together, Medallion Chicago), purchased certain City of Chicago taxicab medallions out of foreclosure which are leased to fleet operators while being held for sale.

A wholly-owned portfolio investment, Medallion Bank, a Federal Deposit Insurance Corporation (FDIC) insured industrial bank, originates medallion loans, commercial loans, and consumer loans, raises deposits, and conducts other banking activities (see Note 3). Medallion 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.

Medallion Bank is not an investment company, and therefore, is not consolidated with the Company, but instead is treated as a portfolio investment. It was initially formed for the primary purpose of originating commercial loans in three categories: 1) loans to finance the purchase of taxicab medallions (licenses), 2) asset-based commercial loans, and 3) SBA 7(a) loans. The loans are marketed and serviced by Medallion Bank’s affiliates who have extensive prior experience in these asset groups. Additionally, Medallion Bank began issuing brokered certificates of deposit in January 2004, and purchased over $84,150,000 of taxicab medallion and asset-based loans from affiliates of the Company. On April 1, 2004, Medallion Bank purchased a consumer loan portfolio from an unrelated financial institution for consideration of $86,309,000. In the 2004 third quarter, Medallion Bank began originating consumer loans similar to the acquired portfolio, which are serviced by a third party.

 

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MEDALLION FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

SEPTEMBER 30, 2010

 

 

In September 2002, MFC established a wholly-owned subsidiary, Taxi Medallion Loan Trust I (Trust), for the purpose of owning medallion loans originated by MFC or others. The Trust was a separate legal and corporate entity with its own creditors who, in any liquidation of the Trust, would have been entitled to be satisfied out of the Trust’s assets prior to any value in the Trust becoming available to the Trust’s equity holders. In 2009, the Trust ceased operations and its assets were reduced to $0.

(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the US 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 persist longer or deteriorate further than expected, it is reasonably possible that the judgments and estimates could change, which may result in future impairments of loans receivable, loans held for sale, investments, among other effects.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, except for Medallion Bank and other portfolio investments. All significant intercompany transactions, balances, and profits have been eliminated in consolidation. As a non-investment company, Medallion Bank is not consolidated with the Company, which is an investment company under the 1940 Act. See Note 3 for the presentation of financial information for Medallion Bank and other controlled subsidiaries.

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 frequently exceed the federally insured limits.

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 entities 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 2, 11, and 12 to the consolidated financial statements.

Investment Valuation

The Company’s loans, net of participations and any unearned discount, are considered investment securities under the 1940 Act and are recorded at fair value. As part of the fair value methodology, loans are valued at cost adjusted for any unrealized appreciation (depreciation). Since no ready market exists for these loans, the fair value is determined in good faith by management, and approved by the Board of Directors. In determining the fair value, the Company and Board of Directors consider factors such as the financial condition of the borrower, the adequacy of the collateral, individual credit risks, historical loss experience, and the relationships between current and projected market rates and portfolio rates of interest and maturities. Foreclosed properties, which represent collateral received from defaulted borrowers, and which are carried in other assets on the consolidated balance sheet, are valued similarly.

Equity investments (common stock and stock warrants, including certain controlled subsidiary portfolio investments) and investment securities (US Treasuries and mortgage backed bonds), in total representing 17% and 16% of the investment portfolio at September 30, 2010 and December 31, 2009, are recorded at fair value, represented as cost, plus or minus unrealized appreciation or depreciation. The fair value of investments that have no ready market are determined in good faith by management, and approved 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. Included in equity investments were marketable securities of $1,663,000 and $1,212,000 at September 30, 2010 and December 31, 2009, and non-marketable securities of $1,925,000 and $1,805,000 in the comparable periods. The $75,759,000 and $72,279,000 related to portfolio investments in controlled subsidiaries at September 30, 2010 and December 31, 2009 were all non-marketable in each period. Because of the inherent uncertainty of valuations, management’s estimates of the values of the investments may differ significantly from the values that would have been used had a ready market for the investments existed, and the differences could be material.

 

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MEDALLION FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

SEPTEMBER 30, 2010

 

 

Our investment in Medallion Bank, as a wholly owned portfolio investment, is also subject to quarterly assessments of fair value. We conduct a thorough valuation analysis as described previously, and determine whether any factors give rise to a valuation different than recorded book value, including various regulatory restrictions that were established at Medallion Bank’s inception, by the FDIC and State of Utah, and also by additional marketplace restrictions, such as on the ability to transfer industrial bank charters. As a result of this valuation process, we used Medallion Bank’s actual results of operations as the best estimate of changes in fair value, and recorded the results as a component of unrealized appreciation (depreciation) on investments, although changes in these restrictions and other applicable factors could change these conclusions in the future. See Note 3 for additional information about Medallion Bank.

A majority of the Company’s investments consist of long-term loans to persons defined by SBA regulations as socially or economically disadvantaged, or to entities that are at least 50% owned by such persons. Approximately 69% and 68% of the Company’s investment portfolio at September 30, 2010 and December 31, 2009 had arisen in connection with the financing of taxicab medallions, taxicabs, and related assets, of which 76% were in New York City at September 30, 2010 and December 31, 2009. These loans are secured by the medallions, taxicabs, and related assets, and are personally guaranteed by the borrowers, or in the case of corporations, are generally guaranteed personally by the owners. A portion of the Company’s portfolio (14% and 16% at September 30, 2010 and December 31, 2009) represents loans to various commercial enterprises, in a wide variety of industries, including manufacturing, wholesaling, administrative and support services, accommodation and food services, and various other industries. Approximately 21% of these loans are made primarily in the metropolitan New York City area, with the balance widely scattered across the United States. Investments in controlled unconsolidated subsidiaries, equity investments, and investment securities were 16%, 1%, and 0% at September 30, 2010, and were 15%, 1%, and 0% at December 31, 2009.

On a managed basis, which includes the investments of Medallion Bank after eliminating the Company’s investment in Medallion Bank, medallion loans were 63% and 57% at September 30, 2010 and December 31, 2009 (77% and 75% in New York City), commercial loans were 14% and 18%, and consumer loans in all 50 states collateralized by recreational vehicles, boats, motorcycles, and trailers were 20% and 22%. Investment securities were 2% at September 30, 2010 and December 31, 2009, and equity investments (including investments in controlled subsidiaries) were 1%.

Investment Transactions and Income Recognition

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, 2010 and December 31, 2009, net loan origination fees were $290,000 and $41,000. Net amortization income (expense) the three months ended September 30, 2010 and 2009 was $113,000 and $0, and was $249,000 and $8,000 for the comparable nine month periods.

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 as an adjustment to the yield of the related investment. At September 30, 2010 and December 31, 2009, there were no premiums or discounts on investment securities, and their related income accretion or amortization was immaterial for 2010 and 2009.

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. At September 30, 2010, December 31, 2009, and September 30, 2009, total nonaccrual loans were $22,138,000, $19,784,000, and $22,046,000, and represented 6%, 5%, and 5% of the gross medallion and commercial loan portfolio at each period end, and were primarily concentrated in the secured mezzanine portfolio. The amount of interest income on nonaccrual loans that would have been recognized if the loans had been paying in accordance with their original terms was $9,607,000, $7,114,000, and $6,565,000 as of September 30, 2010, December 31, 2009, and September 30, 2009, of which $1,129,000 and $1,185,000 would have been recognized in the quarters ended September 30, 2010 and 2009, and $2,497,000 and $2,638,000 would have been recognized in the comparable nine-month periods.

Loan Sales and Servicing Fee Receivable

The Company accounts for its sales of loans in accordance with FASB Accounting Standards Codification Topic 860, Transfers and Servicing (FASB ASC 860). FASB ASC 860 provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. In accordance with FASB ASC 860, we have elected the fair value measurement method for our servicing assets and liabilities. The principal portion of loans serviced for others by the Company was $356,123,000 and $321,875,000 at September 30, 2010 and December 31, 2009, and included $312,097,000 and $229,810,000 of loans serviced for Medallion Bank. The Company has evaluated the servicing aspect of its business in accordance with FASB ASC 860, most of which relates to servicing assets held by Medallion Bank, and determined that no material servicing asset or liability exists as of September 30, 2010 and December 31, 2009.

Unrealized Appreciation (Depreciation) and Realized Gains (Losses) on Investments

Unrealized appreciation (depreciation) on investments is 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. Unrealized appreciation (depreciation) on net investments was $10,707,000, $6,619,000, and $12,144,000 as of September 30, 2010, December 31, 2009, and September 30, 2009. Our investment in Medallion Bank, a wholly owned portfolio investment, is also

 

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MEDALLION FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

SEPTEMBER 30, 2010

 

subject to quarterly assessments of fair value. We conduct a thorough valuation analysis as described previously, and determine whether any factors give rise to valuation different than recorded book value, including various regulatory restrictions that were established at Medallion Bank’s inception, by the FDIC and State of Utah, and also by additional marketplace restrictions, such as on the ability to transfer industrial bank charters. As a result of this valuation process, we used Medallion Bank’s actual results of operations as the best estimate of changes in fair value, and recorded the results as a component of unrealized appreciation (depreciation) on investments, although changes in these restrictions and other applicable factors could change these conclusions in the future. See Note 3 for the presentation of financial information for Medallion Bank.

The following tables set forth the changes in our unrealized appreciation (depreciation) on investments, other than investments in controlled subsidiaries, for the 2010 and 2009 periods shown below.

 

 

(Dollars in thousands)

   Loans     Equity
Investments
    Foreclosed
Properties
    Total  

Balance December 31, 2009

   ($ 4,236   ($ 8,101   $ 18,956      $ 6,619   

Net change in unrealized

        

Appreciation on investments

     —          162        1,516        1,678   

Depreciation on investments

     (3,678     (510     —          (4,188

Reversal of unrealized appreciation (depreciation) related to realized

        

Gains on investments

     —          —          —          —     

Losses on investments (1)

     —          8,232        —          8,232   
                                

Balance March 31, 2010

     (7,914     (217     20,472        12,341   

Net change in unrealized

        

Appreciation on investments

     —          159        (274     (115

Depreciation on investments

     (853     24        —          (829

Reversal of unrealized appreciation (depreciation) related to realized

        

Gains on investments

     —          —          —          —     

Losses on investments

     —          —          —          —     
                                

Balance June 30, 2010

     (8,767     (34     20,198        11,397   

Net change in unrealized

        

Appreciation on investments

     —          212        (40     172   

Depreciation on investments

     (1,069     16        —          (1,053

Reversal of unrealized appreciation (depreciation) related to realized

        

Gains on investments

     —          —          —          —     

Losses on investments

     191        —          —          191   
                                

Balance September 30, 2010

   ($ 9,645   $ 194      $ 20,158      $ 10,707   

 

(1) Represents the writeoffs of $7,725 related to the investments in SPAC and SPAC 2. See Note 10 for additional information on these investments.

 

 

 

(Dollars in thousands)

   Loans     Equity
Investments
    Foreclosed
Properties
    Total  

Balance December 31, 2008

   ($ 5,115   $ 437      $ 15,614      $ 10,936   

Net change in unrealized

        

Appreciation on investments

     —          (656     1,837        1,181   

Depreciation on investments

     (621     (63     —          (684

Reversal of unrealized appreciation (depreciation) related to realized

        

Gains on investments

     —          —          —          —     

Losses on investments

     370        —          —          370   
                                

Balance March 31, 2009

     (5,366     (282     17,451        11,803   

Net change in unrealized

        

Appreciation on investments

     —          101        815        916   

Depreciation on investments

     (366     (447     (481     (1,294

Reversal of unrealized appreciation (depreciation) related to realized

        

Gains on investments

     —          —          (440     (440

Losses on investments

     2,000        —          —          2,000   

Reclassification of unrealized depreciation

     400        —          (400     —     
                                

Balance June 30, 2009

     (3,332     (628     16,945        12,985   

Net change in unrealized

        

Appreciation on investments

     —          360        —          360   

Depreciation on investments

     (751     23        (36     (764

Reversal of unrealized appreciation (depreciation) related to realized

        

Gains on investments

     —          —          (460     (460

Losses on investments

     23        —          —          23   
                                

Balance September 30, 2009

   ($ 4,060   ($ 245   $ 16,449      $ 12,144   

 

 

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MEDALLION FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

SEPTEMBER 30, 2010

 

 

The table below summarizes components of unrealized and realized gains and losses in the investment portfolio for the three and nine months ended September 30, 2010 and 2009.

 

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 

(Dollars in thousands)

   2010     2009     2010     2009  

Net change in unrealized appreciation (depreciation) on investments

        

Unrealized appreciation

   $ 213      $ 360      $ 534      ($ 195

Unrealized depreciation

     (1,053     (728     (5,563     (2,225

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

     1,975        1,243        11,026        951   

Realized gains

     —          —          —          —     

Realized losses (2)

     191        23        950        2,392   

Unrealized gains (losses) on foreclosed properties

     (40     (496     1,202        1,236   
                                

Total

   $ 1,286      $ 402      $ 8,149      $ 2,159   
                                

Net realized gains (losses) on investments

        

Realized gains

   $ —        $ —        $ —        $ —     

Realized losses (3)

     (191     (23     (8,423     (2,392

Other gains

     —          —          141        —     

Direct recoveries (charge offs) (4)

     5        49        (794     71   

Realized gains on foreclosed properties

     —          460        —          917   
                                

Total

   ($ 186   $ 486      ($ 9,076   ($ 1,404

 

(1) Includes $6,966 of net unrealized depreciation related to the investment in SPAC, including $508 that was recorded during the 2010 first quarter, that was reversed during the 2010 first quarter upon the writeoff of the SPAC investment.
(2) Includes $759 related to the writeoff of the investment in SPAC 2 in the 2010 first quarter.
(3) Represents the writeoffs related to the investments in SPAC and SPAC 2 in the 2010 first quarter. See Note 10 for additional information on these investments.
(4) Includes $817 of direct chargeoffs related to the settlement of liabilities associated with the writeoff of SPAC and SPAC 2 in the 2010 nine months, all of which represented a reversal of accrued expenses.

 

Goodwill

In accordance with ASC Topic 350, “Intangibles – Goodwill and Other,” the Company tests its goodwill for impairment, and engages a consultant to help management evaluate its carrying value. The results of this evaluation demonstrated no impairment in goodwill for any period evaluated, and management believes, and the Board of Directors concurs, that there is no impairment as of September 30, 2010. The Company conducts annual, and if necessary, more frequent, appraisals of its goodwill, and will recognize any impairment in the period any impairment is identified as a charge to operating expenses.

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 $48,000 and $59,000 for the three months ended September 30, 2010 and 2009, and was $146,000 and $200,000 for the comparable nine months.

Deferred Costs

Deferred financing costs, included in other assets, represents costs associated with obtaining the Company’s borrowing facilities, and is amortized on a straight line basis over the lives of the related financing agreements. Amortization expense was $308,000 and $335,000 for the three months ended September 30, 2010 and 2009, and was $794,000 and $988,000 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 will be amortized against income over an appropriate period, or written off. The amounts on the balance sheet for all of these purposes were $3,339,000, $3,975,000, and $5,029,000 as of September 30, 2010, December 31, 2009, and September 30, 2009.

Federal Income Taxes

The Company and each of its major subsidiaries other than Medallion Bank and Medallion Funding LLC (the RIC subsidiaries) have qualified to be treated for federal income tax purposes as regulated investment companies (RICs) under the Internal Revenue Code of 1986, as amended (the Code). As RICs, the Company and each of the RIC subsidiaries are not subject to US federal income tax on any gains or investment company taxable income (which includes, among other things, dividends and interest income reduced by deductible expenses) that it distributes to its shareholders, if at least 90% of its investment company taxable income for that taxable year is distributed. It is the Company’s and the RIC subsidiaries’ policy to comply with the

 

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MEDALLION FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

SEPTEMBER 30, 2010

 

provisions of the Code. The Company’s RIC qualification is determined on an annual basis, and it qualified and filed its federal tax returns as a RIC for 2009 and 2008, and anticipates qualifying and filing as a RIC for 2010. As a result, no provisions for income taxes have been recorded for the three and nine months ended September 30, 2010 and 2009. State and local tax treatment follows the federal model.

In the fourth quarter of 2010, based on developments under the Code and after discussions with external advisers, the Company’s Board of Directors determined that the loans received in connection with the Company’s lending activities were “accounts or notes receivables acquired in the ordinary course of a trade or business for services” for purposes of Section 1221(a)(4) of the Code. As a result, commencing with the tax year beginning January 1, 2010, the Company intends to treat losses recognized on worthless loans as ordinary losses rather than as capital losses. The Company’s Board of Directors further determined that the Company may take such position in tax returns subsequently filed without obtaining prior IRS approval.

The change in the characterization of a loss resulting from a worthless loan from a capital loss to an ordinary loss could materially impact the amount or character of the dividends received by the Company’s shareholders. The Company is required to distribute 90% of its taxable income in order to maintain its RIC status. In the event losses from worthless loans are treated as ordinary losses, those losses will offset taxable income in the taxable year in which such losses are recognized. This could result in a decrease in the Company’s taxable income which could result in a decrease in the Company’s dividend. Alternatively, if the Company chooses to maintain its current level of dividend, an increased portion of the dividend could be deemed to be a return of capital to the shareholder.

Medallion Bank is not a RIC and is taxed as a regular corporation. Fin Trust, Medallion Funding LLC, Trust II, and Trust III are not subject to federal income taxation, instead their taxable income is treated as having been earned by the Company.

Net Increase in Net Assets Resulting from Operations per Share (EPS)

Basic earnings per share are computed by dividing net increase in net assets resulting from operations available to common shareholders 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, and has been computed after giving consideration to the weighted average dilutive effect of the Company’s stock options. 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 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,  

(Dollars in thousands)

   2010      2009      2010      2009  

Net increase in net assets resulting from operations available to common shareholders

   $ 3,468       $ 2,889       $ 6,611       $ 6,781   
                                   

Weighted average common shares outstanding applicable to basic EPS

     17,472,385         17,575,877         17,535,826         17,567,602   

Effect of dilutive stock options

     106,884         133,015         123,802         115,969   
                                   

Adjusted weighted average common shares outstanding applicable to diluted EPS

     17,579,269         17,708,892         17,659,628         17,683,571   
                                   

Basic earnings per share

   $ 0.20       $ 0.16       $ 0.38       $ 0.39   

Diluted earnings per share

     0.20         0.16         0.37         0.38   

 

Potentially dilutive common shares excluded from the above calculations aggregated 1,153,020 and 1,145,202 shares as of September 30, 2010 and 2009.

Stock Compensation

The Company follows FASB Accounting Standard Codification Topic 718 (ASC 718), “Compensation – Stock Compensation”, for its stock option plans, and accordingly, the Company recognizes the expense of these grants as required. Stock-based employee compensation costs pertaining to stock options is reflected in net increase in net assets resulting from operations, for both any new grants, as well as for all unvested options outstanding at December 31, 2005, in both cases using the fair values established by usage of the Black-Scholes option pricing model, expensed over the vesting period of the underlying option.

The Company elected the modified prospective transition method in applying ASC 718. Under this method, the provisions of ASC 718 apply to all awards granted or modified after the date of adoption, as well as for all unvested options outstanding at December 31, 2005. During the three and nine months ended September 30, 2010, the Company issued no shares and 68,500 shares of stock-based compensation awards, and recognized $56,000 and $170,000, or $0.00 and $0.01 per diluted common share for the respective periods, of non-cash stock-based compensation expense related to the option grants. During the three and nine months ended September 30, 2009, the Company issued no shares and 68,667 shares of stock-based compensation awards, and recognized $57,000 and $179,000 or $0.00 and $0.01 per diluted common share for the respective periods, of non-cash stock-based compensation expense related to the option grants. As of September 30, 2010, the total remaining unrecognized compensation cost related to unvested stock options was $161,000, which is expected to be recognized over the next eleven quarters (see Note 5).

Derivatives

The Company manages its exposure to increases in market rates of interest by periodically purchasing interest rate caps to lock in the cost of funds of its variable-rate debt in the event of a rapid run up in interest rates. During 2010 and 2009, the Company entered into contracts to purchase interest rate caps on $125,000,000 and $252,000,000, respectively, of notional value of principal from various multinational banks, of which $195,000,000 are active with termination dates ranging to June 2012. The caps provide for payments to the Company if various LIBOR thresholds are exceeded during the cap terms. The 2010 cap purchases of $142,000 were fully expensed in the 2010 third quarter, and the 2009 cap purchases were fully expensed in 2009, including $133,000 and $171,000 in the 2009 third quarter and nine months, and all are carried at $0 on the balance sheet at September 30, 2010.

Reclassifications

Certain reclassifications have been made to prior year balances to conform with the current quarter’s presentation. These reclassifications have no effect on the previously reported results of operations.

 

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MEDALLION FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

SEPTEMBER 30, 2010

 

 

(3) INVESTMENT IN MEDALLION BANK AND OTHER CONTROLLED SUBSIDIARIES

The following table presents information derived from Medallion Bank’s statements of operations and other valuation adjustments on other controlled subsidiaries for the three and nine months ended September 30, 2010 and 2009.

 

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 

(Dollars in thousands)

   2010     2009     2010     2009  

Statement of operations

        

Investment income

   $ 12,257      $ 11,376      $ 35,008      $ 33,283   

Interest expense

     1,874        2,533        5,624        8,908   
                                

Net interest income

     10,383        8,843        29,384        24,375   

Noninterest income

     87        96        404        313   

Operating expenses

     2,886        2,576        7,965        7,427   
                                

Net investment income before income taxes

     7,584        6,363        21,823        17,261   

Income tax provision

     (1,973     (1,417     (4,830     (2,749
                                

Net investment income after income taxes

     5,611        4,946        16,993        14,512   

Net realized/unrealized losses of Medallion Bank

     (2,399     (2,464     (8,595     (9,353
                                

Net increase in net assets resulting from operations of Medallion Bank

     3,212        2,482        8,398        5,159   

Unrealized depreciation on Medallion Bank (1)

     (1,299     (1,161     (3,930     (3,461

Net unrealized gains (losses) of controlled subsidiaries other than Medallion Bank

     62        (78     6,558        (747
                                

Net increase (decrease) in net assets resulting from operations of Medallion Bank and other controlled subsidiaries

   $ 1,975      $ 1,243      $ 11,026        $951   

 

(1) Unrealized depreciation on Medallion Bank reflects the adjustment to the investment carrying amount to reflect the dividends declared to the Company and the US Treasury.

 

The following table presents Medallion Bank’s balance sheets and the net investment in other controlled subsidiaries as of September 30, 2010 and December 31, 2009.

 

(Dollars in thousands)

   2010      2009  

Loans

   $ 500,799       $ 418,853   

Investment securities, at fair value

     21,798         21,060   
                 

Net investments ($0 pledged as collateral under borrowing arrangements at September 30, 2010 and December 31, 2009) (1)

     522,597         439,913   

Cash ($0 at September 30, 2010 and December 31, 2009 restricted as to use by lender)

     16,142         13,340   

Other assets, net

     10,518         11,935   

Due from affiliates

     3         —     
                 

Total assets

   $ 549,260       $ 465,188   
                 

Other liabilities

   $ 2,059       $ 2,462   

Due to affiliates

     —           630   

Deposits, including accrued interest payable

     453,866         373,228   
                 

Total liabilities

     455,925         376,320   

Medallion Bank equity (2)

     93,335         88,868   
                 

Total liabilities and equity

   $ 549,260       $ 465,188   
                 

Investment in other controlled subsidiaries

   $ 3,925       $ 4,280   

Total investment in Medallion Bank and other controlled subsidiaries

   $ 75,759       $ 72,279   

 

(1) Included in Medallion Bank’s net investments is $376 and $528 for purchased loan premium at September 30, 2010 and December 31, 2009.
(2) Includes $21,498 of preferred stock issued to the US Treasury under the Troubled Asset Relief Program (TARP).

 

The following paragraphs summarize the accounting and reporting policies of Medallion Bank, and provide additional information relating to the tables presented above.

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. At September 30, 2010 and December 31, 2009, the net premium on investment securities totaled $180,000 and $185,000, and $14,000 and $51,000 was amortized into interest income for the 2010 third quarter and nine months, and $22,000 and $51,000 were amortized in the comparable 2009 periods.

Medallion Bank’s policies regarding nonaccrual of medallion and commercial loans are similar to those of the Company. The consumer portfolio has different characteristics compared to commercial loans, typified by a larger number of lower dollar loans that have similar characteristics. 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

 

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MEDALLION FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

SEPTEMBER 30, 2010

 

occurs first, at which time appropriate collection and recovery efforts against both the borrower and the underlying collateral are initiated. At September 30, 2010, $2,873,000 or 1% of consumer loans, $385,000 or 1% of commercial loans, and no medallion loans were on nonaccrual, compared to $3,321,000 or 2% of consumer loans, $1,124,000 or 2% of commercial loans, and no medallion loans on nonaccrual at December 31, 2009, and $3,154,000 or 2% of consumer loans, $1,621,000 or 2% of commercial loans, and $148,000 or less than 1% of medallion loans on nonaccrual at September 30, 2009. The amount of interest income on nonaccrual loans that would have been recognized if the loans had been paying in accordance with their original terms was $278,000, $252,000, and $223,000 as of September 30, 2010, December 31, 2009, and September 30, 2009.

Medallion Bank’s loan and investment portfolios are assessed for collectability on a monthly basis, and a loan loss allowance is established for any realizability concerns on specific investments, and general reserves have also been established for any unknown factors. The consumer portfolio purchase was net of unrealized depreciation of $4,244,000, or 5.0% of the balances outstanding, and included a purchase premium of approximately $5,678,000, of which $45,000 and $152,000 was amortized into interest income in the 2010 third quarter and nine months, and $66,000 and $235,000 was amortized into interest income in the comparable 2009 periods. The premium amount on the balance sheet was $376,000 and $528,000 at September 30, 2010 and December 31, 2009. Adjustments to the fair value of this portfolio are based on the historical loan loss data obtained from the seller, adjusted for changes in delinquency trends and other factors as described previously in Note 2.

In January 2004, Medallion Bank commenced raising deposits to fund the purchase of various affiliates’ loan portfolios. The deposits were raised through the use of investment brokerage firms who package deposits qualifying for FDIC insurance into pools that are sold to Medallion Bank. The rates paid on the deposits are highly competitive with market rates paid by other financial institutions, and include a brokerage fee of 0.15% to 0.50%, depending on the maturity of the deposit, which is capitalized and amortized to interest expense over the life of the respective pool. The total amount capitalized at September 30, 2010 and December 31, 2009 was $927,000 and $670,000, and $262,000 and $750,000 was amortized to interest expense during the 2010 third quarter and nine months, and $305,000 and $817,000 were amortized in the comparable 2009 periods. Interest on the deposits is accrued daily and paid monthly, quarterly, semiannually, or at maturity.

The outstanding balances of fixed rate borrowings were as follows:

 

 

     Payments Due for the Fiscal Year Ending September 30,      September  30,
2010
     December  31,
2009
     Interest
Rate (1)
 

(Dollars in thousands)

   2011      2012      2013      2014      2015      Thereafter           

Deposits

   $ 324,930       $ 67,975       $ 59,363       $ —         $ —         $ —         $ 452,268       $ 371,719         1.44

 

(1) Weighted average contractual rate as of September 30, 2010.

 

Medallion Bank is subject to various regulatory capital requirements administered by the FDIC and State of Utah Department of Financial Institutions. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on Medallion Bank’s and our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Medallion Bank must meet specific capital guidelines that involve quantitative measures of Medallion Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Medallion Bank’s capital amounts and classification are also subject to qualitative judgments by Medallion Bank regulators about components, risk weightings, and other factors.

FDIC-insured banks, including Medallion 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, Medallion 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 Medallion Bank to maintain minimum amounts and ratios as defined in the regulations (set forth in the table below). Additionally, as conditions of granting Medallion Bank’s application for federal deposit insurance, the FDIC ordered that beginning paid-in-capital funds of not less than $22,000,000 be provided, that the Tier I Leverage Capital to total assets ratio, as defined, be not less than 15%, and that an adequate allowance for loan losses be maintained. As a result, to facilitate maintenance of the capital ratio requirement and to provide the necessary capital for continued growth, the Company periodically makes capital contributions to Medallion Bank, including $1,750,000 contributed over the 2009 nine months. Separately, Medallion Bank paid dividends to the Company of $1,000,000 in the 2010 and 2009 third quarters and $3,000,000 in the 2010 and 2009 nine months.

On February 27, 2009, Medallion Bank issued and sold, and the US Treasury purchased under the TARP Capital Purchase Program (the CPP), (1) 11,800 shares of Medallion Bank’s Fixed Rate Non-Cumulative Perpetual Preferred Stock, Series A, and (2) a warrant, which was immediately exercised, to purchase up to 590 shares of Medallion Bank’s Fixed Rate Non-Cumulative Perpetual Preferred Stock, Series B, for an aggregate purchase price of approximately $11,800,000 in cash. On December 22, 2009, Medallion Bank issued and sold, and the US Treasury purchased under the CPP, (1) 9,698 shares of Medallion Bank’s Fixed Rate Non-Cumulative Perpetual Preferred Stock, Series C, and (2) a warrant, which was immediately exercised, to purchase up to 55 shares of Medallion Bank’s Fixed Rate Non-Cumulative Perpetual Preferred Stock, Series D, for an aggregate purchase price of approximately $9,698,000 in cash. The liquidation preference of each Series is $1,000 per share.

 

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MEDALLION FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

SEPTEMBER 30, 2010

 

 

The securities were sold in private placements exempt from SEC registration.

Non-cumulative dividends on the Series A and C shares will accrue on the liquidation preference at a rate of 5% per annum for the first five years, and at a rate of 9% per annum thereafter, and the dividends on the Series B and D shares will accrue on the liquidation preference at a rate of 9% per annum, both, if, as, and when declared by Medallion Bank’s Board of Directors out of funds legally available thereof. The Preferred Shares have no maturity date and rank senior to Medallion Bank’s common stock (and pari passu with one another) with respect to the payment of dividends and distributions and amounts payable upon liquidation, dissolution, and winding up of Medallion Bank. Medallion Bank’s Articles of Amendments provide that, subject to the approval of the FDIC, the Preferred Shares are redeemable at the option of Medallion Bank at 100% of their liquidation preference plus declared and unpaid dividends, provided, however, that the Preferred Shares may be redeemed prior to February 27, 2012 and December 22, 2012, respectively, only if (i) Medallion Bank has raised aggregate gross proceeds in one or more Qualified Equity Offerings, as defined, of at least $3,097,500 and $2,438,250, respectively, and (ii) the aggregate redemption price does not exceed the aggregate net proceeds from such offerings. The Series B shares cannot be redeemed until the Series A shares have been redeemed and the Series D shares cannot be redeemed until the Series A, B, and C shares have been redeemed.

On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (the ARRA) was signed into law. The ARRA, among other things, directs the US Treasury to permit CPP participants to redeem the preferred stock issued under the CPP without first requiring a Qualified Equity Offering, upon consultation with the appropriate Federal banking agency.

The agreements between Medallion Bank and the US Treasury pursuant to which the Preferred Shares and the Warrants were sold contain limitations on the payment of common stock dividends to a quarterly rate of $1.00 per share or $1,000,000, and on Medallion Bank’s ability to repurchase its common stock, and subjects Medallion Bank and the Company to certain of the executive compensation limitations and requirements included in the Emergency Economic Stabilization Act of 2008 (the EESA). As a condition to the closing of the transactions, the Company and its senior executive officers have agreed to all terms and conditions.

The interim final rule promulgated pursuant to Section 111 of the EESA, as amended by the ARRA, prescribes certain standards for compensation and corporate governance for CPP participants (which the Company believes to include parent companies such as the Company), which include, among other things, (i) the repayment by the senior executive officers and the next twenty most highly compensated employees of any bonus, retention award, or incentive compensation if the payment was based on materially inaccurate financial information or other materially inaccurate performance metric criteria; (ii) the prohibition of any payment for departure from a CPP participant or change of control event of a CPP participant, other than a payment for services performed or benefits accrued, to the senior executive officers and the next five most highly compensated employees; (iii) the prohibition of the payment or accrual of any bonus, retention award, or incentive compensation to a CPP participant’s most highly compensated employee except through restricted stock with delayed vesting and subject to dollar limits; and (iv) the prohibition from providing tax gross-ups or other reimbursements for the payment of taxes to senior executive officers and the next twenty most highly compensated employees relating to severance payments, perquisites, or any other form of compensation. The interim final rule further requires (i) at least once every six months, the compensation committees of CPP participants to meet to discuss, evaluate, and review the CPP participant’s compensation plans and the risks these plans pose to the CPP participant and annually in the CPP participant’s proxy statement describe how such risks were limited and certify that the compensation committee has completed its reviews of the plans and provide such disclosures and certifications to the Treasury; (ii) CPP participants to disclose to the Treasury and their primary federal regulator on an annual basis, perquisites with a total value over $25,000 for any employee who is subject to the bonus prohibition; (iii) CPP participants to disclose to the Treasury and their primary federal regulator whether they have engaged a compensation consultant and indicate the types of services the compensation consultant or any of its affiliates has provided during the past three years, including any “benchmarking” or comparisons employed to identify certain percentile levels of compensation; (iv) CPP participants to adopt an excessive or luxury expenditures policy; (v) CPP participants to permit stockholders to vote on a non-binding resolution approving the institution’s compensation of executives; and (vi) the principal executive officer and principal financial officer of CPP participants to annually certify compliance of the CPP participant with Section 111 of EESA and provide these certifications as an exhibit to the CPP participant’s annual report on Form 10-K and to the Treasury.

The following table represents Medallion Bank’s actual capital amounts and related ratios as of September 30, 2010 and December 31, 2009, compared to required regulatory minimum capital ratios and the ratio required to be considered well capitalized. As of September 30, 2010, Medallion Bank meets all capital adequacy requirements to which it is subject, and is well-capitalized.

 

 

     Regulatory     September 30,
2010
    December 31,
2009
 

(Dollars in Thousands)

   Minimum     Well-capitalized      

Tier I capital

     —          —        $ 92,971      $ 88,811   

Total capital

     —          —          99,639        94,455   

Average assets

     —          —          537,927        456,681   

Risk-weighted assets

     —          —          526,063        443,566   

Leverage ratio (1)

     4     5     17.3     19.5

Tier I capital ratio (2)

     4        6        17.7        20.0   

Total capital ratio (2)

     8        10        18.9        21.3   

 

(1) Calculated by dividing Tier I capital by average assets.
(2) Calculated by dividing Tier I or total capital by risk-weighted assets.

 

 

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MEDALLION FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

SEPTEMBER 30, 2010

 

 

(4) FUNDS BORROWED

The outstanding balances of funds borrowed were as follows:

 

 

     Payments Due for the Fiscal Year Ending September 30,      September  30,
2010
     December  31,
2009
     Interest
Rate (1)
 

(Dollars in thousands)

   2011      2012      2013      2014      2015      Thereafter           

Revolving lines of credit

   $ —         $ —         $ —         $ 183,442       $ —         $ —         $ 183,442       $ 197,362         1.32

SBA debentures

     7,485         7,500         19,450         13,500         9,250         23,065         80,250         88,250         5.48

Notes payable to banks

     43,204         16,735         16,079         95         —           874         76,987         63,910         4.48

Preferred securities

     —           —           —           —           —           33,000         33,000         33,000         7.68
                                                                          

Total

   $ 50,689       $ 24,235       $ 35,529       $ 197,037       $ 9,250       $ 56,939       $ 373,679       $ 382,522         3.42

 

(1) Weighted average contractual rate as of September 30, 2010.

 

(A) REVOLVING LINES OF CREDIT

In December 2008, Trust III entered into a revolving line of credit 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 line), of which $183,442,000 was outstanding at September 30, 2010. Borrowings under Trust III’s revolving line of credit are collateralized by Trust III’s assets. MFC is the servicer of the loans owned by Trust III. The DZ line includes a borrowing base covenant and rapid amortization in certain circumstances. In addition, if certain financial tests are not met, MFC can be replaced as the servicer. The DZ line matures in December 2013. The interest rate is the lesser of a pooled short-term commercial paper rate (which approximates LIBOR), 30 day LIBOR (0.26% at September 30, 2010) plus 0.75%, or 90 day LIBOR (0.29% at September 30, 2010) plus 0.50%; plus 0.95%.

In December 2006, Trust II entered into a revolving line of credit agreement with Citibank N.A., to provide up to $250,000,000 of financing through a commercial paper conduit to acquire medallion loans from MFC, which was paid off in March 2010, in advance of the May 2010 maturity. In November 2008, the line of credit was reduced to $225,000,000, and was further reduced to $35,000,000 in November 2009. Borrowings under Trust II’s revolving line of credit were collateralized by Trust II’s assets. MFC was the servicer of the loans owned by Trust II. The Citi line included a borrowing base covenant and rapid amortization in certain circumstances. In addition, if certain financial tests were not met, MFC could have been replaced as the servicer. The interest rate was a pooled short-term commercial paper rate, which approximated LIBOR (0.26% at September 30, 2010), plus 1.07% with a facility fee of 1.50% on the aggregate Citi line, and prior to November 2009 was plus 0.82% with a facility fee of 0.15% on the aggregate Citi line, and prior to November 2008 was plus 0.47% with a facility fee of 0.15%.

(B) SBA DEBENTURES

In September 2010, the SBA approved a $5,000,000 commitment for MCI to issue additional debentures during a four year period upon payment of a 1% fee. The SBA also approved a $7,485,000 commitment for FSVC to issue additional debentures during a four year period upon payment of a 1% fee, for the purpose of repaying $7,485,000 of debentures which mature in September 2011. In September 2006, the SBA approved a $6,000,000 commitment for FSVC to issue additional debentures to the SBA during a four year period upon payment of a 1% fee and the infusion of $2,000,000 of additional capital. In March 2006, the SBA approved a $13,500,000 commitment for MCI to issue additional debentures to the SBA during a four year period upon payment of a 1% fee and the infusion of $6,750,000 of additional capital. In November 2003, the SBA approved an $8,000,000 commitment for FSVC, and during 2001, the SBA approved $36,000,000 each in commitments for FSVC and MCI. As of September 30, 2010, $99,500,000 of commitments had been fully utilized, and $12,485,000 was available for borrowing.

The notes are collateralized by substantially all the Company’s assets and are subject to the terms and conditions of agreements with the SBA which, among other things, restrict stock redemptions, disposition of assets, new indebtedness, dividends or distributions, and changes in management, ownership, investment policy, or operations. The debentures have been issued in various tranches for terms of ten years with interest payable semiannually.

 

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MEDALLION FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

SEPTEMBER 30, 2010

 

 

(C) NOTES PAYABLE TO BANKS

The Company and its subsidiaries have entered into (i) note agreements and (ii) participation 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. The Company believes the participation agreements represent legal true sales of the loans to the lender, but for accounting purposes these participations are treated as financings, and are included in funds borrowed as shown on our consolidated balance sheets. The table below summarizes the key attributes of our various borrowing arrangements with banks as of September 30, 2010.

 

 

(Dollars in thousands)

 

Borrower

  # of
Banks
/Notes
    Note Dates     Maturity
Dates
   

Type

  Note
Amounts
    Balance
Outstanding
at September 30,
2010
   

Monthly Payment

  Average
Interest
Rate at
September 30,
2010
    Interest
Rate Index  (1)
 

MFC

    7/17        3/09 – 9/10        3/11 - 2/17      Participated loans treated as financings (2)   $ 35,573      $ 34,948      Proportionate to the payments received on the participated loans     4.51%        4.51% (3)   

The Company

    1/1        4/04        12/10      Revolving line of credit secured by pledged loans     20,000        16,500      Interest only    
 
 
 
3.00% +
0.25%
unused
fee
  
  
  
  
   
 
 
 
 
LIBOR +
2.00%,
minimum
rate of
3.00%
  
  
  
  
  

The Company

    1/4        1/09 – 6/09        3/11 - 7/12      Participated loans treated as financings     21,187        15,127      Proportionate to the payments received on the participated loans     5.23%        N/A   

Medallion Chicago

    3/27        10/06 – 6/08        5/11 - 6/11      Term loans secured by owned Chicago medallions (4)     11,476        10,412      $83 principal & interest     5.60%        N/A   

MFC

    1/1        1/05        5/11      Revolving line of credit secured by pledged loans (5)     8,000        —        Interest only     3.75%       
 
Prime +
0.50%
  
  
                             
          $ 96,236      $ 76,987         

 

(1) At September 30, 2010, 30 day LIBOR was 0.26%, 360 day LIBOR was 0.78%, and the prime rate was 3.25%.
(2) $4,227 guaranteed by the Company.
(3) Generally, each of these notes reprice on their one year anniversary date at the greater of the current interest rate, or the prime rate plus an index, which ranges from 0.25% to 1.375%. One $907 loan remains fixed to term at 5.50%, one $3,964 loan remains fixed to term at 4.50%, and one $4,568 loan remains fixed to term at 4.70%.
(4) $6,312 guaranteed by the Company.
(5) Guaranteed by the Company.

 

D) 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 fixed rate of interest of 7.68% to September 2012, and thereafter a variable rate of interest of 90 day LIBOR (0.29% at September 30, 2010) plus 2.13%. The notes mature in September 2037, and are prepayable at par on or after September 6, 2012. Interest is payable quarterly in arrears. The terms of the preferred securities and the notes are substantially identical. At September 30, 2010, $33,000,000 was outstanding on the preferred securities. In December 2007, $2,000,000 of the preferred securities were repurchased from a third party investor.

(E) COVENANT COMPLIANCE

In the normal course of business, the Company and its subsidiaries enter into agreements, or are subject to regulatory requirements, that result in loan restrictions. Certain of our debt agreements contain restrictions that require the Company to maintain certain financial ratios, including debt to equity and minimum net worth. In addition, the Company’s wholly-owned subsidiary Medallion Bank is subject to regulatory requirements related to the declaration of dividends (see Note 3).

(5) STOCK OPTIONS AND RESTRICTED STOCK

The Company has 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, provides for the issuance of a maximum of 800,000 shares of common stock of the Company. At September 30, 2010, 159,315 shares of the Company’s common stock remained available for future grants. The 2006 Stock Option Plan is administered by the Compensation Committee of the Board of Directors. The option price per share may not be less than the current market value of the Company’s common stock on the date the option is granted. The term and vesting periods of the options are determined by the Compensation Committee, provided that the maximum term of an option may not exceed a period of ten years.

 

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MEDALLION FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

SEPTEMBER 30, 2010

 

 

The Company’s Board of Directors approved a new non-employee director stock option plan (the 2006 Director Plan) on February 15, 2006, which was approved by shareholders on June 16, 2006, and on which exemptive relief to implement the 2006 Director Plan was received from the SEC on August 28, 2007. The 2006 Director Plan provides for an automatic grant of options to purchase 9,000 shares of the Company’s common stock to an Eligible Director upon election to the Board, with an adjustment for directors who are elected to serve less than a full term. A total of 100,000 shares of the Company’s common stock are issuable under the 2006 Director Plan. At September 30, 2010, no shares of the Company’s common stock remained available for future grants. The option price per share may not be less than the current market value of the Company’s common stock on the date the option is granted. Options granted under the 2006 Director Plan are exercisable annually, as defined in the 2006 Director Plan. The term of the options may not exceed ten years.

The Company’s Board of Directors approved the 2009 Employee Restricted Stock Plan (the Employee Restricted Stock Plan) on April 16, 2009. The Employee Restricted Stock Plan became effective upon the Company’s receipt of exemptive relief from the SEC and approval of the Employee Restricted Stock Option Plan by the Company’s shareholders on June 11, 2010. The terms of the Employee Restricted Stock Plan provide 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 that, at the time of issuance, is subject to certain forfeiture provisions, and thus are restricted as to transferability until such forfeiture restrictions have lapsed. A total of 800,000 shares of the Company’s common stock are issuable under the Employee Restricted Stock Plan. Awards under the 2009 Employee Plan are subject to certain limitations as set forth in the Employee Restricted Stock Plan. The Employee Restricted Stock Plan will terminate when all shares of common stock authorized for delivery under the Employee 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 Employee Restricted Stock Plan, whichever first occurs.

The Company’s Board of Directors approved an amendment to the 2006 Director Plan (the Amended Director Plan) on April 16, 2009, which was approved by the Company’s shareholders on June 5, 2009. The Amended Director Plan will become effective upon the Company’s receipt of exemptive relief from the SEC. The Amended Director Plan is intended to amend and restate the 2006 Director Plan by increasing the maximum number of shares of the Company’s common stock that will be available for issuance under the Amended Director Plan from 100,000 to 200,000. 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 will grant options to purchase 9,000 shares of the Company’s common stock to an Eligible Director upon election to the Board, with an adjustment for directors who are elected to serve less than a full term. The option price per share may not be less than the current market value of the Company’s common stock on the date the option is granted. Options granted under the 2006 Director Plan are exercisable annually, as defined in the Amended Director Plan. The term of the options may not exceed ten years.

The Company’s 1996 Stock Option Plan and 1996 Director Plan terminated on May 21, 2006 and no additional shares are available for future issuance. At September 30, 2010, 1,509,017 shares of the Company’s common stock were outstanding under the 1996 and 2006 plans, of which 1,231,833 shares were exercisable. The weighted average fair value of options granted was $0.96 per share for the three and nine months ended September 30, 2010, and was $0.91 per share for the comparable 2009 periods.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The following assumptions were used for the shares granted during 2010 and 2009.

 

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
                 2010                               2009                               2010                              2009               

Risk free interest rate

     NA         NA         2.77     2.89

Expected dividend yield

     NA         NA         8.00        8.00   

Expected life of option in years (1)

     NA         NA         6.00        6.00   

Expected volatility (2)

     NA         NA         30.00        30.00   

 

(1) Expected life is calculated using the simplified method.
(2) We determine our expected volatility using the Black-Scholes option pricing model based on our historical volatility.

 

 

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Table of Contents

MEDALLION FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

SEPTEMBER 30, 2010

 

 

The following table presents the activity for the stock option program under the 1996 and 2006 Stock Option Plans and the 1996 and 2006 Director Plans for the periods ended September 30, 2010 and December 31, 2009.

 

 

   Number of
Options
    Exercise Price
Per Share
     Weighted Average
Exercise Price
 

Outstanding at December 31, 2008

     1,729,187        $3.50 - 18.75       $ 10.25   

Granted

     68,667        7.49 - 7.62         7.57   

Cancelled

     (295,269     7.68 - 18.75         16.68   

Exercised

     (26,653     3.50 - 5.51         4.87   
                         

Outstanding at December 31, 2009

     1,475,932        3.50 - 17.94         8.93   

Granted

     —                  —     

Cancelled

     (16,667     17.94         17.94   

Exercised (1)

     —                  —     
                         

Outstanding at March 31, 2010

     1,459,265        3.50 - 15.56         8.83   

Granted

     68,500        7.17 - 8.21         8.06   

Cancelled

     (18,000     9.27         9.27   

Exercised (1)

     —                  —     
                         

Outstanding at June 30, 2010

     1,509,765        3.50 - 15.56         8.79   

Granted

     —                  —     

Cancelled

     (748     9.22         9.22   

Exercised (1)

     —                  —     
                         

Outstanding at September 30, 2010 (2)

     1,509,017        $3.50 - 15.56       $ 8.79   
                         

Options exercisable at September 30, 2010 (2)

     1,231,833        $3.50 - 15.56       $ 8.79   

 

(1) 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 the 2010 third quarter and nine months, and was $0 and $45,000 for the comparable 2009 periods.
(2) The aggregate intrinsic value, which represents the difference between the price of the Company’s common stock at September 30, 2010 and the related exercise price of the underlying options, was $1,037,000 for outstanding options and $1,020,000 for exercisable options as of September 30, 2010.

 

The following table presents the activity for the unvested options outstanding under the plans for the quarter and nine months ended September 30, 2010.

 

 

     Number of
Options
    Exercise Price
Per Share
   Weighted Average
Exercise Price
 

Outstanding at December 31, 2009

     391,370      $7.49 - 11.24    $ 9.20   

Granted

     —             —     

Cancelled

     —             —     

Vested

     (35,139   9.99-11.21      10.73   
                     

Outstanding at March 31, 2010

     356,231      7.49 - 11.24      9.04   

Granted

     68,500      7.17 - 8.21      8.06   

Cancelled

     —             —     

Vested

     (138,579   7.49 - 11.24      8.97   
                     

Outstanding at June 30, 2010

     286,152      7.17 - 11.21      8.84   

Granted

     —             —     

Cancelled

     (468   9.22      9.22   

Vested

     (8,500   10.76 - 11.21      10.89   
                     

Outstanding at September 30, 2010

     277,184      $7.17 - 11.21    $ 8.78   

 

The intrinsic value of the options vested was $0 for the 2010 third quarter and nine months.

The following table summarizes information regarding options outstanding and options exercisable at September 30, 2010 under the 1996 and 2006 Stock Option Plans and the 1996 and 2006 Director Plans.

 

     Options Outstanding      Options Exercisable  
            Weighted average             Weighted average  

Range of Exercise Prices

   Shares at
September 30,
2010
     Remaining
contractual life
in years
     Exercise price      Shares at
September 30,
2010
     Remaining
contractual life
in years
     Exercise price  

$    3.50-5.51

     350,997         1.79       $ 4.91         350,997         1.79       $ 4.91   

    6.89-13.06

     1,131,072         6.33         9.84         853,888         5.75         10.19   

  14.63-15.56

     26,948         0.18         14.98         26,948         0.18         14.98   
                             

$  3.50-15.56

     1,509,017         5.17         8.79         1,231,833         4.50         8.79   

 

(6) SEGMENT REPORTING

We have one business segment, our lending and investing operations. This segment originates and services medallion, secured commercial, and consumer loans, and invests in both marketable and nonmarketable securities.

 

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MEDALLION FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

SEPTEMBER 30, 2010

 

 

(7) NONINTEREST INCOME AND OTHER OPERATING EXPENSES

The major components of noninterest income were as follows:

 

 

     Three Months Ended September 30,      Nine Months Ended September 30,  

(Dollars in thousands)

               2010                               2009                               2010                               2009               

Servicing fees

   $ 990       $ 637       $ 2,391       $ 1,515   

Prepayment penalties

     273         177         623         506   

Late charges

     47         75         148         196   

Other

     30         74         125         210   
                                   

Total noninterest income

   $ 1,340       $ 963       $ 3,287       $ 2,427   

 

The increase in servicing fees in the 2010 third quarter and nine months primarily reflected the fees earned on the larger serviced Medallion Bank portfolio. The increase in the prepayment penalties in the 2010 third quarter was attributed to early payoff of several large customers. Other noninterest income is lower due to the absence of SPAC management fees which were earned in the 2009 third quarter and nine months.

The major components of other operating expenses were as follows:

 

 

     Three Months Ended September 30,      Nine Months Ended September 30,  

(Dollars in thousands)

               2010                               2009                               2010                              2009               

Loan collection costs and other investment costs

   $ 15       $ 133       ($ 1,564   $ 376   

Travel, meals, and entertainment

     258         349         617        921   

Directors fees

     135         187         408        444   

Office expense

     89         85         264        271   

Miscellaneous taxes

     80         99         385        293   

Investment and referral costs

     48         78         135        156   

Telephone

     57         64         188        169   

Insurance

     57         34         169        182   

Depreciation and amortization

     48         59         146        200   

Other expenses

     375         264         761        603   
                                  

Total operating expenses

   $ 1,162       $ 1,352       $ 1,509      $ 3,615   

 

Loan collection and other investment costs decreased reflecting $1,312,000 of expense reversals related to the costs of winding up the operations of SPAC’s in the 2010 nine months that were reclassified to realized losses on investments, and $310,000 that was reversed as a result of favorable negotiations with the creditors of SPAC, as well as generally more favorable collection activities on the portfolio as a whole. Travel, meals, and entertainment decreased due to a decrease in investment and development activities in 2010.

 

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MEDALLION FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

SEPTEMBER 30, 2010

 

 

(8) SELECTED FINANCIAL RATIOS AND OTHER DATA

The following table provides selected financial ratios and other data:

 

 

     Three Months Ended September 30,     Nine Months Ended September 30,  

(Dollars in thousands, except per share data)

               2010                              2009                              2010                              2009               

Net share data:

        

Net asset value at the beginning of the period

   $ 9.16      $ 9.81      $ 9.27      $ 9.97   

Net investment income

     0.14        0.11        0.42        0.34   

Income tax (provision) benefit

     —          —          —          —     

Net realized losses on investments

     (0.01     0.03        (0.51     (0.08

Net change in unrealized appreciation on investments

     0.07        0.02        0.46        0.12   
                                

Net increase in net assets resulting from operations

     0.20        0.16        0.37        0.38   

Issuance of common stock

     —          —          —          —     

Repurchases of common stock

     0.02        —          0.02        —     

Distribution of net investment income

     (0.15     (0.17     (0.45     (0.55

Distribution of net realized gains on investments

     —          (0.02     —          (0.02

Other

     —          0.01        0.02        0.01   
                                

Total increase (decrease) in net asset value

     0.07        (0.02     (0.04     (0.18
                                

Net asset value at the end of the period (1)

   $ 9.23      $ 9.79      $ 9.23      $ 9.79   
                                

Per share market value at beginning of period

   $ 6.60      $ 7.65      $ 8.17      $ 7.63   

Per share market value at end of period

     7.79        8.36        7.79        8.36   

Total return (2)

     81     47     1     24
                                

Ratios/supplemental data

        

Average net assets

   $ 160,699      $ 172,333      $ 161,600      $ 173,763   

Total expense ratio (3)

     21     21     20     22

Operating expenses to average net assets (4)

     12        11        11        11   

Net investment income after taxes to average net assets

     5.84        4.61        6.24        4.64   

 

(1) Includes $0.13 and $0.12 of undistributed net investment income per share and $0.00 of undistributed net realized gains per share as of September 30, 2010 and 2009.
(2) Total return is calculated by dividing the change in market value of a share of common stock during the period, assuming the reinvestment of dividends on the payment date, by the per share market value at the beginning of the period.
(3) Total expense ratio represents total expenses (interest expense, operating expenses, and income taxes) divided by average net assets.
(4) Includes $1,312 of expense reversals related to the costs of winding up the operations of the SPAC’s in the 2010 nine months that were reclassified to realized losses on investments, and $310 that was reversed as a result of favorable negotiations with the creditors of SPAC. Excluding these amounts, the total expense ratio was 21% for the nine months, and the operating expense ratio was 12%.

 

(9) RECENTLY ISSUED ACCOUNTING STANDARDS

In July 2010, the FASB issued Accounting Standards Update 2010-20, “Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”, which amends Subtopic 310-30 by requiring an entity to provide enhanced and disaggregated disclosures about the credit quality of an entity’s financing receivables and its allowance for credit losses. The objective of enhancing these disclosures is to improve financial statement users’ understanding of both the nature of an entity’s credit risk associated with its financing receivables and the entity’s assessment of that risk in estimating its allowance for credit losses as well as changes in the allowance and the reason for those changes. The update is effective for the first interim or annual period ending on or after December 15, 2010. The Company does not expect adoption of FASB ASU 2010-20 to have a material impact on its financial condition or results of operations, as it is a disclosure standard.

In January 2010, the FASB issued Accounting Standards Update 2010-06, “Fair Value Measurements and Disclosures (Topic 820), Improving Disclosures about Fair Value Measurements” (FASB ASU 2010-06). FASB ASU 2010-06 amends Subtopic 820-10, Fair Value Measurements and Disclosures - Overall, and requires new disclosures related to the transfers in and out of Level 1 and 2, as well as requiring that a reporting entity present separately information about purchases, sales, issuances, and settlements rather than as one net number. Additionally, FASB ASU 2010-06 amends Subtopic 820-10 by clarifying existing disclosures related to level of disaggregation as well as disclosures about inputs and valuation techniques. FASB ASU 2010-06 is effective for reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements, these disclosures are effective for reporting periods beginning after December 15, 2010. The Company has adopted the provisions of FASB ASU 2010-06, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements. The Company does not expect the adoption of FASB ASU 2010-06 related to Level 3 roll forward of activity to have an impact on its financial condition or results of operations, as it is a disclosure standard.

 

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MEDALLION FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

SEPTEMBER 30, 2010

 

 

(10) RELATED PARTY TRANSACTIONS

Certain directors, officers, and shareholders of the Company are also directors and officers of its wholly-owned subsidiaries, MFC, MCI, FSVC, and Medallion Bank, as well as of certain portfolio investment companies. Officer salaries are set by the Board of Directors of the Company, subject to various regulatory constraints imposed by the TARP program (see Note 3).

A member of the Board of Directors of the Company since 1996 is also of counsel in the Company’s primary law firm. Amounts paid to the law firm were approximately $160,000 and $73,000 for the three months ended September 30, 2010 and 2009, and were $444,000 and $501,000 for the comparable nine months.

At September 30, 2010 and 2009, we serviced $312,097,000 and $213,858,000 in loans for Medallion Bank. Included in net investment income were amounts as described below that were received from Medallion Bank for services rendered in originating and servicing loans, and also for reimbursement of certain expenses incurred on their behalf:

 

 

     Three Months Ended September 30,      Nine Months Ended September 30,  

(Dollars in thousands)

               2010                               2009                               2010                               2009               

Servicing fees

   $ 875       $ 452       $ 2,088       $ 1,292   

Loan origination fees

     227         291         640         585   

Reimbursement of operating expenses

     79         77         237         163   

Interest income

     —           1         —           2   
                                   

Total other income

   $ 1,181       $ 821       $ 2,965       $ 2,042   

 

SPAC

Included in investments in controlled subsidiaries at December 31, 2009 was $6,961,000 of investments in and loans to a special purpose acquisition company, Sports Properties Acquisition Corp. (the SPAC), 18%-owned by the Company, which consummated its initial public offering (IPO) in January 2008. Immediately prior to the IPO, the Company purchased warrants for $5,900,000 from the SPAC in a private placement which would have allowed it to acquire 5,900,000 additional shares of common stock in the future under various conditions and restrictions. The SPAC was unable to consummate an approved business combination within 24 months of the IPO, as a result, the Company’s entire investment in the SPAC became worthless in January 2010, and was therefore fully reserved for with a $6,961,000 charge to unrealized depreciation during the year ended December 31, 2009, and was fully written off to realized losses in the 2010 first quarter. All of the assets of the SPAC have been used to repay the public stockholders.

The Company had entered into a consulting agreement with ProEminent Sports, whose principal acted as a consultant to the Company for sports related investments and, included within the scope of his duties, also provided services to the SPAC, including serving as its Chief Executive Officer, and assisting generally with the SPAC’s offering and business combination. The Company had paid ProEminent Sports a monthly fee of $20,000, which during 2009 was reduced to $10,000, and then $0. The Company had previously entered into a consulting agreement with GamePlan, LLC which was terminated as of June 1, 2008, when the SPAC entered into its own consulting agreement with GamePlan, LLC. The Company had paid GamePlan, LLC a monthly fee of $10,000.

The Company had agreed to indemnify the SPAC in the event of the SPAC’s liquidation for all claims of any vendors, service providers, or other entities that are owed money by the SPAC for services rendered or contracted for, or for products sold to the SPAC, including claims of any prospective acquisition targets. At December 31, 2009, the SPAC’s liabilities exceeded its cash on hand by $1,581,000. The SPAC negotiated these liabilities downwards, and obtained forbearance from those associated with a failed deal, and during the 2010 nine months, $1,292,000 of the expenses were paid $310,000 were forgiven, and there were no remaining claims outstanding.

Certain of the Company’s officers and directors also served as officers and directors of the SPAC, and in that role entered into agreements with the SPAC and its underwriter(s) to present to the SPAC, prior to presentation to any other person or entity, opportunities to acquire entities, until the earlier of the SPAC’s consummation of a business combination, the SPAC’s liquidation, or until such time as they ceased to be an officer or director of the SPAC. The Company entered into a similar agreement.

SPAC 2

Included in deferred costs in other assets at December 31, 2009 was $759,000 of investments in and loans to a special purpose acquisition company, National Security Solutions, Inc. (SPAC 2), 74%-owned by the Company, which was in organization prior to registration with the SEC to register units for sale in an initial public offering. As a result of the market conditions which led to the failure of the SPAC, it was determined to cease activities related to SPAC 2, and as a result, the investment was fully reserved for with a $759,000 charge to unrealized depreciation during the year ended December 31, 2009, and was fully written off to realized losses in the 2010 first quarter. In addition, the Company had additional realized losses of $20,000 in the 2010 nine months.

 

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MEDALLION FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

SEPTEMBER 30, 2010

 

 

(11) 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) Investments - The Company’s investments are recorded at the estimated fair value of such investments.

(b) Floating rate borrowings - Due to the short-term nature of these instruments, the carrying amount approximates fair value.

(c) 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, 2010 and December 31, 2009, the estimated fair value of these off-balance-sheet instruments was not material.

(d) Fixed rate borrowings - The fair value of the debentures payable to the SBA is estimated based on current market interest rates for similar debt.

 

 

     September 30, 2010      December 31, 2009  

(Dollars in thousands)

   Carrying
Amount
     Fair Value      Carrying
Amount
     Fair Value  

Financial assets

           

Investments

   $ 471,930       $ 471,930       $ 475,133       $ 475,133   

Cash

     21,525         21,525         33,401         33,401   

Accrued interest receivable

     1,613         1,613         1,661         1,661   

Financial liabilities

           

Funds borrowed

     373,679         373,679         382,522         382,522   

Accrued interest payable

     821         821         2,207         2,207   

 

(12) FAIR VALUE OF ASSETS AND LIABILITIES

The Company follows the provisions of FASB ASC Topic 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. The Company accounts for substantially all of its financial instruments at fair value or considers fair value in its measurement, in accordance with the accounting guidance for investment companies. See Note 2 sections “Fair Value of Assets and Liabilities” and “Investment Valuation” for a description of our valuation methodology which is unchanged during 2010.

In accordance with FASB ASC Topic 820, the Company has categorized its financial instruments, 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).

As required by FASB ASC Topic 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 (level 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).

 

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MEDALLION FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

SEPTEMBER 30, 2010

 

 

Financial assets and liabilities recorded on the consolidated balance sheets are categorized based on the inputs to the valuation techniques as follows:

Level 1. Financial 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. Financial 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. Financial 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, certain residential and commercial mortgage-related assets (including loans, securities, and derivatives), and long-dated or complex derivatives including certain equity derivatives and long-dated options on gas and power).

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 financial 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 tables present Medallion’s fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis as of September 30, 2010 and December 31, 2009.

 

 

September 30, 2010 (Dollars in thousands)

   Level 1      Level 2      Level 3      Total  

Assets

           

Medallion loans

   $ —         $ —         $ 327,425       $ 327,425   

Commercial loans

     —           —           65,158         65,158   

Investment in Medallion Bank and other controlled subsidiaries

     —           —           75,759         75,759   

Equity investments

     285         —           3,303         3,588   

Other assets

     —           35,924         —           35,924   

 

 

 

December 31, 2009 (Dollars in thousands)

   Level 1      Level 2      Level 3      Total  

Assets

           

Medallion loans

   $ —         $ —         $ 321,915       $ 321,915   

Commercial loans

     —           —           77,922         77,922   

Investment in Medallion Bank and other controlled subsidiaries

     543         —           71,736         72,279   

Equity investments

     248         —           2,769         3,017   

Other assets

     —           33,822         —           33,822   

 

Included in level 3 investments in other controlled subsidiaries is the investment in Medallion Bank, and an investment in a start-up business engaged in media-buying consulting. Also included in level 3 equity investments are unregistered shares of common stock in a publicly-held company as well as certain private equity positions in non-marketable securities.

 

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MEDALLION FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

SEPTEMBER 30, 2010

 

 

The following tables provide a summary of changes in fair value of Medallion’s level 3 financial assets and liabilities for the quarters and nine months ended September 30, 2010 and 2009.

 

 

(Dollars in thousands)

   June 30,
2010
     Total Realized and
Unrealized Gains
(Losses) Included
in Income
    Purchases, Issuances,
and Settlements
    September 30,
2010
     Amounts Related
to Held Assets (1)
 

Assets

            

Medallion loans

   $ 333,318       $ —          (5,893   $ 327,425       $ —     

Commercial loans

     71,669         (1,064     (5,447     65,158         (1,099

Investment in Medallion Bank and other controlled subsidiaries

     74,104         1,975        (320     75,759         1,975   

Equity investments

     3,090         213        —          3,303         213   

 

(1) Total realized and unrealized gains (losses) included in income for the 2010 third quarter which relate to assets held as of September 30, 2010.

 

 

 

(Dollars in thousands)

   December 31,
2009
     Total Realized and
Unrealized Gains
(Losses) Included
in Income
    Purchases, Issuances,
and Settlements
    September 30,
2010
     Amounts Related
to Held Assets (1)
 

Assets

            

Medallion loans

   $ 321,915       $ —        $ 5,510      $ 327,425       $ —     

Commercial loans

     77,922         (5,448     (7,316     65,158         (5,632

Investment in Medallion Bank and other controlled subsidiaries

     71,736         4,061        (38     75,759         4,061   

Equity investments

     2,769         534        —          3,303         534   

 

(1) Total realized and unrealized gains (losses) included in income for the 2010 nine months which relate to assets held as of September 30, 2010.

 

 

 

(Dollars in thousands)

   June 30,
2009
     Total Realized and
Unrealized Gains
(Losses) Included
in Income
    Purchases, Issuances,
and Settlements
    September 30,
2009
     Amounts Related
to Held Assets (1)
 

Assets

            

Medallion loans

   $ 375,894       $ —        ($ 34,111   $ 341,783       $ —     

Commercial loans

     82,889         (701     (401     81,787         (751

Investment in Medallion Bank and other controlled subsidiaries

     73,251         1,393        (750     73,894         1,393   

Equity investments

     2,297         360        —          2,657         360   

Other assets

     759         (36     147        870         (36

 

(1) Total realized and unrealized gains (losses) included in income for the 2009 third quarter which relate to assets held as of September 30, 2009.

 

 

 

(Dollars in thousands)

   December 31,
2008
     Total Realized and
Unrealized Gains
(Losses) Included
in Income
    Purchases, Issuances,
and Settlements
    September 30,
2009
     Amounts Related
to Held Assets (1)
 

Assets

            

Medallion loans

   $ 402,964       ($ 3   ($ 61,178   $ 341,783       $ —     

Commercial loans

     89,611         (1,265     (6,559     81,787         (1,735

Investment in Medallion Bank and other controlled subsidiaries

     71,100         1,201        1,593        73,894         1,201   

Equity investments

     3,026         (677     308        2,657         (677

Other assets

     759         (543     654        870         (543

 

(1) Total realized and unrealized gains (losses) included in income for the 2009 nine months which relate to assets held as of September 30, 2009.

 

(13) SUBSEQUENT EVENTS

On November 1, 2010, the Company’s board of directors declared a $0.15 per share common stock dividend, payable on November 23, 2010 to shareholders of record on November 16, 2010.

In October 2010, the Company extended the terms of the Stock Repurchase Program. Purchases were to commence no earlier than November 2010 and are to conclude 180 days after the commencement of the purchases.

 

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

GENERAL

We are a specialty finance company that has a leading position in originating, acquiring, and servicing loans that finance taxicab medallions and various types of commercial businesses. A wholly-owned portfolio company of ours, Medallion Bank, also originates consumer loans for the purchase of recreational vehicles, boats, motorcycles, and trailers. Since 1996, the year in which we became a public company, we have increased our taxicab medallion loan portfolio at a compound annual growth rate of 7%, and our commercial loan portfolio at a compound annual growth rate of 3% (11% and 9% on a managed basis when combined with Medallion Bank). Since Medallion Bank acquired a consumer loan portfolio and began originating consumer loans in 2004, it has increased its consumer loan portfolio at a compound annual growth rate of 13%. Total assets under our management, which includes assets serviced for third party investors and managed by Medallion Bank, were $1,059,666,000 as of September 30, 2010, and $1,039,840,000 and $1,036,883,000 as of December 31, 2009 and September 30, 2009 and have grown at a compound annual growth rate of 12% from $215,000,000 at the end of 1996. Since our initial public offering in 1996, we have paid dividends in excess of $152,105,000 or $9.70 per share.

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

 

   

Medallion Funding, an SBIC, our primary taxicab lending company;

 

   

Medallion Capital, an SBIC and a RIC, which conducts a mezzanine financing business; and

 

   

Freshstart, an SBIC and a RIC, which originates and services taxicab medallion and commercial loans.

We also conduct business through our asset-based lending division, Medallion Business Credit, an originator of loans to small businesses for the purpose of financing inventory and receivables, which prior to December 31, 2007, was a wholly-owned investment company subsidiary. On December 31, 2007, Medallion Business Credit was merged into us and ceased to exist as a separate legal entity.

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

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

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

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

In the fourth quarter of 2010, based on developments under the Code and after discussions with external advisers, our Board of Directors determined that the loans received in connection with our lending activities were “accounts or notes receivables acquired in the ordinary course of a trade or business for services” for purposes of Section 1221(a)(4) of the Code. As a result, commencing with the tax year beginning January 1, 2010, we intend to treat losses recognized on worthless loans as ordinary losses rather than as capital losses. Our Board of Directors further determined that we may take such position in tax returns subsequently filed without obtaining prior IRS approval.

The change in the characterization of a loss resulting from a worthless loan from a capital loss to an ordinary loss could materially impact the amount or character of the dividends received by our shareholders. We are required to distribute 90% of our taxable income in order to maintain our RIC status. In the event losses from worthless loans are treated as ordinary losses, those losses will offset taxable income in the taxable year in which such losses are recognized. This could result in a decrease in our taxable income which could result in a decrease in our dividend. Alternatively, if we choose to maintain our current level of dividend, an increased portion of the dividend could be deemed to be a return of capital to the shareholder.

 

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Trends in Investment Portfolio

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

 

 

    September 30, 2010     June 30, 2010     March 31, 2010     December 31, 2009     September 30, 2009  

(Dollars in thousands)

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

Medallion loans

                   

New York

    5.63   $ 250,260        5.74   $ 257,649        5.88   $ 234,051        5.90   $ 244,082        5.95   $ 260,335   

Chicago

    6.82        30,229        6.86        28,288        6.87        26,654        6.91        25,868        6.93        25,097   

Newark

    7.85        19,714        7.92        20,261        7.95        20,956        7.98        21,790        8.03        23,253   

Boston

    6.89        18,276        7.04        18,917        7.07        20,975        7.14        21,383        7.32        24,224   

Cambridge

    6.93        4,219        7.02        3,525        7.12        3,387        7.10        3,025        7.39        2,842   

Other

    7.09        4,691        7.08        4,729        7.11        5,138        7.14        5,435        7.26        5,816   
                                                 

Total medallion loans

    5.98        327,389        6.07        333,369        6.21        311,161        6.23        321,583        6.29        341,567   
                                                 

Deferred loan acquisition costs

      36          147          335          332          361   

Unrealized depreciation on loans

      —            —            —            —            —     
                                                 

Net medallion loans

    $ 327,425        $ 333,516        $ 311,496        $ 321,915        $ 341,928   
                                                 

Commercial loans

                   

Secured mezzanine

    14.09   $ 56,135        14.18   $ 60,977        14.07   $ 61,005        14.63   $ 61,834        14.54   $ 64,297   

Asset based

    5.69        8,833        5.53        8,905        5.53        9,749        5.74        8,991        5.80        9,265   

Other secured commercial

    7.53        10,161        7.71        10,642        7.83        11,091        7.95        11,706        8.04        12,389   
                                                 

Total commercial loans

    12.21        75,129        12.37        80,524        12.21        81,845        12.71        82,531        12.65        85,951   
                                                 

Deferred loan acquisition income

      (326       (286       (409       (373       (249

Unrealized depreciation on loans

      (9,645       (8,767       (7,914       (4,236       (4,060
                                                 

Net commercial loans

    $ 65,158        $ 71,471        $ 73,522        $ 77,922        $ 81,642   
                                                 

Investment in Medallion Bank and other controlled subsidiaries, net

    5.28   $ 75,759        5.40   $ 74,104        5.51   $ 72,598        5.53   $ 72,279        6.45   $ 77,544   
                                                                               

Equity investments

    1.96   $ 3,394        2.08   $ 3,394        2.32   $ 3,393        2.50   $ 3,393        3.57   $ 3,143   
                                                 

Unrealized appreciation (depreciation) on equities

      194          (34       (217       (376       (245
                                                 

Net equity investments

    $ 3,588        $ 3,360        $ 3,176        $ 3,017        $ 2,898   
                                                 

Investment securities

    —     $ —          —     $ —          —     $ —          —     $ —          —     $ —     
                                                                               

Investments at cost (2)

    6.82   $ 481,671        6.77   $ 491,391        7.12   $ 468,997        7.22   $ 479,786        7.38   $ 508,205   
                                                 

Deferred loan acquisition (income) costs

      (290       (139       (74       (41       112   

Unrealized appreciation (depreciation) on equities

      194          (34       (217       (376       (245

Unrealized depreciation on loans

      (9,645       (8,767       (7,914       (4,236       (4,060
                                                 

Net investments

    $ 471,930        $ 482,451        $ 460,792        $ 475,133        $ 504,012   
                                                 

Medallion Bank investments

                   

Medallion loans

    5.68   $ 247,646        5.85   $ 218,252        6.10   $ 171,087        6.15   $ 160,403        6.23     143,186   

Consumer loans

    17.95        194,056        17.94        194,024        17.93        189,489        17.96        193,382        18.01      $ 197,563   

Commercial loans

    5.86        66,838        5.77        68,777        5.84        73,427        5.84        72,540        5.88        74,584   

Investment securities

    3.50        21,036        3.67        21,556        3.36        19,009        3.99        20,784        3.92        18,632   
                                                 

Medallion Bank investments at cost (2)

    10.11        529,576        10.41        502,609        10.89        453,012        11.11        447,109        11.43        433,965   
                                                 

Deferred loan acquisition costs

      5,893          5,782          5,585          5,633          5,732   

Unrealized appreciation (depreciation) on investment securities

      582          603          280          92          222   

Premiums paid on purchased securities

      180          144          162          185          178   

Unrealized depreciation on loans

      (14,010       (14,214       (13,829       (13,610       (12,860
                                                 

Medallion Bank net investments

    $ 522,221        $ 494,924        $ 445,210        $ 439,409        $ 427,237   

 

(1) Represents the weighted average interest or dividend rate of the respective portfolio as of the date indicated.
(2) The weighted average interest rate for the entire managed loan portfolio (medallion, commercial, and consumer loans) was 8.95%, 9.14%, 9.44%, 9.56%, and 9.64% at September 30, 2010, June 30, 2010, March 31, 2010, December 31, 2009, and September 30, 2009.

 

 

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Investment Activity

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

 

 

     Three Months Ended September 30,     Nine Months Ended September 30,  

(Dollars in thousands)

               2010                              2009                              2010                              2009               

Net investments at beginning of period

   $ 482,451      $ 538,199      $ 475,133      $ 570,597   

Investments originated

     53,411        42,826        139,563        132,010   

Repayments of investments

     (65,145     (77,937     (140,866     (196,709

Net realized gains (losses) on investments (1)

     (186     26        (8,297     (2,321

Net increase in unrealized appreciation (depreciation) (2)

     1,286        898        6,148        923   

Transfers (to) from other assets

     —          —          —          (480

(Amortization) accretion of origination costs

     113        —          249        (8
                                

Net decrease in investments

     (10,521     (34,187     (3,203     (66,585
                                

Net investments at end of period

   $ 471,930      $ 504,012      $ 471,930      $ 504,012   

 

(1) Excludes net realized losses of $779 for the nine months ended September 30, 2010, related to the investment in SPAC 2, and net realized gains of $460 and $917 for the third quarter and nine months ended September 30, 2009, related to foreclosed properties, which were carried in other assets on the consolidated balance sheet.
(2) Excludes the reversal of unrealized depreciation of $759 for the nine months ended September 30, 2010 related to the realized loss of the SPAC 2 investment, and net unrealized appreciation (depreciation) of ($40) and $1,202 for the quarter and nine months ended September 30, 2010, and ($496) and $1,236 for the comparable 2009 periods, related to foreclosed properties, which were carried in other assets on the consolidated balance sheet.

 

Portfolio Summary

Total Portfolio Yield

The weighted average yield of the total portfolio at September 30, 2010 was 6.82% (7.15% for the loan portfolio), a decrease of 40 basis points from 7.22% at December 31, 2009, and a decrease of 56 basis points from 7.38% at September 30, 2009. The weighted average yield of the total managed portfolio at September 30, 2010 was 8.77%, (8.95% for the loan portfolio), a decrease of 58 basis points from 9.35% at December 31, 2009, and a decrease of 61 basis points from 9.38% at September 30, 2009. The decreases from 2009 reflected the general market condition of falling interest rates, the changes in the portfolio mix, and portfolio repricing.

Medallion Loan Portfolio

Our medallion loans comprised 69% of the net portfolio of $471,930,000 at September 30, 2010, compared to 68% of the net portfolio of $475,133,000 at December 31, 2009, and 68% of $504,012,000 at September 30, 2009. Our managed medallion loans of $574,935,000 comprised 63% of the net managed portfolio of $922,317,000 at September 30, 2010, compared to 57% of the net managed portfolio of $846,542,000 at December 31, 2009, and 56% of $864,233,000 at September 30, 2009. The medallion loan portfolio increased by $5,509,000 or 2% in 2010 (an increase of $92,848,000 or 19% on a managed basis), primarily reflecting loan growth in New York and Chicago, the sourcing of most new business to Medallion Bank, and the reduction of sold participation interests to third parties. Total medallion loans serviced for third parties were $53,568,000, $102,307,000, and $93,779,000 at September 30, 2010, December 31, 2009, and September 30, 2009.

The weighted average yield of the medallion loan portfolio at September 30, 2010 was 5.98%, a decrease of 25 basis points from 6.23% at December 31, 2009, and a decrease of 31 basis points from 6.29% at September 30, 2009. The weighted average yield of the managed medallion loan portfolio at September 30, 2010 was 5.85%, a decrease of 35 basis points from 6.20% at December 31, 2009, and a decrease of 42 basis points from 6.27% at September 30, 2009. The decrease in yield primarily reflected the effects of borrower refinancings at the current lower market interest rates. At September 30, 2010, December 31, 2009, and September 30, 2009, 24% of the medallion loan portfolio represented loans outside New York. At September 30, 2010, 23% of the managed medallion loan portfolio represented loans outside New York, compared to 25% at December 31, 2009 and September 30, 2009. We continue to focus our efforts on originating higher yielding medallion loans outside the New York market.

Commercial Loan Portfolio

Our commercial loans represented 14%, 16%, and 16% of the net investment portfolio as of September 30, 2010, December 31, 2009, and September 30, 2009, and were 14%, 18%, and 18% on a managed basis. Commercial loans decreased by $12,764,000 or 16% during 2010 (decreased $18,192,000 or 12% on a managed basis), primarily reflecting loan repayments and an increase in unrealized depreciation in the mezzanine loan portfolio, and on managed basis, also by decreases in the asset-based portfolio at Medallion Bank. Net commercial loans serviced by third parties were $11,930,000 at September 30, 2010, $13,376,000 at December 31, 2009, and $13,270,000 at September 30, 2009.

 

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The weighted average yield of the commercial loan portfolio at September 30, 2010 was 12.21%, a decrease of 50 basis points from 12.71% at December 31, 2009, and a decrease of 44 basis points from 12.65% at September 30, 2009. The weighted average yield of the managed commercial loan portfolio at September 30, 2010 was 9.22%, a decrease of 28 basis points from 9.50% at December 31, 2009, and a decrease of 29 basis points from 9.51% at September 30, 2009. The decreases reflect rate reductions in the mezzanine loan portfolio related to certain restructurings. We continue to originate adjustable-rate and floating-rate loans tied to the prime rate to help mitigate our interest rate risk in a rising interest rate environment. At September 30, 2010, variable-rate loans represented approximately 18% of the commercial portfolio, compared to 17% and 18% at December 31, 2009 and September 30, 2009, and were 54%, 55%, and 55% on a managed basis. Although this strategy initially produces a lower yield, we believe that this strategy mitigates interest rate risk by better matching our earning assets to their adjustable-rate funding sources.

Consumer Loan Portfolio

Our managed consumer loans, all of which are held in the portfolio managed by Medallion Bank, represented 20%, 22%, and 22% of the managed net investment portfolio as of September 30, 2010, December 31, 2009, and September 30, 2009. Medallion Bank originates adjustable rate consumer loans secured by recreational vehicles, boats, motorcycles, and trailers located in all 50 states. The portfolio is serviced by a third party subsidiary of a major commercial bank.

The weighted average gross yield of the managed consumer loan portfolio was 17.95% at September 30, 2010, compared to 17.96% and 18.01% at December 31, 2009 and September 30, 2009. Adjustable rate loans represented 83% of the managed consumer portfolio at September 30, 2010, compared to 85% and 86% at December 31, 2009 and September 30, 2009.

Delinquency and Loan Loss Experience

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

For the consumer loan portfolio, the process to repossess the collateral is started at 60 days past due. If the collateral is not located and the account reaches 120 days delinquent, the account is charged off to realized losses. If the collateral is repossessed, a realized loss is recorded to write the collateral down to 75% of its net realizable value, and the collateral is sent to auction. When the collateral is sold, the net auction proceeds are applied to the account, and any remaining balance is written off as a realized loss, and any excess proceeds are recorded as a realized gain. Proceeds collected on charged off accounts are recorded as realized gains. All collection, repossession, and recovery efforts are handled on behalf of Medallion Bank by the servicer.

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

 

 

     September 30, 2010     June 30, 2010     March 31, 2010     December 31, 2009     September 30, 2009  

(Dollars in thousands)

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

Medallion loans

   $ 104         0.0   $ 217         0.0   $ 1,764         0.4   $ 1,090         0.3   $ 810         0.2

Commercial loans

                         

Secured mezzanine

     11,101         2.8        9,791         2.4        4,117         1.1        6,600         1.6        10,544         2.4   

Asset-based receivable

     —           0.0        —           0.0        —           0.0        —           0.0        —           0.0   

Other secured commercial

     878         0.2        948         0.2        510         0.1        295         0.1        295         0.1   
                                                                                     

Total commercial loans

     11,979         3.0        10,739         2.6        4,627         1.2        6,895         1.7        10,839         2.5   
                                                                                     

Total loans 90 days or more past due

   $ 12,083         3.0   $ 10,956         2.6   $ 6,391         1.6   $ 7,985         2.0   $ 11,649         2.7
                                                                                     

Total Medallion Bank loans

   $ 2,513         0.5   $ 2,229         0.5   $ 4,248         1.0   $ 3,861         0.9   $ 3,917         0.9
                                                                                     

Total managed loans 90 days or more past due

   $ 14,596         1.6   $ 13,185         1.5   $ 10,639         1.3   $ 11,846         1.4   $ 15,566         1.8

 

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

 

 

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In general, collection efforts since the establishment of our collection department have contributed to the reduction in overall delinquencies of medallion and other secured commercial loans. Medallion loan delinquencies decreased due to improved market conditions. Secured mezzanine delinquencies increased as more borrowers conserved cash to fund operating shortages. Other commercial delinquencies decreased slightly reflecting the slight progression of the current state of the economy. Medallion Bank loan delinquencies increased due to the seasonality in consumer portfolios, but decreased from the first quarter due to improvement as a result of resolution of problem commercial loans. We are actively working with each delinquent borrower to bring them current, and believe that any potential loss exposure is reflected in our mark-to-market estimates on each loan. Although there can be no assurances as to changes in the trend rate and further negative changes in the economy, management believes that any loss exposures are properly reflected in reported asset values.

We monitor delinquent loans for possible exposure to loss by analyzing various factors, including the value of the collateral securing the loan and the borrower’s prior payment history. Under the 1940 Act, our loan portfolio must be recorded at fair value or “marked-to-market.” Unlike other lending institutions, we are not permitted to establish reserves for loan losses. Instead, the valuation of our portfolio is adjusted quarterly to reflect our estimate of the current realizable value of our loan portfolio. Since no ready market exists for this portfolio, fair value is subject to the good faith determination of management and the approval of our Board of Directors. Because of the subjectivity of these estimates, there can be no assurance that in the event of a foreclosure or the sale of portfolio loans we would be able to recover the amounts reflected on our balance sheet.

In determining the value of our portfolio, management and the Board of Directors may take into consideration various factors such as the financial condition of the borrower and the adequacy of the collateral. For example, in a period of sustained increases in market interest rates, management and the Board of Directors could decrease its valuation of the portfolio if the portfolio consists primarily of long-term, fixed-rate loans. Our valuation procedures are designed to generate values that approximate that which would have been established by market forces, and are therefore subject to uncertainties and variations from reported results. Based upon these factors, net unrealized appreciation or depreciation on investments is determined, or the amount by which our estimate of the current realizable value of our portfolio is above or below our cost basis.

The following tables set forth the changes in our unrealized appreciation (depreciation) on investments, other than investments in controlled subsidiaries, for the 2010 and 2009 periods shown below.

 

 

(Dollars in thousands)

   Loans     Equity
Investments
    Foreclosed
Properties
    Total  

Balance December 31, 2009

   ($ 4,236   ($ 8,101   $ 18,956      $ 6,619   

Net change in unrealized

        

Appreciation on investments

     —          162        1,516        1,678   

Depreciation on investments

     (3,678     (510     —          (4,188

Reversal of unrealized appreciation (depreciation) related to realized

        

Gains on investments

     —          —          —          —     

Losses on investments (1)

     —          8,232        —          8,232   
                                

Balance March 31, 2010

     (7,914     (217     20,472        12,341   

Net change in unrealized

        

Appreciation on investments

     —          159        (274     (115

Depreciation on investments

     (853     24        —          (829

Reversal of unrealized appreciation (depreciation) related to realized

        

Gains on investments

     —          —          —          —     

Losses on investments

     —          —          —          —     
                                

Balance June 30, 2010

     (8,767     (34     20,198        11,397   

Net change in unrealized

        

Appreciation on investments

     —          212        (40     172   

Depreciation on investments

     (1,069     16        —          (1,053

Reversal of unrealized appreciation (depreciation) related to realized

        

Gains on investments

     —          —          —          —     

Losses on investments

     191        —          —          191   
                                

Balance September 30, 2010

   ($ 9,645   $ 194      $ 20,158      $ 10,707   

 

(1) Represents the writeoffs $7,725 related to the investments in SPAC and SPAC 2. See Note 10 for additional information on these investments.

 

 

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(Dollars in thousands)

   Loans     Equity
Investments
    Foreclosed
Properties
    Total  

Balance December 31, 2008

   ($ 5,115   $ 437      $ 15,614      $ 10,936   

Increase in unrealized

        

Appreciation on investments

     —          (656     1,837        1,181   

Depreciation on investments

     (621     (63     —          (684

Reversal of unrealized appreciation (depreciation) related to realized

        

Gains on investments

     —          —          —          —     

Losses on investments

     370        —          —          370   
                                

Balance March 31, 2009

     (5,366     (282     17,451        11,803   

Increase in unrealized

        

Appreciation on investments

     —          101        815        916   

Depreciation on investments

     (366     (447     (481     (1,294

Reversal of unrealized appreciation (depreciation) related to realized

        

Gains on investments

     —          —          (440     (440

Losses on investments

     2,000        —          —          2,000   

Reclassification of unrealized depreciation

     400        —          (400     —     
                                

Balance June 30, 2009

     (3,332     (628     16,945        12,985   

Increase in unrealized

        

Appreciation on investments

     —          360        —          360   

Depreciation on investments

     (751     23        (36     (764

Reversal of unrealized appreciation (depreciation) related to realized

        

Gains on investments

     —          —          (460     (460

Losses on investments

     23        —          —          23   
                                

Balance September 30, 2009

   ($ 4,060   ($ 245   $ 16,449      $ 12,144   

 

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

 

 

(Dollars in thousands)

   September 30,
2010
    June 30,
2010
    March 31,
2010
    December 31,
2009
    September 30,
2009
 

Total loans

          

Medallion loans

   $ 327,425      $ 333,516      $ 311,496      $ 321,915      $ 341,928   

Commercial loans

     65,158        71,471        73,522        77,922        81,642   
                                        

Total loans

     392,583        404,987        385,018        399,837        423,570   

Investment in Medallion Bank and other controlled subsidiaries

     75,759        74,104        72,598        72,279        77,544   

Equity investments (1)

     3,588        3,360        3,176        3,017        —     

Investment securities

     —          —          —          —          2,898   
                                        

Net investments

   $ 471,930      $ 482,451      $ 460,792      $ 475,133      $ 504,012   
                                        

Net investments at Medallion Bank and other controlled subsidiaries

   $ 522,221      $ 494,924      $ 445,210      $ 439,409      $ 427,237   

Managed net investments

   $ 922,317      $ 906,934      $ 837,087      $ 846,542      $ 864,233   
                                        

Unrealized appreciation (depreciation) on investments

          

Medallion loans

   $ —        $ —        $ —        $ —        $ —     

Commercial loans

     (9,645     (8,767     (7,914     (4,236     (4,060
                                        

Total loans

     (9,645     (8,767     (7,914     (4,236     (4,060

Investment in Medallion Bank and other controlled subsidiaries (2)

     —          —          —          —          —     

Equity investments

     194        (34     (217     (376     (245

Investment securities

     —          —          —          —          —     
                                        

Total unrealized depreciation on investments (2)

   ($ 9,451   ($ 8,801   ($ 8,131   ($ 4,612   ($ 4,305
                                        

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

   ($ 13,428   ($ 13,611   ($ 13,549   ($ 13,519   ($ 12,639

Managed total unrealized depreciation on investments (2)

   ($ 22,879   ($ 22,412   ($ 21,680   ($ 18,131   ($ 16,944
                                        

Unrealized appreciation (depreciation) as a % of balances outstanding (3)

          

Medallion loans

     —       —       —       —       —  

Commercial loans

     (12.84     (10.86     (9.67     (5.13     (4.72

Total loans

     (2.40     (2.12     (2.01     (1.05     (0.95

Investment in Medallion Bank and other controlled subsidiaries

     —          —          —          —          —     

Equity investments

     5.74        (0.99     (6.40     (11.10     (7.80

Investment securities

     —          —          —          —          —     

Net investments

     (1.96     (1.79     (1.73     (0.96     (0.85
                                        

Net investments at Medallion Bank and other controlled subsidiaries

     (2.54 %)      (2.71 %)      (2.99 %)      (3.02 %)      (2.91 %) 

Managed net investments

     (2.44 %)      (2.43 %)      (2.54 %)      (2.11 %)      (1.94 %) 

 

(1) Represents common stock and warrants held as investments.
(2) Excludes $0, $0, $0, $6,966, and $0 for unrealized depreciation on the SPAC, and $1,448, $1,448, $1,523, $1,593, and $1,633 for unrealized appreciation on Medallion Hamptons Holding, a wholly-owned subsidiary, at September 30, 2010, June 30, 2010, March 31, 2010, December 31, 2009, and September 30, 2009.
(3) Unlike other lending institutions, we are not permitted to establish reserves for loan losses. Instead, the valuation of our portfolio is adjusted quarterly to reflect estimates of the current realizable value of the loan portfolio. These percentages represent the discount or premium that investments are 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 portfolios for the three and nine months ended September 30, 2010 and 2009.

 

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 

(Dollars in thousands)

   2010     2009     2010     2009  

Realized gains (losses) on loans and equity investments (1)

        

Medallion loans

   $ —        $ 460      $ —        $ 915   

Commercial loans

     (186     26        (39     (2,319
                                

Total loans

     (186     486        (39     (1,404

Investment in Medallion Bank and other controlled subsidiaries (2)

     —          —          (8,258     —     

Equity investments

     —          —          —          —     

Investment securities

     —          —          —          —     
                                

Total realized gains (losses) on loans and equity investments (2)

     (186     486        (8,297     (1,404
                                

Net realized gains (losses) on investments at Medallion Bank and other controlled subsidiaries

     (2,584     (2,465     (8,483     (7,548
                                

Total managed realized gains (losses) on loans and equity investments (2)

   ($ 2,770   ($ 1,979   ($ 16,780   ($ 8,952
                                

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

        

Medallion loans

     —       0.52     —       0.32

Commercial loans

     (0.96     0.12        (0.06     (3.40

Total loans

     (0.18     0.44        (0.01     (0.40

Investment in Medallion Bank and other controlled subsidiaries

     —          —          (14.93     —     

Equity investments

     —          —          —          —     

Investment securities

     —          —          —          —     

Net investments

     (0.15     0.37        (2.32     (0.34
                                

Net investments at Medallion Bank and other controlled subsidiaries

     (1.98     (2.27     (2.36     (2.39

Managed net investments

     (1.18 %)      (0.89 %)      (2.52 %)      (1.32 %) 

 

(1) Includes $460 and $917 of realized gains for three and nine months ended September 30, 2009, related to foreclosed properties, which are carried in other assets on the consolidated balance sheet.
(2) Excludes $779 of net realized losses for the nine months ended September 30, 2010, related to the investment in SPAC 2, which was carried in other assets on the consolidated balance sheet.

 

The table below summarizes components of unrealized and realized gains and losses in the investment portfolio for the three and nine months ended September 30, 2010 and 2009.

 

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 

(Dollars in thousands)

   2010     2009     2010     2009  

Net change in unrealized appreciation (depreciation) on investments

        

Unrealized appreciation

   $ 213      $ 360      $ 534      ($ 195

Unrealized depreciation

     (1,053     (728     (5,563     (2,225

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

     1,975        1,243        11,026        951   

Realized gains

     —          —          —          —     

Realized losses (2)

     191        23        950        2,392   

Unrealized gains (losses) on foreclosed properties

     (40     (496     1,202        1,236   
                                

Total

   $ 1,286      $ 402      $ 8,149      $ 2,159   
                                

Net realized gains (losses) on investments

        

Realized gains

   $ —        $ —        $ —        $ —     

Realized losses (3)

     (191     (23     (8,423     (2,392

Other gains

     —          —          141        —     

Direct recoveries (chargeoffs) (4)

     5        49        (794     71   

Realized gains on foreclosed properties

     —          460        —          917   
                                

Total

   ($ 186   $ 486      ($ 9,076   ($ 1,404

 

(1) Includes $6,966 of net unrealized depreciation related to the investment in SPAC, including $508 that was recorded during the 2010 first quarter, that was reversed during the 2010 first quarter, upon the writeoff of the SPAC investment.
(2) Includes $759 related to the writeoff of the investment in SPAC 2 in the 2010 first quarter.
(3) Represents the writeoff related to the investments in SPAC and SPAC 2 in the 2010 first quarter. See Note 10 for additional information on these investments.
(4) Includes $817 of direct chargeoffs related to the settlement of the liabilities associated with the writeoff of SPAC and SPAC 2 in the 2010 nine months, all of which represented a reversal of accrued expenses.

 

 

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Investment in Medallion Bank and Other Controlled Subsidiaries

Investment in Medallion Bank and other controlled subsidiaries were 16%, 15%, and 15% of our total portfolio at September 30, 2010, December 31, 2009, and September 30, 2009. The portfolio company investments primarily represent the wholly-owned unconsolidated subsidiaries of ours, substantially all of which is represented by our investment in Medallion Bank, a non-pass-through, taxpaying entity. We are currently in discussions with the IRS to obtain LLC tax treatment for Medallion Bank, which would provide “pass-through” taxation for our shareholders, and which has already been agreed to by the State of Utah. We cannot assure you that we will be successful in our efforts, but if we are successful, this treatment would reduce taxes and increase the reported net income of Medallion Bank. In addition, to facilitate maintenance of Medallion Bank’s capital ratio requirement and to provide the necessary capital for continued growth, we periodically make capital contributions to Medallion Bank, including $1,750,000 contributed in the 2009 first quarter. Separately, Medallion Bank paid dividends to us of $1,000,000 in the 2010 and 2009 third quarters, and $3,000,000 in the 2010 and 2009 nine months. See Note 3 of the consolidated financial statements for additional information about these investments.

Equity Investments

Equity investments were 1% of our total portfolio at September 30, 2010, December 31, 2009, and September 30, 2009. Equity investments were less than 1%, 1%, and 1% of our total managed portfolio at September 30, 2010, December 31, 2009, and September 30, 2009. Equity investments are comprised of common stock, partnership interests, and warrants.

Investment Securities

Investment securities were 0% of our total portfolio at September 30, 2010, December 31, 2009, and September 30, 2009. Investment securities were 2% of our total managed portfolio at September 30, 2010, December 31, 2009, and September 30, 2009. The investment securities are primarily adjustable-rate mortgage-backed securities purchased by Medallion Bank to better utilize required cash liquidity.

Trend in Interest Expense

Our interest expense is driven by the interest rates payable on our short-term credit facilities with banks, bank certificates of deposit, fixed-rate, long-term debentures issued to the SBA, and other short-term notes payable. We established a medallion lending relationship with DZ Bank in December 2008, that provides for growth in the portfolio at generally lower rates than under prior facilities all of which have been fully paid off. In addition, Medallion Bank began raising brokered bank certificates of deposit during 2004, which were at our lowest borrowing costs. As a result of Medallion Bank raising funds through certificates of deposits as previously noted, we were able to realign the ownership of some of our medallion loans and related assets to Medallion Bank allowing us and our subsidiaries to use cash generated through these transactions to retire debt with higher interest rates. In addition, 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 4 to the consolidated financial statements for details on the terms of all outstanding debt. Our debentures issued to the SBA typically have terms of ten years.

 

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We measure our borrowing costs as our aggregate interest expense for all of our interest-bearing liabilities divided by the average amount of such liabilities outstanding during the period. The following table shows the average borrowings and related borrowing costs for the three and nine months ended September 30, 2010 and 2009. Our average balances decreased and Medallion Bank’s average balances increased reflecting the sourcing of more business to Medallion Bank, and an increase in loan participations sold. The decrease in borrowing costs reflected the trend of decreasing interest rates in the economy.

 

 

     Three Months Ended     Nine Months Ended  

(Dollars in thousands)

   Interest
Expense
     Average
Balance
     Average
Borrowing
Costs
    Interest
Expense
     Average
Balance
     Average
Borrowing
Costs
 

September 30, 2010

                

Revolving lines of credits

   $ 931       $ 182,272         2.03   $ 2,456       $ 182,410         1.80

SBA debentures

     1,410         83,805         6.68        4,259         86,752         6.56   

Notes payable to banks

     863         72,335         4.73        2,475         64,184         5.16   

Preferred securities

     634         33,000         7.62        1,903         33,000         7.71   
                                        

Total

   $ 3,838       $ 371,412         4.10      $ 11,093       $ 366,346         4.05   
                                        

Medallion Bank borrowings

   $ 1,874       $ 441,490         1.68      $ 5,624       $ 402,393         1.87   
                                        

Total managed borrowings

   $ 5,712       $ 812,902         2.79      $ 16,717       $ 768,739         2.91   
                                                    

September 30, 2009

                

Revolving lines of credit

   $ 1,439       $ 229,372         2.49   $ 5,389       $ 267,619         2.69

SBA debentures

     1,438         88,250         6.47        4,287         88,250         6.50   

Preferred securities

     634         33,000         7.62        1,903         33,000         7.71   

Notes payable to banks

     663         48,553         5.42        1,477         41,830         4.72   
                                        

Total

   $ 4,174       $ 399,175         4.15      $ 13,056       $ 430,699         4.05   
                                        

Medallion Bank borrowings

   $ 2,533       $ 366,972         2.74      $ 8,908       $ 358,676         3.32   
                                        

Total managed borrowings

   $ 6,707       $ 766,147         3.47      $ 21,964       $ 789,375         3.72   

 

We will continue to seek SBA funding 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 Small Business Investment Act (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, 2010 and 2009, short-term adjustable rate debt constituted 69% and 72% of total debt, and was 31% and 38% on a fully managed basis including the borrowings of Medallion Bank, reflecting the payoff of the floating rate Citi borrowings and its partial replacement with fixed rate debt.

Factors Affecting Net Assets

Factors that affect our net assets include net realized gain or loss on investments and change in net unrealized appreciation or depreciation on investments. Net realized gain or loss on investments is the difference between the proceeds derived upon sale or foreclosure of a loan or an equity investment and the cost basis of such loan or equity investment. Change in net unrealized appreciation or depreciation on investments is the amount, if any, by which our estimate of the fair value of our investment portfolio is above or below the previously established fair value or the cost basis of the portfolio. Under the 1940 Act and the SBIA, our loan portfolio and other investments must be recorded at fair value.

Unlike certain lending institutions, we are not permitted to establish reserves for loan losses, but adjust quarterly the valuation of the loan portfolio to reflect our estimate of the current value of the total loan portfolio. Since no ready market exists for our loans, fair value is subject to our good faith determination. In determining such fair value, we and our Board of Directors consider factors such as the financial condition of its borrowers and the adequacy of their collateral. Any change in the fair value of portfolio loans or other investments as determined by us is reflected in net unrealized depreciation or appreciation of investments and affects net increase in net assets resulting from operations but has no impact on net investment income or distributable income.

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

 

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SELECTED FINANCIAL DATA

Summary Consolidated Financial Data

You should read the consolidated financial information below with the Consolidated Financial Statements and Notes thereto for the three and nine months ended September 30, 2010 and 2009.

 

 

     Three Months Ended September 30,     Nine Months Ended September 30,  

(Dollars in thousands, except per share data)

   2010     2009     2010     2009  

Statement of operations

        

Investment income

   $ 9,553      $ 10,196      $ 28,143      $ 31,544   

Interest expense

     3,838        4,174        11,093        13,056   
                                

Net interest income

     5,715        6,022        17,050        18,488   

Noninterest income

     1,340        963        3,287        2,427   

Operating expenses (1)

     4,687        4,984        12,799        14,889   
                                

Net investment income before income taxes

     2,368        2,001        7,538        6,026   

Income tax (provision) benefit

     —          —          —          —     
                                

Net investment income after income taxes

     2,368        2,001        7,538        6,026   

Net realized gains (losses) on investments

     (186     486        (9,076     (1,404

Net change in unrealized appreciation on Medallion Bank and other controlled subsidiaries (2)

     1,975        1,243        11,026        951   

Net change in unrealized appreciation (depreciation) on investments (2)

     (689     (841     (2,877     1,208   
                                

Net increase in net assets resulting from operations

   $ 3,468      $ 2,889      $ 6,611      $ 6,781   
                                

Per share data

        

Net investment income

   $ 0.14      $ 0.11      $ 0.42      $ 0.34   

Income tax (provision) benefit

     —          —          —          —     

Net realized gains (losses) on investments

     (0.01     0.03        (0.51     (0.08

Net change in unrealized appreciation on investments (2)

     0.07        0.02        0.46        0.12   
                                

Net increase in net assets resulting from operations

   $ 0.20      $ 0.16      $ 0.37      $ 0.38   
                                

Dividends declared per share

   $ 0.15      $ 0.19      $ 0.45      $ 0.57   
                                

Weighted average common shares outstanding

        

Basic

     17,472,385        17,575,877        17,535,826        17,567,602   

Diluted

     17,579,269        17,708,892        17,659,628        17,683,571   
                                
Balance sheet data                September 30, 2010     December 31, 2009  

Net investments

       $ 471,930      $ 475,133   

Total assets

         541,605        555,174   

Total funds borrowed

         373,679        382,522   

Total liabilities

         380,961        392,197   

Total shareholders’ equity

         160,644        162,977   
                    

Managed balance sheet data (3)

        

Net investments

       $ 922,317      $ 846,542   

Total assets

         1,018,028        950,909   

Total funds borrowed

         825,947        754,241   

Total liabilities

         857,385        787,932   

 

 

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     Three Months Ended September 30,     Nine Months Ended September 30,  
     2010     2009     2010     2009  

Selected financial ratios and other data

        

Return on average assets (ROA) (4)

        

Net investment income after taxes

     1.71     1.36     1.86     1.31

Net increase in net assets resulting from operations

     2.51        1.96        1.63        1.48   

Return on average equity (ROE) (5)

        

Net investment income after taxes

     5.84        4.61        6.24        4.64   

Net increase in net assets resulting from operations

     8.56        6.65        5.47        5.22   
                                

Weighted average yield

     7.97     7.84     7.99     7.73

Weighted average cost of funds

     3.20        3.21        3.15        3.20   
                                

Net interest margin (6)

     4.77        4.63        4.84        4.53   
                                

Noninterest income ratio (7)

     1.12     0.74     0.93     0.59

Total expense ratio (1) (9)

     7.11        7.02        6.78        6.78   

Operating expense ratio (1) (9)

     3.91        3.82        3.63        3.61   
                                
As a percentage of net investment portfolio                September 30, 2010     December 31, 2009  

Medallion loans

         69     68

Commercial loans

         14        16   

Investment in Medallion Bank and other controlled subsidiaries

         16        15   

Equity investments

         1        1   

Investment securities

         —          —     
                    

Investments to assets (10)

         87     86

Equity to assets (11)

         30        29   

Debt to equity (12)

         233        235   

 

(1) Includes $1,312 of expense reversals related to the costs of winding up the operations of the SPAC’s in the 2010 nine months that were reclassified to realized losses on investments, and $310 that was reversed as a result of favorable negotiations with the creditors of SPAC. Excluding these charges, the total expense ratio was 7.24%, and the operating expense ratio was 4.09%.
(2) 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.
(3) Includes the balances of wholly-owned, unconsolidated portfolio companies, primarily Medallion Bank.
(4) ROA represents the net investment income after taxes or net increase in net assets resulting from operations, divided by average total assets.
(5) ROE represents the net investment income after taxes or net increase in net assets resulting from operations, divided by average shareholders’ equity.
(6) Net interest margin represents net interest income for the period divided by average interest earning assets, and included interest recoveries and bonuses of $977 and $1,847 in the three and nine months ended September 30, 2010, and $422 and $1,116 for the comparable 2009 periods, and also included $1,000 and $3,000 of dividends from Medallion Bank for the same 2010 periods, and $1,000 and $3,000 for the comparable 2009 periods. On a managed basis, combined with Medallion Bank, the net interest margin was 6.55% and 6.64% for the 2010 three and nine months, and was 6.30% and 5.94% for the 2009 periods.
(7) Noninterest income ratio represents noninterest income divided by average interest earning assets.
(8) Total expense ratio represents total expenses (interest expense, operating expenses, and income taxes) divided by average interest earning assets.
(9) Operating expense ratio represents operating expenses divided by average interest earning assets.
(10) Represents net investments divided by total assets as of the period indicated.
(11) Represents total shareholders’ equity divided by total assets as of the period indicated.
(12) Represents total funds borrowed divided by total shareholders’ equity as of the period indicated.

 

Consolidated Results of Operations

2010 Third quarter and nine months compared to the 2009 periods

Net increase in net assets resulting from operations was $3,468,000 or $0.20 per diluted common share and $6,611,000 or $0.37 in the 2010 third quarter and nine months, up $579,000 or 20% and down $170,000 or 2% from $2,889,000 or $0.16 per share and $6,781,000 or $0.38 in the 2009 third quarter and nine months. The 2010 third quarter increase primarily reflected higher noninterest income, lower operating expenses, and higher net realized/unrealized gains, partially offset by lower net interest income. The decrease in the 2010 nine months also reflected higher net realized/unrealized losses. Net investment income after taxes was $2,368,000 or $0.13 per share and $7,538,000 or $0.43 in the 2010 quarter and nine months, up $367,000 and $1,512,000 from $2,001,000 or $0.11 per share and $6,026,000 or $0.34 in the 2009 periods.

Investment income was $9,553,000 and $28,143,000 in the 2010 third quarter and nine months, down $643,000 or 6% and $3,401,000 or 11% from $10,196,000 and $31,544,000 in the year ago periods, and included $977,000 and $1,847,000 from interest recoveries and bonuses on certain investments in the 2010 quarter and nine months, compared to $422,000 and $1,116,000 in the 2009 periods. Also included in the 2010 quarter and nine months was $1,000,000 and $3,000,000 in dividends from Medallion Bank, compared to $1,000,000 and $3,000,000 in the 2009 third quarter and nine months. Excluding those items, investment income decreased $1,198,000 or 14% in the quarter and $4,132,000 or 15% in the nine months, primarily reflecting loan participations sold and loan prepayments, and to a lesser extent, changes in the yields earned. The yield on the investment portfolio was 7.97% in the

 

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2010 quarter, up 2% from 7.84% in 2009, and was 7.99% in the 2010 nine months, up 3% from 7.73% in the 2009 nine months. Excluding the extra interest and dividends, the 2010 third quarter and nine months yields were down 6% and 2% to 6.32% and 6.61%, from 6.75% and 6.72% in the 2009 quarter and nine months, reflecting the general decrease in market interest rates and changes in the portfolio mix. Average investments outstanding were $475,566,000 and $470,854,000 in the 2010 quarter and nine months, down 8% and 14% from $515,934,000 and $545,939,000 in the year ago periods, primarily reflecting loan participations sold and loan prepayments.

Medallion loans were $327,425,000 at quarter end, down $14,503,000 or 4% from $341,928,000 a year ago, representing 69% of the investment portfolio compared to 68% a year ago, and were yielding 5.98% compared to 6.29% a year ago, a decrease of 5%. The decrease in outstandings primarily reflected sold participations and repayments, partially offset by portfolio growth. The managed medallion portfolio, which includes loans at Medallion Bank and those serviced for third parties, was $628,504,000 at quarter end, up $50,015,000 or 9% from $578,489,000 a year ago, reflecting the above and the strong overall portfolio growth at Medallion Bank. The commercial loan portfolio was $65,158,000 at quarter end, compared to $81,641,000 a year ago, a decrease of $16,483,000 or 20%, and represented 14% of the investment portfolio, compared to 16% a year ago. The decrease primarily reflected repayments and reserve increases in the high-yield mezzanine loan portfolio. Commercial loans yielded 12.21% at quarter end, down 3% from 12.65% a year ago, reflecting the reduced share of high-yield mezzanine loans. The net managed commercial loan portfolio, which includes loans at Medallion Bank and those serviced for or by third parties, was $119,266,000 at quarter end, down $22,761,000 or 16% from $142,027,000 a year ago, primarily reflecting the changes described above and several large payoffs in Medallion Bank’s asset-based portfolio. Investments in Medallion Bank and other controlled subsidiaries were $75,759,000 at quarter end, down $1,785,000 or 2% from $77,544,000 a year ago, primarily reflecting the writeoff of the SPAC investment, partially offset by our equity in the earnings of Medallion Bank, and which represented 16% of the investment portfolio, compared to 15% a year ago, and which yielded 5.28% at quarter end, compared to 6.45% a year ago. See Notes 3 and 10 of the consolidated financial statements for additional information about Medallion Bank and the other controlled subsidiaries. Equity investments were $3,588,000 at quarter end, up $690,000 or 24% from $2,898,000 a year ago, primarily reflecting portfolio appreciation, and represented 1% of the investment portfolio at both quarter ends, and had a dividend yield of 1.96%, compared to 3.57% a year ago. Investment securities were zero at both quarter ends. See page 30 for a table that shows balances and yields by type of investment.

Interest expense was $3,838,000 and $11,093,000 in the 2010 quarter and nine months, down $336,000 or 8% and $1,963,000 or 15% from $4,174,000 and $13,056,000 in the 2009 periods. The decrease in interest expense was primarily due to decreased levels of borrowings. The cost of borrowed funds was 4.10% and 4.05% in the 2010 quarter and nine months, compared to 4.15% and 4.05% in the year ago periods, a decrease of 1% and unchanged, reflecting the stabilization of interest rates, the adjustable rate nature of much of our borrowings, and changes in our funding mix. Average debt outstanding was $371,412,000 and $366,346,000 for the 2010 quarter and nine months, compared to $399,175,000 and $430,699,000 in the year ago periods, decreases of 7% and 15%, primarily reflecting decreased borrowings as portfolio outstandings declined. See page 37 for a table which shows average balances and cost of funds for our funding sources.

Net interest income was $5,715,000 and $17,050,000 and the net interest margin was 4.77% and 4.84% for the 2010 third quarter and nine months, down $308,000 or 5% and $1,438,000 or 8% from $6,022,000 and $18,488,000 in the year ago periods, which represented net interest margins of 4.63% and 4.53%, all reflecting the items discussed above.

Noninterest income, which is comprised of servicing fee income, prepayment fees, late charges, and other miscellaneous income was $1,340,000 and $3,287,000 in the 2010 third quarter and nine months, up $377,000 or 39% and $860,000 or 35% from $963,000 and $2,427,000 a year ago, primarily reflecting higher servicing and other fees generated from a larger portfolio base at Medallion Bank.

Operating expenses were $4,687,000 and $12,799,000 in the 2010 third quarter and nine months, down $297,000 or 6% and $2,090,000 or 14% from $4,984,000 and $14,889,000 in the 2009 periods, primarily reflecting $1,622,000 of expense reversals in the nine months associated with potential liabilities of the SPAC’s. Excluding the SPAC-related amounts, operating expenses decreased $468,000 or 3% in the nine months. Salaries and benefits expense was $2,722,000 and $8,529,000 in the third quarter and nine months, down $135,000 or 5% and $317,000 or 4% from $2,857,000 and $8,846,000 in 2009, primarily reflecting higher salary deferrals related to loan originations and lower bonus accruals. Professional fees were $451,000 and $1,729,000 in the quarter and nine months, down $16,000 or 3% and up $183,000 or 12% from $467,000 and $1,546,000 a year ago, primarily reflecting lower legal and accounting costs, partially offset by higher other professional expenses, and in the nine months also by higher legal expenses related to various investment opportunities and the MFC reorganization. Occupancy expense was $352,000 and $1,032,000 in the 2010 quarter and nine months, up $44,000 or 14% and $150,000 or 17%, from $308,000 and $882,000 in the 2009 periods, primarily reflecting lower rent reimbursements received from an unconsolidated portfolio company. Other operating expenses of $1,162,000 and $1,509,000 in 2010 were down $190,000 or 14% and $2,106,000 or 58% from $1,352,000 and $3,615,000 a year ago, primarily reflecting $1,622,000 of expense reversals in the nine months associated with potential liabilities of the SPAC’s. Excluding the SPAC-related amounts, other operating expenses decreased $484,000 or 13% in the nine months. The

 

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quarterly decrease primarily reflected lower loan collections costs, travel and entertainment expense, directors fees, and printing costs, partially offset by higher other operating expenses; and also by lower depreciation and amortization expense, partially offset by higher franchise tax accruals in the nine months.

Income tax expense was $0 in the 2010 and 2009 third quarters and nine months.

Net change in unrealized appreciation on investments was $1,286,000 and $8,149,000 in the 2010 third quarter and nine months, compared to $402,000 and $2,159,000 in the 2009 third quarter and nine months, an increase in appreciation of $884,000 in the quarter and $5,990,000 in the nine months. Net change in unrealized appreciation (depreciation), net of the net unrealized appreciation or depreciation on Medallion Bank and the other controlled subsidiaries was depreciation of $689,000 and $2,877,000 in the 2010 quarter and nine months, compared to depreciation of $841,000 and appreciation of $1,208,000 in the 2009 periods, resulting in increased appreciation of $152,000 in the quarter and increased depreciation of $4,085,000 in the nine months. Unrealized appreciation (depreciation) arises when we make valuation adjustments to the investment portfolio. When investments are sold or written off, any resulting realized gain (loss) is grossed up to reflect previously recorded unrealized components. As a result, movement between periods can appear distorted. The 2010 activity resulted from net appreciation on Medallion Bank and other controlled subsidiaries of $1,975,000 ($11,026,000 in the nine months), net unrealized appreciation on equity investments of $229,000 ($550,000 in the nine months), reversals of unrealized depreciation associated with fully depreciated loans which were charged off of $191,000 ($191,000 in the nine months), and reversals of unrealized depreciation associated with equity investments (SPAC 2) which were charged off of $0 ($759,000 in the nine months), partially offset by net unrealized depreciation on loans of $1,069,000 ($5,579,000 in the nine months) and depreciation on foreclosed property of $40,000 (appreciation of $1,202,000 in the nine months. The 2009 activity resulted from net appreciation on Medallion Bank and other controlled subsidiaries of $1,243,000 ($951,000 in the nine months), net unrealized appreciation on equity investments of $383,000 ($682,000 of depreciation in the nine months), and reversals of unrealized depreciation associated with fully depreciated loans which were charged off of $23,000 ($2,392,000 in the nine months), partially offset by net unrealized depreciation on loans of $751,000 ($1,738,000 in the nine months), reversals of unrealized appreciation associated with foreclosed properties that were sold of $460,000 ($900,000 in the nine months), and net depreciation on foreclosed property of $36,000 ($2,136,000 of appreciation in the nine months). The net appreciation or depreciation on Medallion Bank and other controlled subsidiaries described above is net of the dividends declared by them to us of $1,000,000 in the 2010 and 2009 third quarters, and $3,000,000 in the 2010 and 2009 nine months, and also in 2010 includes the reversal of unrealized depreciation of $7,473,000 related to the writeoff of the SPAC investment, realized in the 2010 first quarter.

Our net realized losses on investments were $186,000 and $9,076,000 in the 2010 quarter and nine months, compared gains of $486,000 and losses of $1,404,000 in the 2009 quarter and nine months, an increase in realized losses of $672,000 in the quarter and $7,672,000 in the nine months. The 2010 activity reflected the reversals described in the unrealized paragraph above, partially offset by net direct recoveries of $5,000 ($794,000 of net direct chargeoffs in the nine months) and net direct gains on the sale of investments of $0 ($141,000 in the nine months). The 2009 activity reflected the above, and net direct recoveries of $49,000 ($71,000 in the nine months) and net direct gains on the sale of foreclosed properties of $0 ($17,000 in the nine months).

Our net realized/unrealized gains/losses on investments were a gain of $1,100,000 and a loss of $927,000 in the 2010 quarter and nine months, compared to gains of $888,000 and $755,000 in the 2009 periods, an increase of $212,000 of net gains in the quarter and of $1,682,000 of net losses in the nine months, reflecting the above.

ASSET/LIABILITY MANAGEMENT

Interest Rate Sensitivity

We, like other financial institutions, are subject to interest rate risk to the extent that our interest-earning assets (consisting of medallion, commercial, and consumer loans; and investment securities) reprice on a different basis over time in comparison to our interest-bearing liabilities (consisting primarily of credit facilities with banks and other lenders, bank certificates of deposit, and subordinated 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.

 

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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 or the maturities of tranches drawn under the revolving lines of credit or issued as certificates of deposit, for terms of up to five years. We had outstanding SBA debentures of $80,250,000 with a weighted average interest rate of 5.48%, constituting 21% of our total indebtedness as of September 30, 2010. Also, as of September 30, 2010, portions of the adjustable rate debt with banks repriced at intervals of as long as 35 months, and certain of the certificates of deposit were for terms of up to 36 months, further mitigating the immediate impact of changes in market interest rates.

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

The following table presents our interest rate sensitivity gap at September 30, 2010, compared to the respective positions at the end of 2009 and 2008. The principal amount of interest earning assets is 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, 2010 Cumulative Rate Gap (1)

 

(Dollars in thousands)

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

Earning assets

                   

Floating-rate

   $ 11,930      $ —        $ —         $ —         $ —         $ —        $ —        $ 11,930   

Adjustable rate

     28,233        30,831        —           —           —           —          —          59,064   

Fixed-rate

     62,283        72,952        135,631         27,396         29,331         806        3,125        331,524   

Cash

     21,525        —          —           —           —           —          —          21,525   
                                                                   

Total earning assets

   $ 123,971      $ 103,783      $ 135,631       $ 27,396       $ 29,331       $ 806      $ 3,125      $ 424,043   
                                                                   

Interest bearing liabilities

                   

Revolving lines of credit

   $ 183,442      $ —        $ —         $ —         $ —         $ —        $ —        $ 183,442   

SBA debentures

     7,485        7,500        19,450         13,500         9,250         3,565        19,500        80,250   

Notes payable to banks

     65,537        10,858        592         —           —           —          —          76,987   

Preferred securities

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

Total liabilities

   $ 256,464      $ 51,358      $ 20,042       $ 13,500       $ 9,250       $ 3,565      $ 19,500      $ 373,679   
                                                                   

Interest rate gap

   ($ 132,493   $ 52,425      $ 115,589       $ 13,896       $ 20,081       ($ 2,759   ($ 16,375   $ 50,364   
                                                                   

Cumulative interest rate gap (2)

   ($ 132,493   ($ 80,068   $ 35,521       $ 49,417       $ 69,498       $ 66,739      $ 50,364        —     
                                                                   

December 31, 2009 (2)

   ($ 129,336   ($ 39,371   $ 28,151       $ 57,045       $ 65,972       $ 65,089      $ 54,992        —     

December 31, 2008 (2)

   ($ 240,998   ($ 171,785   $ 48,841       $ 57,488       $ 81,687       $ 76,954      $ 66,863        —     

 

(1) The ratio of the cumulative one year gap to total interest rate sensitive assets was (31%), (30%), and (46%), as of September 30, 2010, and December 31, 2009 and 2008, and was (28%), (25%), and (34%) on a combined basis with Medallion Bank.
(2) Adjusted for the medallion loan 40% prepayment assumption results in a cumulative one year negative interest rate gap and related ratio of ($44,715) or (11%) for September 30, 2010, compared to ($34,286) or (8%) and ($107,671) or (20%) for December 31, 2009 and 2008, respectively, and was ($103,841) or (11%), ($85,130) or (9%), and ($155,873) or (16%) on a combined basis with Medallion Bank.

 

Our interest rate sensitive assets were $424,043,000 and interest rate sensitive liabilities were $373,679,000 at September 30, 2010. The one-year cumulative interest rate gap was a negative $132,493,000 or 31% of interest rate sensitive assets, compared to a negative $129,336,000 or 30% at December 31, 2009 and $240,998,000 or 46% at December 31, 2008. However, using our estimated 40% prepayment/refinancing rate for medallion loans to adjust the interest rate gap resulted in a negative gap of $44,715,000 or 11% at September 30, 2010. We seek to manage interest rate risk by originating adjustable-rate loans, by incurring fixed-rate indebtedness, by evaluating appropriate derivatives, pursuing securitization opportunities, and by other options consistent with managing interest rate risk.

 

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On a combined basis with Medallion Bank, our interest rate sensitive assets were $969,761,000 and interest rate sensitive liabilities were $825,947,000 at September 30, 2010. The one year cumulative interest rate gap was a negative $270,636,000 or 28% of interest rate sensitive assets, compared to a negative $225,251,000 or 25% and $326,687,000 or 34% at December 31, 2009 and 2008. Using our estimated 40% prepayment/refinancing rate for medallion loans to adjust the interest rate gap resulted in a negative gap of $103,841,000 or 11% at September 30, 2010.

Interest Rate Cap Agreements

The Company manages its exposure to increases in market rates of interest by periodically purchasing interest rate caps to lock in the cost of funds of its variable-rate debt in the event of a rapid run up in interest rates. During 2010 and 2009, the Company entered into contracts to purchase interest rate caps on $125,000,000 and $252,000,000, respectively, of notional value of principal from various multinational banks, of which $195,000,000 are active with termination dates ranging to June 2012. The caps provide for payments to the Company if various LIBOR thresholds are exceeded during the cap terms. The 2010 cap purchases were fully expensed in the 2010 third quarter ($142,000), and the 2009 cap purchases were fully expensed in 2009, including $133,000 and $171,000 in the 2009 third quarter and nine months, and all are carried at $0 on the balance sheet at September 30, 2010.

Liquidity and Capital Resources

Our sources of liquidity are the revolving lines of credit with DZ Bank and Sterling Bank, unfunded commitments to purchase debentures from the SBA, loan amortization and prepayments, private issuances of debt securities, and participations or sales of loans to third parties. As a RIC, we are required to distribute at least 90% of our investment company taxable income; consequently, we have primarily relied upon external sources of funds to finance growth. Trust III’s $200,000,000 revolving line of credit with DZ Bank had $16,558,000 of availability, and unfunded commitments from the SBA were $12,485,000. Lastly, $11,500,000 was available under revolving credit agreements with commercial banks.

Additionally, Medallion Bank, our wholly-owned, unconsolidated portfolio company has access to independent sources of funds for our business originated there, primarily through brokered certificates of deposit. At the current required capital levels, it is expected, although there can be no guarantee, that deposits of approximately $82,000,000 could be raised by Medallion Bank to fund future loan origination activities, and Medallion Bank also has $30,000,000 available under Fed Funds lines with several commercial banks. In addition, Medallion Bank, as a non-RIC subsidiary of ours, is allowed to retain all earnings in the business to fund future growth.

The components of our debt were as follows at September 30, 2010. See Note 4 to the consolidated financial statements on page 19 for details of the contractual terms of our borrowings.

 

 

(Dollars in thousands)

   Balance      Percentage     Rate (1)  

Revolving lines of credit

   $ 183,442         49     1.32

SBA debentures

     80,250         21        5.48   

Notes payable to banks

     76,987         21        4.48   

Preferred securities

     33,000         9        7.68   
                   

Total outstanding debt

   $ 373,679         100     3.42   
                         

Deposits at Medallion Bank

     452,268         —          1.44
             

Total outstanding debt, including Medallion Bank

   $ 825,947         —          2.34   

 

(1) Weighted average contractual rate as of September 30, 2010.

 

Our contractual obligations expire on or mature at various dates through September 2037. The following table shows all contractual obligations at September 30, 2010.

 

 

     Payments due by period  

(Dollars in thousands)

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

Revolving lines of credit

   $ —         $ —         $ —         $ 183,442       $ —         $ —         $ 183,442   

SBA debentures

     7,485         7,500         19,450         13,500         9,250         23,065         80,250   

Notes payable to banks

     43,204         16,735         16,079         95         —           874         76,987   

Preferred securities

     —           —           —           —           —           33,000         33,000   
                                                              

Total

   $ 50,689       $ 24,235       $ 35,529       $ 197,037       $ 9,250       $ 56,939       $ 373,679   
                                                              

Deposits at Medallion Bank

     324,930         67,975         59,363         —           —           —           452,268   
                                                              

Total, including Medallion Bank

   $ 375,619       $ 92,210       $ 94,892       $ 197,037       $ 9,250       $ 56,939       $ 825,947   

 

 

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We value our portfolio at fair value as determined in good faith by management and approved by the Board of Directors in accordance with our valuation policy. Unlike certain lending institutions, we are not permitted to establish reserves for loan losses. Instead, we must value each individual investment and portfolio loan on a quarterly basis. We record unrealized depreciation on investments and loans when we believe that an asset has been impaired and full collection is unlikely. We record unrealized appreciation on equities if we have a clear indication that the underlying portfolio company has appreciated in value and, therefore, our equity investment has also appreciated in value. Without a readily ascertainable market value, the estimated value of our portfolio of investments and loans may differ significantly from the values that would be placed on the portfolio if there existed a ready market for the investments. We adjust the valuation of the portfolio quarterly to reflect management’s estimate of the current fair value of each investment in the portfolio. Any changes in estimated fair value are recorded in our statement of operations as net unrealized appreciation (depreciation) on investments. Our investment in Medallion Bank, as a wholly-owned portfolio investment, is also subject to quarterly assessments of its fair value. We conduct a thorough valuation analysis as described previously, and determine whether any factors give rise to valuation different than recorded book value. As a result of this valuation process, we used Medallion Bank’s actual results of operations as the best estimate of changes in fair value, and recorded the result as a component of unrealized appreciation (depreciation) on investments, although changes in these restrictions and other applicable factors could change these conclusions in the future.

In addition, the illiquidity of our loan portfolio and investments may adversely affect our ability to dispose of loans at times when it may be advantageous for us to liquidate such portfolio or investments. In addition, if we were required to liquidate some or all of the investments in the portfolio, the proceeds of such liquidation may be significantly less than the current value of such investments. Because we borrow money to make loans and investments, our net operating income is dependent upon the difference between the rate at which we borrow funds and the rate at which we invest these funds. As a result, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our interest income. In periods of sharply rising interest rates, our cost of funds would increase, which would reduce our net operating income before net realized and unrealized gains. We use a combination of long-term and short-term borrowings and equity capital to finance our investing activities. Our long-term fixed-rate investments are financed primarily with short-term floating-rate debt, and to a lesser extent by term fixed-rate debt. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. Such techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act. 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, and including the impact on Medallion Bank, a hypothetical immediate 1% increase in interest rates would have positively impacted net increase in net assets resulting from operations as of September 30, 2010 by approximately $1,218,000 on an annualized basis, compared to a positive impact of $1,149,000 at December 31, 2009, and the impact of such an immediate increase of 1% over a one year period would have been ($1,941,000) at September 30, 2010, compared to ($1,943,000) for December 31, 2009. Although management believes that this measure is indicative of our sensitivity to interest rate changes, it does not adjust for potential changes in credit quality, size, and composition of the assets on the balance sheet, and other business developments that could affect net increase in net assets resulting from operations in a particular quarter or for the year taken as a whole. Accordingly, no assurances can be given that actual results would not differ materially from the potential outcome simulated by these estimates.

We 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 spin off certain assets or divisions, the development of a securitization conduit program, and other independent financing for certain subsidiaries or asset classes. These financing options would also provide additional sources of funds for both external expansion and continuation of internal growth.

 

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The following table illustrates sources of available funds for us and each of our subsidiaries, and amounts outstanding under credit facilities and their respective end of period weighted average interest rates at September 30, 2010. See Note 4 to the consolidated financial statements for additional information about each credit facility.

 

 

(Dollars in thousands)

  The Company     MFC     MCI     MBC     FSVC     UTAH     Total     12/31/2009  

Cash

  $ 5,190      $ 2,852      $ 9,603      $ 1,274      $ 2,606      $ —        $ 21,525      $ 33,401   

Bank loans

    35,127        53,360        —          —          —          —          88,487        72,867   

Amounts undisbursed

    3,500        8,000        —          —          —          —          11,500        8,957   

Amounts outstanding

    31,627        45,360        —          —          —          —          76,987        63,910   

Average interest rate

    4.06     4.76     —          —          —          —          4.48     4.48

Maturity

    12/10-7/12        3/11-2/17        —          —          —          —          12/10-2/17        5/10-11/12   

Preferred securities

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

Average interest rate

    7.68     —          —          —          —          —          7.68     7.68

Maturity

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

Lines of credit

    —          200,000        —          —          —          —          200,000        235,000   

Amounts undisbursed

    —          16,558        —          —          —          —          16,558        37,638   

Amounts outstanding

    —          183,442        —          —          —          —          183,442        197,362   

Average interest rate

    —          1.32     —          —          —          —          1.32     1.32

Maturity

    —          12/13        —          —          —          —          12/13        5/10-12/13   

SBA debentures

    —          —          41,250        —          51,485        —          92,735        96,750   

Amounts undisbursed

    —          —          5,000        —          7,485        —          12,485        8,500   

Amounts outstanding

    —          —          36,250        —          44,000        —          80,250        88,250   

Average interest rate

    —          —          4.94     —          5.93     —          5.48     6.09

Maturity

    —          —          3/12-3/21        —          9/11-3/19        —          9/11-3/21        9/11-3/19   
                                                               

Total cash and amounts remaining undisbursed under credit facilities

  $ 8,690      $ 27,410      $ 14,603      $ 1,274      $ 10,091      $ —        $ 62,068      $ 88,496   
                                                               

Total debt outstanding

  $ 64,627      $ 228,802      $ 36,250      $ —        $ 44,000      $ —        $ 373,679      $ 382,522   
                                                               

Including Medallion Bank

               

Cash

    —          —          —          —          —        $ 16,142      $ 16,142      $ 13,340   

Certificates of deposit

    —          —          —          —          —          452,268        452,268        371,719   

Average interest rate

    —          —          —          —          —          1.44     1.44     1.85

Maturity

    —          —          —          —          —          10/10-9/13        10/10-9/13        1/10-12/12   

Total cash and amounts remaining undisbursed under credit facilities

  $ 8,690      $ 27,410      $ 14,603      $ 1,274      $ 10,091      $ 16,142      $ 78,210      $ 101,836   
                                                               

Total debt outstanding

  $ 64,627      $ 228,802      $ 36,250      $ —        $ 44,000      $ 452,268      $ 825,947      $ 754,241   

 

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 have available liquidity of $16,558,000 under our revolving credit agreement with DZ Bank as of September 30, 2010. 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. Also, Medallion Bank is not a RIC, and therefore is able to retain earnings to finance growth.

Recently Issued Accounting Standards

In July 2010, the FASB issued Accounting Standards Update 2010-20, “Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”, which amends Subtopic 310-30 by requiring an entity to provide enhanced and disaggregated disclosures about the credit quality of an entity’s financing receivables and its allowance for credit losses. The objective of enhancing these disclosures is to improve financial statement users’ understanding of both the nature of an entity’s credit risk associated with its financing receivables and the entity’s assessment of that risk in estimating its allowance for credit losses as well as changes in the allowance and the reason for those changes. The update is effective for the first interim or annual period ending on or after December 15, 2010. The Company does not expect adoption of FASB ASU 2010-20 to have a material impact on its financial condition or results of operations, as it is a disclosure standard.

 

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In January 2010, the FASB issued Accounting Standards Update 2010-06, “Fair Value Measurements and Disclosures (Topic 820), Improving Disclosures about Fair Value Measurements” (FASB ASU 2010-06). FASB ASU 2010-06 amends Subtopic 820-10, Fair Value Measurements and Disclosures - Overall, and requires new disclosures related to the transfers in and out of Level 1 and 2, as well as requiring that a reporting entity present separately information about purchases, sales, issuances, and settlements rather than as one net number. Additionally, FASB ASU 2010-06 amends Subtopic 820-10 by clarifying existing disclosures related to level of disaggregation as well as disclosures about inputs and valuation techniques. FASB ASU 2010-06 is effective for reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements, these disclosures are effective for reporting periods beginning after December 15, 2010. The Company has adopted the provisions of FASB ASU 2010-06, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements. The Company does not expect the adoption of FASB ASU 2010-06 related to Level 3 roll forward of activity to have an impact on its financial condition or results of operations, as it is a disclosure standard.

Common Stock

Our common stock is quoted on the Nasdaq Global Select Market under the symbol “TAXI.” Our common stock commenced trading on May 23, 1996. As of November 2, 2010, there were approximately 128 holders of record of the Company’s common stock.

On November 2, 2010, the last reported sale price of our common stock was $8.23 per share. Historically, our common stock has traded at a premium to net asset value per share, but there can be no assurance that our stock will trade at a premium in the future.

The following table sets forth, for the periods indicated, the range of high and low closing prices for our common stock on the Nasdaq Global Select Market.

 

 

2010

   DIVIDENDS
DECLARED
     HIGH      LOW  

Third Quarter

   $ 0.15       $ 7.79       $ 6.50   

Second Quarter

     0.15         8.24         6.59   

First Quarter

     0.15         8.45         7.81   
                          

2009

        

Fourth Quarter

   $ 0.15       $ 8.49       $ 7.76   

Third Quarter

     0.19         8.83         6.87   

Second Quarter

     0.19         8.71         6.56   

First Quarter

     0.19         8.04         3.61   

 

As a RIC, we intend to distribute at least 90% of our investment company taxable income to our shareholders. Distributions of our income are generally required to be made within the calendar year the income was earned as a RIC; however, in certain circumstances distributions can be made up to a full calendar year after the income has been earned. Investment company taxable income includes, among other things, interest, dividends, and capital gains reduced by deductible expenses. Our ability to make dividend payments as a RIC is restricted by certain asset coverage requirements under the 1940 Act and has been dependent upon maintenance of our status as a RIC under the Code in the past, by SBA regulations, and under the terms of the SBA debentures. There can be no assurances, however, that we will have sufficient earnings to pay such dividends in the future.

We have adopted a dividend reinvestment plan pursuant to which shareholders may elect to have distributions reinvested in additional shares of common stock. When we declare a dividend or distribution, all participants will have credited to their plan accounts the number of full and fractional shares (computed to three decimal places) that could be obtained with the cash, net of any applicable withholding taxes that would have been paid to them if they were not participants. The number of full and fractional shares is computed at the weighted average price of all shares of common stock purchased for plan participants within the 30 days after the dividend or distribution is declared plus brokerage commissions. The automatic reinvestment of dividends and capital gains distributions will not release plan participants of any income tax that may be payable on the dividend or capital gains distribution. Shareholders may terminate their participation in the dividend reinvestment plan by providing written notice to the Plan Agent at least 10 days before any given dividend payment date. Upon termination, we will issue to a shareholder both a certificate for the number of full shares of common stock owned and a check for any fractional shares, valued at the then current market price, less any applicable brokerage commissions and any other costs of sale. There are no additional fees or expenses for participation in the dividend reinvestment plan. Shareholders may obtain additional information about the dividend reinvestment plan by contacting American Stock Transfer & Trust Company, LLC at 59 Maiden Lane, New York, NY, 10038.

 

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ISSUER PURCHASES OF EQUITY SECURITIES (1)

 

 

Period

   Total Number of
Shares
Purchased
     Average Price
Paid per Share
     Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs
     Maximum Number of
Shares (or Approximate
Dollar Value) that May
Yet Be Purchased Under
the Plans or Programs
 

November 5 through December 31, 2003

     10,816       $ 9.20         10,816       $ 9,900,492   

January 1 through December 31, 2004

     952,517         9.00         952,517         11,329,294   

January 1 through December 31, 2005

     389,900         9.26         389,900         7,720,523   

January 1 through December 31, 2006

     —           —           —           7,720,523   

January 1 through December 31, 2007

     33,200         9.84         33,200         7,393,708   

January 1 through December 31, 2008

     7,691         9.66         7,691         7,319,397   

January 1 through December 31, 2009

     —           —           —           7,319,397   

January 1 through September 30, 2010

     177,844         6.82         177,844         6,106,354   
                       

Total

     1,571,968         8.84         1,571,968      

 

(1) We publicly announced our Stock Repurchase Program in a press release dated November 5, 2003, after the Board of Directors approved the repurchase of up to $10,000,000 of our outstanding common stock, which was increased by an additional $10,000,000 authorization on November 3, 2004. The stock repurchase program expires 180 days after the commencement of the purchases. If we have not repurchased the additional $10,000,000 of common stock by the end of such period, we are permitted to extend the stock repurchase program for additional 180-day periods until we have repurchased the total amount authorized. In October 2010, we extended the terms of the Stock Repurchase Program. Purchases were to commence no earlier than November 2010 and are to conclude 180 days after the commencement of the purchases.

 

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There has been no material change in disclosure regarding quantitative and qualitative disclosures about market risk since the Company filed its Annual Report on Form 10-K for the year ended December 31, 2009.

 

ITEM 4. 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 and internal control over financial reporting 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, 2010. In addition, based on our evaluation as of September 30, 2010, there have been no changes that occurred during the 2010 nine months that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

We and our subsidiaries 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 would result in a material adverse effect on our results of operations or financial condition.

 

ITEM 1A. RISK FACTORS

Risks Relating to Our Business and Structure

We are currently in a period of capital markets disruption and severe recession and we do not expect these conditions to improve in the near future.

The current market conditions have materially and adversely affected the debt and equity capital markets in the US, which could have a negative impact on our business and operations. The US capital markets have been experiencing extreme volatility and disruption for more than 24 months as evidenced by a lack of liquidity in the debt capital markets, significant write-offs in the financial services sector, the repricing of credit risk in the broadly syndicated credit market and the failure of major financial institutions. These events have contributed to worsening general economic conditions that are materially and adversely impacting the

 

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broader financial and credit markets and reducing the availability of credit and equity capital for the markets as a whole and financial services firms in particular. We believe that the US economy is experiencing a prolonged recession, and forecasts for 2010 generally call for a continuation of the economic recession. As a result, we believe these conditions may continue for a prolonged period of time or worsen in the future. A prolonged period of market illiquidity will continue to have an adverse effect on our business, financial condition, and results of operations. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. Equity capital may be difficult to raise because, subject to some limited exceptions, we generally are not able to issue and sell our common stock at a price below net asset value per share. In addition, the debt capital that will be available, if at all, may be at a higher cost and on less favorable terms and conditions.

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

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

As of September 30, 2010, we had $373,679,000 of outstanding indebtedness, which had a weighted average borrowing cost of 3.42% at September 30, 2010, and our wholly-owned unconsolidated portfolio companies, primarily Medallion Bank, had $452,268,000 of outstanding indebtedness at a weighted average borrowing cost of 1.44%.

Consumer lending by Medallion Bank carries a higher risk of loss and could be adversely affected by an economic downturn.

By its nature, lending to consumers that have blemishes on their credit reports carries with it a higher risk of loss. Although the net interest margins should be higher to compensate us for this increased risk, the current economic downturn could result in higher loss rates and lower returns than expected, and could affect the profitability of the consumer loan portfolio.

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

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

We operate in a highly regulated environment which may constrain our ability to grow our business.

The 1940 Act imposes numerous constraints on the operations of business development companies. For example, business development companies are required to invest at least 70% of their total assets in qualifying assets, primarily securities of “eligible portfolio companies” (as defined under the 1940 Act), cash, cash equivalents, US government securities, and other high quality debt investments that mature in one year or less. Our regulatory requirements may hinder our ability to take advantage of attractive investment opportunities and, as a result, achieve our investment objective. In addition, we rely upon several exemptive orders from the SEC permitting us to consolidate our financial reporting and operate our business as presently conducted. Our failure to satisfy the conditions set forth in those exemptive orders could result in our inability to rely upon such orders or to cause the SEC to revoke the orders which could result in material changes in our financial reporting or the way in which we conduct our business. Furthermore, any failure to comply with the requirements imposed on business development companies by the 1940 Act could cause the SEC to bring an enforcement action against us. If we do not remain a business development company, we might be regulated as a closed-end investment company under the 1940 Act, which would further significantly decrease our operating flexibility.

On February 27, 2009, Medallion Bank issued and sold, and the US Treasury purchased under the TARP Capital Purchase Program, or the CPP, (1) 11,800 shares of Medallion Bank’s Fixed Rate Non-Cumulative Perpetual Preferred Stock, Series A, and (2) a warrant, which was immediately exercised, to purchase up to 590 shares of Medallion Bank’s Fixed Rate Non-Cumulative Perpetual Preferred Stock, Series B, for an aggregate purchase price of approximately $11,800,000 in cash. On December 22, 2009, Medallion Bank issued and sold, and the US Treasury purchased under the CPP, (1) 9,698 shares of Medallion Bank’s Fixed Rate

 

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Non-Cumulative Perpetual Preferred Stock, Series C, and (2) a warrant, which was immediately exercised, to purchase up to 55 shares of Medallion Bank’s Fixed Rate Non-Cumulative Perpetual Preferred Stock, Series D, for an aggregate purchase price of approximately $9,698,000 in cash. The US Congress, through the Emergency Economic Stabilization Act of 2008, or the EESA, and the American Recovery and Reinvestment Act of 2009, or the ARRA, has imposed a number of restrictions and limitations on the operations of CPP participants. The interim final rule promulgated pursuant to Section 111 of the EESA, as amended by the ARRA, prescribes certain standards for compensation and corporate governance for CPP participants (which we believe to include parent companies such as us). The rules and regulations applicable to CPP participants continue to evolve and their scope, timing and effect cannot be predicted.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, was signed into law on July 21, 2010. The Dodd-Frank Act significantly changes federal financial services regulation and affects, among other things, the lending, deposit, investment, trading, and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations. The federal agencies have significant discretion in issuing these rules and regulations, and consequently, many of the details and much of the effect of the Dodd-Frank Act may not be known for many months or years. As such, we cannot predict and may not be able to anticipate all the effects of the Dodd-Frank Act on our financial condition or operations.

Regulations governing our operation as a business development company will affect our ability to, and the way in which, we raise additional capital.

Our business may periodically require capital. We may acquire additional capital from the following sources:

Senior Securities and Other Indebtedness. We may issue debt securities or preferred stock, and/or borrow money from banks or other financial institutions, which we refer to collectively as senior securities, up to the maximum amount permitted by the 1940 Act. If we issue senior securities, including debt or preferred stock, we will be exposed to additional risks, including the following:

 

   

Under the provisions of the 1940 Act, we are permitted, as a business development company, to issue senior securities only in amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after each issuance of senior securities. If the value of our assets declines, we may be unable to satisfy this test. If that happens, we may be restricted from issuing additional debt, may be limited in making distributions on our stock, and may be required to sell a portion of our investments and, depending on the nature of our leverage, to repay a portion of our debt at a time when such sales and/or repayments may be disadvantageous.

 

   

Any amounts that we use to service our debt or make payments on preferred stock will not be available for dividends to our common shareholders.

 

   

It is likely that any senior securities or other indebtedness we issue will be governed by an indenture or other instrument containing covenants restricting our operating flexibility. Additionally, some of these securities or other indebtedness may be rated by rating agencies, and in obtaining a rating for such securities and other indebtedness, we may be required to abide by operating and investment guidelines that further restrict operating and financial flexibility.

 

   

We and, indirectly, our shareholders will bear the cost of issuing and servicing such securities and other indebtedness.

 

   

Preferred stock or any convertible or exchangeable securities that we issue in the future may have rights, preferences, and privileges more favorable than those of our common stock, including separate voting rights, and could delay or prevent a transaction or a change in control to the detriment of the holders of our common stock.

Additional Common Stock. We are not generally able to issue and sell our common stock at a price below net asset value per share. We may, however, sell our common stock, warrants, options, or rights to acquire our common stock, at a price below the current net asset value of the common stock if our Board of Directors determines that such sale is in our best interests and that of our shareholders, and our shareholders approve such sale. In any such case, the price at which our securities are to be issued and sold may not be less than a price which, in the determination of our Board of Directors, closely approximates the market value of such securities (less any distributing commission or discount). We may also make rights offerings to our shareholders at prices per share less than the net asset value per share, subject to applicable requirements of the 1940 Act. If we raise additional funds by issuing more common stock or senior securities convertible into, or exchangeable for, our common stock, the percentage ownership of our shareholders at that time would decrease and they may experience dilution. Moreover, we can offer no assurance that we will be able to issue and sell additional equity securities in the future, on favorable terms or at all.

If our primary investments are deemed not to be qualifying assets, we could be deemed to be in violation of the 1940 Act.

As a business development company, we are not permitted to acquire any assets other than “qualifying assets” unless, at the time of such acquisition, at least 70% of our total assets are qualifying assets. Our investment in Medallion Bank may constitute an ineligible investment. As of September 30, 2010, up to 28% of our total assets were invested in ineligible investments.

 

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At the end of each fiscal quarter, we may take proactive steps to prospectively preserve investment flexibility in the next quarter which is assessed against our total assets at our most recent quarter end. We can accomplish this in many ways including purchasing US Treasury bills or other investment-grade debt securities, and closing out our position on a net cash basis subsequent to quarter end. However, if such proactive measures are ineffective and our primary investments are deemed not to be qualifying assets, we could be deemed in violation of the 1940 Act, which could have a material effect on our business.

We will be subject to corporate-level income tax if we are unable to qualify as a RIC under Subchapter M of the Code.

To obtain and maintain RIC tax treatment under the Code, we must meet the following annual distribution, income source, and asset diversification requirements.

 

   

The annual distribution requirement for a RIC will be satisfied if we distribute to our shareholders on an annual basis at least 90% of our net ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, and at least 90% of our net tax exempt income. Because we use debt financing, we are subject to certain asset coverage ratio requirements under the 1940 Act and financial covenants under loan and credit agreements that could, under certain circumstances, restrict us from making distributions necessary to satisfy the distribution requirement. If we are unable to obtain cash from other sources, we could fail to qualify for RIC tax treatment and thus become subject to corporate-level income taxes.

 

   

The income source requirement will be satisfied if we obtain at least 90% of our income for each year from dividends, interest, gains from the sale of stock or securities or similar sources.

 

   

The asset diversification requirement will be satisfied if we meet certain asset diversification requirements at the end of each quarter of our taxable year. Failure to meet those requirements may result in our having to dispose of certain investments quickly in order to prevent the loss of RIC status. Because most of our investments will be in private companies, and therefore will be relatively illiquid, any such dispositions could be made at disadvantageous prices and could result in substantial losses.

If we do not qualify as a RIC for more than two consecutive years, and then seek to requalify and elect RIC status, we would be required to recognize gain to the extent of any unrealized appreciation on our assets unless we make a special election to pay corporate-level tax on any such unrealized appreciation recognized during the succeeding 10-year period.

If we fail to qualify for RIC tax treatment for any reason and are subject to corporate income tax, the resulting corporate taxes could substantially reduce our net assets, the amount of income available for distribution and the amount of our distributions. In addition, the asset coverage and distribution requirements impose significant cash flow management restrictions on us and limit our ability to retain earnings to cover periods of loss, provide for future growth, and pay for extraordinary items. Additionally, we could fail to satisfy the requirement that a RIC derive at least 90% of its gross income from qualifying sources, with the result that we would not qualify as a RIC. Qualification as a RIC is made on an annual basis and, although we and some of our subsidiaries have qualified in the past, we cannot assure you that we will qualify for such treatment in the future.

A change in our treatment of losses recognized on worthless loans could result in a decrease in taxable income.

In the fourth quarter of 2010, based on developments under the Code and after discussions with external advisers, our Board of Directors determined that the loans received in connection with our lending activities were “accounts or notes receivables acquired in the ordinary course of a trade or business for services” for purposes of Section 1221(a)(4) of the Code. As a result, commencing with the tax year beginning January 1, 2010, we intend to treat losses recognized on worthless loans as ordinary losses rather than as capital losses. Our Board of Directors further determined that we may take such position in tax returns subsequently filed without obtaining prior IRS approval.

The change in the characterization of a loss resulting from a worthless loan from a capital loss to an ordinary loss could materially impact the amount or character of the dividends received by our shareholders. We are required to distribute 90% of our taxable income in order to maintain our RIC status. In the event losses from worthless loans are treated as ordinary losses, those losses will offset taxable income in the taxable year in which such losses are recognized. This could result in a decrease in our taxable income which could result in a decrease in our dividend. Alternatively, if we choose to maintain our current level of dividend, an increased portion of the dividend could be deemed to be a return of capital to the shareholder.

The Code’s diversification requirements may limit our ability to expand our business.

RIC qualification rules require that at the end of each quarter of our taxable year, (i) at least 50% of the market value of our assets must be represented by cash, securities of other RICs, US government securities, and other securities, with such other securities limited, in respect of any one issuer, to an amount not greater than 5% of our assets and not greater than 10% of the outstanding voting securities of such issuer and (ii) not more than 25% of the value of our assets may be invested in the securities (other than US government securities or securities of other RICs) of any one issuer, any two or more issuers of which 20% or more of the voting stock is held by us and that are determined to be engaged in the same or similar trades or businesses or related trades or businesses or in the securities of one or more qualified publicly traded partnerships.

As of September 30, 2010, our largest investment subject to this test was our investment in Medallion Bank, representing 16% of our RIC assets. No other investments were more than 5% of our RIC assets. We will continue to monitor the levels of this and any other investment concentrations in conjunction with the diversification tests.

We may have difficulty paying our required distributions if we recognize income before or without receiving cash representing such income.

For US federal income tax purposes, we will include in taxable income certain amounts that we have not yet received in cash, such as original issue discount, which may arise if we receive warrants in connection with the origination of a loan or possibly in other circumstances, or contractual payment-in-kind interest, which represents contractual interest added to the loan balance and due at the end of the loan term. Such original issue discount or increases in loan balances as a result of payment-in-kind interest will be included in income before we receive any corresponding cash payments. We also may be required to include in income certain other amounts that we will not receive in cash.

 

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Since, in certain cases, we may recognize income before or without receiving cash representing such income, we may have difficulty meeting the annual distribution requirement necessary to achieve and maintain RIC tax treatment under the Code. Accordingly, we may have to sell some of our investments at times and/or at prices we would not consider advantageous, raise additional debt or equity capital, or reduce new investment originations for this purpose. If we are not able to obtain cash from other sources, we may fail to qualify for RIC tax treatment and thus become subject to corporate-level income tax.

Our SBIC subsidiaries may be unable to meet the investment company requirements, which could result in the imposition of an entity-level tax.

Some of our subsidiaries are subject to the SBIA. Our SBIC subsidiaries that are also RICs may be prohibited by the SBIA from making the distributions necessary to qualify as a RIC. Each year, in order to comply with the SBA regulations and the RIC distribution requirements, we must request and receive a waiver of the SBA’s restrictions. While the current policy of the SBA’s Office of SBIC Operations is to grant such waivers if the SBIC makes certain offsetting adjustments to its paid-in capital and surplus accounts, we cannot assure you that this will continue to be the SBA’s policy or that our subsidiaries will have adequate capital to make the required adjustments. If our subsidiaries are unable to obtain a waiver, compliance with the SBA regulations may result in loss of RIC status and a consequent imposition of an entity-level tax.

We operate in a highly competitive market for investment opportunities.

We compete for investments with other business development companies and other investment funds as well as traditional financial services companies such as commercial banks and credit unions. Many of our competitors are substantially larger and have considerably greater financial, technical, and marketing resources than we do. For example, some competitors may have a lower cost of funds and access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments. These characteristics could allow our competitors to consider a wider variety of investments, establish more relationships, and offer better pricing and more flexible structuring than us. We may lose investment opportunities if we do not match our competitors’ pricing, terms, and structure. If we are forced to match our competitors’ pricing, terms, and structure, we may not be able to achieve acceptable returns on our investments or may bear substantial risk of capital loss. Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a business development company.

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

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

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

We depend on cash flow from our subsidiaries to make dividend payments and other distributions to our shareholders.

We are primarily a holding company, and we derive most of our operating income and cash flow from our subsidiaries. As a result, we rely heavily upon distributions from our subsidiaries to generate the funds necessary to make dividend payments and other distributions to our shareholders. Funds are provided to us by our subsidiaries through dividends and payments on intercompany indebtedness, but we cannot assure you that our subsidiaries will be in a position to continue to make these dividend or debt payments. Furthermore, as a condition of its approval by its regulators, Medallion Bank is required to maintain a 15% capital ratio, which may inhibit its ability to declare and pay dividends, which are further restricted by the US Treasury to $4,000,000 per year.

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

Medallion Bank relies on the established brokered deposit market to originate deposits to fund its operations. While Medallion Bank has developed contractual relationships with a diversified group of investment brokers, and the brokered deposit market is well developed and utilized by many banking institutions, conditions could change that might affect the availability of deposits. If the capital levels at Medallion Bank fall below the “well-capitalized” level, or if Medallion Bank experiences a period of sustained operating losses, the cost of attracting deposits from the brokered deposit market could increase significantly, and the ability of Medallion Bank to raise deposits from this source could be impaired. Medallion Bank’s ability to manage its growth to stay within the “well-capitalized” level, and the capital level currently required by the FDIC, which is also considerably higher than the level required to be classified as “well-capitalized”, is critical to Medallion Bank’s retaining open access to this funding source.

 

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

Our borrowers generally have the right to prepay their loans upon payment of a fee ranging from 30 to 120 days interest for standard commodity loans, and for higher amounts, as negotiated, for larger more custom loan arrangements. A borrower is likely to exercise prepayment rights at a time when the interest rate payable on the borrower’s loan is high relative to prevailing interest rates. In a lower interest rate environment, we will have difficulty re-lending prepaid funds at comparable rates, which may reduce the net interest income that we receive. When this occurs, we will generally reinvest these proceeds in temporary investments, pending their future investment in new portfolio companies. These temporary investments will typically have substantially lower yields than the debt being prepaid, and we could experience significant delays in reinvesting these amounts. Any future investment in a new portfolio company may also be at lower yields than the debt that was repaid. As a result, our results of operations could be materially adversely affected if a substantial number of our portfolio companies elect to prepay amounts owed to us and we are not able to reinvest the proceeds for comparable yields in a timely fashion. Additionally, prepayments could negatively impact our return on equity, which could result in a decline in the market price of our common stock.

Our investment portfolio is, and will continue to be, recorded at fair value as determined in good faith by our management and approved by our Board of Directors and, as a result, there is, and will continue to be, uncertainty as to the value of our portfolio investments.

Under the 1940 Act, we are required to carry our portfolio investments at market value or, if there is no readily available market value, at fair value as determined by our management and approved by our Board of Directors. Unlike other lending institutions, we are not permitted to maintain a general reserve for anticipated losses. Instead, we are required by the 1940 Act to specifically value each individual investment and record an unrealized gain or loss for any asset we believe has increased or decreased in value. Typically, there is not a public market for most of the investments in which we have invested and will generally continue to invest. As a result, we value our investments on a quarterly basis based on a determination of their fair value made in good faith and in accordance with the written guidelines approved by our Board of Directors. The types of factors that may be considered in determining the fair value pricing of our investments include the nature and realizable value of any collateral, the portfolio company’s earnings and its ability to make payments on its indebtedness, the markets in which the portfolio company does business, comparison to publicly traded companies, discounted cash flow, and other relevant factors. Because such valuations, and particularly valuations of private securities and private companies, are inherently uncertain, the valuations may fluctuate over short periods of time and may be based on estimates. As a result, our determinations of fair value may differ materially from the values that would have been used if a ready market for these investments existed. Our net asset value could be adversely affected if our determinations regarding the fair value of our investments were materially higher than the values that we ultimately realize upon the disposal of such securities. Considering these factors, we have determined that the fair value of our portfolio is below its cost basis. As of September 30, 2010, our net unrealized depreciation on investments other than in controlled subsidiaries, foreclosed properties, and other assets was $9,451,000 or 2.33% of our investment portfolio.

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

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

In addition, the illiquidity of our loan portfolio and investments may adversely affect our ability to dispose of loans at times when it may be advantageous for us to liquidate such portfolio or investments. In addition, if we were required to liquidate some or all of the investments in the portfolio, the proceeds of such liquidation may be significantly less than the current value of such investments. Because we borrow money to make loans and investments, our net operating income is dependent upon the difference between the rate at which we borrow funds and the rate at which we invest these funds. As a result, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our interest income. In periods of sharply rising interest rates, our cost of funds would increase, which would reduce our net operating income before net realized and unrealized gains. We use a combination of long-term and short-term borrowings and equity capital to finance our investing activities. Our long-term fixed-rate investments are financed primarily with short-term floating-rate debt, and to a lesser extent by term fixed-rate debt. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. Such techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act. 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, and including the impact on Medallion Bank, a hypothetical

 

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immediate 1% increase in interest rates would have positively impacted net increase in net assets resulting from operations as of September 30, 2010 by approximately $1,218,000 on an annualized basis, compared to a positive impact of $1,149,000 at December 31, 2009, and the impact of such an immediate increase of 1% over a one year period would have been ($1,941,000) at September 30, 2010, compared to ($1,943,000) for December 31, 2009. Although management believes that this measure is indicative of our sensitivity to interest rate changes, it does not adjust for potential changes in credit quality, size, and composition of the assets on the balance sheet, and other business developments that could affect net increase in net assets resulting from operations in a particular quarter or for the year taken as a whole. Accordingly, no assurances can be given that actual results would not differ materially from the potential outcome simulated by these estimates.

We may experience fluctuations in our quarterly results.

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

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

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

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

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

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

Acquisitions may lead to difficulties that could adversely affect our operations.

By their nature, corporate acquisitions entail certain risks, including those relating to undisclosed liabilities, the entry into new markets, operational, and personnel matters. We may have difficulty integrating acquired operations or managing problems due to sudden increases in the size of our loan portfolio. In such instances, we might be required to modify our operating systems and procedures, hire additional staff, obtain and integrate new equipment, and complete other tasks appropriate for the assimilation of new business activities. We cannot assure you that we would be successful, if and when necessary, in minimizing these inherent risks or in establishing systems and procedures which will enable us to effectively achieve our desired results in respect of any future acquisitions.

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

The 1940 Act restricts our ability to knowingly participate in certain transactions with our affiliates. These restrictions limit our ability to buy or sell any security from or to our affiliates, or engage in “joint” transactions with our affiliates, which could include investments in the same portfolio company (whether at the same or different times). With respect to controlling or certain closely affiliated persons, we will generally be prohibited from engaging in such transactions absent the prior approval of the SEC. With respect to other affiliated persons, we may engage in such transactions only with the prior approval of our independent directors.

 

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Our Board of Directors may change our operating policies and strategies without prior notice or shareholder approval, the effects of which may be adverse.

Our Board of Directors has the authority to modify or waive our current operating policies and strategies without prior notice and without shareholder approval. We cannot predict the effect any changes to our current operating policies and strategies would have on our business, operating results, and value of our stock. However, the effects might be adverse, which could negatively impact our ability to pay you dividends and cause you to lose all or part of your investment.

Risks Relating to Our Investments

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

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

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

Our portfolio is and may continue to be concentrated in a limited number of portfolio companies and industries. As of September 30, 2010, investments in New York City taxi medallion loans represented approximately 77% of our managed taxi medallion loans. Beyond the asset diversification requirements associated with our qualification as a RIC, we do not have fixed guidelines for diversification, and while we are not targeting any specific industries, our investments are, and could continue to be, concentrated in relatively few industries. As a result, the aggregate returns we realize may be adversely affected if a small number of investments perform poorly or if we need to write down the value of any one investment. Additionally, a downturn in any particular industry in which we are invested could also negatively impact the aggregate returns we realize.

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

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

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

Changes in taxicab industry regulations that result in the issuance of additional medallions or increases in the expenses involved in operating a medallion could lead to a decrease in the value of our medallion loan collateral.

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

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

A significant portion of our loan revenue is derived from loans collateralized by New York City taxicab medallions. According to New York City TLC data, over the past 20 years New York City taxicab medallions have appreciated in value from under $100,000 to $825,000 for corporate medallions and $610,000 for individual medallions. However, for sustained periods during that time, taxicab medallions have declined in value. Since December 31, 2008, the value of New York City taxicab medallions increased by approximately 11% for individual medallions and 10% for corporate medallions.

 

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

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

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

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

We may not control many of our portfolio companies.

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

We may not realize gains from our equity investments.

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

 

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ITEM 6. EXHIBITS

 

Number

  

Description

  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.

IMPORTANT INFORMATION RELATING TO FORWARD-LOOKING STATEMENTS

The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those projected in such statements. 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 the control of the Company. Accordingly, there can be no assurance that the forward-looking statements contained in this Form 10-Q will be realized or that actual results will not be significantly higher or lower. 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. These risks and others that are detailed in this Form 10-Q and other documents that the Company files from time to time with the Securities and Exchange Commission, including annual reports on Form 10-K, quarterly reports on Form 10-Q, and any current reports on Form 8-K must be considered by any investor or potential investor in the Company.

 

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SIGNATURES

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.

MEDALLION FINANCIAL CORP.

Date: November 3, 2010

By:   /s/    ALVIN MURSTEIN        
  Alvin Murstein
  Chairman and Chief Executive Officer
By:   /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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