10-Q 1 d10q.txt FORM 10-Q FOR PERIOD ENDING 3/31/2001 ================================================================================ U.S. 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 March 31, 2001 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 0-27812 MEDALLION FINANCIAL CORP. (Exact name of registrant as specified in its charter) DELAWARE No. 04-3291176 (State of Incorporation) (IRS Employer Identification No.) 437 Madison Ave, 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 --- --- Number of shares of Common Stock outstanding at the latest practicable date, May 10, 2001: Class Outstanding Par Value Shares Outstanding ----------------- --------- ------------------ Common Stock....................................$.01..............14,602,846 ================================================================================ 1 MEDALLION FINANCIAL CORP. FORM 10-Q INDEX PART I........................................................................................................3 FINANCIAL INFORMATION.........................................................................................3 ITEM.1 Basis Of Preparation.............................................................................3 CONSOLIDATED BALANCE SHEETS..........................................................................4 CONSOLIDATED STATEMENTS OF OPERATIONS................................................................5 CONSOLIDATED STATEMENTS OF CASH FLOWS................................................................6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS..........14 PART II......................................................................................................29 OTHER INFORMATION............................................................................................29 ITEM 1. Legal Proceedings..............................................................................29 ITEM 2. Changes in Securities and Use of Proceeds......................................................29 ITEM 3. Defaults Upon Senior Securities................................................................29 ITEM 4. Submission of Matters to a Vote of Security Holders............................................29 ITEM 5. Other Information..............................................................................29 ITEM 6. Exhibits and reports on form 8-K...............................................................29 SIGNATURES.............................................................................................30
2 PART I. FINANCIAL INFORMATION ITEM.1 Basis Of Preparation Medallion Financial Corp. (the Company) is a closed-end management investment company organized as a Delaware corporation. The Company has elected to be regulated as a business development company 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 Corp. (MFC). As an adjunct to the Company's taxicab medallion finance business, the Company operates a taxicab rooftop advertising business, Medallion Taxi Media, Inc. (Media). The financial information is divided into two sections. The first section, Item 1, includes the unaudited consolidated financial statements of the Company 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 months ended March 31, 2001. The consolidated balance sheets of the Company as of March 31, 2001, the related consolidated statements of operations for the three months ended March 31, 2001, and the consolidated statements of cash flows for the three months ended March 31, 2001 included in Item 1 have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the accompanying consolidated financial statements include all adjustments (consisting of normal, recurring adjustments) necessary to summarize fairly the Company's financial position and results of operations. The results of operations for the three months ended March 31, 2001 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 the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2000. 3 MEDALLION FINANCIAL CORP. CONSOLIDATED BALANCE SHEETS (UNAUDITED)
================================================================================================================== March 31, 2001 December 31, 2000 ================================================================================================================== Assets Investments: Medallion loans $285,341,499 $299,302,548 Commercial loans 205,383,713 212,721,373 Equity investments 1,729,544 2,129,685 ----------------------------------------------------- Net investments 492,454,756 514,153,606 Investment in and loans to unconsolidated subsidiary 2,117,365 1,856,421 ----------------------------------------------------- Total investments 494,572,121 516,010,027 Cash 24,513,968 15,652,878 Accrued interest receivable 9,601,269 8,701,981 Servicing fee receivable 6,355,354 6,632,516 Fixed assets, net 1,940,839 2,050,808 Goodwill, net 5,517,519 5,650,045 Other assets, net 6,157,523 6,016,747 ----------------------------------------------------- Total assets 548,658,593 560,715,002 ================================================================================================================== Liabilities Accounts payable and accrued expenses 9,720,526 7,723,812 Dividends payable - 5,244,281 Accrued interest payable 1,925,079 3,887,589 Commercial paper 763,708 24,066,269 Notes payable to banks 319,470,000 305,700,000 Senior secured notes 45,000,000 45,000,000 SBA debentures payable 21,360,000 21,360,000 ----------------------------------------------------- Total liabilities 398,239,313 412,981,951 ================================================================================================================== Shareholders' Equity Preferred Stock (1,000,000 shares of $.01 par value stock authorized - none outstanding) - - Common stock (50,000,000 shares of $.01 par value stock authorized - 14,582,035 and 14,546,637 shares outstanding at March 31, 2001 and December 31, 2000, respectively) 145,821 145,467 Capital in excess of par value 146,776,023 146,379,377 Accumulated undistributed net investment income 3,497,436 1,208,207 ----------------------------------------------------- Total shareholders' equity 150,419,280 147,733,051 ----------------------------------------------------- Total liabilities and shareholders' equity $548,658,593 $560,715,002 ================================================================================================================== Number of common shares 14,582,035 14,546,637 Net asset value per share $10.32 $10.16 ==================================================================================================================
The accompanying notes are an integral part of these unaudited consolidated financial statements. 4 MEDALLION FINANCIAL CORP. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
========================================================================================================== Three Months Ended March 31, ========================================================================================================== 2001 2000 ========================================================================================================== Investment income Interest and dividend income on investments $ 13,329,179 $ 14,451,068 Interest income on short-term investments 44,952 79,877 --------------------------------------------------- Total investment income 13,374,131 14,530,945 ---------------------------------------------------------------------------------------------------------- Interest expense Notes payable to banks 5,790,472 3,304,556 Commercial paper 155,529 2,281,159 Senior secured notes 821,864 821,865 SBA debentures 433,172 409,418 --------------------------------------------------- Total interest expense 7,201,037 6,816,998 --------------------------------------------------- Net-interest income 6,173,094 7,713,947 ---------------------------------------------------------------------------------------------------------- Non-interest income Gain on sale of loans 433,180 686,098 Equity in losses of unconsolidated subsidiary (427,184) (319,349) Accretion of negative goodwill - 180,600 Other income 971,246 799,907 --------------------------------------------------- Total non-interest income 977,242 1,347,256 ---------------------------------------------------------------------------------------------------------- Non-interest expense Salaries and benefits 2,677,076 2,455,981 Professional fees 395,247 416,617 Amortization of goodwill 132,526 136,578 Administrative and advisory fees 3,135 61,541 Other operating expenses 1,610,857 1,624,429 --------------------------------------------------- Total non-interest expenses 4,818,841 4,695,146 ---------------------------------------------------------------------------------------------------------- Net investment income 2,331,495 4,366,057 Net realized gains (losses) on investments (898,413) 246,749 Change in unrealized appreciation (depreciation), net 893,264 (112,711) Income tax provision (37,117) (150) ---------------------------------------------------------------------------------------------------------- Net increase in net assets resulting from operations $ 2,289,229 $ 4,499,945 Basic .16 $ 0.31 Diluted .16 0.31 Weighted average common shares outstanding Basic 14,571,731 14,524,428 Diluted 14,583,299 14,591,352 ==========================================================================================================
The accompanying notes are an integral part of these unaudited consolidated financial statements. 5 MEDALLION FINANCIAL CORP. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
===================================================================================================================== Three Months Ended March 31, ===================================================================================================================== 2001 2000 ===================================================================================================================== CASH FLOWS FROM OPERATING ACTIVITIES Net increase in net assets resulting from operations $ 2,289,229 $ 4,499,945 Adjustments to reconcile net increase in net assets resulting from operations to net cash provided by operating activities: Depreciation and amortization 286,151 240,523 Amortization of goodwill 132,526 134,009 Amortization of origination costs 272,447 255,874 Accretion of negative goodwill - (180,600) Increase in unrealized appreciation (893,264) 112,711 Net realized loss on investments 898,413 (246,749) Equity in Losses in unconsolidated subsidiary 427,184 319,349 Increase in accrued interest receivable (899,287) (2,156,943) Decrease in receivable from sale of loans - 7,431,892 Decrease (increase) in servicing fee receivable 277,162 (525,803) Increase in other assets, net (140,776) (676,341) Increase (decrease) in accounts payable and accrued expenses 1,996,713 (1,923,646) Decrease in accrued interest payable (1,962,509) (1,702,549) ----------------------------------------- Net cash provided by operating activities 2,683,989 5,581,672 --------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Originations of investments (20,411,200) (85,515,419) Proceeds from sales and maturities of investments 41,832,448 61,444,491 Investment in and loans to unconsolidated subsidiary, net (688,128) 697,158 Capital expenditures (176,178) (101,780) ----------------------------------------- Net cash used in investing activities 20,556,942 (23,475,550) --------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from notes payable (repayments) to banks-net 13,770,000 (17,450,000) Proceeds from issuance of (repayments of) commercial paper-net (23,302,560) 42,673,483 Proceeds from exercise of stock options 374,000 36,000 Issuance of stock 23,000 - Payment of declared dividends to current stockholders (5,244,281) (5,609,773) ----------------------------------------- Net cash (used in) provided by financing activities (14,379,841) 19,649,710 --------------------------------------------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN CASH 8,861,090 1,755,832 CASH beginning of period 15,652,878 7,459,284 ----------------------------------------- CASH end of period 24,513,968 9,215,116 --------------------------------------------------------------------------------------------------------------------- SUPPLEMENTAL INFORMATION Cash paid during the period for interest $ 9,163,547 $ 8,519,546 =====================================================================================================================
The accompanying notes are an integral part of these unaudited consolidated financial statements. 6 MEDALLION FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 2001 (1) Organization of Medallion Financial Corp. and Its Subsidiaries Medallion Financial Corp. (the Company) is a closed-end management investment company organized as a Delaware corporation. The Company has elected to be regulated as a business development company 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 Corp. (MFC). As an adjunct to the Company's taxicab medallion finance business, the Company operates a taxicab rooftop advertising business, Medallion Taxi Media, Inc. (Media). The Company also conducts its business through Business Lenders, LLC (BLL), licensed under the Small Business Administration (SBA) section 7(a) program, Medallion Business Credit LLC (MBC), an originator of loans to small businesses for the purpose of financing inventory and receivables, Medallion Capital, Inc. (Medallion Capital) which conducts a mezzanine financing business, and Freshstart Venture Capital Corp. (Freshstart), a Specialized Small Business Investment Company (SSBIC) which also originates and services medallion and commercial loans. (2) Summary of Significant Accounting Policies Use of Estimates The accounting and reporting policies of the Company conform with generally accepted accounting principles and general practices in the investment company industry. The preparation of financial statements in conformity with generally accepted accounting principles requires the Company to make estimates and assumptions that affect the reporting and disclosure of assets and liabilities, including those that are of a contingent nature, at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Principles of Consolidation and Use of the Equity Method The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, except for Media. All significant intercompany transactions, balances, and profits have been eliminated in consolidation. The consolidated statements give retroactive effect to the merger with Freshstart, retroactively combined with the Company's financial statements as if the merger had occurred at the beginning of the earliest period presented. The Company's investment in Media is accounted for under the equity method. All significant intercompany transactions, balances and profits have been eliminated in the use of the equity method. As a non-investment company, Media cannot be consolidated with the Company, which is an investment company under the 1940 Act. Refer to Note 3 for the presentation of financial information for Media. Investment Valuation The Company's loans, net of participations and any unearned discount, are considered investments under the 1940 Act and are recorded at fair value. Loans are valued at cost less unrealized depreciation. Since no ready market exists for these loans, the fair value is determined in good faith 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. Investments in equity securities and stock warrants are recorded at fair value, represented as cost, plus or minus unrealized appreciation or depreciation, respectively. The fair value of investments that have no ready market, are determined by the Board of Directors based upon assets and revenues of the underlying investee company as well as general market trends for businesses in the same industry. Included in equity investments at March 31, 2001 are marketable and non-marketable securities of approximately $1,090,000 and $640,000, respectively. Included in equity investments at December 31, 2000 are marketable and non-marketable securities 7 of approximately $1,490,000 and $640,000, respectively. Because of the inherent uncertainty of valuations, the Board of Directors' 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. The Company's investments consist primarily 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 58% of the Company's loan portfolio at March 31, 2001 and December 31, 2000, had arisen in connection with the financing of taxicab medallions, taxicabs, and related assets, of which 79% and 77%, respectively, are in New York City. These loans are secured by the medallions, taxicabs and related assets, and are personally guaranteed by the borrowers, or in the case of corporations, personally guaranteed by the owners. A portion of the Company's portfolio represents loans to various commercial enterprises, including dry cleaners, laundromats, restaurants, garages, and gas stations. These loans are secured by various equipment and/or real estate and are generally guaranteed by the owners, and in certain cases, by the equipment dealers. These loans are made primarily in the metropolitan New York City area. The remaining portion of the Company's portfolio is from the origination of loans guaranteed by the SBA under its Section 7(a) program, less the sale of the guaranteed portion of those loans. Funding for the Section 7(a) program depends on annual appropriations by the U.S. Congress. Collateral Appreciation Participation Loans During the 2000 first half, the Company originated collateral appreciation participation loans collateralized by Chicago taxi medallions of $30 million, of which $21 million was syndicated to other financial institutions. In consideration for modifications from it's normal taxi medallion lending terms, the Company offered loans at higher loan-to-value ratios and is entitled to earn additional interest income based upon any increase in the value of all $30 million of the collateral. The fair value of the collateral appreciation participation loan portfolio at March 31, 2001 was $12.8 million, which represented approximately 3% of the total loan portfolio. Additional interest income totaled approximately $700,000 and $1,100,000 for the quarters ended March 31, 2001 and 2000, and is included in investment income on the consolidated statements of operations and in accrued interest receivable on the consolidated balance sheets. The Company believes that the additional interest income recorded is fully realizable through operation of the collateral or orderly sales in the market. As a regulated investment company, the Company is required to mark-to-market these investments on a quarterly basis, just as it does on all of its other investments. The Company feels that it has adequately calculated the fair market value on these investments and relies upon information such as recent and historical medallion sale prices. If there is a decrease in the value of taxicab medallions, the reduction in the value of the investments will be reversed against investment income. Income Recognition Interest income is recorded on the accrual basis. Loans are placed on non-accrual status, and all uncollected accrued interest is reversed, when there is doubt as to the collectibility 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 non-accrual loans is recognized when cash is received. At March 31, 2001 and December 31, 2000 total non-accrual loans were approximately $13,601,000 and $13,197,000. 8 Loan Sales and Servicing Fee Receivable The principal portion of loans serviced for others by the Company at March 31, 2001 and December 31, 2000 amounted to approximately $232,000,000 and $231,000,000. Receivables from loans sold and gain or losses on loan sales are primarily attributable to the sale of commercial loans which have been at least partially guaranteed by the SBA. The Company recognizes gains or losses from the sale of the SBA-guaranteed portion of a loan at the date of the sales agreement when control of the future economic benefits embodied in the loan is surrendered. The estimated net servicing income is based, in part, on management's estimate of prepayment speeds, including default rates, and accordingly, there can be no assurance of the accuracy of these estimates. If the prepayment speeds occur at a faster rate than anticipated, the amortization of the servicing assets will be accelerated and it's value will decline; and as a result, servicing income during that and subsequent periods would decline. If prepayments occur slower than anticipated, cash flows would exceed estimated amounts and servicing income would increase. The constant prepayment rates utilized by the Company in estimating the lives of the loans depend on the original term of the loan, industry trends, and the Company's historical data. The activity in the reserve for servicing fee receivable follows:
=============================================================================================================== Three Months Ended March 31, --------------------------------------------------------------------------------------------------------------- 2001 2000 --------------------------------------------------------------------------------------------------------------- Beginning Balance $205,000 $- Additions charged to operations 31,000 - --------------------------------------------------------------------------------------------------------------- Ending Balance $236,000 $- ===============================================================================================================
Unrealized Appreciation (Depreciation) and Gains/(Losses) on Investments The change in unrealized appreciation/(depreciation) of 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 write-offs of loans or assets acquired in satisfaction of loans, net of recoveries. Unrealized depreciation at March 31, 2001 and 2000 amounted to $6.1 million and $7.4 million, respectively. Goodwill Cost of purchased businesses in excess of the fair value of net assets acquired (goodwill) is amortized on a straight-line basis over fifteen years. The excess of fair value of net assets over cost of business acquired (negative goodwill) was accreted on a straight-line basis over approximately four years. The Company reviews its goodwill for events or changes in circumstances that may indicate that the carrying amount of the assets may not be recoverable, and if appropriate, reduces the carrying amount through a charge to income. Federal Income Taxes The Company has elected to be treated for tax purposes as a regulated investment company (RIC) under the Internal Revenue Code of 1986, as amended (the Code). As a RIC, the Company will not be subject to U.S. federal income tax on any investment company taxable income (which includes, among other things, dividends and interest reduced by deductible expenses) that it distributes to its stockholders if at least 90% of its investment company taxable income for that taxable year is distributed. It is the Company's policy to comply with the provisions of the Code applicable to regulated investment companies. Media, as a non-investment company, has elected to be taxed as a regular corporation. 9 Net Increase in Net Assets Resulting from Operations per Share (EPS) Basic earnings per share is 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 common stock and stock options. Basic and diluted EPS for the three months ended March 31, 2001 and 2000 are as follows:
=========================================================================================================================== (Dollars in thousands, except per share amount) 2001 2000 =========================================================================================================================== Net increase in net assets resulting from operations available to common shareholders $ 2,289 $ 4,500 --------------------------------------------------------------------------------------------------------------------------- Weighted average common shares outstanding applicable to basic EPS 14,571,731 14,524,428 Effect of dilutive stock options 11,568 66,924 -------------------------------- Adjusted weighted average common shares outstanding applicable to diluted EPS 14,583,299 14,591,352 --------------------------------------------------------------------------------------------------------------------------- Basic earnings per share .16 .31 Diluted earnings per share $ .16 $ .31 ===========================================================================================================================
Derivatives In June 1998, the Financial Accounting Standards Board issued SFAS 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 133 establishes new standards regarding accounting and reporting requirements for derivative instruments and hedging activities. In June 1999, the Board issued SFAS 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133." The new standard deferred the effective date of SFAS 133 to fiscal years beginning after June 15, 2000. The Company adopted SFAS 133 beginning January 1, 2001. The cumulative effect of adoption was not material. The Company is party to certain interest rate cap agreements. These contracts were entered into as part of the Company's management of interest rate exposure and effectively limit the amount of interest rate risk that may be taken on a portion of the Company's outstanding debt. All interest rate caps are designated as hedges of certain liabilities, however, any hedge ineffectiveness is charged to earnings in the period incurred. For the three months ended March 31, 2001 and 2000, the amount charged to earnings was $102,000 and $0. Premiums paid on the interest rate caps were previously amortized over the lives of the cap agreements and amortization of these costs was recorded as an adjustment to interest expense. Upon adoption of SFAS 133, the interest rate caps are recorded at fair value which is determined based on information provided by the Company's counterparties. Interest rate settlements, if any, are recorded as a reduction of interest expense over the lives of the agreements. The fair value of the Company's interest rate caps as of March 31, 2001 was $260. Reclassifications Certain reclassifications have been made to prior year balances to conform with the current year presentation. 10 (3) Investment in Unconsolidated Subsidiary The balance sheets at March 31, 2001 and December 31, 2000 for Media are as follows:
=================================================================================================================== March 31, December 31, --------------------------------------- 2001 2000 =================================================================================================================== Cash $ 19,087 $ 5,259 Accounts receivable 1,069,669 2,652,055 Equipment, net 3,299,606 3,281,011 Goodwill 1,650,551 1,659,624 Prepaid signing bonuses 1,823,935 1,521,253 Other 3,163,845 2,882,750 Due from parent - 321,723 --------------------------------------- Total assets $ 11,026,693 $ 12,323,675 ------------------------------------------------------------------------------------------------------------------- Accounts payable and accrued expenses 1,140,131 $ 683,369 Note payable-bank 3,900,000 3,900,000 Notes payable-parent 362,303 - Deferred revenue 3,713,005 5,453,550 --------------------------------------- Total liabilities 9,115,439 10,036,919 ------------------------------------------------------------------------------------------------------------------- Equity 1,001,000 1,001,000 Retained Earnings 910,254 1,285,756 --------------------------------------- Total equity 1,911,254 2,286,756 --------------------------------------- Total liabilities and equity $ 11,026,693 $ 12,323,675 ===================================================================================================================
The statements of operations of Media for the three months ended March 31, 2001 and 2000 are as follows:
=================================================================================================================== Three Months Ended =================================================================================================================== March 31, --------------------------------------- 2001 2000 =================================================================================================================== Advertising revenue $3,355,226 $2,276,321 Cost of fleet services 2,066,959 1,163,103 --------------------------------------- Gross profit 1,288,267 1,113,218 Other operating expenses 2,038,592 1,396,216 --------------------------------------- Loss before taxes (750,325) (282,998) Income tax benefit (323,141) (113,199) --------------------------------------- Net loss $(427,184) $(169,799) ===================================================================================================================
Included in advertising revenue for the quarter ended March 31, 2001 is approximately $567,000 related to contracts that were cancelled in prior periods due to legislative changes and other factors. This revenue was recognized upon determination that Media had no further obligations under the contract. 11 (4) Commercial Paper, Notes payable to banks and senior secured notes Borrowings under the commercial paper, revolving credit, and senior note agreements are secured by the assets of the Company. The outstanding balances were as follows as of March 31, 2001 and December 31, 2000.
=================================================================================================================== Description 2001 2000 =================================================================================================================== Commercial paper $ 763,708 $ 24,066,269 Revolving credit agreements 319,470,000 305,700,000 Senior secured notes 45,000,000 45,000,000 ------------------------------------------------------------------------------------------------------------------- Total $ 365,233,708 $374,766,269 ===================================================================================================================
(a) Commercial Paper On March 13, 1998, MFC entered into a commercial paper agreement to sell up to an aggregate principal amount of $195 million in secured commercial paper through private placements, and coincident with the extension and expansion of the Revolving Credit Agreement (the Revolver), the commercial paper line was expanded to $220,000,000. The commercial paper program ranks on a pari passu basis with the Revolver. The commercial paper program has a specified maturity date of June 30, 2001, which represents the maturity date of MFC's Revolver, but may be terminated by the Company at anytime. During December 2000, MFC'S outstanding commercial paper began to mature and was replaced by draws on the Revolver at a cost of 7.83%, compared to a cost of 7.10%. On November 22, 2000, Fitch IBCA placed Medallion's "BBB" senior secured debt rating and "F2" secured commercial paper rating on negative watch. In addition, in December 2000, Medallion's other rating agency, Thompson's Bankwatch, was acquired by Fitch IBCA, leaving it with only one commercial paper rating. Primarily as a result of these factors, a substantial portion of Medallion's commercial paper did not rollover and has subsequently been replaced by Medallion's bank facility. On January 18, 2001, Fitch IBCA lowered the Company's senior secured debt rating and secured commercial paper rating to "BB+" and "B", respectively, and removed them from negative watch. At March 31, 2001 and December 31, 2000, MFC had approximately $764,000 and $24,066,000 outstanding at a weighted average interest rate of 7.18% and 7.10%. For the three months ended March 31, 2001 and year ended December 31, 2000, MFC's weighted average borrowings related to commercial paper were $7,653,000 and $135,568,000 with a weighted average interest rate of 7.45% and 7.25%. Commercial paper outstandings are deducted from the Revolver as the Revolver acts as a liquidity facility for the commercial paper. (b) Revolving Credit Agreements On March 27, 1992 (and as subsequently amended), MFC entered into the Revolver with a group of banks. Effective on February 10, 2000, MFC extended the Revolver until June 30, 2001 at an aggregate credit commitment amount of $220,000,000, an increase from $195,000,000 previously, pursuant to the Loan Agreement dated December 24, 1997. Amounts available under the Revolver are reduced by amounts outstanding under the commercial paper program as the Revolver acts as a liquidity facility for the commercial paper program. As of March 31, 2001 and December 31, 2000, amounts available under the Revolver were $0. The Revolver may be extended annually after June 30, 2001 upon the option of the participating banks and acceptance by MFC. Outstanding borrowings under the Revolver were $212,670,000 and $195,700,000 at weighted average interest rates of 6.48% and 7.68% at March 31, 2001 and December 31, 2000. On July 31, 1998, (and as subsequently amended) the Company closed its existing $25,000,000 revolving credit line and entered into a committed revolving credit agreement (the Loan Agreement) with a group of banks. The aggregate credit commitment amount was $100,000,000 maturing on June 28, 2000 and was extended on September 22, 2000 to September 21, 2001 at an increased commitment level of $110,000,000. The Loan Agreement may be extended annually thereafter upon the option of the participating banks and acceptance by the Company. Outstanding borrowings under the Loan Agreement were $103,300,000 and $106,500,000 at a weighted average interest rate of 6.40% and 8.09% at March 31, 2001 and December 31, 2000. On March 6, 1997, Freshstart established a $5,000,000 line of credit with a bank at a rate of LIBOR plus 1.75%. Persuant to the terms of the line of credit, the Company is required to comply with certain terms, 12 covenants, and conditions, including maintaining minimum balances with the bank. The line of credit is unsecured. In connection with the Freshstart merger, the line was reduced to $3,500,000 with no specific maturity. The weighted average interest rate for the Company's consolidated outstanding revolver borrowings at March 31, 2001 and December 31, 2000 was 6.46% and 7.83%. During the three months ended March 31, 2001 and 2000, the Company's weighted average borrowings were $302,724,000 and $175,687,500 with a weighted average interest rate of 7.50% and 6.97%, respectively. On March 30, 2001 Medallion finalized certain amendments and was granted a waiver of compliance with certain provisions. These amendments clarified and revised certain provisions of the agreements related to business activities and financial covenants of Medallion and MFC, and adjusted the rate of interest paid on the notes. As of the effective date of the amendments, Medallion believes it and MFC are in compliance with the requirements of the credit facilities, as amended, and expect to remain in compliance with the amended credit facilities for the foreseeable future. Medallion, MFC, and their lenders have initiated discussions as to the next renewal of the existing bank loans which mature in June and September, 2001. Although, there can be no assurances, the Company expects a satisfactory result from these discussions. Periodically MFC must maintain certain covenants under its Revolver. At March 31, 2001, MFC was not in compliance with the covenant relating to interest expense ratios (resulting in similar non-compliance under the Notes (as defined below) and the Loan Agreement). The Company is presently seeking a waiver under the Revolver which would cure all such non-compliance under these agreements. (c) Senior Secured Notes On June 1, 1999, MFC issued $22.5 million of Series A senior secured notes that mature on June 1, 2004, and on September 1, 1999, MFC issued $22.5 million of Series B senior secured notes that mature on September 1, 2004 (together, the Notes). The Notes bear a fixed rate of interest of 7.20% (7.35% effective March 30, 2001 pursuant to the amendments discussed above) and interest is paid quarterly in arrears. The Notes rank pari passu with the revolvers and commercial paper through inter-creditor agreements. (d) Interest Rate Cap Agreements On June 22, 2000, MFC entered into an interest cap agreement limiting the Company's maximum LIBOR exposure on $10,000,000 of MFC's revolving credit facility to 7.25% until June 24, 2002. On July 6, 1999, MFC entered into two interest rate cap agreements limiting the Company's maximum LIBOR exposure on a total of $20,000,000 of MFC's revolving credit facility to 6.50% until July 6, 2001. On April 7, 1998, MFC entered into an interest rate cap agreement limiting the company's maximum LIBOR exposure on $20,000,000 of MFC's revolving credit facility to 6.50% until September 30, 1999 and 7.0% until March 30, 2001. The Company is exposed to credit loss in the event of nonperformance by the counterparties on the interest rate cap agreements. The Company does not anticipate nonperformance by any of these parties. 13 (5) SBA Debentures Payable Outstanding SBA debentures are as follows at March 31, 2001 and December 31, 2000:
============================================================================================================= Due Date 2001 2000 Interest Rate ============================================================================================================= December 1, 2006 $5,500,000 $5,500,000 7.08% March 1, 2007 4,210,000 4,210,000 7.38 September 1, 2007 4,060,000 4,060,000 7.76 June 1, 2007 3,000,000 3,000,000 7.07 March 1, 2006 2,000,000 2,000,000 7.08 December 16, 2002 1,300,000 1,300,000 4.51 June 1, 2005 520,000 520,000 6.69 December 1, 2005 520,000 520,000 6.54 June 1, 2006 250,000 250,000 7.71 --------------------------------------------------- $21,360,000 $21,360,000 =============================================================================================================
(6) Segment Reporting The Company has two reportable business segments, lending and taxicab rooftop advertising. The lending segment originates and services secured commercial loans. The taxicab rooftop advertising segment sells advertising space to advertising agencies and companies in several major markets across the United States. The segment is reported as an unconsolidated subsidiary, Medallion Taxi Media, Inc. The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies. The lending segment is presented in the consolidated financial statements of the Company. Financial information relating to the taxicab rooftop advertising segment is presented in Note 3, and represents an immaterial part of total Company revenues, expenses, income, assets and liabilities. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information contained in this section should be read in conjunction with the Consolidated Financial Statements and Notes thereto appearing in this Report on Form 10-Q and the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2000. In addition, this section contains forward-looking statements. These forward-looking statements are subject to inherent uncertainties in predicting future results and conditions. Certain factors that could cause actual results and conditions to differ materially from those projected in these forward-looking statements are set forth below in the Investment Considerations section. General We are a specialty finance company that originates and services loans that finance taxicab medallions and various types of commercial loans. We have a leading position in taxicab medallion financing. Since 1996, we have increased our medallion loan portfolio at a compound annual growth rate of 18% and our commercial loan portfolio at a compound annual growth rate of 38%. Our total assets under our management was approximately $780 million and has grown from $215 million at the end of 1996, a compound annual growth rate of 35%. Medallion's loan related earnings depend primarily on its level of net interest income. Net interest income is the difference between the total yield on Medallion's loan portfolio and the average cost of funds. Medallion funds its operations through a wide variety of interest-bearing sources, such as revolving bank facilities, secured commercial paper, senior secured notes and debentures issued to and guaranteed by the SBA. Net interest income fluctuates with changes in the yield on Medallion's loan portfolio and changes in the cost of funds, as well as changes in the amount of interest-bearing assets and interest-bearing liabilities held 14 by Medallion. Net interest income is also affected by economic, regulatory and competitive factors that influence interest rates, loan demand and the availability of funding to finance Medallion's lending activities. Medallion, like other financial institutions, is subject to interest rate risk to the degree that its interest-earning assets reprice on a different basis than its interest-bearing liabilities. Medallion originates loans under the Section 7(a) loan program of the SBA through its wholly owned subsidiary BLL. Up to 75% of the amount of these loans (up to $1,000,000) are guaranteed by the SBA. Medallion regularly sells the guaranteed portion of these loans in the secondary market and holds the non-guaranteed portion until maturity. Medallion also invests in small businesses in selected industries through its subsidiary Medallion Capital. Medallion Capital's investments are typically in the form of secured debt instruments with fixed interest rates accompanied by warrants to purchase an equity interest for a nominal exercise price (such warrants are included in "Equity Investments"). Interest income is earned on the debt investments. Realized gains or losses on investments are recognized when the investments are sold or written-off. The realized gains or losses represent the difference between the proceeds received from the disposition of portfolio assets, if any, and the cost of such portfolio assets. In addition, changes in unrealized appreciation or depreciation of investments are recorded and represent the net change in the estimated fair values of the portfolio assets at the end of the period as compared with their estimated fair values at the beginning of the period. Generally, "realized gains (losses) on investments" and "changes in unrealized appreciation (depreciation) of 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 an unrealized loss is realized by the sale or other disposition of a depreciated portfolio asset, the reclassification of the loss from "unrealized" to "realized" causes an increase in net unrealized appreciation and an increase in realized loss. Medallion's income from the taxicab rooftop advertising business, operated by Media, is reflected on Medallion's books as earnings from an unconsolidated subsidiary. Medallion continues to explore other opportunities in the taxicab and lending industries, including possible strategies to participate directly and/or indirectly in the appreciation of taxicab medallions. 15 Trend in Loan Portfolio Medallion's investment income is driven by the principal amount of and yields on its loan portfolio. To identify trends in the yields, the portfolio is grouped by medallion loans, commercial loans, and equity investments. Since December 31, 1998, medallion loans, while still making up a significant portion of the total portfolio, have decreased in relation to the total portfolio composition and commercial loans have increased. The following table illustrates Medallion's investments at fair value and the weighted average portfolio yields calculated using the contractual interest rates of the loans at the dates indicated:
=================================================================================================================================== 3/31/2000 12/31/2000 3/31/2001 % of Interest Principal % of Interest Principal % of Interest Principal Portfolio Rate Balance Portfolio Rate Balance Portfolio Rate Balance =================================================================================================================================== Medallion Loans New York 49.8% 8.41% $259,039 41.5% 8.67% $215,607 42.5% 8.62% $211,103 Fresh Start-New York 3.1% 9.27% 15,889 2.5% 9.10% 12,851 3.0% 9.17% 15,088 Boston 1.6% 10.38% 8,549 3.3% 11.21% 17,279 3.1% 11.16% 15,612 Cambridge 0.5% 9.97% 2,718 0.2% 10.58% 927 0.4% 11.78% 1,742 Chicago 5.3% 10.75% 27,599 6.3% 10.47% 32,621 5.0% 10.38% 24,825 Newark 2.4% 11.79% 12,377 2.1% 11.59% 11,092 2.0% 11.54% 9,783 Other 1.1% 10.29% 5,596 1.6% 11.16% 8,230 1.3% 11.42% 6,477 ----------------------------------------------------------------------------------------------------------------------------------- Total Medallion Loans 63.7% 8.87% 331,767 57.5% 9.22% 298,607 57.3% 9.12% 284,630 ----------------------------------------------------------------------------------------------------------------------------------- Add: FASB 91 915 697 712 =================================================================================================================================== Medallion Loans, net 65.0% 332,682 58.2% 299,304 57.9% $285,342 =================================================================================================================================== Commercial Loans Dry Cleaning 1.9% 13.30% 10,013 1.4% 13.26% 7,438 1.3% 13.14% $ 6,597 Laundromat 2.7% 12.56% 14,162 1.9% 12.37% 9,844 1.8% 12.23% 9,041 Commercial Secured 12.3% 12.49% 64,294 16.6% 12.84% 86,216 17.7% 12.16% 88,087 7 a Loans 11.0% 11.25% 57,439 12.7% 11.50% 66,058 12.2% 11.05% 60,573 Asset based receivable 6.6% 10.72% 34,241 8.3% 12.98% 43,120 8.2% 12.06% 40,611 Fresh Start 1.1% 11.00% 5,729 1.1% 11.00% 5,927 1.1% 10.00% 5,429 ----------------------------------------------------------------------------------------------------------------------------------- Total Commercial Loans 35.7% 11.78% 185,878 42.1% 12.41% 218,603 42.3% 11.80% 210,338 ----------------------------------------------------------------------------------------------------------------------------------- Add: FASB 91 1,639 1,107 974 Less: Reserve (8,852) (6,989) (5,929) =================================================================================================================================== Commercial loans, net 35.0% 178,665 41.4% 212,721 41.7% 205,383 =================================================================================================================================== Equity investments 0.0061 3,037 0.5% 0.00% 2,552 0.4% 0.00% 1,855 ------------------------------------------------------------------------------------------------------ Less: Unrealized depreciation (562) (423) (125) -------------- -------------- ------------- 2,475 2,129 1,730 =================================================================================================================================== Total investments at cost 100.0% 9.91% 520,682 100.0% 10.56% 519,762 100% 10.26% 496,823 =================================================================================================================================== Add: FASB 91 2,554 1,804 1,686 Less: Net depreciation on equities (562) (423) (125) Less: Reserve (8,852) (6,989) (5,929) =================================================================================================================================== Total investments, net 100.0% $513,822 100% $514,154 100% $492,455 ===================================================================================================================================
16 PORTFOLIO SUMMARY Total Portfolio Yield The weighted average yield of the total portfolio at March 31, 2001 was 10.26%, which is an increase of 35 basis points from 9.91% at March 31, 2000, but down 30 basis points from year end. The increase in the total portfolio yield compared to a year ago was due to the shift in the composition of the portfolio to an increased percentage of higher yielding commercial loans. The decline compared to the prior quarter resulted from the decrease in the yields of the medallion and commercial loan portfolios primarily due to the Federal Reserve's lowering of interest rates during the quarter, partially offset by an increased percentage of commercial loans in Medallion's portfolio. Medallion expects to try to continue increasing both the percentage of commercial loans in the total portfolio and the origination of floating and adjustable-rate loans and non-New York medallion loans. Medallion Loan Portfolio Medallion loans comprised 58% of the total portfolio of $492 million at March 31, 2001 and $514 million at December 31, 2000, compared to 65% of the total portfolio of $514 million at March 31, 2000. The medallion loan portfolio decreased by $14.0 million or 5% in the quarter, reflecting a decrease in medallion loan originations in most markets, and Medallion's execution of participation agreements with third parties for $26.1 million of low yielding New York medallion loans. Medallion retains a portion of these participating loans and earns a fee for servicing the loans for the third parties. The weighted average yield of the medallion loan portfolio at March 31, 2001 was 9.12%, an increase of 25 basis points from 8.87% at March 31, 2000, which was down 10 basis points from 9.22% at December 31, 2000. The decrease from year end primarily reflected the reduction in interest rates during the quarter and the increase compared to March 31, 2000, primarily reflects Medallion's expansion into markets outside of New York, which produced yields 100 to 300 basis points higher than loans originated in the New York medallion market, offset by the effects of continuing competition in the New York medallion market. At March 31, 2001, 21% of the medallion loan portfolio represented loans outside New York compared to 23% at year-end 2000 and 17% a year ago. Medallion continues to focus its efforts on originating higher yielding medallion loans outside the New York market. Collateral Appreciation Participation Loans During the 2000 first half, we originated collateral appreciation participation loans collateralized by Chicago taxi medallions of $30 million, of which $21 million was syndicated to other financial institutions. In consideration for modifications from its normal taxi medallion lending terms, the Company offered loans at higher loan-to-value ratios and is entitled to earn additional interest income based upon any increase in the value of all $30 million of the collateral. The fair value of the collateral appreciation participation loan portfolio at March 31, 2001 was $12.8 million, which represented 2.6% of the total loan portfolio. Additional interest income totaled approximately $700,000, ($400,000) and $1.1 million in the 2001 first quarter, 2000 fourth quarter, and 2000 first quarter respectively, and is included in investment income on the consolidated statements of operations and in accrued interest receivable on the consolidated balance sheets. The Company believes that the additional interest income recorded is fully realizable through operation of the collateral or orderly sales in the market. As a regulated investment company, Medallion is required to mark-to-market these investments on a quarterly basis, just as it does on all of its other investments. Medallion feels that it has adequately calculated the fair market value on these investments and relies upon information such as recent and historical medallion sale prices. If there is a decrease in the value of taxicab medallions, the reduction in the value of the investments will be reversed against investment income. The additional interest income is not reflected in the yield calculations shown in the table above. Commercial Loan Portfolio Since 1997, Medallion has continued to shift the total portfolio mix toward a higher percentage of commercial loans, which historically have had higher yields than its medallion loans. Commercial loans were 42% of the total portfolio at March 31, 2001 compared to 41% and 36% at December 31, 2000 and March 31, 2000. The increase in the commercial loan portfolio was due to strong growth in the SBA Section 7(a) loan program and in the asset-based lending portfolio, compared to a year ago, and the decline since year end primarily reflected contractions in the SBA Section 7(a) loan programs, primarily reflecting sales and paydowns. 17 The weighted average yield of the commercial loan portfolio at March 31, 2001 was 11.80%, a decrease of 61 basis points from 12.41% at year end, and compared to March 31, 2000, the yield increased 2 basis points from 11.78%. The decrease from year-end primarily reflected the drop of interest rates in the economy. The rate movement primarily reflected a shift in the mix within the commercial portfolio from fixed-rate loans to floating-rate or adjustable-rate loans tied to the prime rate, and the corresponding sensitivity of the yield to movements in the prime rate. Medallion continues to originate adjustable-rate and floating-rate loans tied to the prime rate to help mitigate its interest rate risk in a rising interest rate environment. At March 31, 2001, floating- rate loans represented approximately 69% of the commercial portfolio, unchanged from year end. 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. Equity Investments Equity Investments were 0.4%, 0.5%, and 0.6% of Medallion's total portfolio at March 31, 2001, December 31, 2000, and March 31, 2000. Equity investments are comprised of common stock and warrants. Trend in Interest Expense Medallion's interest expense is driven by the interest rate payable on its LIBOR-based short-term credit facilities with bank syndicates, long-term notes payable and, to a lesser degree, secured commercial paper and fixed-rate, long-term debentures issued to or guaranteed by the SBA. The following table provides the interest rates and interest expense of Medallion's major credit facilities for the three months ended March 31, 2001, December 31, 2000 and March 31, 2000.
============================================================================================================= Percentage Actual of Total Interest Interest Average Cost of Funds Expense Expense ============================================================================================================= March 31, 2001 Notes payable to banks 7.50% $ 5,790,472 80.41% SBA debentures 7.33% 433,172 6.0 Commercial paper 7.45% 155,529 2.2 Senior secured notes 7.06% 821,864 11.4 ------------------------------------------------------------------------------------------------------------- December 31, 2000 Notes payable to banks 8.18% $ 4,024,483 51.0% Commercial paper 7.38% 2,471,784 31.3 Senior secured notes 7.27% 821,864 10.4 SBA debentures 10.48% 572,093 7.3 ------------------------------------------------------------------------------------------------------------- March 31, 2000 Notes payable to banks 7.48% $ 3,304,556 48.5% Commercial paper 7.15% 2,281,159 33.5 Senior Secured Notes 7.27% 821,865 12.1 SBA debentures 7.15% 409,418 5.9 =============================================================================================================
Medallion 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. Accordingly, Medallion plans to limit its use of SBA funding to the subsidiary level to fund loans that qualify under the SBIA and SBA regulations. Further, Medallion believes that its transition to financing operations primarily with short-term LIBOR-based secured bank debt and secured commercial paper has generally decreased its interest expense, but has also increased Medallion's exposure to the risk of increases in market interest rates, which Medallion attempts to mitigate with certain hedging strategies. At March 31, 2001, December 31, 2000 and March 31, 2000, short-term LIBOR-based debt including commercial paper constituted 82.8%, 83.2% and 82.3% of total debt, respectively. Medallion's cost of funds is primarily driven by the rates paid on its various debt instruments and their relative mix and changes in the levels of average borrowings outstanding. Medallion incurs LIBOR-based debt for terms generally ranging from 1 to 180 days. Medallion's debentures issued to or guaranteed by the SBA typically have initial terms of ten years. Medallion's cost of funds reflects changes in LIBOR to a greater degree than in the past because LIBOR-based debt represents a greater proportion of Medallion's debt. Medallion measures its cost of funds as its aggregate interest expense for all of its interest-bearing liabilities divided by the 18 face amount of such liabilities. Medallion analyzes its cost of funds in relation to the average of the 90 and 180 day LIBOR (the "LIBOR Benchmark"). Medallion's average cost of funds for the 2001 first quarter was 7.44%, down from 7.93% in the 2000 fourth quarter, but up from 7.32% in the 2000 first quarter. The increase compared to a year ago, reflects the higher rate environment resulting from the series of rate increases initiated by the Federal Reserve Board during 2000, and the decline from the fourth quarter reflects the rate reductions which occurred in the first quarter, partially offset by the impact of the shift from commercial paper to bank debt. During December 2000, Medallion's outstanding commercial paper began to mature and was replaced by draws on the notes payable to banks, at costs of approximately 75 basis points higher than if the commercial paper program had been maintained. The commercial paper was not renewed, partially as a result of the loss of a credit rating due to the merger of the two rating agencies providing credit ratings to Medallion and due to the remaining rating agency placing Medallion's rating on negative credit watch. Taxicab Advertising In addition to its finance business, Medallion also conducts a taxicab rooftop advertising business through Media, which began operations in November 1994. Media's revenue is affected by: the number of taxicab rooftop advertising displays, currently showing advertisements, and the rate charged customers for those displays. At March 31, 2001, Media had approximately 10,800 installed displays. Medallion expects that Media will continue to expand its operations by entering new markets on its own or through acquisition of existing taxicab rooftop advertising companies. Although Media is a wholly-owned subsidiary of Medallion, its results of operations are not consolidated with Medallion's operations because the Securities and Exchange Commission regulations prohibit the consolidation of non-investment companies with investment companies. On February 8, 2001, we announced that Media entered into an agreement to acquire Taxi Media Network, the largest taxicab advertising company in Japan, which holds the rights to provide advertising on 7,000 taxis in Japan. The transaction is subject to due diligence reviews and other customary closing conditions. On August 30, 2000, Media purchased all the assets of Out There Media L.L.C. ("Out There"), a privately held company headquartered in Cleveland. Out There has the right to place an advertisement on top of more than 250 taxis in Cleveland, Columbus, and Toledo, and has contracts with some of the largest taxi fleets in these cities. On August 7, 2000, Media entered into an agreement for up to ten years with Yellow Cab Service Corp., the taxi division of Coach USA, the leading taxi and bus charter company in the U.S., to sell advertising space on the top of over 2,300 taxicabs throughout the United States. Going forward, as Coach USA acquires taxi companies around the U.S., Media will have the right to place advertisements on top of those taxis as well Factors Affecting Net Assets Factors that affect Medallion's net assets include, net realized gain or loss on investments and change in net unrealized appreciation or depreciation of 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 of investments is the amount, if any, by which Medallion's estimate of the fair value of its investment portfolio is above/below the previously established fair value or the cost basis of the portfolio. Under the 1940 Act and the SBIA, Medallion's loan portfolio and other investments must be recorded at fair value. Unlike certain lending institutions, Medallion is not permitted to establish reserves for loan losses, but adjusts quarterly the valuation of our loan portfolio to reflect Medallion's estimate of the current value of the total loan portfolio. Since no ready market exists for Medallion's loans, fair value is subject to the good faith determination of Medallion. In determining such fair value, Medallion and its Board of Directors takes into consideration factors such as the financial condition of its borrowers and the adequacy of its collateral. Any change in the fair value of portfolio loans or other investments as determined by Medallion 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. 19 CONSOLIDATED RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2001 AND MARCH 31, 2000. Net increase in net assets resulting from operations was $2.3 million or $0.16 per share in the 2001 first quarter, a decrease of $2.2 million or 49% from $4.5 million or $0.31 per share in the 2000 first quarter, primarily reflecting the net interest and non-interest income. Investment income was $13.4 million in the quarter, down $1.2 million or 8% from $14.5 million in 2000. The decrease compared to 2000 reflected a decreased level of loans and reduced additional interest income recorded on the collateral appreciation participation loans, partially offset by improved yields on the portfolios. Net investments declined $21.4 million or 4% to $492.4 million in 2001 from $513.8 million in 2000. The yield on the total portfolio at March 31, 2001 was 10.26%, an increase of 35 basis points compared with a yield of 9.91% a year-ago. The increase primarily reflects the series of rate hikes initiated by the Federal Reserve bank during late 1999 and continuing through most of 2000. Also impacting the improvement in investment income was the continuing movement of portfolio composition towards higher-yielding commercial loans from lower-yielding medallion loans. Yields on medallion loans at quarter end were 9.12%, up from 8.87% a year ago, and the yields on commercial loans were 11.80% at year-end, down from 11.78% a year ago. As rates began to rise, management made a conscious effort to sell or not renew these typically fixed, lower-rate medallion loans and replace them with floating, higher-rate commercial loans. Medallion loans were $285.3 million at March 31, 2001, down $47.3 million or 14.2% from $332.7 million a year ago, and were down $14.0 million or 5% from $299.3 million at year end, primarily reflecting reductions in most markets. The commercial loan portfolio was $205.4 million at quarter end, compared to $178.7 million a year earlier, an increase of $26.7 million or 15%, but was down $7.3 million or 3% from $212.7 million at year end. The increase compared to a year ago was in most commercial lending categories, including $6.4 million in the asset-based lending business and $3.1 million in the SBA 7(a) lending program. The balance of the commercial loan increase was spread amongst many generic commercial lending categories, including restaurants, real estate, mezzanine financing, and other small business pursuits. The decline from year-end was spread amongst all loan categories. During the 2000 first half, we originated collateral appreciation participation loans collateralized by Chicago taxi medallions of $30.0 million, of which $21.0 million was syndicated to other financial institutions. In consideration for modifications from our normal taxi medallion lending terms, we offered loans at higher loan-to-value ratios, and we are entitled to earn additional interest income based upon any increase in the value of the taxi medallion collateral on the entire $30.0 million portfolio. The value of Chicago taxi medallions increased during 2001 and 2000, and accordingly, additional interest of $700,000 million was recorded as investment income during the 2001 first quarter compared to $1.1 million recorded during the 2000 first quarter. Interest expense was $7.2 million in the 2001 first quarter, up $384,000 or 5.3% compared to 2000 period, primarily reflecting increased borrowing levels, coupled with the impact of an increased interest rate environment. The increase in average debt outstanding was $6.5 million, a 8% increase compared to the 2000 period. In addition to the higher borrowing levels, Medallion's debt is primarily tied to floating rate indexes, which rose during most of 2000. As a result, the average cost of funds was 7.44% in 2001, compared to 7.32% in 2000, a 2% increase of 12 basis points. Approximately 83% of Medallion's debt is short-term and floating rate, up slightly from 82% in 2000. Net interest income was $6.2 million for 2001, down $1.5 million or 20% from 2000, primarily reflecting the decrease in the loan portfolio, the additional interest recorded on the collateral appreciation participation loans in 2000 and higher borrowing costs in 2001. Medallion had gains on the sale of the guaranteed portion of SBA 7(a) loans of $433,000 in 2000, down $253,000 or 37% from $686,000 in 2000. During 2001, $5.7 million of loans were sold under the SBA program compared to $13.4 million during 2000. The decline in gains on sale reflected a decrease in loans sold of $7.7 million or 57%, along with a decrease in the level of market-determined premiums received on the sales. Equity in earnings (losses) of unconsolidated subsidiary reflects the operations of the Media division of Medallion. The loss of $427,000 in 2001 increased $108,000 from losses of $319,000 in 2000, and reflected the greater costs associated with the rapid increase in tops under contract and cities serviced, which outpaced the $1.0 million or 47% increase in revenue. Included in advertising revenue for the quarter ended March 31, 2001 is $567,000 20 related to contracts that were cancelled in prior periods due to legislative changes and other factors. This revenue was recognized upon determination that Media had no further continued obligations under the contract. During 2001, vehicles under contract increased 3,600 or 50% to 10,800 from 7,200 in 2000. As a result of the substantial growth in tops inventory, Media's fleet payment costs and related operating expenses to service those tops increased, at a greater rate than the growth in revenue, resulting in a loss for the quarter. Negative goodwill was fully accreted during 2000, and accordingly, accretion of $181,000 in 2000 compared to $0 in 2001. Other income of $971,000 increased $171,000 from $800,000 in 2000, primarily reflecting an increase in servicing fee income, prepayment fees, late charges, and other miscellaneous income. Non-interest expense was $4.8 million, up $124,000 or 3%, from $4.7 million in 2000. Salaries and benefits expense of $2.7 million was up $221,000 or 9%, reflecting normal salary increases and the impact of new senior management hires. Professional fees of $395,000 were down $21,000 or 5% from $416,000 in 2000. Rent expense of $256,000 was up $ 12,000 or 5% from $244,000 a year ago, reflecting normal rent escalation adjustments. Amortization of goodwill was $133,000 in 2001, essentially unchanged from 2000. Administration and advisory fees were $3,000 in 2001, down $58,000 from $61,000 in 2000, reflecting the completion of the advisory services contract in early 2000. Other operating expenses of $1.4 million were down $28,000 or 2% from $1.4 million in 2000. Net unrealized appreciation on investments was $893,000 in 2001, compared to net unrealized depreciation of $113,000 in 2000, an increase of $1.0 million. Unrealized appreciation/(depreciation) arises when Medallion makes 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 increase in 2001 activity primarily resulted from the reversal of unrealized depreciation related to the final disposition of a portfolio investment that resulted in realized losses of $693,000 (that had been fully reserved in prior periods) and recoveries of $565,000, partially offset a net increase in unrealized depreciation of $207,000 in 2000. Net realized loss on investments in 2001 was $898,000, compared to a net gain of $247,000 in 2000, a decrease of $1.1 million, primarily reflecting the realized loss reflected above. The balance of the increase in 2001, net realized loss of $205,000 represented the write-off of various commercial loans that had previously been fully written down through the quarterly valuation adjustment process Medallion's net realized/unrealized loss on investments in 2001 was $5,000, which primarily reflected losses on commercial loans, compared to a net realized/unrealized gain in 2000 of $134,000, which primarily represented increased valuation allowances for commercial loans. ASSET/LIABILITY MANAGEMENT Interest Rate Sensitivity Medallion, like other financial institutions, is subject to interest rate risk to the extent its interest-earning assets (consisting of medallion loans and commercial loans) reprice on a different basis over time in comparison to its interest-bearing liabilities (consisting primarily of credit facilities with bank syndicates, secured commercial paper, senior secured notes 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. The effect of changes in interest rates is mitigated by regular turnover of the portfolio. Based on past experience, Medallion anticipates that approximately 40% of the portfolio will mature or be prepaid each year. Medallion believes that the average life of its 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 21 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. Interest Rate Cap Agreements Medallion seeks to manage the exposure of the portfolio to increases in market interest rates by entering into interest rate cap agreements to hedge a portion of its variable-rate debt against increases in interest rates and by incurring fixed-rate debt consisting primarily of subordinated SBA debentures. We entered into an interest rate cap agreements limiting our maximum LIBOR exposure on our revolving credit facility in accordance with the terms shown in the following table:
========================================================================================== Libor Effective Maturity Amount Rate Date Date ------------------------------------------------------------------------------------------ $10,000,000 6.5 7/6/99 7/6/01 10,000,000 6.5 7/6/99 7/6/01 10,000,000 7.25 6/22/00 6/24/02 ==========================================================================================
Medallion will seek to manage interest rate risk by originating adjustable-rate loans, by incurring fixed-rate indebtedness, by evaluating and purchasing, if appropriate, additional derivatives, and by revising, if appropriate, its overall level of asset and liability matching. In addition, Medallion manages its exposure to increases in market rates of interest by incurring fixed-rate indebtedness, such as five year senior secured notes and subordinated SBA debentures. Medallion currently has outstanding $45 million of senior secured notes maturing June 1, 2004, at a fixed interest rate of 7.20% (7.35% beginning March 30, 2001) and SBA debentures in the principal amount of $21.4 million with a weighted average interest rate of 7.47%. At March 31, 2001, these notes and debentures constituted 11.6% and 5.5% of Medallion's total indebtedness respectively. Liquidity and Capital Resources Our sources of liquidity are credit facilities with bank syndicates, senior secured notes, long-term SBA debentures that are issued to or guaranteed by the SBA, our secured commercial paper program and loan amortization and prepayments. As a RIC, we distribute at least 90% of our investment company taxable income; consequently, we primarily rely upon external sources of funds to finance growth. At March 31, 2001, our $386.6 million of outstanding debt was comprised as follows: 82.6% bank debt, substantially all of which was at variable effective interest rates with a weighted average interest rate of 6.46%, 0.2% secured commercial paper with an annual weighted average interest rate of 7.18%, 11.64% long-term senior secured notes fixed at an interest rate of 7.20%, and 5.53% subordinated SBA debentures, with fixed-rates of interest with an annual weighted average rate of 7.47%. Medallion is eligible to seek SBA funding and will seek such funding when the rates presented are advantageous. In March 2001, we applied for $72.0 million of additional funding with the SBA ($108.0 million to be committed by the SBA, subject to our raising of additional equity capital.) This application is currently under review, although no assurance can be given that such funding will be obtained. Since SBA financing subjects its recipients to certain regulations, Medallion will seek funding at the subsidiary level to maximize its benefits. Currently, Medallion has fully drawn down its existing bank lines of credit. Medallion has observed a practice of minimizing credit facility fees associated with the unused component of credit facilities by keeping the unused component as small as possible and periodically increasing the amounts available under such credit facilities only when necessary to fund portfolio growth. Additionally, Medallion's lead member in the lending syndicate has approximately doubled its exposure to Medallion and MFC to $95 million as a result of a merger between such lead member and another bank in the lending syndicate in September 2000. This bank has asked Medallion to find an additional participant to reduce its exposure. Medallion is actively seeking new members for the lending syndicate. As a result, Medallion is currently unable to expand its borrowing lines until new banks join the lending syndicate or a debt offering is completed. Medallion's bank and commercial paper facilities are subject to periodic reviews by the lending syndicate funding the borrowings and are also subject to certain covenants and restrictions. On March 30, 2001 Medallion finalized certain amendments and was granted a waiver of compliance with certain provisions. These amendments 22 clarified and revised certain provisions of the agreements related to business activities and financial covenants of Medallion and MFC, and adjusted the rate of interest paid on the notes. Medallion, MFC, and their lenders have initiated discussions as to the next renewal of the existing bank loans which mature in June and September, 2001. Although, there can be no assurances, the Company expects a satisfactory result from these discussions. Periodically MFC must maintain certain covenants under its Revolver. At March 31, 2001, MFC was not in compliance with the covenant relating to interest expense ratios (resulting in similar non-compliance under the Notes and the Loan Agreement). The Company is presently seeking a waiver under the Revolver which would cure all such non-compliance under these agreements. On November 22, 2000, Fitch IBCA placed Medallion's "BBB" senior secured debt rating and "F2" secured commercial paper rating on negative watch. In addition, in December 2000, Medallion's other rating agency, Thompson's Bankwatch was acquired by Fitch IBCA, leaving it with only one commercial paper rating. Primarily as a result of these factors, a substantial portion of Medallion's commercial paper did not rollover and has subsequently been replaced by Medallion's bank facility. On January 18, 2001, Fitch IBCA lowered our senior secured debt rating and secured commercial paper rating to "BB+" and "B", respectively, and removed them from negative watch. Medallion believes that its bank credit facilities and cash flow from operations (after distributions to stockholders) will be adequate to fund the continuing operations of Medallion's loan portfolio and advertising business. Nevertheless, Medallion continues to explore additional options, which may increase available funds for Medallion's growth and expansion strategy. In addition, to the application for SBA funding described above, these financing options would provide additional sources of funds for both external expansion and continuation of internal growth. We are working with investment banking firms to investigate the viability of a number of other financing options which include an equity offering of securities, the sale or spin-off of certain assets or divisions, and the development of a securitization conduit program. These financing options would also provide additional sources of funds for both external expansion and continuation of internal growth. If none of these financing options occur, management believes liquidity would still be adequate to fund the continuing operations of Medallion's loan portfolio and advertising business. Deferred costs related to these financing options was approximately $257,000 as of March 31, 2001 and were included in other assets on Medallion's consolidated balance sheets. The following table illustrates sources of available funds for Medallion and each of the subsidiaries, and amounts outstanding under credit facilities and their respective end of period weighted average interest rate at March 31, 2000:
============================================================================================================================= Medallion (dollars in thousands) Financial MFC BLLC MCC MBC FSVC Total ============================================================================================================================= Cash $9,934 $8,320 $188 $397 $3,275 $2,400 $24,514 Revolving credit lines (1) 110,000 220,000 3,500 333,500 Amounts undisbursed 6,700 6,566 13,266 Amounts outstanding 103,300 212,670 3,500 319,470 Average interest rate 6.40% 6.48% 7.02% 6.46% Maturity 9/01 6/01 On Demand 6/01 - 9/01 Commercial paper 764 764 Average interest rate 7.18% 7.18% Maturity 6/01 6/01 SBA debentures 10,500 10,860 21,360 Average interest rate 7.08% 7.86% 7.47% Maturity 3/06 - 6/07 12/02 - 9/07 12/02 - 9/07 Senior secured notes 45,000 45,000 Average interest rate 7.20% 7.20% Maturity 6/04 - 9/04 6/04-9/04 ----------------------------------------------------------------------------------------------------------------------------- Total cash and remaining amounts undisbursed under credit facilities 16,634 14,886 188 397 3,275 2,400 37,780 ----------------------------------------------------------------------------------------------------------------------------- Total debt outstanding $103,300 $258,434 $10,500 $14,360 $386,594 =============================================================================================================================
(1) Commercial paper outstanding is deducted from revolving credit lines available as the line of credit acts as a liquidity facility for the commercial paper. -------------------------------------------------------------------------------- 23 Loan amortization, prepayments, and sales also provide a source of funding for Medallion. Prepayments on loans are influenced significantly by general interest rates, medallion loan market rates, economic conditions, and competition. Medallion loan prepayments have slowed since early 1994, initially because of increases, and then stabilization, in the level of interest rates, and more recently because of an increase in the percentage of medallion loans, which are refinanced with Medallion rather than through other sources of financing. Loan sales are a major focus of the SBA Section 7(a) loan program conducted by BLL, which is primarily set up to originate and sell loans. Increases in SBA 7(a) loan balances in any given period generally reflect timing differences in selling and closing transactions. On June 1, 1999, MFC issued $22.5 million of Series A senior secured notes that mature on June 1, 2004, and on September 1, 1999, MFC issued $22.5 million of Series B senior secured notes that mature on September 1, 2004 (together, the Notes). The Notes bear a fixed rate of interest of 7.2% (7.35% as of March 31, 2000) and interest is paid quarterly in arrears. The Notes rank pari passu with the revolvers and commercial paper through inter-creditor agreements. The proceeds of the Notes were used to prepay certain of the Company's outstanding SBA debentures. See also description of amendments referred to above. Media funds its operations through internal cash flow and inter-company debt. Media is not a RIC and, therefore, is able to retain earnings to finance growth. INVESTMENT CONSIDERATIONS Interest rate fluctuations may adversely affect the interest rate spread we receive on our taxicab medallion and commercial loans. Because we borrow money to finance the origination of loans, our income is dependent upon the difference between the rate at which we borrow funds and the rate at which we loan funds. While the loans in our portfolio in most cases bear interest at fixed-rates or adjustable-rates, we finance a substantial portion of such loans by incurring indebtedness with floating interest rates. As short-term interest rates rise, our interest costs increase, decreasing the net interest rate spread we receive and thereby adversely affect our profitability. Although we intend to continue to manage our interest rate risk through asset and liability management, including the use of interest rate caps, general rises in interest rates will tend to reduce our interest rate spread in the short term. In addition, we rely on our counterparties to perform their obligations under such interest rate caps. A decrease in prevailing interest rates may lead to more loan prepayments, which could adversely affect our business. 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 spread we receive. Lending to small businesses involves a high degree of risk and is highly speculative. Our commercial loan activity has increased in recent years. 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 have limited resources and that are generally unable to achieve 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 borrowers may default on their loans. We primarily invest in and lend to companies that may have limited financial resources. Numerous factors may affect a borrower's ability to repay its loan, including: o the failure to meet its business plan; o a downturn in its industry or negative economic conditions; 24 o the death, disability or resignation of one or more of the key members of management; or o the inability to obtain additional financing from traditional sources. Deterioration in a borrower's financial condition and prospects may be accompanied by deterioration in the collateral for the loan. Expansion of our portfolio and increases in the proportion of our portfolio consisting of commercial loans could have an adverse impact on the credit quality of the portfolio. Because we must distribute our income, we have a continuing need for capital. We have a continuing need for capital to finance our lending activities. Our current sources of liquidity are the following: o bank credit facilities; o senior secured notes; o sales of participations in loans; o fixed-rate, long-term SBA debentures that are issued to or guaranteed by the SBA; o a secured commercial paper program; and o loan amortization and prepayments. As a RIC, we distribute at least 90% of our investment company taxable income. Consequently, we primarily rely upon external sources of funds to finance growth. At March 31, 2001, we had fully drawn all capacity available under our $334 million bank credit facilities at variable effective rates of interest averaging below the prime rate. We minimize credit facility fees associated with the unused component of credit facilities by keeping the unused component as small as possible and periodically increasing the amounts available under the credit facilities only when necessary to fund portfolio growth. In addition, we are eligible to seek SBA funding. In the event that we seek SBA funding, no assurance can be given that the funding will be obtained. We may have difficulty raising capital to finance our planned level of lending operations. We may have difficulty raising the capital necessary to finance our planned level of lending operations. During December 2000, our outstanding commercial paper began to mature and was replaced by draws on the notes payable to our bank facility. The commercial paper was not renewed as a result of the loss of a credit rating due to the merger of our rating agencies and due to the remaining rating agency lowering our rating. In addition, we are currently unable to expand our borrowing lines until new banks join the lending syndicate or a debt offering is completed. The lead bank in our lending syndicate has recently approximately doubled its exposure to Medallion and MFC to $95 million as a result of a merger between the lead bank and another member of the lending syndicate. In September 2000, this bank asked us to find an additional participant to reduce its exposure. We are actively seeking new members for the lending syndicate. If we are unable to continue to diversify geographically, our business may be adversely affected if the New York taxicab industry experiences an economic downturn. Although we are diversifying from the New York City area, a significant portion of our taxicab advertising and loan revenue is derived from New York City taxicabs and 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 and may also adversely affect the operation of our taxicab rooftop advertising business. In addition, an economic downturn could impact the value of our medallion collateral. There can be no assurance that we will be able to sufficiently diversify our operations geographically. If there is an economic downturn, our commercial loan customers may experience difficulty in servicing their debt with us and the level of our delinquencies and loan losses may increase An economic downturn could result in certain of our commercial loan customers experiencing declines in business activities, which could lead to difficulties in their servicing of their loans with us. If this were to happen, the level of delinquencies, defaults, and loan losses in commercial loan portfolio could increase. The loss of certain key members of our senior management could adversely affect us. 25 Our success is largely dependent upon the efforts of senior management. The death, incapacity or loss of the services of certain of these individuals could have an adverse effect on our operation and financial results. There can be no assurance that other qualified officers could be hired. 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 and personnel matters. Difficulties could also arise integrating the 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 and increased business activities. There can be no assurance 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 of these or any future acquisitions. Competition from entities with greater resources and less regulatory restrictions may decrease our profitability. We compete with banks, credit unions and other finance companies, some of which are Small Business Investment Companies, or SBICs, in the origination of taxicab medallion loans and commercial loans. We also compete with finance subsidiaries of equipment manufacturers. Many of these competitors have greater resources than Medallion and certain competitors are subject to less restrictive regulations than Medallion. As a result, there can be no assurance that we will be able to continue to identify and complete financing transactions that will permit us to continue to compete successfully. Our taxicab rooftop advertising business competes with other taxicab rooftop advertisers as well as with all segments of the out-of-home advertising industry. We also compete with other types of advertising media, including cable and network television, radio, newspapers, magazines and direct mail marketing. Certain of these competitors have also entered into the rooftop advertising business. Many of these competitors have greater financial resources than Medallion and offer several forms of advertising as well as production facilities. There can be no assurance that we will continue to compete with these businesses successfully. The valuation of our loan portfolio is subjective and we may not be able to recover our estimated value in the event of a foreclosure. 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, we adjust quarterly the valuation of our portfolio 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 our 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 rates of interest, management and the Board of Directors could decrease its valuation of the portfolio if the portfolio consists primarily of fixed-rate loans. Our valuation procedures are designed to generate values which approximate the value that would have been established by market forces and are therefore subject to uncertainties and variations from reported results. Considering these factors, we have determined that the fair value of our portfolio is below its cost basis. At March 31, 2001, our net unrealized depreciation on investments was approximately $6.1 million. Based upon current market conditions and current loan-to-value ratios, our Board of Directors believes that the net unrealized depreciation of investments is adequate to reflect the fair value of the portfolio. Changes in taxicab industry regulations that result in the issuance of additional medallions 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 United States, limits the supply of taxicab medallions. This regulation results in supply restrictions that support the value of medallions. Actions that loosen these restrictions and result in the issuance of additional medallions into a market could decrease the value of medallions in that market. As a result, the value of the collateral securing our 26 then outstanding medallion loans in that market could be adversely affected. We are unable to forecast with any degree of certainty whether any potential increases in the supply of medallions will occur. In New York City, Chicago and 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, and could cause borrowers to default on loans from Medallion, and could potentially adversely affect the value of Medallion's collateral. A significant portion of our taxicab advertising and loan revenue is derived from loans collateralized by New York City taxicab medallions. According to New York City Taxi and Limousine Commission data, over the past 20 years New York City taxicab medallions have appreciated in value an average of 10.0% each year. However, for sustained periods during that time, taxicab medallions have declined in value. Over the past year, the value of New York City taxicab medallions has declined by approximately 9%. Our failure to maintain our Subchapter M status could lead to a substantial reduction in the amount of income distributed to our shareholders. We, along with some of our subsidiaries, have qualified as regulated investment companies under Subchapter M of the Internal Revenue Code. Thus, we will not be subject to federal income tax on investment company taxable income (which includes, among other things, dividends and interest reduced by deductible expenses) distributed to our shareholders. If we or those of our subsidiaries that are also regulated investment companies were to fail to maintain Subchapter M status for any reason, our respective incomes would become fully taxable and a substantial reduction in the amount of income available for distribution to us and to our shareholders would result. To qualify under Subchapter M, we must meet certain income, distribution and diversification requirements. However, because we use leverage, we are subject to certain asset coverage ratio requirements set forth in the 1940 Act. These asset coverage requirements could, under certain circumstances, prohibit us from making distributions that are necessary to maintain our Subchapter M status or require that we reduce our leverage. 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. Certain of our loans, including the medallion collateral appreciation participation loans, could also be re-characterized in a manner that would generate non-qualifying income for purposes of Subchapter M. In this event, if such income exceeds the amount permissible, we could fail to satisfy the requirement that a regulated investment company derive at least 90% of its gross income from qualifying sources, with the result that we would not meet the requirements of Subchapter M for qualification as a regulated investment company. Qualification as a regulated investment company under Subchapter M is made on an annual basis and, although we and some of our subsidiaries are qualified as regulated investment companies, no assurance can be given that we will each continue to qualify for such treatment. Failure to qualify under Subchapter M would subject us to tax on our income and would have material adverse effect on our financial condition and results operations. Our SBIC subsidiaries may be unable to meet the investment company requirements, which could result in the imposition of an entity-level tax. The Small Business Investment Act of 1958 regulates some of our subsidiaries. The Small Business Investment Act restricts distributions by an SBIC. Our SBIC subsidiaries that are also regulated investment companies could be prohibited by SBA regulations from making the distributions necessary to qualify as a regulated investment company. Each year, in order to comply with the SBA regulations and the regulated investment company 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, there can be no assurance 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 regulated investment company status and a consequent imposition of an entity-level tax. The Internal Revenue Code's diversification requirements may limit our ability to expand our taxicab rooftop advertising business and our medallion collateral appreciation participation loan business. 27 We intend to continue to pursue an expansion strategy in our taxicab rooftop advertising business. We believe that there are growth opportunities in this market. However, the asset diversification requirements under the Internal Revenue Code could restrict such expansion. These requirements provide that, as a RIC, not more than 25% of the value of our total assets may be invested in the securities (other than U.S. Government securities or securities of other regulated investment companies) of any one issuer. While our investments in our regulated investment company subsidiaries are not subject to this diversification test so long as these subsidiaries are regulated investment companies, our investment in Media is subject to this test. At the time of the commencement of our operations in May 1996, Media represented less than 25% of our assets and the diversification test was satisfied. Presently, Media represents approximately 1% of our assets. The subsequent growth in the value of Media by itself will not re-trigger the test even if Media represents in excess of 25% of our assets. However, under the Internal Revenue Code, the test must be reapplied in the event that we make a subsequent investment in Media, lend to it or acquire another taxicab rooftop advertising business. If we were to fail a subsequent test, we would lose our regulated investment company status. As a result, our maintenance of regulated investment company status could limit our ability to expand our taxicab rooftop advertising business. It will be our policy to expand our advertising business through internally generated growth. We will only consider an acquisition in this area if we will be able to meet the Internal Revenue Code's diversification requirements. The fair value of the collateral appreciation participation loan portfolio at March 31, 2001 was $12.8 million, which represented approximately 3.0% of the total loan portfolio. We will continue to monitor the levels of these asset types in conjunction with the diversification tests. We depend on cash flow from our subsidiaries to make dividend payments and other distributions to our shareholders. We are 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 there can be no assurance that our subsidiaries will be in a position to continue to make these dividend or debt payments. We operate in a highly regulated environment. We are regulated by the Securities Exchange Commission and the SBA. In addition, changes in the laws or regulations that govern business development companies, RIC's or SBIC's may significantly affect our business. Laws and regulations may be changed from time to time, and the interpretations of the relevant laws and regulations also are subject to change. Any change in the laws or regulations that govern our business could have a material impact on our operations or us. 28 PART II OTHER INFORMATION ITEM 1. Legal Proceedings From time to time, the Company is subject to legal proceedings and claims in the ordinary course of business. The Company is not currently aware of any legal proceedings or claims that the Company believes will have, individually or in the aggregate, a material adverse effect on the Company's financial position or results of operations. ITEM 2. Changes in Securities and Use of Proceeds None ITEM 3. Defaults Upon Senior Securities Periodically MFC must maintain certain covenants under its Revolver. At March 31, 2001, MFC was not in compliance with the covenant relating to interest expense ratios (resulting in similar non-compliance under the Notes and the Loan Agreement). The Company is presently seeking a waiver under the Revolver which would cure all such non-compliance under these agreements. ITEM 4. Submission of Matters to a Vote of Security Holders None ITEM 5. Other Information None ITEM 6. Exhibits and reports on form 8-K Exhibits 27. Medallion Financial Corp. Financial Data Schedule. Filed herewith. 29 MEDALLION FINANCIAL CORP. 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: May 15, 2001 By: /s/ Larry D. Hall -------------------------- Larry D. Hall Corporate Controller Signing on behalf of the registrant and as principal financial and accounting officer. 30