Medallion Financial: Staying Away
At 11 a.m. EST, Medallion Financial (MFIN) is the Biggest Loser amongst the 45 BDCs we track.
The price is down to $3.54.
The BDC Reporter read the earnings press release on November 7th.
The stock price was soaring and reached $4.24 the next day from a recent low of $3.26.
We warned: “We suggest not drawing any conclusions from the press release alone“
Suggested: “Wait for the 10-Q”
Then, we waited, and waited. We even complained a little.
On November 10th, the 10-Q finally arrived.
Coincidentally or otherwise, the enthusiasm has abated and MFIN is almost back at the starting point.
See the Yahoo Finance 1 Month Chart.
We did spend a couple of hours with the almost indecipherable 10-Q back on November 10th.
There is not enough time to provide chapter & verse at this point.
We’ve been promising ourselves another, longer review of the Q.
Our first reaction,though, was not positive by any means.
The obvious bad news is that non-accruing medallion loans have soared in a very short period. Two data points jumped out at us. First, see page 68 of the 10-Q.
As of September 30, 2016, 15.9% of our managed medallion loan portfolio and 19.4% of our on-balance sheet loan portfolios were 90 days or more past due, compared to 4.1% and 3.8% at December 31, 2015.
Of the $300mn in total taxi loans on the Company’s books, $86mn are not current on their obligations. That’s twice the level of a year ago. The over 90 have quintupled…
The less obvious-but wore worrying development-is that the net worth of Medallion Bank-the key subsidiary of the Company- may be in danger.
If net worth drops too low from write-downs and write-offs, MFIN will have a problem with the bank regulators.
[Nobody wants to have a problem with the regulators because they have wide powers].
Even if regulators can be appeased, Medallion Bank has to worry about continuing to attract depositors. See page 76 of the Q where the risk is spelled out.
A QUESTION OF VALUES
One of the ways Medallion Bank is being kept solvent is by an about face in how the bank is valued quarter by quarter.
MFIN has been writing up the value of Medallion Bank since last year based on the assumption that there are potential buyers out there.
As a result, the perceived value of the Bank should be higher. Here is the whole issue summed up on page 9 of the 10-Q:
The Company’s investment in Medallion Bank, as a wholly owned portfolio investment, is also subject to quarterly assessments of fair value. The Company conducts a thorough valuation analysis as described previously, and also receives an opinion regarding the valuation from an independent third party to assist the Board of Directors in its determination of the fair value of Medallion Bank on at least an annual basis. The Company’s analysis includes factors such as various regulatory restrictions that were established at Medallion Bank’s inception, by the FDIC and State of Utah, and also by additional regulatory restrictions, such as the prior moratorium imposed by the Dodd-Frank Act on the acquisition of control of an industrial bank by a “commercial firm” (a company whose gross revenues are primarily derived from non-financial activities) which expired in July 2013 and the lack of any new charter issuances since the moratorium’s expiration. Because of these restrictions and other factors, the Company’s Board of Directors had previously determined that Medallion Bank had little value beyond its recorded book value. As a result of this valuation process, the Company had previously used Medallion Bank’s actual results of operations as the best estimate of changes in fair value, and recorded the results as a component of unrealized appreciation (depreciation) on investments. In the second quarter of 2015, the Company first became aware of external interest in Medallion Bank and its portfolio’s assets at values in excess of their book value. The Company incorporated these new factors in the Medallion Bank’s fair value analysis and the Board of Directors determined that Medallion Bank had a fair value in excess of book value. Expression of interest in Medallion Bank from both investment bankers and interested parties has continued through 2016. In addition, in the third quarter of 2016 there was a court ruling involving a marketplace lender that the Company believes heightens the interest of marketplace lenders to acquire or merge with Utah industrial banks. The Company also engaged a valuation specialist to assist the Board of Directors in their determination of Medallion Bank’s fair value, and this appreciation of $15,500,000 was thereby recorded in 2015, and additional appreciation of $28,600,000 was recorded in 2016.
BOTTOM LINE BENEFIT
Let’s put some context round these numbers. At 9-30-2016, Medallion Bank had $193mn in equity value using their current methodology for valuation.
Without the new method, that net worth would be $45mn lower or nearly 25%.
We have the curious situation of a bank whose principal loan asset class is fast deteriorating (medallion loans) but which is apparently increasing in value.
IN REAL TIME
We doubt regulators want to face the prospect that Medallion Bank might be headed to the knackers yard, and that action might be necessary.
Nonetheless, we hear from the filing that the regulators are in the building as we write this:
As a regulated entity, Medallion Bank is subject to periodic routine examination from its regulators. Medallion Bank is currently undergoing such an examination, [emphasis added] and while the final results of the examination are unknown at this time, it is possible that the regulators could require additional loan loss reserves or other financial adjustments at the Bank. While this would be, if it occurs at all, a subsequent event to our current regulatory filings, it is possible that the regulators could require the Bank to record any adjustment as a restatement of the Bank’s previously filed regulatory reports, resulting in certain of the supplemental Medallion Bank disclosures in this Form 10-Q to differ from the adjusted numbers…
A BDC IS SUPPOSED TO BE DIVERSIFIED
Unfortunately, MFIN’s long standing strategy of being a one industry specialist is coming back to bite and is limiting its options to deal with capital problems that might occur at the Bank. This is spelled out in the 10-Q:
The Company did not satisfy the requirement that no more than 30% of its total assets be comprised of non-qualifying assets, and is currently not permitted to acquire any non-qualifying assets. The Company is therefore unable to make any investments in non-qualifying assets, including follow-on investments in Medallion Bank…The Company would also not be able to support Medallion Bank’s capital requirements, if any, and Medallion Bank may also not be able to grow as quickly because the Company is precluded from providing additional funding to Medallion Bank.
That’s just a quick selection of the disturbing items we identified in the 10-Q. Other worries include other regulatory issues at an SBIC, possible defaults with lenders, debt obligations coming due in the next couple of years and on and on. Management may yet find a way out of these multiple challenges (although just stopping being a BDC-as the Company has been forewarning- by itself is only a minor move forward). We get the impression this situation could accelerate towards a conclusion of some kind sooner rather than later as none of the catalysts that have caused MFIN’s troubles are going away. However, for investors who will always be the last to know, an investment in MFIN is only for someone with nerves of steel. Certainly we are “staying away in droves”.
We have no position in MFIN or the Unsecured Notes with the ticker MFINL. However, we did sell our position in the latter following our review of the 10-Q. Management may yet succeed but with the bulk of the value of MFIN in its subsidiary bank (which may or might not be effectively insolvent) and substantial secured debt needing to be paid out before the Notes at the holdings company level just when many assets are questionable, the risk was not worth taking.