Description

“I’d go to an auction, I’d run up the price of a medallion, then I’d run to my bankers and say, ‘Look how high the medallions priced! Let me borrow against my portfolio.’ And they let me do that.”

‘Taxi King’ Gene Freidman

Bloomberg interview, August 2015

1. Thesis Overview

1.1. Sell short common shares of Medallion Financial Corp. (ticker MFIN, formerly TAXI)

We believe that the common shares of Medallion Financial Corp. (“MFIN”) will either go to zero or option value within 18 months:

• Taxi markets are increasingly being disrupted by ride-share apps like Uber, Lyft and others.

• Taxi medallions serve as collateral for 45.2% MFIN’s consolidated loan portfolio and medallion prices have dropped significantly since the end of 2014.

• MFIN’s current valuation is already expensive assuming their current medallion valuations and credit loss provisioning are correct.

• However, MFIN is marking its medallions too aggressively; we estimate a real medallion loan portfolio LTV of 132% instead of the 82% disclosed by MFIN.

• Based on comparable portfolios at competitors, recent delinquencies and market developments, we expect an accelerated deterioration of MFIN’s loan portfolio resulting in steep NAV write-downs.

• MFIN has a large amount of debt coming due in 2016, while repayments from its medallion loans are drying up fast.

• Its subsidiary Medallion Bank will not be able to provide additional cash flows as it faces its own credit and capital issues.

• MFIN’s freedom of movement is also severely curtailed because of regulatory restrictions due to its BDC status.

As the above scenario unfolds MFIN’s access to capital markets will be cut-off – leading to a funding squeeze that will result in a complete loss of equity value or a massively dilutive recapitalisation.

This write-up was our VIC application.

1.2. Company intro

Medallion Financial Corp. (IPOed in 1996) is a specialty finance company structured as a closed-end, non-diversified investment company. It finances taxicab medallions, mainly in New York and Chicago. The company also engages in small business lending and has a sizable high yield consumer loan book. The Murstein family have been running the business since its inception in 1979 and own 13.3% of the shares.

MFIN currently has 645m medallion loans outstanding out of a total portfolio of 1.5bn. The reported book value of its equity is 279m.

2. Background

2.1. Medallion boom and bust and the disruption from ride-sharing apps

Medallions are tradable taxi permits that have been appreciating in value for decades, easily outperforming the S&P 500 since at least the 1970s. In 2000 prices started to rise even faster and they went exponential in 2012-13.

This extreme price inflation has been driven by:

• Historically restricted supply of medallions e.g. NYC has 13,619 medallions today vs. 11,787 in 1937 when they were first issued

• The conviction that medallion prices will always go up

• Availability of generous financing at low interest rates

The monopolistic barriers to entry that a medallion permitting system provided have recently been eroded by ride-share apps like Uber, Lyft and others, which provide ever decreasing waiting times thanks to their unconstrained and flexible capacity. This has allowed the medallion price bubble to implode. Metrics are showing an undisputable and increasing effect from ride-sharing apps:

• NYC yellow cab trips per day have been trending down since August 2012 and the trend has accelerated recently. The rolling twelve month average number of yellow cab trips per day has decreased by 12% compared to the same number one year ago.

• Ride-share apps continue to take market share in NYC. During 2015 the trips per day evolved as follows:

• Uber: increase of 89.7k to a total of 150.3k trips per day

• Yellow cab:  decrease of 59.4k to a total of 351.8k trips per day

• Lyft has started providing data only recently and is currently taking 19.9k trips per day, starting from almost zero in April of 2015.

   

For further supporting data and excellent visualisation please see: Taxi Uber Lyft usage NYC.

The operating and financial leverage of medallion owners causes limited declines in revenue to have a large impact on their bottom line. An 11% drop in revenue from March 2014 to March 2015 decreased estimated income by 24% (see: How Uber is actually killing the value of a NYC taxi medallion). In the meantime, taxi graveyards have become a common urban sighting (see: Brooklyn neighbors demand action over so called taxi graveyard).

2.2. Group structure and legal/regulatory status

MFIN conducts its loan origination, funding and servicing businesses through various wholly owned subsidiaries. All of the wholly subsidiaries are fully consolidated onto MFIN’s balance sheet except for Medallion Bank (“MB”), a regulated bank that shows up as an equity stake. MB was formed in 2003 to provide low cost, FDIC insured funding for MFIN’s taxi and commercial loan businesses and has subsequently expanded into sub-prime consumer lending. For the remainder of this discussion we use “Holdco” to refer to the MFIN business excluding the MB portfolio.

MFIN has elected to be treated as a business development company (“BDC”) - the main benefit of which is that it can subsequently qualify as a regulated investment company (RIC) and not pay any US corporate income tax.

BDCs/RICs have a number of conditions that need to be satisfied. The most important ones for our thesis are:

• Minimum income distribution: 90% of “investment company taxable income” needs to be distributed.

• Asset Coverage Ratio: the investment company needs to maintain a 200% asset coverage ratio.

2.3. Breakdown of MFIN’s 1.5bn loan and investment portfolio as of Q1 2016

• 644.6m medallion loans

• Residing at Holdco and MB with an average yield of 4.0%

• Geographic split of notional exposure: NY 74% / Chicago 14% / Other 9%

• 128.7m commercial loans

• Small business lending book, residing at Holdco and MB with an average yield of 10.3%

• 652.3m consumer loans

• Recreational vehicles and home improvement loans to subprime borrowers, growing rapidly 31.8% yoy, residing at MB with an average yield of 14.0%

• 59.0m investments

• A medley of wholly owned and participating equity participations in small businesses, residing at Holdco and MB. Generating zero income but still good for a TTM re-valuation based return of 17.2%.

2.4. Typical medallion loan product mechanics

Medallion loans generally require monthly payments covering accrued interest and a small amortization of principal. MFIN and other lenders have usually originated 1 to 5 year maturities with the borrower refinancing the remaining balloon payment. When medallion prices were rising, borrowers tended refinance early and often increased loan amounts in order to support other investment or consumption. Borrowers can be individuals or businesses.

3. Base Case Financials

3.1. MFIN is already overvalued based on current financials

As a BDC MFIN calculates its total earnings using NAV increases/decreases.

• For Q1 of 2016 MFIN’s reported NAV increase was 6.8m (for an annualised rate of NAV increase of 27.2m) while the company also paid 6.1m in dividends.

• The majority, or 5.7m, of the Q1 NAV increase resulted from a revaluation of 3 small subsidiaries: Medallion Fine Art Inc., Medallion Motorsports LLC and LAX Group LLC. These are all non-income producing investments and the first two entities have large high interest PIK loans from MFIN outstanding. We will remove this source of NAV increases from any future projections.

• The company issued a 33.6m 9% senior unsecured bond in April 2016, this will result in extra interest cost of 757k/quarter.

• The company has valued 159 Chicago medallions at 36.3m implying a mark of 228k per medallion. Q2 saw market prices stabilising in the 50-60k area. Using a mark of 60k per medallion implies a NAV loss of 26.8m to MFIN.

Adjusting Q1 2016 for the above returns a base case annual NAV increase of 7.6m (see table), implying a current P/E ratio of 22.9x and an unsustainable dividend policy. On top of that we expect that MFIN will have to take 26.8m of impairments on its owned Chicago medallions in 2016.

4. Impending Credit Losses: LTVs, Delinquencies and Provisioning

4.1. Current medallion prices imply unsustainable LTVs

We estimate current clearing prices for medallions to be to be 55-60k in Chicago, 300-400k for NYC independent and 400-550k for NYC minifleet medallions.

• Liquidity in Chicago picked up again, with more than 12 transactions in the 55-60k area in April. Because the average number of transaction in 2015 was only 2.8 per quarter and they considered the market liquid then, we expect that MFIN will be forced to accept the latest market prices.

• Liquidity in NY is still poor but the last transactions in April and May were done at 325 and 405k.

• We analysed the NYC medallions offered on the websites mynytaxi.com and nycitycab.com we found that an increasing overhang of medallions is offered for sale at continuously lower offer prices. Please see graph below where show the offers from these websites with smoothed traded price for medallions as per the NYC Taxi and Limousine Commission.

Source: mynytaxi.com, nycitycab.com for medallion offers and NYC TLC for traded medallion prices. For the traded prices series: a) smoothed by taking a 2-month rolling average and b) if no transfers were available we applied linear interpolation.

Note that our estimated clearing prices assume an orderly market - a fire sale scenario could imply significantly lower prices. Please refer to Appendix A for a more detailed analysis of medallion prices in Chicago and New York.

If we use the top end of our estimated medallion valuation ranges we get to a 132% medallion loan portfolio LTV vs. the 82% as last reported by MFIN.

4.2. Delinquencies and provisioning

MFIN’s loss provisioning is based on LTVs, nonaccrual balances and a lot of management discretion. Loans are put on nonaccrual if payments are more than 90 days overdue or if the borrower went bankrupt, unless management overrules this. Note that MFIN does not technically provision for credit losses but, as a BDC, applies a net unrealised depreciation/appreciation to its NAV.

4.2.1. Provisioning has dropped as a percentage of nonaccruals

• The company has been increasing its quarterly provisioning on the medallion loan portfolio and provisioned 0.8% of its notional size in Q1 2016 to a total of 2.8%.

• The nonaccrual-balance on the MFIN medallion portfolio was 9.7% at the end of Q1 2016. This means that only 23.8% of the non accrual-balance is covered by loss provisions (2.3% / 9.7%).

• This ‘provisioning coverage’ ratio seems to be dropping as the ratio between the increase in provisions and the increase in nonaccurals was 18.4% in Q1 of 2016. We would expect this ratio to increase when the LTV goes down.

4.2.2. Fast rise in delinquencies imply increasing future nonaccruals

• We believe that the 31-90 days overdue balance is a good indication of future nonaccruals. MFIN’s 31-90 days overdue balance increased by 65% from Q4 2015 to Q1 2016. This implies the non accrual-balance will continue its rapid upward trajectory.

4.2.3. Similar portfolio at healthier bank is provisioned much more conservatively

• Signature Bank’s medallion loan portfolio is quite similar to the MFIN portfolio looking at size, geography, borrower type, LTV and legal structure.

• Signature Bank, an institution that is under pressure to reduce the impact of its medallion loans but can afford adequate provisioning, made a loss allowance of 1.6% of its medallion portfolio notional in Q1, which is double MFIN’s 0.8%.

4.3. Loss analysis / conclusion

At the end of the day provisioning will have to be at least equal to the realised losses in the portfolio, otherwise the difference will have to be made up with additional charge-offs. We believe MFIN should provision at least double its current 3.2% annualised rate.

• Based on current market and delinquency trends (31-90 days overdue growing by 65% qoq), we expect nonaccruals to increase by 40-50m a quarter going forward (vs. 30.7m in Q1).

• If we assume 26.5% provisioning coverage against 40m of additional nonaccruals MFIN will have to provision 10.6m a quarter (vs. 5.3m in Q1).

• A provisioning coverage equal to 26.5% of new nonaccurals is extremely conservative taking into account that MFIN has currently provisioned 23.8% of nonaccurals using an 82% LTV and we have found the real LTV to be 132%.

Applying a 6.4% provisioning rate to MFIN’s base case scenario above would cost MFIN an extra 17.7m per year.

5. Funding: impending squeeze

5.1. Significant amount of debt due in 2016

As of Q1 of 2016 MFIN had 418.7m of debt outstanding. Of this amount, a total of 241.6m in bank financing is due in 2016:

1. 130.6m revolving credit line due December 2016

• Medallion Funding LLC has dropped down 194m of medallion loans into a trust called Taxi Medallion Loan Trust III where non-recourse funding has been raised from DZ Bank. This facility includes a borrowing base covenant and rapid amortization in certain circumstances.

• With the quality of the collateral deteriorating, this facility has been amended several times, most recently with a reduction of notional down to 125m (from an initial 200m).

• In light of the above it is highly improbable that this facility will be extended beyond December of this year. We think bank funding for medallion loans will become unavailable going forward.

2. 87.4m revolving line of credit

• Secured by pledged loans due between April-July 2016

• We do not expect the MFIN loans to be usable as collateral for bank facilities anymore.

3. 23.3m term loans due December 2016

• Secured by 159 Chicago medallions owned by MFIN

• Given the implosion of the value of Chicago medallions we do not expect these medallions to support any more refinancing (see above under “3 Base Case Financials”).

5.2 Liquidity limitations 

Apart from a large amount of debt coming due in 2016, MFIN is also subject to several non-debt related liquidity limitations due to declining repayments, regulatory obligations and subsidiary restrictions.

5.2.1. MFIN Asset side related liquidity limitations

• 7.8m of cash at Holdco is pledged to a lender of an affiliate.

• Increasing asset-liability mismatch due to a decrease of voluntary repayments and maturity extensions through restructurings. In Q1 of 2016 total Holdco loans repayments (net of refinancing) dropped to 11.1m vs. an average of 20.8m per quarter in 2014.

5.2.2. Regulatory liquidity limitations

• Minimum Income Distribution: The requirement to pay out 90% of net income in dividends will deplete cash flow (it will also stop MB dividends from providing much help to Holdco, since these are part of MFIN net income).

• Asset Coverage Ratio: As a BDC, MFIN also has a 200% minimum asset coverage test which it is likely to fail after December. At the moment the consolidated asset coverage ratio stands at a comfortable 260%. It is currently quite high because MFIN is allowed to keep the 130.6m of debt residing in Taxi Medallion Loan Trust III out of the calculation (as per two 1988 and 1996 exemptive orders agreed with the SEC). If this debt was included assuming a Holdco “with recourse” refinancing if the non-recourse DZ Bank facility terminates in December of 2016 as expected), the ratio will drop to 148% (using the Q1 2016 balance sheet). This breach will result in MFIN being restricted from issuing additional debt, paying dividends and could result in the company being forced to de-lever.

Taking stock of the regulatory restrictions above and chances are that MFIN will have to transform into a tax paying C-corp within the next few quarters.

5.2.3. No relief from Medallion Bank

It is unlikely that MFIN will be able to extract additional cash flows from MB going forward

• MB will need extra capital:

• In its last FDIC report on March 31, 2016 MB reported a 14.88% Tier 1 Capital Ratio, below its 15% FDIC requirement.

• Because loans that are on nonaccrual automatically carry a 150% risk weight (vs. 100% for accruing loans), more capital will be required in the near future. We expect a minimum capital contribution of 5m will be needed for the next quarter.

• MB’s status as an effective funding vehicle depends on access to the brokered deposit market. At the end of Q1 MB had 929.2m of brokered FDIC insured deposits outstanding, of which 421.1m is due before the end of Q1 2017. Although this is a cheap funding source with an average interest rate of 1.07%, access to the brokered deposit market can be hampered if the capital of the bank falls below required levels or if sustained operating losses are incurred.

• Regulation also impairs MB’s ability to raise deposits. MB is only able to raise an extra 10m of deposits as per their own Q1 2016 estimate.

5.3. Liquidity shortfall 2016

A projected cash shortfall of 157m in 2016 would result in a negative income effect of 10.7m per year after refinancing.

• Under conservative assumptions MFIN has a 157m cash flow shortfall.

• We do not believe normal bank lending will be available, as MFIN currently has no assets that could serve as collateral for a credit facility.

• If we assume the 157m shortfall is funded in the debt market at the 9% rate MFIN paid on its senior unsecured note in April of 2016, the total income effect of the refinancing will be a negative 10.7m pa.

Please refer to Appendix B for details about the assumptions used in the liquidity analysis.

5.4. Other anecdotal warning signs indicating imminent liquidity issues:

• In May 2016, a 17.5m revolving line of credit with a maturity date of May 1, 2016 was extended through May 18, 2016.

• The aforementioned senior unsecured note issuance in April of 2016 just before the Q1 2016 results came out, totalling 33.6m at an extremely high 9% rate of interest.

• In April 2016, a 10m revolving line of credit with a maturity date of April 30, 2016 was refinanced into an 8m demand note due April 30, 2017.

• On May 23, 2016, Marc Adelson abruptly tendered his resignation as Chief Credit Officer and Chief Operating Officer of Medallion Financial Corp. 

6. Conclusion

6.1. Company is not viable without significant equity dilution

• We started off the analysis by correcting the reported NAV growth for subsequent developments and one-time items. This resulted in a projected annual NAV increase rate of 7.6m and an already high pe of 23.

• Doubling the current provisioning rate to properly provision for future credit losses would cost 17.7m of NAV a year.

• Refinancing its debt maturing in 2016 would result in an annual income reduction of 10.7m.

• Subtracting the effect of extra credit provisioning and the refinancing from the base case results in a pro forma annual NAV decrease of 20.8m.

• On the basis of these pro forma numbers and the implicit NAV erosion for the foreseeable future, we believe the debt market will be be closed for MFIN and refinancing its large 2016 liquidity shortfall will fail.

• This means that MFIN will almost certainly face a funding squeeze followed by a complete elimination of equity value.

• An alternative scenario could be a large (say 100m) recapitalisation, which would probably be executed at a very low stock price.

• In case of a recapitalisation the stock will converge to option value because of the massive dilution and the prospect of years of negative NAV growth (the credit issues will not go away).

• Based on the maturity profile of the debt we believe this thesis should play out over the next 18 months.

See appendix C for some auxiliary support for the short thesis based on a recent SEC inquiry and the quality of the non-medallion loan portfolios.

6.2. Execution: Short Risk and Cost

Short interest: 12.97%

Borrow rate: 16,5% (high but bearable)

Free float: 85.5%

Daily volume: 150k

Disclosure: we are short MFIN common stock.

7. Discussion of Risks to the Thesis

7.1. Restructuring of the loans

Restructuring of delinquent and maturing debt can delay provisioning and loss taking on the medallion loan portfolio.

As highlighted earlier a decrease in repayments is already impacting liquidity – restructurings will only make this worse while interests rate reduction will eat into income.. So far restructuring efforts have not turned out well. Of the 24 debt restructurings that the company executed in 2015, 12 loans representing 69,5% of the original notional had already re-defaulted per December 31, 2015. Hence we believe that restructurings are not a material risk to the short thesis.

7.2. Regulatory Risks

Both Chicago and New York have pending lawsuits where taxi interest groups (including medallion lenders) have claimed that ride-share apps basically subject them to unfair competition. The trend here is that attempts to restrain the number of ride-share drivers fail while in different cities measures are (being) implemented to level the playing field by loosening artificial restrictions on medallion owners and by subjecting ride-share services to the same regulation as normal taxi drivers. NYC recently abolished the ‘owner must drive’ rule for independent medallions for example.

We believe that levelling the regulatory playing field does not represent a real threat to the short thesis as the medallion owners would still be dependent on the value of having a monopoly on street hails in Manhattan south of the northern boundary of Central Park. This value will continue to decline as ride-share app waiting time decreases and the waiting time for hailing a yellow cabs increases (because the number on the road is dropping)..

7.3. Most medallion loans have personal guarantees

In theory medallion lenders can fall back on personal guarantees included in the loan terms. Most borrowers are disadvantaged groups and the medallion collateral forms the bulk of their assets, casting doubt on the value these personal guarantees. This is supported by anecdotal evidence: Melrose foreclosed on a loan with a personal guarantee in 2015 and received a 10% recovery on the part not covered by the collateral. Attempts to enforce the personal guarantees can also be expected to be met with a lot of resistance (see for example: Ruining medallion borrowers is ruining communities.).

7.4. A taxi industry bailout from the government

This plan is floated periodically but government and the public do not seem receptive (see for example: NY taxi king is going down).

7.5. Insider buying in February and March 2016

The amounts involved are insignificant compared to the holdings of these buyers (mostly the Murstein family). Substantive insider buying going forward is a definite red flag but the purchase of few thousand shares here and there from a family already owning 13.3% does not look like real insider demand.

Appendix A: Chicago and New York Medallion Price Analysis

A.1. Recent price history

• Medallion prices peaked in 2013 at 370k in Chicago, NYC prices peaked at 1.35m for minifleet licences and just over a million for independent licences.

• The market was also quite liquid with about 90 valid transactions occurring every quarter in Chicago and about 20 per quarter in NY in 2013. LTVs on MFIN’s medallion book were around 40% at this point in time.

• In Q1 of 2015 the effect of ride-sharing apps became obvious and prices started to slide. Liquidity also came down, since the start of 2015 up to April of 2016 the number of quarterly transactions averaged 5.4 for Chicago and 4.7 for NY.

   

A.2. Market observations vs. Q4 2015 and Q1 2016 MFIN reported values and LTVs

• There were only 2 transactions in Q4 of 2015 and MFIN marked the price of Chicago medallions at 238k (the highest of the two), even though the last transaction was at 150k. In Q1 of 2016 a total of 3 transactions were executed with the last two at 50k. Even though Q4 2015 was even less liquid, MFIN at this point stated there was no observable market anymore and applied a mark of 228k for Q1 2016.

• The NYC market was even more illiquid in Q1 with only 2 valid transactions. MFIN did use market prices for this part of their book however, using 580k and 793k for independent and minifleet medallions respectively. We deem these observed prices to be aggressive; the 793k minifleet observation was a December transaction and the 580k was the highest of the two independent transactions that did occur in Q1 (the other medallion traded at 520k).

A.3. Q2 2016 medallion price update

• Liquidity in Chicago picked up with 12 transactions clearing between 55 and 60k in April.

• NYC saw only two valid independent medallion transaction at 325 and 405k. There were three foreclosures at 540 to 615k to but we do not incorporate these as the bidding prices could be inflated by the foreclosing bank, bidding flat to the loan balance.

A.4. Liquidity and offer interest

Some commentators argue that the lack of liquidity is an indication that the value of medallions could very well be higher than the prices observed in the market. We would argue the reverse. People are reluctant to transact at the current lower levels because they either have a medallion loan with negative equity or they are a lender that foreclosed on a medallion loan and do not want to realise a loss on the loan.

We analysed the NYC medallions offered on the websites mynytaxi.com and nycitycab.com, the go-to places for NYC Medallion trading, and there seems to be a large and increasing overhang of people wanting to sell their medallions.

• We observe that the number of Medallion offers jumped from 27 in H1 2015 to 53 in H2 2015, in the first 4.5 months of 2016 a total of 51 offers have already been made.

• At the same time a significant decline in offer prices can be observed: the average observed offer price for 2016 is 614k for the individual and 701k for the minifleet medallions. The minimum offer levels observed in 2016 are 400k for both types of medallion.

• These low offer prices are not enough to entice any bidders however; only 17 medallions have traded since mid 2015 up to the end of April 2016 vs. 40 in the same (already depressed) period one year earlier. This is a strong indication that observed offer prices are still too low to attract any bids and, most importantly, that there is a significant supply overhang.

A.5. Conclusion

Based on the above we estimate current clearing prices for medallions to be 55-60k in Chicago, 300-400k for NYC independent and 400-550k for NYC minifleet medallions.

• Please note that our NYC prices (based on a very small number of transactions) might be too conservative looking at the Chicago discount-to-peak. Also note that our estimated price ranges assume an orderly market. If one or more parties would start to liquidate medallions, clearing prices could easily break the lower bound to a significant extent.

• The risk of medallion liquidations seems to be increasing as taxi companies are starting to go bankrupt and increasingly strained lenders will get stuck with increasing numbers of medallions. MFIN is not the only financial that is overexposed to medallions, another one is Melrose Credit Union, this company sports a 1.5bn medallion loan portfolio with a 40% delinquency rate and increasing pressure on their capital ratios.

Appendix B: Assumptions liquidity analysis

Running MFIN’s financials forward, we calculate the 157m shortfall using the following assumptions:

• BDC/RIC regulations do not cause problems for MFIN because Holdco converts back to a C-corp. We assume Holdco does not pay any 2016 tax in this scenario.

• MB needs an immediate capital injection of 5m.

• MFIN cash flow from operations minus dividends paid out to the common equals 0.

• Minimum cash balance at Holdco is 10m

• MFIN manages to extract 15m of cash from net loan redemptions every quarter.

We calculate the total income effect of a best case refinancing to be a negative 10.7m pa. using the following assumptions:

• Banks will not step in with financing as there is no longer a secure collateral pool available to back a credit facility.

• We do assume the high yield debt market offers a solution and MFIN finances the entire 157m shortfall at a 9% interest rate. This rate is equal to the rate on the senior notes issued in April of 2016, just before the Q1 results came out.

• The average interest rate on the debt maturing in 2016 is 2.4%. The increase in interest paid from 2.4% to 9% results in an extra cost of 8.4m per year.

• MFIN will also incur an additional loss of income of 2.3m in this scenario because the asset base shrunk by 45m because of the assumed loan amortisations (using a 5% yield on the amortised assets).

Appendix C: Non-medallion related support for thesis

C.1. Other loan portfolios

• Holdco’s 84.5m commercial loan portfolio leaves no margin for error. The interest on this portfolio is 12.95% against a 2.0% unrealized depreciation reserve. The overdue loans only amount to 2.7% of notional but credit stress in this portfolio can easily cause problems.

• Similarly, MB’s fast growing 652.3m consumer loan portfolio is only experiencing a ca.1.5% annual loss rate. Given the 13.99% average interest rate and fact that the loans concern financing for recreational vehicles and home improvements to customers with prior credit blemishes, we think this could easily increase if the economy is subjected to stress.

• The consumer loans are sourced through brokers and serviced by another bank so it would not be too hard to replicate, begging the question why other market participants are not loading up on this exposure if the reward is so high. We believe this is the case because much of this portfolio is still quite young and these loans have a very long maturity (typically 10 years) compared to the economic life of the collateral. If this is the case loss rates can be expected to increase even without a recession.

C.2. SEC questioning revaluations

• The SEC asked MFIN a series of questions to MFIN on its 2014 reporting and its planned 33.6m bond offering from September 30, 2015 to February 5, 2016. These questions were about the valuation of loans, medallions and MB. The SEC also forced MFIN to make a significant number of changes to its risk disclosures and wanted additional information included about its investment affiliates. The company replied on February 18, 2016. This SEC attention is certainly interesting given the increasing possibility that medallion values and equity participations are marked at inflated valuations.

• In Q3 of 2015 the value of MB was increased by 15.5m on the basis of an indication of interest from a third party (that was subsequently withdrawn) and an external valuation report. This external valuation is repeated every year and we expect the current market stress will at least lead to a return to book value. Even without further prompting from the SEC, we expect to see a 15.5m impairment Holdco’s ownership of MB in 2016.
  
  
  

Catalyst

* Write-down of owned Chicago medallions to fair value

* Incorporation of Chicago medallion fair value in the reported LTV

* Increased liquidity in the NYC market confirming lower prices and affecting reported LTV

* Medallions starting to be sold at fire sale prices.

* An adverse event at a medallion lender with more advanced issues (e.g. Melrose Credit Union).

* Increasing delinquencies over the next few quarters

* Increasing credit loss provisioning affecting NAV

* Lower NAV increase or an NAV loss next quarter when management runs out of assets to revalue

* MB equity value reassessment on MFIN balance sheet Q3 2016

* Significant MB recapitalisation(s)

* MFIN loss of BDC status and reversion to tax paying C-corp

* Dilutive equity raise

* Inability to repay the large amount of debt coming due during 2016

* Raising debt at an extremely high interest rate

* Breach of the asset coverage ratio in December of 2016

* SEC taking action on asset (re)valuation and/or LTV calculation