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Medallion Financial: Restructuring Agreement Announced

BACKGROUND: Throughout the day on Tuesday January 31, 2017, Medallion Financial’s (TAXI) stock price was in free fall, off 13%.  That followed prior day declines, recorded by the BDC Reporter on several occasions, most recently on January 30th 2017. After the close of business, TAXI issued the following press release on Business Wire:

Medallion Financial Corp. (MFIN) (“Medallion” or the “Company”) announced today its plans to transform the Company’s overall strategy, which should allow the Company to consolidate and ultimately simplify its business for the long-term.Foremost, the Company is announcing that is evolving toward primarily focusing on its successful Medallion Bank and consumer finance segments. As of September 30, 2016, Medallion Bank held a $676 million consumer loan portfolio, which currently generates a 13% yield as well as an above 30% after-tax return on equity. The consumer finance loans originated by Medallion Bank are typically collateralized by recreational vehicles, boats, motorcycles and horse trailers, and are also originated to finance small-scale home improvements.

“After a careful review of our entire business, it became clear that an effective transformation of our business is critical in order to maximize our potential and take advantage of our continued success in our consumer lending segment,” stated Andrew Murstein, President of Medallion Financial. “We believe that our ongoing transition away from medallion lending and placing our strategic focus fully on our growing and profitable consumer finance business – which currently generates over 90% of our earnings – will allow us to streamline our structure and amplify the value and prominence of Medallion Bank to our Company.”

As part of its strategic evolution, Medallion also announced today that its wholly-owned subsidiary Freshstart Venture Capital Corp. (“Freshstart”), which was mainly engaged in the taxi medallion lending area, has come to terms with the U.S. Small Business Administration (“SBA”) to restructure its outstanding debentures with the SBA into a new $34.0 million loan, effective March 1, 2017. Commensurate with the loan agreement, Freshstart will no longer originate any new medallion loans. The loan will bear interest at a rate of 3.25% per annum, which provides a lower cost of funds than the prior debentures, with a maturity date of February 1, 2020.

The Company also announced that it will not be a regulated investment company (RIC) for the tax year ending December 31, 2016. By electing to not be a RIC in 2016, the Company expects to benefit by lowering its tax burden through the consolidation of the tax returns of Medallion Bank with some of the Company’s medallion lending entities that have taken significant reserves in the past, which may result in increased profits and cash flow for the year.

“With this new structure and our shift in strategy, coupled with our reduction in overhead, and the renewals of all of our warehouse facilities that have come due, we are well positioned in 2017 and confident in our future,” added Mr. Murstein. after-tax return on equity. The consumer finance loans originated by Medallion Bank are typically collateralized by recreational vehicles, boats, motorcycles and horse trailers, and are also originated to finance small-scale home improvements.

“After a careful review of our entire business, it became clear that an effective transformation of our business is critical in order to maximize our potential and take advantage of our continued success in our consumer lending segment,” stated Andrew Murstein, President of Medallion Financial. “We believe that our ongoing transition away from medallion lending and placing our strategic focus fully on our growing and profitable consumer finance business – which currently generates over 90% of our earnings – will allow us to streamline our structure and amplify the value and prominence of Medallion Bank to our Company.”

As part of its strategic evolution, Medallion also announced today that its wholly-owned subsidiary Freshstart Venture Capital Corp. (“Freshstart”), which was mainly engaged in the taxi medallion lending area, has come to terms with the U.S. Small Business Administration (“SBA”) to restructure its outstanding debentures with the SBA into a new $34.0 million loan, effective March 1, 2017. Commensurate with the loan agreement, Freshstart will no longer originate any new medallion loans. The loan will bear interest at a rate of 3.25% per annum, which provides a lower cost of funds than the prior debentures, with a maturity date of February 1, 2020.

The Company also announced that it will not be a regulated investment company (RIC) for the tax year ending December 31, 2016. By electing to not be a RIC in 2016, the Company expects to benefit by lowering its tax burden through the consolidation of the tax returns of Medallion Bank with some of the Company’s medallion lending entities that have taken significant reserves in the past, which may result in increased profits and cash flow for the year.

“With this new structure and our shift in strategy, coupled with our reduction in overhead, and the renewals of all of our warehouse facilities that have come due, we are well positioned in 2017 and confident in our future,” added Mr. Murstein.”

TOO LITTLE AND VERY LATE

The new announcement by MAIN was not explicitly tied to the stock price drop.

Nonetheless, with the common stock at its lowest level since going public in 2007, and its publicly traded Note (MFINL) at a two month low, the BDC’s managers appear to have been impelled to “do something”.

However, there is very little new “news” in the press release.

RIC NO MORE

TAXI had previously warned that consideration was being given to abandoning BDC and Registered Investment Company (“RIC”) status.

Likewise, the “strategic focus” on Medallion Bank and its consumer lending business was a staple of prior announcements.

FRESHSTART

The only new information is that TAXI has been negotiating with the Small Business Administration (SBA) regarding the future of its subsidiary Freshstart Venture Capital Corp.

[Freshstart-the VC moniker notwithstanding-is involved in taxi medallion lending/investing].

In an SEC filing, published at the same time as the press release is the revised Loan Agreement.

BDC REPORTER ANALYSIS OF LOAN AGREEMENT

The new Loan Agreement between Freshstart and the SBA involve $33mn in debentures (i.e. long term loans) provided by the latter to fund taxi medallion loans.

According to the Loan Agreement, Freshstart has defaulted under the terms of the debentures and the new $34mn Loan Agreement is a restructuring intended to arrange the liquidation of the underlying assets, and full repayment of amounts owed the SBA.

The interest rate charged is very low at 3.25%, as the SBA’s main objective is recouping its advances.

The Loan matures in three years, but partial payments are required in years one and two, with the balance at maturity in February 2020.

In any case, the SBA is requiring that proceeds from any asset sale/disposition be directed to paying down the debt, minus pre-agreed amounts for operating costs.

The SBA is allowing Freshstart $150,000 a year from proceeds to pay expenses and $75,000 a month for “Management Fees”, presumably owed to Medallion Financial.

Even that amount may not be paid and the accrued liability will be treated as subordinate to the SBA obligations.

Luckily for Freshstart, the SBA has magnanimously agreed to pre-fund a reserve for operating costs of $1.575mn, equal to 18 months of costs and management fee expenses.

Otherwise, the Loan Agreement contains a long list of standard positive and negative covenants intended to protect the SBA and give them latitude to accelerate the debt if needed.

A trial by jury has been explicitly waived should there be litigation between the parties.

MISSING

Although the Loan Agreement contains references to several Exhibits, including useful data about Freshstart’s assets and liabilities, these are not included in the SEC filing.

Or, at least, we were not able to find them.

CONCLUSION: RE LOAN

Obviously Freshstart is in liquidation and will be wound up one way or another by “getting out” of the medallion lending business.

The SBA has provided-as far as we can tell-a very reasonable Loan Agreement to TAXI’s subsidiary in an effort to maximize recovery.

KNOWN UNKNOWNS

Nothing in the press release or in the Loan Agreement allows investors to evaluate the practical likelihood of the restructuring succeeding.

We don’t know the current real value of the subsidiary’s portfolio, and how liquid or otherwise are those assets.

We know from other medallion lenders that default rates on existing medallion loans are shooting up and (in New York City at least), their value has dropped by 50% or more.

This restructuring may work out or crash and burn.

BIGGER PICTURE

Of course, this precedent is writing on the wall writ large both for Medallion Bank’s taxi medallion portfolio and MFIN itself, which has several other pockets of financing.

In the press release, TAXI made reference in its typically opaque style that “warehouse facilities” that had come due had been renewed by the lenders.

Unfortunately, without a list of those renewed facilities and those which have not come due, assessing whether TAXI is out of the woods-as the press release suggests-is impossible.

A reasonable guess is that TAXI’s troubles are just beginning and much will depend on its ability to exit from its medallion loans and investments.

We are not optimistic.