Annual Statements Open main menu

MEDALLION FINANCIAL CORP - Annual Report: 2007 (Form 10-K)

Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

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

For the Fiscal Year Ended December 31, 2007

OR

 

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

For the transition period from              to             

Commission file number 814-00188

 

 

MEDALLION FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

 

 

 

DELAWARE   04-3291176
(State of Incorporation)   (IRS Employer Identification No.)

 

437 MADISON AVENUE, 38th Floor, NEW YORK, NEW YORK 10022
(Address of principal executive offices) (Zip Code)

(212) 328-2100

(Registrant’s telephone number, including area code)

 

 

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act

Common Stock, par value $0.01 per share

(Title of class)

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    YES  ¨    NO  x

Indicated by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act:    YES  ¨    NO  x

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K  ¨

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

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

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

The aggregate market value of the voting common equity held by non-affiliates of the registrant, computed by reference to the last reported price at which the stock was sold on June 30, 2007 (the last business day of the registrant’s most recently completed second quarter) was $11.83.

The number of outstanding shares of registrant’s Common Stock, par value $0.01, as of March 11, 2008 was, 17,488,174.

 

 

 


Table of Contents

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Definitive Proxy Statement for its 2008 Annual Meeting of Shareholders, which Definitive Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the registrant’s fiscal year-end of December 31, 2007, are incorporated by reference into Part III of this form 10-K

MEDALLION FINANCIAL CORP.

2007 FORM 10-K ANNUAL REPORT

TABLE OF CONTENTS

 

PART I

   3

ITEM 1.

  

OUR BUSINESS

   3

ITEM 1A.

  

RISK FACTORS

   18

ITEM 1B.

  

UNRESOLVED STAFF COMMMENTS

   29

ITEM 2.

  

PROPERTIES

   29

ITEM 3.

  

LEGAL PROCEEDINGS

   29

ITEM 4.

  

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

   30

PART II

   30

ITEM 5.

  

MARKET FOR THE REGISTRANT’S COMMON STOCK, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASE OF EQUITY SECURITIES

   30

ITEM 6.

  

SELECTED FINANCIAL DATA

   32

ITEM 7.

  

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

   33

ITEM 7A.

  

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

   53

ITEM 8.

  

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

   54

ITEM 9.

  

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES

   54

ITEM 9A.

  

CONTROLS AND PROCEDURES

   54

ITEM 9B.

  

OTHER INFORMATION

   57

PART III

   57

ITEM 10.

  

DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE

   57

ITEM 11.

  

EXECUTIVE COMPENSATION

   57

ITEM 12.

  

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

   57

ITEM 13.

  

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

   57

ITEM 14.

  

PRINCIPAL ACCOUNTANT FEES AND SERVICES

   57

PART IV

   57

ITEM 15.

  

EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

   57

SIGNATURES

   63

CERTIFICATIONS

   69


Table of Contents

The following discussion should be read in conjunction with our financial statements and the notes to those statements and other financial information appearing elsewhere in this report.

This report contains forward-looking statements relating to future events and future performance applicable to us within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including, without limitation, statements regarding our expectations, beliefs, intentions, or future strategies that are signified by the words expects, anticipates, intends, believes, or similar language. Actual results could differ materially from those anticipated in such forward-looking statements. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any forward-looking statements. We caution investors that our business and financial performance are subject to substantial risks and uncertainties.

PART I

 

ITEM 1. OUR BUSINESS

We, Medallion Financial Corp. or the Company, are a specialty finance company that has a leading position in originating, acquiring, and servicing loans that finance taxicab medallions and various types of commercial businesses. A wholly-owned portfolio company of ours, Medallion Bank, also originates consumer loans for the purchase of recreational vehicles, boats, and trailers. Our core philosophy has been “In niches there are riches.” We try to identify markets that are profitable and where we can become an industry leader. Our investment objectives are to provide a high level of distributable income, consistent with the preservation of capital, as well as long-term growth of net asset value and our stock price. We also provide other debt, mezzanine, and equity investment capital to companies in a variety of industries, consistent with our investment objectives. For additional information about our business and operations, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Since 1996, the year in which we became a public company, we have increased our taxicab medallion loan portfolio at a compound annual growth rate of 13%, and our commercial loan portfolio at a compound annual growth rate of 7% (14% for both portfolios on a managed basis when combined with Medallion Bank). Since Medallion Bank acquired a consumer loan portfolio and began originating consumer loans in 2004, it has increased its consumer loan portfolio at a compound annual growth rate of 20%. Total assets under our management, which includes assets serviced for third party investors and managed by unconsolidated portfolio companies, were approximately $1,017,433,000 as of December 31, 2007 and $907,133,000 as of December 31, 2006, and have grown at a compound annual growth rate of 15% from $215,000,000 at the end of 1996. Since our initial public offering in 1996, we have paid dividends in excess of $118,249,000 or $7.77 per share.

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

 

   

Medallion Funding Corp., or Medallion Funding, a Small Business Investment Company, or SBIC, and a regulated investment company, or RIC, our primary taxicab lending company;

 

   

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

 

   

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

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

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

We are a closed-end, non-diversified management investment company under the Investment Company Act of 1940 (the 1940 Act). We have elected to be treated as a business development company under the 1940 Act. We have also elected to be treated for federal income tax purposes as a RIC under Subchapter M of the Internal Revenue Code, or the Code. As a RIC, we generally do not have to pay corporate-level federal income taxes on any net ordinary income or capital gains that we distribute to our shareholders as dividends if we meet certain source-of-income and asset diversification requirements. Medallion Bank is not a RIC and must pay corporate-level federal income taxes.

 

3


Table of Contents

We are managed by our executive officers under the supervision of our board of directors. As a result, we do not pay investment advisory fees, but instead we incur the operating costs associated with employing investment and portfolio management professionals. Alvin Murstein, our chairman and chief executive officer, has over 45 years of experience in the ownership, management, and financing of taxicab medallions and other commercial businesses. Andrew M. Murstein, our president, has 20 years of experience and is the third generation in his family to participate in the business.

Since Medallion Bank commenced operations in December 2003, we had historically consolidated Medallion Bank’s financial statements with those of our own. Although Medallion Bank is not an investment company, and SEC rules generally do not permit investment companies such as ours to consolidate the financial statements of non-investment companies, such as Medallion Bank, we had sought and obtained a letter from the SEC in March 2004 permitting such consolidation. We believed that consolidating Medallion Bank provided a more complete and accurate representation of our full scope of operations, and our complete financial position and results of operations.

During August 2006, we filed a registration statement on Form N-2 which the SEC staff reviewed and on which they provided comments, including those relating to the consolidation of the accounts of Medallion Bank which have evolved since 2004. Based on discussions with the SEC staff, we determined during the 2006 fourth quarter to voluntarily not consolidate Medallion Bank and present Medallion Bank as a portfolio company. We determined that this change represents a change in the reporting entity as described in SFAS No. 154, “Accounting Changes and Error Corrections.” Accordingly we retrospectively applied this change to the financial statements of all prior periods presented, including previously issued interim periods presented, included in our 2006 Form 10-K. The effect of this retrospective application was to present our financial position and results of operations as if Medallion Bank had not been consolidated for all periods presented and to present Medallion Bank as an unconsolidated portfolio investment. Although this created changes in the reported levels of assets, liabilities, revenues, and expenses, our net increase in net assets resulting from operations, shareholders’ equity, and the related amounts per common share were unchanged.

Because of the change in the reporting entity described above and in note 3 to our consolidated financial statements, our financial condition and results of operations included in this annual report for the years ended December 31, 2005, 2004, and 2003, including for any interim periods presented, have been adjusted to reflect the change retrospectively for all periods and information presented.

Our Market

We provide loans to individuals and small to mid-size businesses, both directly through our investment company subsidiaries and also through Medallion Bank, in three primary markets:

 

   

loans that finance taxicab medallions;

 

   

loans that finance commercial businesses; and

 

   

loans that finance consumer purchases of recreational vehicles, boats, and trailers.

The following chart shows the components of our $934,955,000 managed net investment portfolio as of December 31, 2007.

 

(Dollars in thousands)

   On-Balance Sheet    Off-Balance Sheet (1)     Total Managed Investments

Medallion loans

   $ 498,883    $ 87,615     $ 586,498

Commercial loans

     91,782      87,844       179,626

Consumer loans

     —        138,446       138,446

Investment securities

     —        21,838       21,838

Equity investments

     4,880      —         4,880

Investments in Medallion Bank and other controlled subsidiaries

     57,501      (53,834 )     3,667
                     

Net investment portfolio

   $ 653,046    $ 281,909     $ 934,955
                     

 

(1)

Off-balance sheet investments are those owned by our wholly-owned unconsolidated portfolio companies, primarily Medallion Bank.

Medallion Loans

Taxi medallion loans of $498,883,000 comprised 76% of our $653,046,000 net investment portfolio as of December 31, 2007, compared to $428,249,000 or 72% of our $592,933,000 net investment portfolio as of December 31, 2006. Managed taxi medallion loans of $586,498,000 comprised 63% of our $934,955,000 managed net investment portfolio as of December 31, 2007, compared to $522,193,000 or 63% of our $833,639,000 managed net investment portfolio as of December 31, 2006. Including loans to unaffiliated investors, the total amount of medallion loans under our management was $590,941,000 as of December 31, 2007, compared to $527,976,000 as of December 31, 2006. Since 1979, we and Medallion Bank have originated, on a combined basis, approximately

 

4


Table of Contents

$1,159,002,000 in medallion loans in New York City, Chicago, Boston, Newark, Cambridge, and other cities within the United States. In addition, our management has a long history of owning, managing, and financing taxicab fleets, taxicab medallions, and corporate car services, dating back to 1956.

Medallion loans collateralized by New York City taxicab medallions and related assets comprised approximately 80% of the value of the medallion loan portfolio as of December 31, 2007 and 79% of the value of the medallion loan portfolio as of December 31, 2006, and were 83% and 82% on a managed basis. The New York City Taxi and Limousine Commission, or TLC, estimates that the total value of all of New York City taxicab medallions and related assets exceeded $7.2 billion as of December 31, 2007. We estimate that the total value of all taxicab medallions and related assets in the US exceeded $8.8 billion as of December 31, 2007.

Although some of the medallion loans have from time to time been in arrears or in default, our loss experience on medallion loans has been negligible. We believe that our medallion loan portfolio is of high credit quality because medallions have generally increased in value and are relatively simple to repossess and resell in an active market. In the past, when a borrower has defaulted on a loan, we have repossessed the medallion collateralizing that loan. If the loan was not brought current, the medallion was sold in the active market at prices at or in excess of the amounts due.

The following table displays information on managed medallion loans outstanding (other than those managed for third party investors) in each of our major markets at December 31, 2007. For a presentation of only the consolidated on-balance sheet medallion loans, see the Consolidated Schedule of Investments in the consolidated financial statements on page F-31.

 

(Dollars in thousands)

   # of Loans    % of Medallion
Loan Portfolio (1)
    Average
Interest Rate (2)
    Principal
Balance
 

Managed medallion loans

         

New York

   1,369    83 %   6.87 %   $ 485,626  

Chicago

   298    6     7.43       33,877  

Boston

   165    5     8.42       32,753  

Newark

   169    4     8.38       22,927  

Cambridge

   26    1     8.38       5,243  

Other

   33    1     7.59       5,587  
                     

Total managed medallion loans

   2,060    100 %   7.07       586,013  
                   

Deferred loan acquisition costs

            892  

Unrealized depreciation on loans

            (407 )
               

Net managed medallion loans

          $ 586,498  
               

 

(1)

Based on principal balance outstanding.

(2)

Based on the contractual adjustable or fixed rates of the portfolios at December 31, 2007.

The New York City Market. A New York City taxicab medallion is the only permitted license to operate a taxicab and accept street hails in New York City. As reported by the TLC, individual (owner-driver) medallions sold for approximately $426,000 and corporate medallions sold for approximately $600,000 as of December 31, 2007. The number of taxicab medallions is limited by law, and as a result of the limited supply of medallions, an active market for medallions has developed. The law limiting the number of medallions also stipulates that the ownership for the 13,000 medallions outstanding as of December 31, 2007 shall remain divided into 5,571 individual medallions and 7,429 fleet or corporate medallions. Corporate medallions are more valuable because they can be aggregated by businesses, leased to drivers, and operated for more than one shift. New York City auctioned 600 additional medallions during 2004 and auctioned an additional 308 medallions during 2006. The medallions auctioned in 2006 were restricted to hybrid fuel vehicles and wheelchair accessible vehicles. In addition, New York City auctioned an additional 63 medallions for wheelchair accessible vehicles in 2007. New York City announced a 25% fare hike to support the increased level of medallions, which took effect in the 2004 second quarter. The results of the auctions held were highly successful with a large number of bids received, and record-setting medallion values established, with corporate hybrid medallions alone garnering a minimum acceptable bid of $500,000.

A prospective medallion owner must qualify under the medallion ownership standards set and enforced by the TLC. These standards prohibit individuals with criminal records from owning medallions, require that the funds used to purchase medallions be derived from legitimate sources, and mandate that taxicab vehicles and meters meet TLC specifications. In addition, before the TLC will approve a medallion transfer, the TLC requires a letter from the seller’s insurer stating that there are no outstanding claims for personal injuries in excess of insurance coverage. After the transfer is approved, the owner’s taxicab is subject to quarterly TLC inspections.

Most New York City medallion transfers are handled through approximately 22 medallion brokers licensed by the TLC. In addition to brokering medallions, these brokers also arrange for TLC documentation insurance, vehicles, meters, and financing. We have excellent relations with many of the most active brokers, and regularly receive referrals from them. Brokers generated 47% of the loans originated during 2007, and 25% for 2006. However, we receive most of our referrals from a small number of brokers.

 

5


Table of Contents

The Chicago Market. We estimate that Chicago medallions currently sell for approximately $100,000 as of December 31, 2007. Pursuant to a municipal ordinance, the number of outstanding medallions is currently capped at 6,950. We estimate that the total value of all Chicago medallions and related assets is over $751,000,000 as of December 31, 2007.

The Boston Market. We estimate that Boston medallions currently sell for approximately $376,500 as of December 31, 2007. The number of Boston medallions is currently capped at 1,825. We estimate that the total value of all Boston medallions and related assets is over $592,000,000 as of December 31, 2007.

The Newark Market. We estimate that Newark medallions currently sell for approximately $330,000 as of December 31, 2007. The number of Newark medallions has been limited to 600 since 1950 by local law. We estimate that the total value of all Newark medallions and related assets is over $201,000,000 as of December 31, 2007.

The Cambridge Market. We estimate that Cambridge medallions currently sell for approximately $377,500 as of December 31, 2007. The number of Cambridge medallions has been limited to 255 since 1945 by a Cambridge city ordinance. We estimate that the total value of all Cambridge medallions and related assets is over $98,000,000 as of December 31, 2007.

Commercial Loans

Commercial loans finance either the purchase of the equipment and related assets necessary to open a new business or the purchase or improvement of an existing business. From the inception of the commercial loan business in 1987 through December 31, 2007, we and Medallion Bank have originated more than 10,146 commercial loans for an aggregate principal amount of approximately $755,484,000. Commercial loans of $91,782,000 comprised 14% of our $653,046,000 net investment portfolio as of December 31, 2007, compared to $88,207,000 or 15% of our $592,933,000 net investment portfolio as of December 31, 2006. Managed commercial loans of $179,626,000 comprised 19% of our $934,955,000 net investment portfolio as of December 31, 2007, compared to $148,444,000 or 18% of our $833,639,000 managed net investment portfolio as of December 31, 2006. We have increased our commercial loan activity in recent years, primarily because of the attractive higher yielding, floating rate nature of most of this business. The outstanding balances of managed commercial loans have grown at a compound annual rate of 14% since 1996. The increase since 1996 has been primarily driven by internal growth through the origination of additional commercial loans. We plan to continue expanding our commercial loan activities by developing a more diverse borrower base, a wider geographic area of coverage, and by expanding targeted industries.

Commercial loans are generally secured by equipment, accounts receivable, real estate, or other assets, and have interest rates averaging 487 basis points over the prevailing prime rate. As with medallion loans, the vast majority of the principals of borrowers personally guarantee commercial loans. The aggregate realized loss of principal on managed commercial loans has averaged 2.48% per annum for the last five years.

The following table displays information on managed commercial loans outstanding (other than those managed for third party investors) in each of our major markets at December 31, 2007. For a presentation of only the consolidated on-balance sheet commercial loans, see the Consolidated Schedule of Investments in the consolidated financial statements on page F-31.

 

(Dollars in thousands)

   # of Loans    % of
Commercial
Loan Portfolio (1)
    Average
Interest Rate (2)
    Principal
Balance
 

Managed commercial loans

         

Asset-based

   86    49 %   9.15 %   $ 92,800  

Secured mezzanine

   37    32     14.19       59,152  

Other secured commercial

   408    19     8.93       35,110  
                     

Total managed commercial loans

   531    100 %   10.70       187,062  
                   

Deferred loan acquisition costs

            164  

Unrealized depreciation on loans

            (7,600 )
               

Net managed commercial loans

          $ 179,626  
               

 

(1)

Based on principal balance outstanding

(2)

Based on the contractual rates of the portfolios at December 31, 2007.

Asset Based Loans. Through our Medallion Business Credit division, we originate, manage, and service asset-based loans to small businesses which require working capital credit facilities ranging from $500,000 to $8,000,000. Medallion Business Credit frequently refers a portion of its potential commercial loans to Medallion Bank to originate, so that we can benefit from Medallion

 

6


Table of Contents

Bank’s lower cost of funds. Additionally, from time to time, Medallion Business Credit also sells and purchases loan participations from independent third parties. Together, these loans represent approximately 49% of the managed commercial loan portfolio as of December 31, 2007 and 50% as of December 31, 2006. The credit facilities are secured principally by the borrower’s accounts receivable, but may also be secured by inventory, machinery, equipment, and/or real estate, and are personally guaranteed by the principals. Currently, our clients are mostly located in the New York metropolitan area and include manufacturers, distributors, and service organizations. We had successfully established 41 credit lines as of December 31, 2007.

Secured Mezzanine Loans. Through our subsidiary Medallion Capital, we originate both senior and subordinated loans nationwide to businesses in a variety of industries, including manufacturing, accommodation and food service operations, and various service providers, about half of which are located in the upper Midwest and Great Lakes region, with the rest scattered across the country. These loans are primarily secured by a second position on all assets of the businesses, generally range from $1,000,000 to $5,000,000, and represent approximately 32% of our managed commercial loan portfolio as of December 31, 2007, and 35% as of December 31, 2006. Frequently, we receive warrants to purchase an equity interest in the borrowers of secured mezzanine loans.

Other Secured Commercial Loans. We originate other commercial loans that are not concentrated in any particular industry. These loans represented approximately 19% of the managed commercial loan portfolio as of December 31, 2007, and 15% as of December 31, 2006. Historically, this portfolio had consisted of fixed-rate loans, but much of the business originated over the last five years has been at adjustable interest rates, generally repricing on their anniversary date. Borrowers include food service, real estate, retail establishments, and other service providers.

SBA Section 7(a) Loans. Through our subsidiary Business Lenders, we originated loans under the Section 7(a) program of the SBA. On October 17, 2005, we sold substantially all of the assets of Business Lenders to a subsidiary of Merrill Lynch.

Consumer Loans

Consumer loans are originated by Medallion Bank, a wholly-owned, unconsolidated portfolio company. Consumer loans of $138,446,000 comprised 15% of our $934,955,000 managed net investment portfolio as of December 31, 2007 and consumer loans of $111,799,000 comprised 13% of our $833,639,000 managed net investment portfolio as of December 31, 2006. The loans are collateralized by recreational vehicles, boats, motorcycles, and trailers located in all 50 states. The portfolio is serviced by a third party subsidiary of a major commercial bank. We believe that Medallion Bank’s consumer loan portfolio is of acceptable credit quality given the high interest rates earned on the loans, which compensate for the higher degree of credit risk in the portfolio.

Other

As a business development company, we also provide debt, mezzanine, and equity investment capital to companies in a variety of industries. These investments may be venture capital style investments which may not be fully collateralized. This is a small, but growing portion of our business.

Our Strategy

Our core philosophy has been “In niches there are riches.” We try to identify markets that are profitable and where we can be an industry leader. Key elements of our strategy include:

Capitalize on our relationships with brokers and dealers. We are committed to establishing, building, and maintaining our relationships with our brokers and dealers. Our marketing efforts are focused on building relationships with brokers in the medallion market and dealers in the consumer market. We believe that our relationships with brokers and dealers provide us with, in addition to potential investment opportunities, other significant benefits, including an additional layer of due diligence and additional monitoring capabilities. We have assembled a management team that has developed an extensive network of broker and dealer relationships in our target market over the last 50 years. We believe that our management team’s relationships with these brokers and dealers have and will continue to provide us with significant investment opportunities. During 2007, approximately 58% of our originated investment transactions were generated by brokers and dealers.

Employ disciplined underwriting policies and maintain rigorous portfolio monitoring. We have an extensive investment underwriting and monitoring process. We conduct a thorough analysis of each potential investment and its prospects, competitive position, financial performance, and industry dynamics. We stress the importance of credit and risk analysis in our underwriting process. We believe that our continued adherence to this disciplined process will permit us to continue to generate a stable, diversified and increasing revenue stream of current income from our debt investments to enable us to make distributions to our shareholders.

Leverage the skills of our experienced management team. Our management team is led by our Chief Executive Officer, Mr. Alvin Murstein, and our President, Mr. Andrew M. Murstein. Alvin Murstein has over 45 years of experience in the ownership, management, and financing of taxicab medallions and other commercial businesses, and Andrew M. Murstein is the third generation in his family to participate in the business. The other members of our management team have broad investment backgrounds, with

 

7


Table of Contents

prior experience at specialty finance companies, middle market commercial banks, and other financial services companies. We believe that the experience and contacts of our management team will continue to allow us to effectively implement the key aspects of our business strategy.

Perform Strategic Acquisitions. In addition to increasing market share in existing lending markets and identifying new niches, we seek to acquire medallion financing businesses and related portfolios and specialty finance companies that make secured loans to small businesses which have experienced historically low loan losses similar to our own. Since our initial public offering in May 1996, eight specialty finance companies, four loan portfolios, and three taxicab rooftop advertising companies have been acquired. Our most recent acquisition was the purchase of a taxicab medallion loan portfolio by Medallion Funding and Medallion Bank in January 2006 for $35,703,000.

Investment Activity

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

 

     Year ended December 31,  

(Dollars in thousands)

   2007     2006     2005  

Net investments at beginning of year

   $ 833,639     $ 722,748     $ 643,168  

Investments originated

     455,325       434,627       337,886  

Repayments of investments

     (342,102 )     (358,898 )     (225,513 )

Net increase in unrealized depreciation (1)

     (13,005 )     (1,671 )     (6,559 )

Net realized gains (losses) on investments (2)

     8,268       6,273       1,243  

Transfers to other assets/liabilities

     (5,392 )     (3,664 )     (7,012 )

Amortization of origination costs

     (1,778 )     (1,479 )     (1,936 )

Purchase of Banco Popular medallion loan portfolio

     —         35,703       —    

Cash received for sold Business Lenders SBA Section 7(a) loans

     —         —         (19,414 )

Realized gains on sales of loans

     —         —         885  
                        

Net increase in investments

     101,316       110,891       79,580  
                        

Net investments at end of year

   $ 934,955     $ 833,639     $ 722,748  
                        

 

(1)

Excludes net unrealized appreciation (depreciation) of $6,740, $921, and ($1,123) for the years ended December 31, 2007, 2006, and 2005, related to foreclosed properties, which are carried in other assets on the consolidated balance sheet.

(2)

Excludes net realized gains of $1,336, $4, and $0 for the years ended December 31, 2007, 2006, and 2005, related to foreclosed properties, which are carried in other assets on the consolidated balance sheet, and $700,000 for the year ended December 31, 2007 related to the retirement of trust preferred securities.

Investment Characteristics

Medallion Loans. Our medallion loan portfolio consists of mostly fixed-rate loans, collateralized by first security interests in taxicab medallions and related assets (vehicles, meters, and the like). The portfolio was originated at an approximate loan-to-value ratio range of 80-90%. We estimate that the average loan-to-value ratio of all of the medallion loans was approximately 54% as of December 31, 2007. In addition, we have recourse against a vast majority of the owners of the taxicab medallions and related assets through personal guarantees.

Medallion loans generally require equal monthly payments covering accrued interest and amortization of principal over a ten to fifteen year schedule, subject to a balloon payment of all outstanding principal after four or five years. More recently, we have begun to originate loans with one-to-three year maturities where interest rates are adjusted and a new maturity period set. Borrowers may prepay medallion loans upon payment of a fee of approximately 90 days’ interest.

We generally retain the medallion loans we originate; however, from time to time, we participate or sell shares of some loans or portfolios to interested third party financial institutions. In these cases, we retain the borrower relationships and service the sold loans.

Commercial Loans. We have originated commercial loans in principal amounts ranging from $50,000 to approximately $8,000,000. These loans are generally retained and typically have maturities ranging from one to ten years and require equal monthly payments covering accrued interest and amortization of principal over a four to five year term. Substantially all loans may be prepaid with a fee ranging from 30 to 120 days’ interest. The term of, and interest rate charged on, certain of our outstanding loans are subject to SBA regulations. Under SBA regulations, the maximum rate of interest permitted on loans originated by us is 19%. Unlike medallion loans, for which competition precludes us from charging the maximum rate of interest permitted under SBA regulations, we are able to charge the maximum rate on certain commercial loans. We believe that the increased yield on commercial loans compensates for their higher risk relative to medallion loans and further illustrates the benefits of diversification.

 

8


Table of Contents

Commercial loans are generally originated at an average loan-to-value ratio of 70 to 75%. Substantially all of the commercial loans are collateralized by security interests in the assets being financed by the borrower. In addition, we have recourse against the vast majority of the principals of borrowers who personally guarantee the loans. Although personal guarantees increase the commitment of borrowers to repay their loans, we cannot assure you that the assets available under personal guarantees would, if required, be sufficient to satisfy the obligations secured by such guarantees. In certain cases, equipment vendors may provide full and partial recourse guarantees on loans.

Consumer Loans. Consumer loans generally require equal monthly payments covering accrued interest and amortization of principal over a negotiated term, generally around ten years. Interest rates offered are both floating and fixed, and certain of the floating rate notes have built in caps or floors. Borrowers may prepay consumer loans without any prepayment penalty. In general, Medallion Bank has established relationships with dealers in the industry, who are the sources for most of the customers of Medallion Bank.

Marketing, Origination, and Loan Approval Process

We employ 23 loan originators to originate medallion, commercial, and consumer loans. Each loan application is individually reviewed through analysis of a number of factors, including loan-to-value ratios, a review of the borrower’s credit history, public records, personal interviews, trade references, personal inspection of the premises, and approval from the TLC, SBA, or other regulatory body, if applicable. Each medallion and commercial loan applicant is required to provide personal or corporate tax returns, premises leases, and/or property deeds. Senior management establishes loan origination criteria. Loans that conform to such criteria may be processed by a loan officer with the proper credit authority, and non-conforming loans must be approved by the chief executive officer and/or the chief credit officer. Both medallion and commercial loans are sourced from brokers with extensive networks of applicants, and commercial loans are also referred by contacts with banks, attorneys, and accounting firms. Consumer loans are primarily sourced through relationships which have been established with recreational vehicle and boat dealers throughout our market area.

Sources of Funds

We have historically funded our lending operations primarily through credit facilities with bank syndicates and, to a lesser degree, through equity or debt offerings or private placements, and fixed-rate, senior secured notes and long-term subordinated debentures issued to or guaranteed by the SBA. Since the inception of Medallion Bank, substantially all of Medallion Bank’s funding has been provided by FDIC insured brokered certificates of deposit. The determination of funding sources is established by our management, based upon an analysis of the respective financial and other costs and burdens associated with funding sources. Our funding strategy and interest rate risk management strategy is to have the proper structuring of debt to minimize both rate and maturity risk, while maximizing returns with the lowest cost of funding over an intermediate period of time.

 

9


Table of Contents

The table below summarizes our cash levels and borrowings as of December 31, 2007, and amounts outstanding under credit facilities and their respective end of period weighted average interest rates at December 31, 2007. See notes 4 and 5 to the consolidated financial statements for additional information about each credit facility.

 

Consolidated Sources of Funds (Dollars in thousands)

   Total  

Cash

   $ 33,454  

Bank loans

     38,000  

Amounts undisbursed

     24,000  

Amounts outstanding

     20,850  

Average interest rate

     6.81 %

Maturity

     6/08-6/10  

Preferred securities

     33,000  

Average interest rate

     7.68 %

Maturity

     9/37  

Lines of credit

   $ 625,000  

Amounts undisbursed

     213,551  

Amounts outstanding

     411,449  

Average interest rate

     5.58 %

Maturity

     9/08-12/09  

Margin loan

     —    

Average interest rate

     —    

Maturity

     N/A  

SBA debentures

   $ 96,750  

Amounts undisbursed

     19,500  

Amounts outstanding

     77,250  

Average interest rate

     6.05 %

Maturity

     9/11-3/16  
        

Total cash and amounts remaining undisbursed under credit facilities

   $ 290,505  
        

Total debt outstanding

   $ 542,549  
        

Medallion Bank Sources of Funds

  
        

Cash

   $ 17,025  

Deposits

   $ 299,083  

Average Interest Rate

     4.85 %

Maturity

     1/08-10/10  
        

Total cash and amounts remaining undisbursed under credit facilities, including Medallion Bank

   $ 307,530  
        

Total debt outstanding, including Medallion Bank

   $ 841,632  
        

We fund our fixed-rate loans with variable-rate credit lines and bank debt, and with fixed-rate SBA debentures. The mismatch between maturities and interest-rate sensitivities of these balance sheet items results in interest rate risk. We seek to manage our exposure to increases in market rates of interest to an acceptable level by:

 

   

Originating adjustable rate loans;

 

   

Incurring fixed-rate debt; and

 

   

Purchasing interest rate caps to hedge a portion of variable-rate debt against increases in interest rates.

Nevertheless, we accept varying degrees of interest rate risk depending on market conditions. For additional discussion of our funding sources and asset liability management strategy, see Asset/Liability Management on page 47.

Competition

Banks, credit unions, and finance companies, some of which are SBICs, compete with us in originating medallion, commercial, and consumer loans. In addition, finance subsidiaries of equipment manufacturers also compete with us in originating commercial loans. Many of these competitors have greater resources than we do and certain competitors are subject to less restrictive regulations than us. As a result, we cannot assure you that we will be able to identify and complete the financing transactions that will permit us to compete successfully.

 

10


Table of Contents

Employees

As of December 31, 2007 we employed 118 persons, including 28 at our Medallion Bank subsidiary. We believe that relations with all of our employees are good.

CERTAIN U.S. FEDERAL INCOME TAX CONSIDERATIONS

The following discussion is a general summary of the material US federal income tax considerations applicable to us and to an investment in shares of our common stock. This summary does not purport to be a complete description of the income tax considerations applicable to such an investment. For example, we have not described tax consequences that we assume to be generally known by investors or certain considerations that may be relevant to certain types of holders subject to special treatment under US federal income tax laws, including shareholders subject to the alternative minimum tax, tax-exempt organizations, insurance companies, dealers in securities, pension plans and trusts, and financial institutions. This summary assumes that investors hold our common stock as capital assets (within the meaning of the Code). The discussion is based upon the Code, Treasury regulations, and administrative and judicial interpretations, each as of the date of this annual report and all of which are subject to change, possibly retroactively, which could affect the continuing validity of this discussion. We have not sought and will not seek any ruling from the Internal Revenue Service, or the IRS, regarding an investment in our common stock. This summary does not discuss any aspects of US estate or gift tax; or foreign, state, or local tax. It does not discuss the special treatment under US federal income tax laws that could result if we invested in tax-exempt securities or certain other investment assets.

A “US shareholder” is a beneficial owner of shares of our common stock that is for US federal income tax purposes:

 

   

a citizen or individual resident of the United States;

 

   

a corporation, or other entity treated as a corporation for US federal income tax purposes, created or organized in or under the laws of the US or any state thereof or the District of Columbia; or

 

   

a trust or an estate, the income of which is subject to US federal income taxation regardless of its source.

A “non-US shareholder” is a beneficial owner of shares of our common stock that is not a US shareholder.

If a partnership (including an entity treated as a partnership for US federal income tax purposes) holds shares of our common stock, the tax treatment of a partner in the partnership will generally depend upon the status of the partner and the activities of the partnership. A prospective shareholder that is a partner of a partnership holding shares of our common stock should consult its tax advisors with respect to the purchase, ownership, and disposition of shares of our common stock.

Tax matters are very complicated and the tax consequences to an investor of an investment in our shares will depend on the facts of his, her, or its particular situation. We encourage investors to consult their own tax advisors regarding the specific consequences of such an investment, including tax reporting requirements, the applicability of federal, state, local, and foreign tax laws, eligibility for the benefits of any applicable tax treaty and the effect of any possible changes in the tax laws.

Election to be Taxed as a RIC

As a business development company, we have elected to be treated as a RIC under Subchapter M of the Code. As a RIC, we generally will not have to pay corporate-level federal income taxes on any ordinary income or capital gains that we distribute to our shareholders as dividends. To qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements (as described below). In addition, to obtain RIC tax treatment we must distribute to our shareholders, for each taxable year, at least 90% of our “investment company taxable income,” which is generally our ordinary income plus the excess of realized net short-term capital gains over realized net long-term capital losses, or the Annual Distribution Requirement.

Taxation as a RIC

If we:

 

   

qualify as a RIC; and

 

   

satisfy the Annual Distribution Requirement;

then we will not be subject to federal income tax on the portion of our investment company taxable income and net capital gain ( i.e. , net long-term capital gains in excess of net short-term capital losses) we distribute to shareholders. We will be subject to US federal income tax at the regular corporate rates on any income or capital gain not distributed (or deemed distributed) to our shareholders.

We will be subject to a 4% nondeductible federal excise tax on certain undistributed income of RICs unless we distribute in a timely manner an amount at least equal to the sum of (1) 98% of our ordinary income for each calendar year, (2) 98% of our capital gain net income for the one-year period ending October 31 in that calendar year, and (3) any income realized, but not distributed, in preceding years, or the Excise Tax Avoidance Requirement. We currently intend to make sufficient distributions each taxable year to satisfy the Excise Tax Avoidance Requirement.

 

11


Table of Contents

In order to qualify as a RIC for federal income tax purposes, we must, among other things:

 

   

qualify to be treated as a business development company under the 1940 Act at all times during each taxable year;

 

   

derive in each taxable year at least 90% of our gross income from dividends, interest, payments with respect to certain securities loans, gains from the sale of stock or other securities, or other income derived with respect to our business of investing in such stock or securities, and net income derived from interests in “qualified publicly traded partnerships” (i.e., partnerships that are traded on an established securities market or tradable on a secondary market, other than partnerships that derive 90% of their income from interest, dividends, capital gains, and other traditional permitted mutual fund income) or the 90% Income Test; and

 

   

diversify our holdings so that at the end of each quarter of the taxable year:

 

   

at least 50% of the value of our assets consists of cash, cash equivalents, US Government securities, securities of other RICs, and other securities if such other securities of any one issuer do not represent more than 5% of the value of our assets or more than 10% of the outstanding voting securities of the issuer; and

 

   

no more than 25% of the value of our assets is invested in the securities, other than US Government securities or securities of other RICs, of one issuer or of two or more issuers that are controlled, as determined under applicable tax rules, by us and that are engaged in the same or similar or related trades or businesses or in the securities of one or more qualified publicly traded partnerships, or the Diversification Tests.

We may be required to recognize taxable income in circumstances in which we do not receive cash. For example, if we hold debt obligations that are treated under applicable tax rules as having original issue discount (such as debt instruments with payment-in-kind interest or, in certain cases, increasing interest rates or issued with warrants), we must include in income each year a portion of the original issue discount that accrues over the life of the obligation, regardless of whether cash representing such income is received by us in the same taxable year. Because any original issue discount accrued will be included in our investment company taxable income for the year of accrual, we may be required to make a distribution to our shareholders in order to satisfy the Annual Distribution Requirement, even though we will not have received any corresponding cash amount.

Gain or loss realized by us from warrants acquired by us as well as any loss attributable to the lapse of such warrants generally will be treated as capital gain or loss. Such gain or loss generally will be long-term or short-term, depending on how long we held a particular warrant.

We are authorized to borrow funds and to sell assets in order to satisfy distribution requirements. However, under the 1940 Act, we are not permitted to make distributions to our shareholders while our debt obligations and other senior securities are outstanding unless certain “asset coverage” tests are met. See “Regulation—Senior Securities.” Moreover, our ability to dispose of assets to meet our distribution requirements may be limited by (1) the illiquid nature of our portfolio and/or (2) other requirements relating to our status as a RIC, including the diversification tests. If we dispose of assets in order to meet the Annual Distribution Requirement or the Excise Tax Avoidance Requirement, we may make such dispositions at times that, from an investment standpoint, are not advantageous.

If we fail to satisfy the Annual Distribution Requirement or otherwise fail to qualify as a RIC in any taxable year, we will be subject to tax in that year on all of our taxable income, regardless of whether we make any distributions to our shareholders. In that case, all of our income will be subject to corporate-level federal income tax, reducing the amount available to be distributed to our shareholders. In contrast, assuming we qualify as a RIC, our corporate-level federal income tax should be substantially reduced or eliminated. See “Election to be Taxed as a RIC” above.

The remainder of this discussion assumes that we qualify as a RIC and have satisfied the Annual Distribution Requirement.

Taxation of US Shareholders

Distributions by us generally are taxable to US shareholders as ordinary income or capital gains. Distributions of our “investment company taxable income” (which is, generally, our ordinary income plus realized net short-term capital gains in excess of realized net long-term capital losses) will be taxable as ordinary income to US shareholders to the extent of our current or accumulated earnings and profits, whether paid in cash or reinvested in additional common stock. To the extent such distributions paid by us to non-corporate shareholders (including individuals) are attributable to dividends from US corporations and certain qualified foreign corporations, such distributions generally will be eligible for a maximum tax rate of 15% for taxable years beginning before January 1, 2011. In this regard, it is anticipated that distributions paid by us will generally not be attributable to dividends and, therefore, generally will not qualify for the 15% maximum rate. Distributions of our net capital gains (which is generally our realized net long-term

 

12


Table of Contents

capital gains in excess of realized net short-term capital losses) properly designated by us as “capital gain dividends” will be taxable to a US shareholder as long-term capital gains (currently at a maximum rate of 15% in the case of individuals, trusts, or estates), regardless of the US shareholder’s holding period for his, her, or its common stock, and regardless of whether paid in cash or reinvested in additional common stock. Distributions in excess of our earnings and profits first will reduce a US shareholder’s adjusted tax basis in such shareholder’s common stock and, after the adjusted basis is reduced to zero, will constitute capital gains to such US shareholder.

Although we currently intend to distribute any long-term capital gains at least annually, we may in the future decide to retain some or all of our long-term capital gains, but designate the retained amount as a “deemed distribution.” In that case, among other consequences, we will pay tax on the retained amount, each US shareholder will be required to include his, her, or its share of the deemed distribution in income as if it had been actually distributed to the US shareholder, and the US shareholder will be entitled to claim a credit equal to his, her, or its allocable share of the tax paid thereon by us. The amount of the deemed distribution net of such tax will be added to the US shareholder’s tax basis for his, her, or its common stock. Since we expect to pay tax on any retained capital gains at our regular corporate tax rate, and since that rate is in excess of the maximum rate currently payable by individuals on long-term capital gains, the amount of tax that individual shareholders will be treated as having paid and for which they will receive a credit will exceed the tax they owe on the retained net capital gain. Such excess generally may be claimed as a credit against the US shareholder’s other federal income tax obligations or may be refunded to the extent it exceeds a shareholder’s liability for federal income tax. A shareholder that is not subject to federal income tax or otherwise required to file a federal income tax return would be required to file a federal income tax return on the appropriate form in order to claim a refund for the taxes we paid. In order to utilize the deemed distribution approach, we must provide written notice to our shareholders prior to the expiration of 60 days after the close of the relevant taxable year. We cannot treat any of our investment company taxable income as a “deemed distribution.”

For purposes of determining (1) whether the Annual Distribution Requirement is satisfied for any year and (2) the amount of capital gain dividends paid for that year, we may, under certain circumstances, elect to treat a dividend that is paid during the following taxable year as if it had been paid during the taxable year in question. If we make such an election, the US shareholder will still be treated as receiving the dividend in the taxable year in which the distribution is made. However, any dividend declared by us in October, November, or December of any calendar year, payable to shareholders of record on a specified date in such a month and actually paid during January of the following year, will be treated as if it had been received by our US shareholders on December 31 of the year in which the dividend was declared.

If an investor purchases shares of our common stock shortly before the record date of a distribution, the price of the shares will include the value of the distribution and the investor will be subject to tax on the distribution even though it represents a return of his, her, or its investment.

A shareholder generally will recognize taxable gain or loss if the shareholder sells or otherwise disposes of his, her, or its shares of our common stock. Any gain arising from such sale or disposition generally will be treated as capital gain or loss if the shareholder has held his, her or its shares for more than one year. Otherwise, it would be classified as short-term capital gain or loss. However, any capital loss arising from the sale or disposition of shares of our common stock held for six months or less will be treated as long-term capital loss to the extent of the amount of capital gain dividends received, or undistributed capital gain deemed received, with respect to such shares. In addition, all or a portion of any loss recognized upon a disposition of shares of our common stock may be disallowed if other shares of our common stock are purchased (whether through reinvestment of distributions or otherwise) within 30 days before or after the disposition.

In general, individual and other non-corporate US shareholders currently are subject to a maximum federal income tax rate of 15% on their net capital gain, i.e., the excess of realized net long-term capital gain over realized net short-term capital loss for a taxable year, including a long-term capital gain derived from an investment in our shares. Such rate is lower than the maximum rate on ordinary income currently payable by individuals. Corporate US shareholders currently are subject to federal income tax on net capital gain at the maximum 35% rate also applied to ordinary income. Non-corporate shareholders with net capital losses for a year (i.e., capital losses in excess of capital gains) generally may deduct up to $3,000 of such losses against their ordinary income each year; any net capital losses of a non-corporate shareholder in excess of $3,000 generally may be carried forward and used in subsequent years as provided in the Code. Corporate shareholders generally may not deduct any net capital losses against ordinary income for a year, but may carryback such losses for three years or carry forward such losses for five years.

We will send to each of our US shareholders, as promptly as possible after the end of each calendar year, a notice detailing, on a per share basis, the amounts includible in such US shareholder’s taxable income for such year as ordinary income and as long-term capital gain. In addition, the federal tax status of each year’s distributions generally will be reported to the IRS (including the amount of dividends, if any, eligible for the 15% maximum rate). Distributions may also be subject to additional state, local, and foreign taxes depending on a US shareholder’s particular situation. Dividends distributed by us generally will not be eligible for the dividends-received deduction or the 15% maximum rate applicable to qualifying dividends.

 

13


Table of Contents

We may be required to withhold federal income tax (“backup withholding”) currently at a rate of 28% from all taxable distributions to any non-corporate US shareholder (1) who fails to furnish us with a correct taxpayer identification number or a certificate that such shareholder is exempt from backup withholding, or (2) with respect to whom the IRS notifies us that such shareholder has failed to properly report certain interest and dividend income to the IRS and to respond to notices to that effect. An individual’s taxpayer identification number is his or her social security number. Any amount withheld under backup withholding is allowed as a credit against the US shareholder’s federal income tax liability and may entitle such shareholder to a refund, provided that proper information is timely provided to the IRS.

Taxation of Non-US Shareholders

Whether an investment in our common stock is appropriate for a non-US shareholder will depend upon that person’s particular circumstances. An investment in our common stock by a non-US shareholder may have adverse tax consequences. Non-US shareholders should consult their tax advisers before investing in our common stock.

Dividends paid by us to non-US shareholders are generally subject to withholding at a 30% rate or a reduced rate specified by an applicable income tax treaty to the extent derived from investment income and short-term capital gains. In order to obtain a reduced rate of withholding, a non-US shareholder will be required to provide an IRS Form W-8BEN certifying its entitlement to benefits under a treaty. The withholding tax does not apply to regular dividends paid to a non-US shareholder who provides a Form W-8ECI, certifying that the dividends are effectively connected with the non-US shareholder’s conduct of a trade or business within the United States. Instead, the effectively connected dividends will be subject to regular US income tax as if the non-US shareholder were a US shareholder. A non-US corporation receiving effectively connected dividends may also be subject to additional “branch profits tax” imposed at a rate of 30% (or lower treaty rate). A non-US shareholder who fails to provide an IRS Form W-8BEN or other applicable form may be subject to backup withholding at the appropriate rate.

In general, US federal withholding tax will not apply to any gain or income realized by a non-US shareholder in respect of any distributions of net long-term capital gains over net short-term capital losses, exempt-interest dividends, or upon the sale or other disposition of shares of our common stock.

For taxable years beginning before January 1, 2008, properly-designated dividends are generally exempt from US federal withholding tax where they (i) are paid in respect of our “qualified net interest income” (generally, our US source interest income, other than certain contingent interest and interest from obligations of a corporation or partnership in which we are at least a 10% shareholder, reduced by expenses that are allocable to such income) or (ii) are paid in respect of our “qualified short-term capital gains” (generally, the excess of our net short-term capital gain over our long-term capital loss for such taxable year). However, depending on our circumstances, we may designate all, some or none of its potentially eligible dividends as such qualified net interest income or as qualified short-term capital gains, and/or treat such dividends, in whole or in part, as ineligible for this exemption from withholding. In order to qualify for this exemption from withholding, a non-US shareholder will need to comply with applicable certification requirements relating to its non-US status (including, in general, furnishing an IRS Form W-8BEN or substitute Form). In the case of shares held through an intermediary, the intermediary may withhold even if we designate the payment as qualified net interest income or qualified short-term capital gain. Non-US shareholders should contact their intermediaries with respect to the application of these rules to their accounts.

Non-US persons should consult their own tax advisors with respect to the US federal income tax and withholding tax, and state, local, and foreign tax consequences of an investment in the shares.

Failure to Qualify as a RIC

If we were unable to qualify for treatment as a RIC, we would be subject to tax on all of our taxable income at regular corporate rates. We would not be able to deduct distributions to shareholders, nor would they be required to be made. Distributions would generally be taxable to our shareholders as ordinary dividend income eligible for the 15% maximum rate for taxable years beginning before 2011 to the extent of our current and accumulated earnings and profits. Subject to certain limitations under the Code, corporate distributees would be eligible for the dividends received deduction. Distributions in excess of our current and accumulated earnings and profits would be treated first as a return of capital to the extent of the shareholder’s tax basis, and any remaining distributions would be treated as a capital gain.

GOVERNMENT REGULATION

Regulation under the 1940 Act

We have elected to be treated as a business development company under the 1940 Act. The 1940 Act contains prohibitions and restrictions relating to transactions between business development companies and their affiliates (including any investment advisers or

 

14


Table of Contents

sub-advisers), principal underwriters and affiliates of those affiliates or underwriters, and requires that a majority of the directors be persons other than “interested persons,” as that term is defined in the 1940 Act. In addition, the 1940 Act provides that we may not change the nature of our business so as to cease to be, or to withdraw our election as, a business development company unless approved by a majority of our outstanding voting securities voting as a class.

Qualifying Assets

Under the 1940 Act, a business development company may not acquire any asset other than assets of the type listed in Section 55(a) of the 1940 Act, which are referred to as qualifying assets, unless, at the time the acquisition is made, qualifying assets represent at least 70% of the company’s total assets. The principal categories of qualifying assets relevant to our business are the following:

(1) Securities purchased in transactions not involving any public offering from the issuer of such securities, which issuer (subject to certain limited exceptions) is an eligible portfolio company, or from any person who is, or has been during the preceding 13 months, an affiliated person of an eligible portfolio company, or from any other person, subject to such rules as may be prescribed by the SEC. An eligible portfolio company is defined in the 1940 Act as any issuer which:

(a) is organized under the laws of, and has its principal place of business in, the US;

(b) is not an investment company (other than a small business investment company wholly owned by the business development company) or a company that would be an investment company but for certain exclusions under the 1940 Act; and

(c) satisfies any of the following:

 

   

does not have any class of securities listed on a national securities exchange;

 

   

is controlled by a business development company or a group of companies including a business development company and the business development company has an affiliated person who is a director of the eligible portfolio company; or

 

   

is a small and solvent company having total assets of not more than $4 million and capital and surplus of not less than $2 million.

(2) Securities of any eligible portfolio company which we control.

(3) Securities purchased in transactions not involving any public offering from a US issuer that is not an investment company or from an affiliated person of the issuer, or in transactions incident thereto, if the issuer is in bankruptcy and subject to reorganization or if the issuer, immediately prior to the purchase of its securities was unable to meet its obligations as they came due without material assistance other than conventional lending or financing arrangements.

(4) Securities of an eligible portfolio company purchased from any person in a private transaction if there is no ready market for such securities and we already own at least 60% of the outstanding equity of the eligible portfolio company.

(5) Securities received in exchange for or distributed on or with respect to securities described in (1) through (4) above, or pursuant to the exercise of warrants or rights relating to such securities.

(6) Cash, cash equivalents, US Government securities or high-quality debt securities maturing in one year or less from the time of investment.

(7) Securities issued by a company that met the definition of eligible portfolio company at the time of our initial investment but subsequently does not meet the definition because the company no longer meets the definition set forth above.

Managerial Assistance to Portfolio Companies

In addition, a business development company must have been organized and have its principal place of business in the US and must be operated for the purpose of making investments in the types of securities described in (1), (2), or (3) above. However, in order to count portfolio securities as qualifying assets for the purpose of the 70% test, the business development company must either control the issuer of the securities or must offer to make available to the issuer of the securities (other than small and solvent companies described above) significant managerial assistance; except that, where the business development company purchases such securities in conjunction with one or more other persons acting together, one of the other persons in the group may make available such managerial assistance. Making available managerial assistance means, among other things, any arrangement whereby the business development company, through its directors, officers, or employees, offers to provide, and, if accepted, does so provide, significant guidance and counsel concerning the management, operations, or business objectives and policies of a portfolio company.

Temporary Investments

Pending investment in other types of “qualifying assets,” as described above, our investments may consist of cash equivalents, US government securities, or high-quality debt securities maturing in one year or less from the time of investment, which we refer to, collectively, as temporary investments, so that 70% of our assets are qualifying assets. Typically, we will invest in US Treasury bills

 

15


Table of Contents

or in repurchase agreements, provided that such agreements are fully collateralized by cash or securities issued by the US government or its agencies. A repurchase agreement involves the purchase by an investor, such as us, of a specified security and the simultaneous agreement by the seller to repurchase it at an agreed-upon future date and at a price which is greater than the purchase price by an amount that reflects an agreed-upon interest rate. There is no percentage restriction on the proportion of our assets that may be invested in such repurchase agreements.

Senior Securities

We are permitted, under specified conditions, to issue multiple classes of indebtedness and one class of stock senior to our common stock if our asset coverage, as defined in the 1940 Act, is at least equal to 200% immediately after each such issuance. In addition, while any senior securities remain outstanding, we must make provisions to prohibit any distribution to our shareholders or the repurchase of such securities or shares unless we meet the applicable asset coverage ratios at the time of the distribution or repurchase. We may also borrow amounts up to 5% of the value of our total assets for temporary or emergency purposes without regard to full asset coverage requirements. In addition to the 1940 Act, we are subject to two exemptive orders which govern how we calculate our senior securities. For a discussion of the risks associated with leverage, see “Risk Factors—Risks Relating to Our Business and Structure—Regulations governing our operation as a business development company will affect our ability to, and the way in which we raise additional capital.”

Regulation by the SBA

Medallion Funding, Medallion Capital, and Freshstart each operate as Small Business Investment Companies, or SBIC’s. The SBIA authorizes the organization of SBIC’s as vehicles for providing equity capital, long term financing, and management assistance to small business concerns. The SBIA and the SBA regulations define a “small business concern” as a business that is independently owned and operated, which does not dominate its field of operation, and which (i) has a net worth, together with any affiliates, of $18.0 million or less and average annual net income after US federal income taxes for the preceding two years of $6.0 million or less (average annual net income is computed without the benefit of any carryover loss), or (ii) satisfies alternative criteria under SBA regulations that focus on the industry in which the business is engaged and the number of persons employed by the business or its gross revenues. In addition, at the end of each year, at least 20% of the total amount of loans made after April 25, 1994 must be made in “smaller businesses” which have a net worth of $6.0 million or less, and average net income after federal income taxes for the preceding two years of $2.0 million or less. SBA regulations also prohibit an SBIC from providing funds to a small business concern for certain purposes, such as relending and reinvestment.

Medallion Funding is authorized to make loans to borrowers other than disadvantaged businesses (that is, businesses that are at least 50% owned, and controlled, and managed, on a day to day basis, by a person or persons whose participation in the free enterprise system is hampered because of social or economic disadvantage) if, at the time of the loan, Medallion Funding has in its portfolio outstanding loans to disadvantaged businesses with an aggregate cost basis equal to or exceeding the value of the unamortized repurchase discount under the preferred stock repurchase agreement between Medallion Funding and the SBA, which is currently zero.

Under current SBA Regulations, the maximum rate of interest that Medallion Funding may charge may not exceed the higher of (i) 19% or (ii) the sum of (a) the higher of (i) that company’s weighted average cost of qualified borrowings, as determined under SBA Regulations, or (ii) the current SBA debenture rate, plus (b) 11%, rounded to the next lower eighth of one percent. As of December 31, 2007, the maximum rate of interest permitted on loans originated by the Medallion Funding, Medallion Capital, and Freshstart was 19%. As of December 31, 2007, our outstanding medallion loans had a weighted average rate of interest 7.13% and our outstanding commercial loans had a weighted average rate of interest of 12.12%. Current SBA regulations also require that each loan originated by an SBIC have a term of between one and 20 years; loans to disadvantaged businesses also may be for a minimum term of one year.

The SBA restricts the ability of SBICs to repurchase their capital stock, to retire their SBA debentures, and to lend money to their officers, directors, and employees, or invest in affiliates thereof. The SBA also prohibits, without prior SBA approval, a “change of control” or transfers which would result in any person (or group of persons acting in concert) owning 10% or more of any class of capital stock of an SBIC. A “change of control” is any event which would result in the transfer of the power, direct or indirect, to direct the management and policies of an SBIC, whether through ownership, contractual arrangements, or otherwise.

Under SBA Regulations, without prior SBA approval, loans by licensees with outstanding SBA leverage to any single small business concern may not exceed 20% of an SBIC’s regulatory capital, as defined. Under the terms of the respective conversion agreements with the SBA, however, Medallion Funding is authorized to make loans to disadvantaged borrowers in amounts not exceeding 30% of its respective regulatory capital.

SBICs must invest idle funds that are not being used to make loans in investments permitted under SBA regulations. These permitted investments include direct obligations of, or obligations guaranteed as to principal and interest by, the government of the US with a term of 15 months or less and deposits maturing in one year or less issued by an institution insured by the FDIC. These

 

16


Table of Contents

permitted investments must be maintained in (i) direct obligations of, or obligations guaranteed as to principal and interest by, the US, which mature within 15 months from the date of the investment; (ii) repurchase agreements with federally insured institutions with a maturity of seven days or less if the securities underlying the repurchase agreements are direct obligations of, or obligations guaranteed as to principal and interest by the US, and such securities must be maintained in a custodial account in a federally insured institution; (iii) certificates of deposit with a maturity of one year or less, issued by a federally insured institution; (iv) a deposit account in a federally insured institution, subject to withdrawal restriction of one year or less; (v) a checking account in a federally insured institution; or (vi) a reasonable petty cash fund.

SBICs may purchase voting securities of small business concerns in accordance with SBA regulations. Although prior regulations prohibited an SBIC from controlling a small business concern except in limited circumstances, new regulations adopted by the SBA on October 22, 2002 (pursuant to Public Law 106-554) now allow an SBIC to exercise control over a small business for a period of seven years from the date on which the SBIC initially acquires its control position. This control period may be extended for an additional period of time with the SBA’s prior written approval.

Regulation of Medallion Bank as an Industrial Bank

In May 2002, we formed Medallion Bank, which received approval from the FDIC for federal deposit insurance in October 2003. Medallion Bank, a Utah-chartered industrial bank, is a depository institution subject to regulatory oversight and examination by both the FDIC and the Utah Department of Financial Institutions. Under its banking charter, Medallion Bank is empowered to make consumer and commercial loans, and may accept all FDIC-insured deposits other than demand deposits (checking accounts). The creation of Medallion Bank allows us to apply stable and low-cost bank deposit funding for key lending business activities throughout our business.

Medallion Bank is subject to certain federal laws that restrict and control its ability to extend credit and provide or receive services between affiliates. In addition, the FDIC has regulatory authority to prohibit Medallion Bank from engaging in any unsafe or unsound practice in conducting its business.

Medallion Bank is further subject to capital adequacy guidelines issued by the Federal Financial Institutions Examination Council, or the FFIEC. These guidelines make regulatory capital requirements more sensitive to differences in risk profiles among banking organizations and consider off-balance sheet exposures in determining capital adequacy. Under the rules and regulations of the FFIEC, at least half of a bank’s total capital is required to be Tier I capital, comprised of common equity, retained earnings and a limited amount of non-cumulative perpetual preferred stock. The remaining capital, Tier II capital, may consist of other preferred stock, certain hybrid debt/equity instruments, a limited amount of term-subordinated debt, or a limited amount of the reserve for possible credit losses. The FFIEC has also adopted minimum leverage ratios for banks, which are calculated by dividing Tier I capital by total average assets. Recognizing that the risk-based capital standards address only credit risk, and not interest rate, liquidity, operational, or other risks, many banks are expected to maintain capital in excess of the minimum standards.

In addition, pursuant to provisions of the FDIC Improvement Act of 1991, or FDICIA, and related regulations with respect to prompt corrective action, FDIC-insured institutions such as Medallion Bank may only accept brokered deposits without FDIC permission if they meet specified capital standards, and are subject to restrictions with respect to the interest they may pay on deposits unless they are well-capitalized. To be well-capitalized under the prompt corrective action provisions, a bank must have a ratio of combined Tier I and Tier II capital to risk-weighted assets of not less than 10%, Tier I capital to risk-weighted assets of not less than 6%, and a Tier I to average assets of not less than 5%.

We, the FDIC, and Medallion Bank have agreed that the capital levels of Medallion Bank will at all times meet or exceed the levels required for Medallion Bank to be considered well-capitalized under the FDIC rules and regulations, that Medallion Bank’s Tier I capital to total assets ratio will be maintained at not less than 15%, and that Medallion Bank will maintain an adequate allowance for loan and lease losses.

Sections 23A and 23B of the Federal Reserve Act and applicable regulations also impose restrictions on Medallion Bank. These restrictions limit the transfer of funds by a depository institution to certain of its affiliates, including us, in the form of loans, extensions of credit, investments, or purchases of assets. Sections 23A and 23B also require generally that the depository institution’s transactions with its affiliates be on terms no less favorable to Medallion Bank than comparable transactions with unrelated third parties.

The USA Patriot Act and the International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001, or the Patriot Act, was enacted on October 26, 2001, and is intended to detect and prosecute terrorism and international money laundering. The Patriot Act establishes new standards for verifying customer identification incidental to the opening of new accounts. Medallion Bank has undertaken appropriate measures to comply with the Patriot Act and associated regulations. Other provisions of the Patriot Act provide for special information sharing procedures governing communications with the government and other financial institutions with respect to suspected terrorists and money laundering activity, and enhancements to suspicious activity reporting, including electronic filing of suspicious activity reports over a secure filing network.

 

17


Table of Contents

Other

We may also be prohibited under the 1940 Act from knowingly participating in certain transactions with our affiliates without the prior approval of our board of directors who are not interested persons and, in some cases, prior approval by the SEC.

We will be periodically examined by the SEC for compliance with the 1940 Act.

We are required to provide and maintain a bond issued by a reputable fidelity insurance company to protect us against larceny and embezzlement. Furthermore, as a business development company, we are prohibited from protecting any director or officer against any liability to us or our shareholders arising from willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of such person’s office.

We have adopted and implemented written policies and procedures reasonably designed to prevent violation of the federal securities laws, and intend to review these policies and procedures annually for their adequacy and the effectiveness of their implementation. We have designated a chief compliance officer to be responsible for administering our policies and procedures.

Compliance with the Sarbanes-Oxley Act of 2002 and NASDAQ Corporate Governance Regulations

The Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, imposes a wide variety of regulatory requirements on publicly-held companies and their insiders. Many of these requirements affect us. The Sarbanes-Oxley Act has required us to review our policies and procedures to determine whether we comply with the Sarbanes-Oxley Act and the new regulations promulgated thereunder. We will continue to monitor our compliance with all future regulations that are adopted under the Sarbanes-Oxley Act and will take actions necessary to ensure that we are in compliance therewith.

In addition, NASDAQ has adopted or is in the process of adopting corporate governance changes to its listing standards. We believe we are in compliance with such corporate governance listing standards. We will continue to monitor our compliance with all future listing standards and will take actions necessary to ensure that we are in compliance therewith.

AVAILABLE INFORMATION

Our corporate website is located at www.medallion.com. We make copies of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendment to those reports filed with or furnished to the SEC available to investors on or through our website free of charge as soon as reasonably practicable after we electronically file them with or furnish them to the SEC. Our SEC filings can be found in the For Investors section of our website, the address of which is http://www.medallion.com/investors.htm. Our Code of Ethical Conduct and Insider Trading Policy can be located in the Corporate Governance section of our website at http://www.medallion.com/investors_governance.htm. These documents, as well as our SEC filings are available in print to any stockholder who requests a copy from our Secretary.

 

ITEM 1A. RISK FACTORS

Risks Relating to Our Business and Structure

Based on discussions with the SEC, we have determined that we should no longer consolidate Medallion Bank’s accounts with those of our own.

Since the inception of Medallion Bank, we have historically consolidated the financial position and results of operations of Medallion Bank with those of our own. We did so in reliance upon a letter from the staff of the SEC permitting such consolidation. During August 2006, we filed the initial registration statement related to an offering of common stock which the SEC staff reviewed and on which they provided comments, including the appropriateness of consolidating the accounts of Medallion Bank which have evolved since 2004. Based on several discussions with the SEC; our management, Audit Committee, and Board of Directors have determined, and our auditors have concurred, that we should no longer consolidate Medallion Bank in reliance upon the SEC letter, and have determined, and our auditors have concurred, that this change represents a change in the reporting entity as described in SFAS No. 154, “Accounting Changes and Error Corrections.” Accordingly we adopted the retrospective treatment provided for in that statement, including for any interim periods presented, included in our 2006 Form 10-K. Based on the available facts, and after due investigation, we believe we relied upon the no-action letter in good faith and with a reasonable basis for such reliance and we have articulated these facts to the SEC. After reviewing our response, the SEC has indicated it has no further comments regarding the consolidation of Medallion Bank, but they have not formally concurred with our conclusion. We cannot assure you that the SEC or any other regulatory agency may not come to a different conclusion than ours. Such a different conclusion could result in our having to restate our financial statements.

 

18


Table of Contents

We had a material weakness in internal control over financial reporting.

Management identified a material weakness in our internal control over financial reporting for the year ended December 31, 2006 relating to the documentation and oversight of the monitoring of certain of the loans and/or investments included in the portfolio of one of our subsidiaries, Medallion Capital, which was remediated during 2007, see “Item 9A. Controls and Procedures”. Although we believe that the consolidated financial statements included in this Annual Report present fairly, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with GAAP, we cannot assure you that material weaknesses in our internal control over financial reporting will not be identified in the future that could cause us to fail to meet our periodic reporting obligations or result in material misstatements in our financial statements. Any such failure could also adversely affect the results of periodic management evaluations and annual auditor reports regarding the effectiveness of our internal control over financial reporting required under Section 404 of the Sarbanes-Oxley Act of 2002 and the rules promulgated under Section 404.

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

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

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

The 1940 Act imposes numerous constraints on the operations of business development companies. For example, business development companies are required to invest at least 70% of their total assets in qualifying assets, primarily in securities of “eligible portfolio companies” (as defined under the 1940 Act), cash, cash equivalents, US government securities, and other high quality debt investments that mature in one year or less. Our regulatory requirements may hinder our ability to take advantage of attractive investment opportunities and, as a result, achieve our investment objective. In addition, we rely upon several exemptive orders from the SEC permitting us to consolidate our financial reporting and operate our business as presently conducted. Our failure to satisfy the conditions set forth in those exemptive orders could result in our inability to rely upon such orders or to cause the SEC to revoke the orders which could result in material changes in our financial reporting or the way in which we conduct our business. Furthermore, any failure to comply with the requirements imposed on business development companies by the 1940 Act could cause the SEC to bring an enforcement action against us. At December 31, 2007, approximately 24% of our total assets were non-qualifying assets. If we do not remain a business development company, we might be regulated as a closed-end investment company under the 1940 Act, which would further decrease our operating flexibility.

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

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

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

 

   

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

 

19


Table of Contents
   

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

 

   

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

 

   

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

 

   

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

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

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

As a business development company, we are not permitted to acquire any assets other than “qualifying assets” unless, at the time of such acquisition, at least 70% of our total assets are qualifying assets.

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

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

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

 

   

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

 

   

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

 

   

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

 

20


Table of Contents

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

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

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

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

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

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

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

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

To qualify as a RIC, not more than 25% of the value of our total assets may be invested in the securities, other than US government securities or securities of other RICs, of any one issuer. As of December 31, 2007, our largest investment subject to this test was our investment in Medallion Bank, representing 23% of our RIC assets. No other investments were more than 5% of our RIC assets. We will continue to monitor the levels of this and any other investment concentrations in conjunction with the diversification tests.

We operate in a highly competitive market for investment opportunities.

We compete for investments with other business development companies and other investment funds as well as traditional financial services companies such as commercial banks and credit unions. Many of our competitors are substantially larger and have considerably greater financial, technical, and marketing resources than we do. For example, some competitors may have a lower cost of funds and access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments. These characteristics could allow our competitors to consider a wider variety of investments, establish more relationships, and offer better pricing and more flexible structuring than us. We may lose investment opportunities if

 

21


Table of Contents

we do not match our competitors’ pricing, terms, and structure. If we are forced to match our competitors’ pricing, terms, and structure, we may not be able to achieve acceptable returns on our investments or may bear substantial risk of capital loss. Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a business development company.

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

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

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

As of December 31, 2007, we had approximately $542,549,000 of outstanding indebtedness, which had a weighted average borrowing cost of 5.83% at December 31, 2007, and our wholly-owned unconsolidated portfolio companies, primarily Medallion Bank, had $299,083,000 of outstanding indebtedness at a weighted average borrowing cost of 4.85%.

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

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

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

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

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

Medallion Bank relies on the established brokered deposit market to originate deposits to fund its operations. While Medallion Bank has developed contractual relationships with a diversified group of investment brokers, and the brokered deposit market is well developed and utilized by many banking institutions, conditions could change that might affect the availability of deposits. If the capital levels at Medallion Bank fall below the “well-capitalized” level, or if Medallion Bank experiences a period of sustained operating losses, the cost of attracting deposits from the brokered deposit market could increase significantly, and the ability

 

22


Table of Contents

of Medallion Bank to raise deposits from this source could be impaired. Medallion Bank’s ability to manage its growth to stay within the “well-capitalized” level, and the capital level currently required by the FDIC, which is also considerably higher than the level required to be classified as “well-capitalized”, is critical to Medallion Bank’s retaining open access to this funding source.

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

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

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

Under the 1940 Act, we are required to carry our portfolio investments at market value or, if there is no readily available market value, at fair value as determined by our management and approved by our Board of Directors. Unlike other lending institutions, we are not permitted to maintain a general reserve for anticipated losses. Instead, we are required by the 1940 Act to specifically value each individual investment and record an unrealized gain or loss for any asset we believe has increased or decreased in value. Typically, there is not a public market for most of the investments in which we have invested and will generally continue to invest. As a result, we value our investments on a quarterly basis based on a determination of their fair value made in good faith and in accordance with the written guidelines approved by our Board of Directors. The types of factors that may be considered in determining the fair value pricing of our investments include the nature and realizable value of any collateral, the portfolio company’s earnings and its ability to make payments on its indebtedness, the markets in which the portfolio company does business, comparison to publicly traded companies, discounted cash flow, and other relevant factors. Because such valuations, and particularly valuations of private securities and private companies, are inherently uncertain, the valuations may fluctuate over short periods of time and may be based on estimates. As a result, our determinations of fair value may differ materially from the values that would have been used if a ready market for these investments existed. Our net asset value could be adversely affected if our determinations regarding the fair value of our investments were materially higher than the values that we ultimately realize upon the disposal of such securities. Considering these factors, we have determined that the fair value of our portfolio is below its cost basis. As of December 31, 2007, our net unrealized depreciation on investments other than in controlled subsidiaries and foreclosed properties was approximately $3,727,000 or 0.57% of our investment portfolio.

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

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

In addition, the illiquidity of our loan portfolio and investments may adversely affect our ability to dispose of loans at times when it may be advantageous for us to liquidate such portfolio or investments. In addition, if we were required to liquidate some or all of the investments in the portfolio, the proceeds of such liquidation may be significantly less than the current value of such investments. Because we borrow money to make loans and investments, our net operating income is dependent upon the difference between the rate at which we borrow funds and the rate at which we invest these funds. As a result, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our interest income. In periods of sharply rising interest rates, our cost of funds would increase, which would reduce our net operating income before net realized and unrealized gains. We use a combination of long-term and short-term borrowings and equity capital to finance our investing activities. Our long-term

 

23


Table of Contents

fixed-rate investments are financed primarily with short-term floating-rate debt, and to a lesser extent by term fixed-rate debt. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. Such techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act. We have analyzed the potential impact of changes in interest rates on net interest income. Assuming that the balance sheet were to remain constant and no actions were taken to alter the existing interest rate sensitivity, and including the impact on Medallion Bank, a hypothetical immediate 1% increase in interest rates would have positively impacted net increase in net assets resulting from operations as of December 31, 2007 by approximately $374,000 on an annualized basis, compared to a positive impact of $399,000 at December 31, 2006, and the impact of such an immediate increase of 1% over a one year period would have been ($2,895,000) at December 31, 2007 compared to ($2,334,000) at December 31, 2006. Although management believes that this measure is indicative of our sensitivity to interest rate changes, it does not adjust for potential changes in credit quality, size and composition of the assets on the balance sheet, and other business developments that could affect net increase in net assets resulting from operations in a particular quarter or for the year taken as a whole. Accordingly, no assurances can be given that actual results would not differ materially from the potential outcome simulated by these estimates.

We may experience fluctuations in our quarterly results.

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

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

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

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

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

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

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

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

 

24


Table of Contents

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

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

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

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

Risks Relating to Our Investments

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

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

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

Our portfolio is and may continue to be concentrated in a limited number of portfolio companies and industries. As of December 31, 2007, investments in New York City taxi medallion loans represented approximately 83% of our managed taxi medallion loans. Beyond the asset diversification requirements associated with our qualification as a RIC, we do not have fixed guidelines for diversification, and while we are not targeting any specific industries, our investments are, and could continue to be, concentrated in relatively few industries. As a result, the aggregate returns we realize may be adversely affected if a small number of investments perform poorly or if we need to write down the value of any one investment. Additionally, a downturn in any particular industry in which we are invested could also negatively impact the aggregate returns we realize.

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

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

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

 

25


Table of Contents

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

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

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

A significant portion of our loan revenue is derived from loans collateralized by New York City taxicab medallions. According to New York City TLC data, over the past 20 years New York City taxicab medallions have appreciated in value from under $100,000 to $600,000 for corporate medallions and over $426,000 for individual medallions. However, for sustained periods during that time, taxicab medallions have declined in value. Since December 31, 2006, the value of New York City taxicab medallions increased by approximately 4% for individual medallions and 14% for corporate medallions.

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

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

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

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

We may not control many of our portfolio companies.

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

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

The 2004 acquisition of Medallion Bank’s consumer loan portfolio, and the subsequent commencement of lending operations in this line of business, represents an entry into the relatively new market of consumer lending for Medallion Bank. Although the purchased portfolio was seasoned, and Medallion Bank’s management has considerable experience in originating and managing consumer loans, we cannot assure you that these loans will perform at their historical levels as expected under Medallion Bank’s management.

 

26


Table of Contents

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

We may not realize gains from our equity investments.

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

Our investment in a special purpose acquisition company, or SPAC, may be subject to forfeit.

We have an investment in a SPAC, Sports Properties Acquisition Corp., that consummated its initial public offering in January 2008. The SPAC has 24 months from the date of its prospectus to complete a business combination. If the SPAC fails to consummate a business combination within the required time frame, its corporate existence will cease except for the purposes of winding up its affairs and liquidating its assets. We own shares of the common stock of the SPAC that were issued prior to the SPAC’s offering, but we have waived our right to receive distributions with respect to those shares upon the liquidation of the SPAC. Additionally, we purchased warrants directly from the SPAC in a private placement prior to the effective date of the SPAC’s prospectus. We own approximately 20% of the SPAC’s issued and outstanding common stock. If the SPAC does not consummate a business combination within the required time frame, we will not receive a return on our investment and we will lose our investment.

We have also agreed to indemnify the SPAC upon the SPAC’s liquidation for all claims of any providers of financing, vendors, service providers, or other entities that are owed money by the SPAC for services or financing provided or contracted for or products sold to the SPAC, or the claims of any target businesses, to the extent that the SPAC fails to obtain valid and enforceable waivers from such entities in order to protect the amounts held in the SPAC’s trust account. In the event of a liquidation of the SPAC, we may not only lose the amount of capital we invested in the SPAC, but we may also be liable to the SPAC under those indemnification obligations.

While we believe that the SPAC is an eligible portfolio company prior to a business combination by the SPAC, we cannot assure you that the SEC or a court would not take a contrary view, or that we can maintain our control following a business combination.

As a business development company we are required to invest at least 70% of our total assets in qualifying assets which include eligible portfolio companies. One of they ways in which we can treat an investment as an investment in an eligible portfolio company is if we control such entity. Under the 1940 Act, control is defined as the power to exercise a controlling influence over such company’s management or policies. Although control does not require ownership of a particular percentage of securities, the 1940 Act contains a rebuttable presumption that a party who owns 25% or more of the voting securities of a company has control over such company. While we believe, prior to a business combination by the SPAC, that we control the SPAC and that the SPAC is therefore an eligible portfolio company, we cannot assure you that the SEC or a court would not take a contrary view, or that we can maintain our control following a business combination.

We have paid expenses relating to the SPAC for which we will not be reimbursed.

Pursuant to a consulting agreement between us and ProEminent Sports, LLC, Tony Tavares acts as a consultant to us for sports related investments and, included within the scope of his duties, is his service to the SPAC. Pursuant to the consulting agreement, Mr. Tavares has, among other things, agreed to serve as Chief Executive Officer of the SPAC, review and comment on the SPAC’s prospectus, and help define the SPAC’s scope of business. Following consummation of the SPAC’s offering, Mr. Tavares has agreed to help the SPAC identify a target business, perform due diligence on the proposed target, and negotiate and consummate a business combination with such a target business. Following a business combination, in the event Mr. Tavares is not offered

 

27


Table of Contents

employment with the SPAC or a board position with the SPAC, we have agreed to continue the consulting arrangement for at least an additional twelve months. For the services rendered by ProEminent Sports, LLC to us, we pay ProEminent Sports a monthly fee of $20,000. The SPAC’s advisors, Robert Caporale and Randel E. Vataha, are Chairman and President, respectively, and each own 50% of the membership interests of Game Plan LLC. We are also a party to an agreement with Game Plan LLC pursuant to which Game Plan LLC will provide certain consulting services to us and to the SPAC, including advising the SPAC in identifying a target business. Following consummation of the SPAC’s offering, Game Plan LLC has agreed to help the SPAC identify a target business, perform due diligence on the proposed target, and negotiate and consummate a business combination with such a target business. For the services rendered by Game Plan to us, we pay Game Plan a monthly fee of $10,000. The fees paid by us pursuant to the consulting agreements are solely borne by us and will not be reimbursed by the SPAC from the proceeds of the offering.

If the SPAC is successful in consummating a business combination, we will face restrictions limiting our ability to liquidate our SPAC common stock.

The privately issued shares and warrants we purchased have been placed in escrow and will not be released to us before one year from the business combination, except in very limited circumstances. In addition, the privately issued shares and warrants will become freely tradable only after they are registered pursuant to an effective registration statement. We have further agreed that we will not sell or transfer any shares of the SPAC’s common stock purchased by us in the open market, if any, until 180 days after the SPAC has completed a business combination.

Our executive officers and directors may allocate some portion of their time to the business of the SPAC, which may create conflicts of interest.

Our investment in the SPAC may create conflicts of interest. Andrew M. Murstein, our President and a director, serves as the Vice Chairman and Secretary of the SPAC. Larry D. Hall, our Chief Financial Officer, serves as the Chief Financial Officer of the SPAC. Henry L. Aaron and Mario M. Cuomo serve as our directors and as directors of the SPAC. Prior to the effective date of the SPAC’s prospectus, Messrs. Murstein, Hall, Aaron, and Cuomo will enter into an agreement with the SPAC and with the SPAC’s underwriter(s) whereby they will agree to present to the SPAC, prior to presentation to any other person or entity, opportunities to acquire entities, until the earlier of the SPAC’s consummation of a business combination, the SPAC’s liquidation or until such time as they cease to be an officer or director of the SPAC, subject to any pre-existing fiduciary or contractual obligation they have. We will also enter into an agreement with the SPAC and with the SPAC’s underwriter(s) whereby we will agree to present to the SPAC, prior to our own consideration or presentation to any other person or entity, opportunities to acquire entities in the sports, leisure, or entertainment industries that, in our reasonable discretion, have a value equal to or exceeding $160,000,000, which constitutes at least 80% of the SPAC’s total assets held in trust, at the time that we become aware of such opportunity.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

ITEM 2. PROPERTIES

We lease approximately 17,000 square feet of office space in New York City for our corporate headquarters under a lease expiring in June 2016, and lease a facility in Long Island City, New York, of approximately 6,000 square feet for certain corporate back-office operations. We also lease office space for loan origination offices and subsidiaries operations in Boston, MA, Chicago, IL, Minneapolis, MN, and Flemington, NJ. Medallion Bank leases space in Salt Lake City, UT. We do not own any real property, other than foreclosed property obtained as a result of lending relationships. We believe that our leased properties, taken as a whole, are in good operating condition and are suitable for our current business operations.

 

ITEM 3. LEGAL PROCEEDINGS

We and our subsidiaries are currently involved in various legal proceedings incident to the ordinary course of our business, including collection matters with respect to certain loans. We intend to vigorously defend any outstanding claims and pursue our legal rights. In the opinion of our management and based upon the advice of legal counsel, there is no proceeding pending, or to the knowledge of management threatened, which in the event of an adverse decision would result in a material adverse effect on our results of operations or financial condition.

 

28


Table of Contents
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the 2007 fourth quarter.

PART II

 

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON STOCK, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASE OF EQUITY SECURITIES

Our common stock is quoted on the Nasdaq Global Select Market under the symbol “TAXI.” Our common stock commenced trading on May 23, 1996. As of March 11, 2008, there were approximately 118 holders of record of the Company’s common stock.

On March 11, 2008, the last reported sale price of our common stock was $9.89 per share. Historically, our common stock has traded at a premium to net asset value per share, but there can be no assurance that our stock will trade at a premium in the future.

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

 

2007

   DIVIDENDS
DECLARED
   HIGH    LOW

Fourth Quarter

   $ 0.19    $ 11.00    $ 9.70

Third Quarter

     0.19      12.00      10.39

Second Quarter

     0.19      12.43      11.15

First Quarter

     0.19      12.34      10.80
                    

2006

              

Fourth Quarter

   $ 0.19    $ 12.52    $ 11.17

Third Quarter

     0.18      13.43      10.67

Second Quarter

     0.17      13.74      12.74

First Quarter

     0.16      13.55      11.12
                    

Information about our equity compensation plan is incorporated by reference in all information under the caption “Equity Compensation Plan Information” included in our definitive Proxy Statement for the Annual Meeting of Stockholders to be held on June 13, 2008.

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

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

 

29


Table of Contents

ISSUER PURCHASES OF EQUITY SECURITIES (1)

 

Period

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

November 5 through December 31, 2003

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

January 1 through December 31, 2004

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

January 1 through December 31, 2005

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

January 1 through December 31, 2006

   —        —      —        7,720,523

January 1 through December 31, 2007 (1)

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

Total

   1,386,433      9.09    1,386,433      —  
                       

 

(1)

We publicly announced our stock repurchase program in a press release dated November 5, 2003, after the Board of Directors approved the repurchase of up to $10,000,000 of our outstanding common stock, which was increased by an additional $10,000,000 authorization on November 3, 2004. The stock repurchase program expires after a certain number of days, except as may be extended. In November 2007, we extended the terms of the stock repurchase program. Purchases were to commence no earlier than December 2007, and were to conclude 180 days after the commencement of the purchases. All of the 2007 repurchases were made during the 2007 fourth quarter.

 

30


Table of Contents
ITEM 6. SELECTED FINANCIAL DATA

Summary Consolidated Financial Data

You should read the consolidated financial information below with the Consolidated Financial Statements and Notes thereto for the years ended December 31, 2007, 2006, 2005, 2004, and 2003. Because of the change in the reporting entity described in note 3 to our consolidated financial statements, our financial condition and results of operations included in this annual report for the years ended December 31, 2005, 2004, and 2003, including for any interim periods presented, have been adjusted to reflect the change retrospectively for all periods and information presented.

 

      Year ended December 31,  

(Dollars in thousands, except per share data)

   2007     2006     2005     2004     2003  

Statement of operations

          

Investment income

   $ 51,393     $ 39,635     $ 34,811     $ 24,833     $ 26,205  

Interest expense

     30,704       24,190       17,997       12,834       12,042  
                                        

Net interest income

     20,689       15,445       16,814       11,999       14,163  

Noninterest income

     2,444       2,646       4,738       4,334       4,457  

Operating expenses

     17,835       14,926       16,984       16,083       16,238  
                                        

Net investment income before income taxes

     5,298       3,165       4,568       250       2,382  

Income tax (provision) benefit

     —         —         14       (259 )     (41 )
                                        

Net investment income (loss) after income taxes

     5,298       3,165       4,582       (9 )     2,341  

Net realized gains on investments

     14,172       3,080       3,606       2,329       11,527  

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

     2,292       7,454       5,012       343       (4,860 )

Net change in unrealized appreciation (depreciation) on investments (1)

     (6,326 )     (591 )     (6,339 )     19,849       (6,990 )
                                        

Net increase in net assets resulting from operations

   $ 15,436     $ 13,108     $ 6,861     $ 22,512     $ 2,018  
                                        

Per share data

          

Net investment income

   $ 0.30     $ 0.18     $ 0.26     $ 0.01     $ 0.13  

Income tax (provision) benefit

     —         —         —         (0.01 )     —    

Net realized gains on investments

     0.80       0.17       0.21       0.13       0.63  

Net change in unrealized appreciation (depreciation) on investments (1)

     (0.23 )     0.39       (0.08 )     1.09       (0.65 )
                                        

Net increase in net assets resulting from operations

   $ 0.87     $ 0.74     $ 0.39     $ 1.22     $ 0.11  
                                        

Dividends declared per share

   $ 0.76     $ 0.70     $ 0.54     $ 0.37     $ 0.16  
                                        

Weighted average common shares outstanding

          

Basic

     17,480,523       17,293,665       17,087,034       18,001,604       18,245,774  

Diluted

     17,786,310       17,761,039       17,552,228       18,424,518       18,287,952  
                                        

Balance sheet data

          

Net investments

   $ 653,046     $ 592,933     $ 530,222     $ 481,081     $ 405,404  

Total assets

     721,262       631,605       573,355       522,090       456,912  

Total funds borrowed

     542,549       455,137       400,915       339,395       287,454  

Total liabilities

     548,839       461,977       407,000       351,629       294,378  

Total shareholders’ equity

     172,423       169,628       166,354       170,461       162,116  
                                        

Managed balance sheet data (2)

          

Net investments

   $ 934,955     $ 833,639     $ 723,253     $ 643,541     $ 379,159  

Total assets

     1,025,633       893,588       792,973       709,910       456,939  

Total funds borrowed

     841,632       716,620       620,022       525,933       287,454  

Total liabilities

     853,211       723,960       626,619       539,448       294,378  
                                        

 

31


Table of Contents
     Year ended December 31,  
     2007     2006     2005     2004     2003  

Selected financial ratios and other data

          

Return on average assets (ROA) (3)

          

Net investment income (loss) after taxes

   0.79 %   0.53 %   0.82 %   0.00 %   0.54 %

Net increase in net assets resulting from operations

   2.30     2.20     1.23     4.96     0.47  

Return on average equity (ROE) (4)

          

Net investment income (loss) after taxes

   3.09     1.89     2.73     (0.01 )   1.44  

Net increase in net assets resulting from operations

   9.00     7.82     4.09     13.82     1.24  
                              

Weighted average yields

   8.44 %   7.71 %   7.15 %   6.32 %   6.93 %

Weighted average cost of funds

   5.04     4.70     3.75     3.33     3.21  
                              

Net interest margin (5)

   3.40     3.01     3.40     2.99     3.72  
                              

Noninterest income ratio (6)

   0.40     0.52     0.99     1.13     1.19  

Total expense ratio (7)

   7.98     7.62     7.28     7.57     7.54  

Operating expense ratio (8)

   2.93     2.91     3.54     4.17     4.32  
                              

As a percentage of net investment portfolio

          

Medallion loans

   76 %   72 %   71 %   65 %   76 %

Commercial loans

   14     15     17     21     23  

Investment in subsidiaries

   9     8     8     7     —    

Equity investments

   1     3     4     7     1  

Investment securities

   —       2     —       —       —    
                              

Investments to assets (9)

   91 %   94 %   92 %   92 %   83 %

Equity to assets (10)

   24     27     29     33     36  

Debt to equity (11)

   315     268     241     199     177  
                              

 

(1)

Unrealized appreciation (depreciation) on investments represents the increase (decrease) for the year in the fair value of our investments, including the results of operations for Medallion Bank, Medallion Taxi Media, and other controlled subsidiaries, where applicable.

(2)

Includes the balances of wholly-owned, unconsolidated portfolio companies, primarily Medallion Bank.

(3)

ROA represents the net investment income (loss) after taxes or net increase in net assets resulting from operations, divided by average total assets.

(4)

ROE represents the net investment income (loss) after taxes or net increase in net assets resulting from operations, divided by average shareholders’ equity.

(5)

Net interest margin represents net interest income for the year divided by average interest earning assets, and included interest recoveries of $821 in 2007 and $1,556 in 2006, and also included $5,750 of dividends from Medallion Bank in 2007. On a managed basis, combined with Medallion Bank, the net interest margin was 4.21%, 4.40%, 4.65%, and 4.37% for 2007, 2006, 2005, and 2004.

(6)

Noninterest income ratio represents noninterest income divided by average interest earning assets.

(7)

Total expense ratio represents total expenses (interest expense, operating expenses, and income taxes) divided by average interest earning assets.

(8)

Operating expense ratio represents operating expenses divided by average interest earning assets.

(9)

Represents net investments divided by total assets as of December 31.

(10)

Represents total shareholders’ equity divided by total assets as of December 31.

(11)

Represents total funds borrowed divided by total shareholders’ equity as of December 31.

 

ITEM 7. 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 for the years ended December 31, 2007, 2006, and 2005. In addition, this section contains forward-looking statements. These forward-looking statements are subject to the 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 described in the Risk Factors section on page 18.

CRITICAL ACCOUNTING POLICIES

        The SEC has recently issued cautionary advice regarding disclosure about critical accounting policies. The SEC defines critical accounting policies as those that are both most important to the portrayal of a company’s financial condition and results, and that require management’s most difficult, subjective, or complex judgments, often as a result of the need to make estimates about matters that are inherently uncertain and may change materially in subsequent periods. The preparation of our consolidated financial statements requires estimates and assumptions that affect amounts reported and disclosed in the financial statements and related notes. Significant estimates made by us include valuation of loans, evaluation of the recoverability of accounts receivable and income tax assets, and the assessment of litigation and other contingencies. The matters that give rise to such provisions are inherently uncertain and may require complex and subjective judgments. Although we believe that estimates and assumptions used in determining the recorded amounts of net assets and liabilities at December 31, 2007, are reasonable, actual results could differ materially from the estimated amounts recorded in our financial statements.

 

32


Table of Contents

Change in reporting entity

Since Medallion Bank commenced operations in December 2003, we had historically consolidated Medallion Bank’s financial statements with those of our own. Although Medallion Bank is not an investment company, and SEC rules generally do not permit investment companies such as ours to consolidate the financial statements of non-investment companies, such as Medallion Bank, we had sought and obtained a letter from the SEC in March 2004 permitting such consolidation. We believed that consolidating Medallion Bank provided a more complete and accurate representation of our full scope of operations, and our complete financial position and results of operations.

During August 2006, we filed a registration statement on Form N-2 which the SEC staff reviewed and on which they provided comments, including those relating to the consolidation of the accounts of Medallion Bank which have evolved since 2004. Based on discussion with the SEC staff, we determined during the 2006 fourth quarter to voluntarily not consolidate Medallion Bank and present Medallion Bank as a portfolio company. We determined that this change represents a change in the reporting entity as described in SFAS No. 154, “Accounting Changes and Error Corrections.” Accordingly we retrospectively applied this change to the financial statements of all prior periods presented, including previously issued interim periods presented, included in our 2006 Form 10-K. The effect of this retrospective application was to present our financial position and results of operations as if Medallion Bank had not been consolidated for all periods presented and to present Medallion Bank as an unconsolidated portfolio investment. Although this created changes in the reported levels of assets, liabilities, revenues, and expenses, our net increase in net assets resulting from operations, shareholders’ equity, and the related amounts per common share were unchanged.

GENERAL

We are a specialty finance company that has a leading position in originating, acquiring, and servicing loans that finance taxicab medallions and various types of commercial businesses. A wholly-owned portfolio company of ours, Medallion Bank, also originates consumer loans for the purchase of recreational vehicles, boats, motorcycles, and trailers. Since 1996, the year in which we became a public company, we have increased our taxicab medallion loan portfolio at a compound annual growth rate of 13%, and our commercial loan portfolio at a compound annual growth rate of 7% (14% for both on a managed basis combined with Medallion Bank). Since Medallion Bank acquired a consumer loan portfolio and began originating consumer loans in 2004, it has increased its consumer loan portfolio at a compound annual growth rate of 20%. Total assets under our management, which includes assets serviced for third party investors and managed by unconsolidated portfolio companies, were approximately $1,017,433,000 as of December 31, 2007 and $907,133,000 at December 31, 2006, and have grown at a compound annual growth rate of 15% from $215,000,000 at the end of 1996.

Our loan-related earnings depend primarily on our level of net interest income. Net interest income is the difference between the total yield on our loan portfolio and the average cost of borrowed funds. We fund our operations through a wide variety of interest-bearing sources, such as revolving bank facilities, bank certificates of deposit issued to customers, debentures issued to and guaranteed by the SBA, and bank term debt. Net interest income fluctuates with changes in the yield on our loan portfolio and changes in the cost of borrowed funds, as well as changes in the amount of interest-bearing assets and interest-bearing liabilities held by us. 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 our lending activities. We, like other financial institutions, are subject to interest rate risk to the degree that our interest-earning assets reprice on a different basis than our interest-bearing liabilities.

We also provide debt, mezzanine, and equity investment capital to companies in a variety of industries, consistent with our investment objectives. These investments may be venture capital style investments which may not be fully collateralized. 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 on the consolidated balance sheets). Interest income is earned on the debt investments.

We are a closed-end, non-diversified management investment company under the 1940 Act. We have elected to be treated as a business development company under the 1940 Act. We have also elected to be treated for federal income tax purposes as a RIC under Subchapter M of the Code. As a RIC, we generally do not have to pay corporate-level federal income taxes on any net ordinary income or capital gains that we distribute to our shareholders as dividends if we meet certain source-of-income and asset diversification requirements. Medallion Bank is not a RIC and must pay corporate-level federal income taxes.

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

 

33


Table of Contents

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) on investments are inversely related. When an appreciated asset is sold to realize a gain, a decrease in the previously recorded unrealized appreciation occurs. Conversely, when a loss previously recorded as unrealized depreciation is realized by the sale or other disposition of a depreciated portfolio asset, the reclassification of the loss from unrealized to realized causes a decrease in net unrealized depreciation and an increase in realized loss.

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

 

34


Table of Contents

Trends in Investment Portfolio

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

 

     December 31, 2007     December 31, 2006     December 31, 2005  

(Dollars in thousands)

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

Medallion loans

            

New York

   6.91 %   $ 399,955     6.74 %   $ 340,110     6.27 %   $ 285,927  

Chicago

   7.43       33,008     6.88       31,077     6.95       48,045  

Boston

   8.44       32,446     8.12       32,787     7.50       25,556  

Newark

   8.40       22,058     8.32       10,233     8.40       4,399  

Cambridge

   8.41       5,174     7.93       8,184     7.24       5,409  

Other

   7.58       5,481     7.55       5,586     7.46       5,977  
                              

Total medallion loans

   7.13       498,122     6.93       427,977     6.50       375,313  
                        

Deferred loan acquisition costs

       798         729         1,047  

Unrealized depreciation on loans

       (37 )       (457 )       (1,097 )
                              

Net medallion loans

     $ 498,883       $ 428,249       $ 375,263  
                              

Commercial loans

            

Secured mezzanine

   14.19 %   $ 59,152     13.78 %   $ 53,732     14.06 %   $ 53,207  

Asset based

   8.91       19,870     10.28       18,668     9.49       19,187  

Other secured commercial

   9.05       19,256     9.59       18,504     8.85       25,979  
                              

Total commercial loans

   12.12       98,278     12.21       90,904     11.79       98,373  
                        

Deferred loan acquisition (income) costs

       (64 )       (98 )       (88 )

Unrealized depreciation on loans

       (6,432 )       (2,599 )       (6,799 )
                              

Net commercial loans

     $ 91,782       $ 88,207       $ 91,486  
                              

Investment in Medallion Bank and other controlled subsidiaries

   13.79 %   $ 57,501     0.00 %   $ 50,448     0.00 %   $ 40,335  
                                          

Investment securities

   —   %   $ —       5.09 %   $ 9,961     —   %   $ —    
                        

Unrealized depreciation on investment securities

       —           —           —    
                              

Net investment securities

     $ —         $ 9,961       $ —    
                              

Equity investments

   4.70 %   $ 2,138     2.23 %   $ 13,955     1.59 %   $ 22,509  
                              

Unrealized appreciation on equities

       2,742         2,113         629  
                              

Net equity investments

     $ 4,880       $ 16,068       $ 23,138  
                              

Investments at cost

   8.45 %   $ 656,039     7.01 %   $ 593,245     6.78 %   $ 536,529  
                              

Deferred loan acquisition costs

       734         631         960  

Unrealized appreciation on equities

       2,742         2,113         629  

Unrealized depreciation on loans

       (6,469 )       (3,056 )       (7,896 )
                              

Net investments

     $ 653,046       $ 592,933       $ 530,222  
                              

Medallion Bank investments

            
                                      

Consumer loans

   18.54 %   $ 139,972     18.48 %   $ 113,777     18.45 %   $ 88,280  

Commercial loans

   9.14       88,785     10.35       60,929     9.60       54,978  

Medallion loans

   6.72       87,891     6.65       94,176     6.25       73,987  

Investment securities

   4.82       21,707     4.60       21,841     4.11       17,873  
                              

Medallion Bank investments at cost (2)

   12.12       338,355     11.90       290,723     11.45       235,118  
                        

Deferred loan acquisition costs

       4,569         3,155         1,674  

Unrealized appreciation (depreciation) on investment securities

       39         (402 )       (243 )

Premiums paid on purchased securities

       91         245         463  

Unrealized depreciation on loans

       (7,311 )       (6,057 )       (5,025 )
                              

Medallion Bank net investments

     $ 335,743       $ 287,664       $ 231,987  
                              

 

(1)

Represents the weighted average interest or dividend rate of the respective portfolio as of the date indicated.

(2)

The weighted average interest rate for the entire managed loan portfolio (medallion, commercial, and consumer loans) was 9.57%, 9.44%, and 9.00% at December 31, 2007, 2006, and 2005.

 

35


Table of Contents

PORTFOLIO SUMMARY

Total Portfolio Yield

The weighted average yield of the total portfolio at December 31, 2007 was 8.45% (7.95% for the loan portfolio), an increase of 144 basis points from 7.01% at December 31, 2006, which was an increase of 23 basis points from 6.78% at December 31, 2005. The weighted average yield of the total managed portfolio at December 31, 2007 was 9.41% (9.57% for the loan portfolio), an increase of 37 basis points from 9.04% at December 31, 2006, which was an increase of 40 basis points from 8.64% at December 31, 2005. The increases in both years primarily reflected the market increase in interest rates, and the 2005 increase also reflected strong growth in the commercial loan portfolio. Managed portfolio yields were helped by the inclusion and growth of the high-yield consumer loan portfolio. We expect to try to increase the percentage of commercial loans in the total portfolio, the origination of floating and adjustable-rate loans, and the level of non-New York medallion loans to enhance our yields. Additionally, Medallion Bank expects to try to increase the percentage of consumer loans originated for the managed portfolio to increase our overall returns.

Medallion Loan Portfolio

Our medallion loans comprised 76% of the net portfolio of $653,046,000 at December 31, 2007, compared to 72% of $592,933,000 at December 31, 2006 and 71% of $530,222,000 at December 31, 2005. Our managed medallion loans of $586,498,000 comprised 63% of the net portfolio of $934,955,000 at December 31, 2007, compared to 63% of $833,639,000 at December 31, 2006 and 62% of $723,254,000 at December 31, 2005. The medallion loan portfolio increased by $70,634,000 or 16% in 2007 ($64,305,000 or 12% on a managed basis), primarily reflecting increases in New York and Boston. The increase in the New York market can be attributed to new business marketing efforts, the conversion of participations into owned loans, and the general increase in medallion values and related refinancings. Total medallion loans serviced for third parties were $4,443,000, $5,783,000, and $8,784,000 at December 31, 2007, 2006, and 2005.

The weighted average yield of the medallion loan portfolio at December 31, 2007 was 7.13%, an increase of 20 basis points from 6.93% at December 31, 2006, which was an increase of 43 basis points from 6.50% at December 31, 2005. The weighted average yield of the managed medallion loan portfolio at December 31, 2007 was 7.07%, an increase of 19 basis points from 6.88% at December 31, 2006, which was an increase of 42 basis points from 6.46% at December 31, 2005. The increase in yield primarily reflected the impact of rising interest rates in the economy and the effects of borrower refinancings. At December 31, 2007, 20% of the medallion loan portfolio represented loans outside New York, compared to 21% and 24% at year-end 2006 and 2005. At December 31, 2007, 17% of the managed medallion loan portfolio represented loans outside New York, compared to 18% and 22% at year-end 2006 and 2005. We continue to focus our efforts on originating higher yielding medallion loans outside the New York market.

Commercial Loan Portfolio

Our commercial loans represented 14% of the net investment portfolio as of December 31, 2007, compared to 15% and 17% at December 31, 2006 and 2005, and were 19%, 18%, and 20% on a managed basis. Commercial loans increased by $3,575,000 or 4% during 2007 (increased by $31,182,000 or 21% on a managed basis), primarily reflecting loan participations purchased. Net commercial loans purchased from third parties were $12,643,000 at December 31, 2007, compared to loans serviced for third parties of $7,761,000 and $349,000 at December 31, 2006, and 2005.

The weighted average yield of the commercial loan portfolio at December 31, 2007 was 12.12%, a decrease of 9 basis points from 12.21% at December 31, 2006, which was up 42 basis points from 11.79% at December 31, 2005. The weighted average yield of the managed commercial loan portfolio at December 31, 2007 was 10.70%, a decrease of 76 basis points from 11.46% at December 31, 2006, which was up 45 basis points from 11.01% at December 31, 2005. The decreased yield reflected the loan participations purchased at generally lower rates than the portfolio as a whole, as well as decreases in market interest rates. We continue to originate adjustable-rate and floating-rate loans tied to the prime rate to help mitigate our interest rate risk in a rising interest rate environment. At December 31, 2007, variable-rate loans represented approximately 28% of the commercial portfolio, compared to 26% and 29% at December 31, 2006 and 2005, and were 57%, 55%, and 54% on a managed basis. Although this strategy initially produces a lower yield, we believe that this strategy mitigates interest rate risk by better matching our earning assets to their adjustable-rate funding sources.

 

36


Table of Contents

Consumer loan portfolios

Our managed consumer loans, all of which are held in the portfolio managed by Medallion Bank, represented 15% of the managed net investment portfolio as of December 31, 2007, compared to 13% at December 31, 2006 and 12% at December 31, 2005. Medallion Bank started originating new adjustable rate consumer loans during the 2004 third quarter. Recreational vehicles, boats, and trailers located in all 50 states collateralize the loans. The portfolio is serviced by a third party subsidiary of a major commercial bank.

The weighted average gross yield of the managed consumer loan portfolio was 18.54% at December 31, 2007, compared to 18.48% and 18.45% at December 31, 2006 and 2005. Amortization of the portfolio purchase premium reduced the yield by an average of 0.51%, 0.96%, and 1.90% in 2007, 2006, and 2005. Adjustable rate loans represented approximately 91% of the managed consumer portfolio compared to 84% and 89% at December 31, 2006 and 2005.

Delinquency and Loan Loss Experience

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

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

The following table shows the trend in loans 90 days or more past due as of December 31,

 

(Dollars in thousands)

   2007     2006     2005  

Medallion loans

   $ 3,519    0.6 (1)   $ 5,707    1.1 (1)   $ 6,080    1.3 (1)
                                       

Commercial loans

               

Secured mezzanine

     2,819    0.5       3,459    0.7       7,970    1.7  

Asset-based receivable

     —      0.0       —      0.0       —      0.0  

Other secured commercial

     1,195    0.2       1,652    0.3       2,673    0.5  
                                       

Total commercial loans

     4,014    0.7       5,111    1.0       10,643    2.2  
                                       

Total loans 90 days or more past due

   $ 7,533    1.3 %   $ 10,818    2.1 %   $ 16,723    3.5 %
                                       

Total Medallion Bank loans

   $ 1,036    0.3 %   $ 631    0.2 %   $ 695    0.3 %
                                       

Total managed loans 90 days or more past due

   $ 8,569    0.9 %   $ 11,449    1.5 %   $ 17,418    2.5 %
                                       

 

(1)

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

In general, collection efforts since the establishment of our collection department have substantially contributed to the sizable reduction in overall delinquencies. The decreases in medallion delinquencies primarily resulted from a restructuring of a large past due relationship which resulted in substantial cash payments in 2007 and also reflected the 2006 foreclosure of $900,000 of Chicago medallions and improvements in other borrower payment patterns. Secured mezzanine financing delinquencies increased in 2007 primarily as a result of an additional loan, not previously delinquent, becoming over 90 days past due in the current year, and decreased in 2006 primarily reflecting payment activity, restructurings, and to a lesser extent chargeoffs. The decrease in other secured commercial loans primarily related to the resolution of several customers who had been monitored by the collections group. We are actively working with each delinquent borrower to bring them current, and believe that any potential loss exposure is reflected in our mark-to-market estimates on each loan. Although there can be no assurances as to changes in the trend rate, management believes that any loss exposures are properly reflected in reported asset values.

 

37


Table of Contents

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

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

The following table sets forth the changes in our unrealized appreciation (depreciation) on investments, other than investments in controlled subsidiaries, for the years ended December 31, 2007, 2006, and 2005.

 

(Dollars in thousands)

   Loans     Equity
Investments
    Foreclosed
Properties
    Total  

Balance December 31, 2004

   $ (7,791 )   $ 685     $ (512 )   $ (7,618 )

Increase in unrealized

        

Appreciation on investments

     158       (520 )     —         (362 )

Depreciation on investments

     (1,925 )     (1,022 )     (1,123 )     (4,070 )

Reversal of unrealized appreciation (depreciation) related to realized

        

Gains on investments

     —         1,486       —         1,486  

Losses on investments

     309       —         238       547  

Reversal of reserves on sold SBA Section 7(a) loans

     1,340       —         —         1,340  

Other

     13       —         —         13  
                                

Balance December 31, 2005

     (7,896 )     629       (1,397 )     (8,664 )

Increase in unrealized

        

Appreciation on investments

     —         4,236       921       5,157  

Depreciation on investments

     824       (173 )     —         651  

Reversal of unrealized appreciation (depreciation) related to realized

        

Gains on investments

     —         (2,579 )     —         (2,579 )

Losses on investments

     4,016       —         1,423       5,439  
                                

Balance December 31, 2006

     (3,056 )     2,113       947       4  

Increase in unrealized

        

Appreciation on investments

     —         2,127       8,245       10,372  

Depreciation on investments

     (4,246 )     (133 )     (159 )     (4,538 )

Reversal of unrealized appreciation (depreciation) related to realized

        

Gains on investments

     —         (1,361 )     (571 )     (1,932 )

Losses on investments

     833       —         —         833  

Other

     —         (4 )     (121 )     (125 )
                                

Balance December 31, 2007

   $ (6,469 )   $ 2,742     $ 8,341     $ 4,614  
                                

 

38


Table of Contents

The following table presents credit-related information for the investment portfolios as of December 31.

 

(Dollars in thousands)

   2007     2006     2005  

Total loans

      

Medallion loans

   $ 498,883     $ 428,249     $ 375,263  

Commercial loans

     91,782       88,207       91,486  
                        

Total loans

     590,665       516,456       466,749  

Investment in Medallion Bank and other controlled subsidiaries

     57,501       50,448       40,335  

Equity investments (1)

     4,880       16,068       23,138  

Investment securities

     —         9,961       —    
                        

Net investments

   $ 653,046     $ 592,933     $ 530,222  
                        

Net investments at Medallion Bank and other controlled subsidiaries

   $ 335,743     $ 287,664     $ 231,987  

Managed net investments

   $ 934,955     $ 833,639     $ 723,254  
                        

Unrealized appreciation (depreciation) on investments

      

Medallion loans

   $ (37 )   $ (457 )   $ (1,097 )

Commercial loans

     (6,432 )     (2,599 )     (6,799 )
                        

Total loans

     (6,469 )     (3,056 )     (7,896 )

Investment in Medallion Bank and other controlled subsidiaries (2)

     —         —         —    

Equity investments

     2,742       2,113       629  

Investment securities

     —         —         —    
                        

Total unrealized appreciation (depreciation) on investments (2)

   $ (3,727 )   $ (943 )   $ (7,267 )
                        

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

   $ (7,272 )   $ (6,459 )   $ (5,268 )

Managed total unrealized appreciation (depreciation) on investments (2)

   $ (10,999 )   $ (7,402 )   $ (12,535 )
                        

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

      

Medallion loans

     (0.01 )%     (0.11 )%     (0.29 )%

Commercial loans

     (6.54 )     (2.86 )     (6.91 )

Total loans

     (1.08 )     (0.59 )     (1.67 )

Investment in Medallion Bank and other controlled subsidiaries

     —         —         —    

Equity investments

     128.22       (15.14 )     2.79  

Investment securities

     —         —         —    

Net investments

     (0.57 )     (0.16 )     (1.36 )
                        

Net investments at Medallion Bank and other controlled subsidiaries

     (2.15 )%     (2.22 )%     (2.24 )%

Managed net investments

     (1.17 )%     (0.88 )%     (1.71 )%
                        

 

(1)

Represents common stock and warrants held as investments.

(2)

Excludes $1,920, $1,250, and $0 for unrealized appreciation on Medallion Hamptons Holding, a wholly-owned subsidiary, at December 31, 2007, 2006, and 2005.

(3)

Unlike other lending institutions, we are not permitted to establish reserves for loan losses. Instead, the valuation of our portfolio is adjusted quarterly to reflect estimates of the current realizable value of the loan portfolio. These percentages represent the discount or premiums that investments are carried on the books at, relative to their par or gross value.

 

39


Table of Contents

The following table presents the gain/loss experience on the investment portfolios for the years ended December 31, 2007, 2006, and 2005.

 

(Dollars in thousands)

   2007     2006     2005  

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

      

Medallion loans

   $ 1,316     $ 19     $ (391 )

Commercial loans

     (784 )     (5,473 )     (326 )
                        

Total loans

     532       (5,454 )     (717 )

Investment in Medallion Bank and other controlled subsidiaries

     —         —         —    

Equity investments

     13,640       8,534       4,323  

Investment securities

     —         —         —    
                        

Total realized gains on loans and equity investments

   $ 14,172     $ 3,080     $ 3,606  
                        

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

     (3,868 )     (2,140 )     (2,525 )
                        

Total managed realized gains on loans and equity investments

   $ 10,304     $ 940     $ 1,081  
                        

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

      

Medallion loans

     0.28 %     0.00 %     (0.11 )%

Commercial loans

     (0.82 )     (5.87 )     (0.29 )

Total loans

     0.09       (1.11 )     (0.16 )

Investment in Medallion Bank and other controlled subsidiaries

     —         —         —    

Equity investments

     408.53       40.81       18.68  

Investment securities

     —         —         —    

Net investments

     2.27       0.59       0.70  
                        

Net investments at Medallion Bank and other controlled subsidiaries

     (1.24 )%     (0.83 )%     (1.17 )%

Managed net investments

     1.16 %     0.12 %     0.16 %
                        

 

(1)

Includes realized gains/losses of $1,336, $4, and $0 for the years ended December 31, 2007, 2006, and 2005 related to foreclosed properties, which are carried in other assets on the consolidated balance sheet.

The table below summarizes components of unrealized and realized gains and losses in the investment portfolios for the years ended December 31, 2007, 2006, and 2005.

 

(Dollars in thousands)

   2007     2006     2005  

Net change in unrealized appreciation (depreciation) on investments

      

Unrealized appreciation

   $ 2,127     $ 4,236     $ 1,136  

Unrealized depreciation

     (4,379 )     (7,185 )     (1,320 )

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

     2,292       7,454       5,012  

Realized gains

     (11,647 )     (2,579 )     (5,514 )

Realized losses

     833       4,016       482  

Unrealized gains (losses) on foreclosed properties

     6,740       921       (1,123 )
                        

Total

   $ (4,034 )   $ 6,863     $ (1,327 )
                        

Net realized gains on investments

      

Realized gains

   $ 2,914     $ 2,579     $ 5,514  

Realized losses

     (833 )     (4,016 )     (919 )

Other gains

     10,732       5,997       2,533  

Direct recoveries (charge-offs)

     23       (1,484 )     (3,522 )

Realized gains on foreclosed properties

     1,336       4       —    
                        

Total

   $ 14,172     $ 3,080     $ 3,606  
                        

Investment in Medallion Bank and Other Controlled Subsidiaries

Investment in Medallion Bank and other controlled subsidiaries were 9%, 9%, and 8% of our total portfolio at December 31, 2007, 2006, and 2005. The portfolio company investments primarily represent the wholly-owned unconsolidated subsidiaries of ours, substantially all of which is represented by our investment in Medallion Bank, a non-pass-through, taxpaying entity. We are currently in discussions with the IRS to obtain LLC tax treatment for Medallion Bank, which would provide “pass-through” taxation for our shareholders, and which has already been agreed to by the State of Utah. We cannot assure you that we will be successful in our efforts, but if we are successful, this treatment would reduce taxes and increase the reported net income of Medallion Bank. In addition, to facilitate maintenance of Medallion Bank’s capital ratio requirement and to provide the necessary capital for continued growth, the Company periodically makes capital contributions to Medallion Bank, including an aggregate of $6,800,000 contributed over various months in 2007 and an aggregate of $1,550,000 contributed similarly in 2006. Separately, Medallion Bank paid

 

40


Table of Contents

dividends to the Company of $5,750,000 in 2007 and $0 in 2006. Without the capital infusions by the Company, a portion of the Medallion Bank dividends would have been retained to ensure Medallion Bank met its capital ratio requirements, and in such circumstance, if the Company maintained its dividend at the existing levels, a portion of those dividends could have represented a tax-free return of capital. See note 4 of the consolidated financial statements for additional information about these investments.

Equity Investments

Equity investments were 1%, 3%, and 4%, of our total portfolio at December 31, 2007, 2006, and 2005. Equity investments were 1%, 2%, and 3%, of our total managed portfolio at December 31, 2007, 2006, and 2005. Equity investments are comprised of common stock, partnership interests, and warrants. The decreases in equity investments primarily reflected the sale of shares of common stock of Clear Channel that were received in a tax-free exchange for 100% of our ownership interest in Medallion Taxi Media.

Investment Securities

Investment securities were 0%, 2%, and 0% of our total portfolio at December 31, 2007, 2006, and 2005. Investment securities were 2%, 4%, and 3% of our total managed portfolio at December 31, 2007, 2006, and 2005. The investment securities are primarily US Treasuries and/or adjustable-rate mortgage-backed securities purchased by us and Medallion Bank to better utilize required cash liquidity.

Trend in Interest Expense

Our interest expense is driven by the interest rates payable on its short-term credit facilities with banks, bank certificates of deposit, fixed-rate, long-term debentures issued to the SBA, and other short-term notes payable. The establishment of the Merrill Lynch Commercial Finance Corp. line of credit in September 2002, and its favorable subsequent renegotiations had the effect of substantially reducing our cost of funds. Most recently, in December 2006, we established an additional medallion lending relationship with Citibank that provides for future growth in the portfolio at generally lower rates than under the existing facility with Merrill Lynch. In addition, Medallion Bank began raising brokered bank certificates of deposit during 2004, which were at our lowest borrowing costs. As a result of Medallion Bank raising funds through certificates of deposits as previously noted, we were able to realign the ownership of some of our medallion loans and related assets to Medallion Bank allowing us and our subsidiaries to use cash generated through these transactions to retire debt with higher interest rates. In addition, Medallion Bank is able to bid on these deposits at a wide variety of maturity levels which allows for improved interest rate management strategies.

Our cost of funds is primarily driven by the rates paid on its various debt instruments and their relative mix, and changes in the levels of average borrowings outstanding. See Note 5 to the consolidated financial statements for details on the terms of all outstanding debt. Our debentures issued to the SBA typically have terms of ten years.

 

41


Table of Contents

We measure our borrowing costs as our aggregate interest expense for all of our interest-bearing liabilities divided by the average amount of such liabilities outstanding during the period. The following table shows the average borrowings and related borrowing costs for the years ended December 31, 2007, 2006, and 2005. Average balances have increased, primarily reflecting the funding needs to support the growth in our investment portfolios. The increase in borrowing costs reflected the trend of increasing interest rates in the economy.

 

(Dollars in thousands)

   Interest
Expense
   Average
Balance
   Average
Borrowing
Costs
 

December 31, 2007

        

Revolving line of credits

   $ 23,185    $ 380,405    6.09 %

SBA debentures

     5,007      77,250    6.48  

Notes payable to banks (1)

     2,387      32,146    7.43  

Margin loans

     125      2,221    5.63  
                

Total

   $ 30,704    $ 492,022    6.24  
                

Medallion Bank borrowings

     13,804      268,962    5.13  
                

Total managed borrowings

   $ 44,508    $ 760,984    5.85  
                    

December 31, 2006

        

Revolving line of credits

   $ 17,550    $ 323,823    5.42 %

SBA debentures

     4,981      77,250    6.45  

Notes payable to banks

     1,119      14,824    7.55  

Margin loans

     540      9,165    5.89  
                

Total

   $ 24,190    $ 425,062    5.69  
                

Medallion Bank borrowings

     10,454      232,605    4.49  
                

Total managed borrowings

   $ 34,644    $ 657,667    5.27  
                    

December 31, 2005

        

Revolving line of credit

   $ 12,164    $ 282,000    4.31 %

SBA debentures

     4,599      71,637    6.42  

Notes payable to banks

     757      12,606    6.01  

Margin loans

     477      11,631    4.10  
                

Total

   $ 17,997    $ 377,874    4.76  
                

Medallion Bank borrowings

     6,400      195,732    3.27  
                

Total managed borrowings

   $ 24,397    $ 573,606    4.25  
                    

 

(1)

Includes Trust Preferred Securities issued in June 2007.

We will continue to seek SBA funding to the extent it offers attractive rates. SBA financing subjects its recipients to limits on the amount of secured bank debt they may incur. We use SBA funding to fund loans that qualify under SBIA and SBA regulations. We believe that financing operations primarily with short-term floating rate secured bank debt has generally decreased our interest expense, but has also increased our exposure to the risk of increases in market interest rates, which we mitigate with certain interest rate strategies. At December 31, 2007, 2006, and 2005, short-term floating rate debt constituted 78%, 82%, and 81% of total debt, and was 51%, 53%, and 52% on a fully managed basis including the borrowings of Medallion Bank.

Factors Affecting Net Assets

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

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

 

42


Table of Contents

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

Consolidated Results of Operations

Since Medallion Bank commenced operations in December 2003, we had historically consolidated Medallion Bank’s financial statements with those of our own. Although Medallion Bank is not an investment company, and SEC rules generally do not permit investment companies such as ours to consolidate the financial statements of non-investment companies, such as Medallion Bank, we had sought and obtained a letter from the SEC in March 2004 permitting such consolidation. We believed that consolidating Medallion Bank provided a more complete and accurate representation of our full scope of operations, and our complete financial position and results of operations.

During August 2006, we filed a registration statement on Form N-2 which the SEC staff reviewed and on which they provided comments, including those relating to the consolidation of the accounts of Medallion Bank which have evolved since 2004. Based on discussion with the SEC staff, we determined during the 2006 fourth quarter to voluntarily not consolidate Medallion Bank and present Medallion Bank as a portfolio company. We determined that this change represents a change in the reporting entity as described in SFAS No. 154, “Accounting Changes and Error Corrections.” Accordingly we retrospectively applied this change to the financial statements of all prior periods presented, including previously issued interim periods presented, included in our 2006 Form 10-K. The effect of this retrospective application was to present our financial position and results of operations as if Medallion Bank had not been consolidated for all periods presented and to present Medallion Bank as an unconsolidated portfolio investment. Although this created changes in the reported levels of assets, liabilities, revenues, and expenses, our net increase in net assets resulting from operations, shareholders’ equity, and the related amounts per common share were unchanged.

For the Years Ended December 31, 2007 and 2006

Net increase in net assets resulting from operations was $15,436,000 or $0.87 per diluted common share in 2007, up $2,328,000 or 18% from $13,108,000 or $0.74 per share in 2006. The 2007 increase primarily reflected higher net interest income and net realized/unrealized gains, partially offset by higher operating expenses and lower noninterest income. Net investment income after taxes was $5,298,000 or $0.30 per share in 2007, up $2,133,000 or 67% from $3,165,000 or $0.18 per share in 2006.

Investment income was $51,393,000 in 2007, up $11,758,000 or 30% from $39,635,000 a year ago, and included $821,000 from interest recoveries on certain investments in 2007, compared to $1,556,000 in 2006. Also included in 2007 were $5,750,000 in dividends from Medallion Bank. Excluding those items, investment income increased $6,743,000 or 18%, primarily reflecting growth in the investment portfolios and to a lesser extent, changes in the yields earned. The yield on the investment portfolio was 8.44% in 2007, up 9% from 7.71% in 2006. Excluding the interest recoveries and dividends, the 2007 yield was down 1% to 7.36% from 7.42% in 2006, reflecting the general decrease in market interest rates and changes in the portfolio mix. Average investments outstanding were $608,626,000 in 2007, up 19% from $513,059,000 a year ago, primarily reflecting growth in the medallion loan portfolio.

Medallion loans were $498,883,000 at year end, up $70,634,000 or 16% from $428,249,000 a year ago, representing 76% of the investment portfolio compared to 72% a year ago, and were yielding 7.13% compared to 6.93% a year ago, an increase of 3%. The increase in outstandings primarily reflected efforts to book new business, primarily in the New York City market, and also reflected the increase in medallion values. The managed medallion portfolio, which includes loans at Medallion Bank and those serviced for third parties, was $590,941,000 at year end, up $62,965,000 or 12% from $527,976,000 a year ago. The commercial loan portfolio was $91,782,000 at year end, compared to $88,207,000 a year ago, an increase of $3,575,000 or 4%, and represented 14% of the investment portfolio compared to 15% a year ago. The increase primarily reflected growth in the high-yield mezzanine loan portfolio, partially offset by increases in valuation allowances. Commercial loans yielded 12.12% at year end, down 1% from 12.21% a year ago, reflecting the interest rate cycle peak in 2007 and the beginning of market rate decreases. The managed commercial portfolio, which includes loans at Medallion Bank and those serviced for third parties, was $166,983,000 at year end, up $10,778,000 or 7% from $156,205,000 a year ago, primarily reflecting the increases described above and growth at Medallion Bank, partially offset by the net increase in third party loan participations purchased. Investments in Medallion Bank and other controlled subsidiaries was $57,501,000 at year end, up $7,053,000 or 14% from $50,448,000 a year ago, primarily reflecting the increased value of those

 

43


Table of Contents

investments, a large portion of which reflected the earnings of Medallion Bank, and which represented 9% of the investment portfolio for both years, and which yielded 13.79% the end of 2007, compared to 0.00% a year ago. See Note 4 of the consolidated financial statements for additional information about Medallion Bank and the other controlled subsidiaries. Equity investments were $4,880,000, down $11,188,000 or 70% from $16,068,000 a year ago, primarily reflecting the sale of a portion of the Clear Channel common stock received for our ownership interest in Media, partially offset by portfolio appreciation, and represented 1% of the investment portfolio and had a dividend yield of 4.70%, compared to 3% and 2.23% a year ago. Investment securities were zero at year end, compared to $9,961,000 a year ago, when they represented 2% of the investment portfolio and yielded 5.09%. See page 36 for a table that shows balances and yields by type of investment.

Interest expense was $30,704,000 in 2007, up $6,514,000 or 27% from $24,190,000 in 2006. The increase in interest expense was due to increased levels of borrowings compounded by the higher cost of borrowed funds. Average debt outstanding was $492,022,000 for 2007, compared to $425,061,000 a year ago, an increase of 16%, primarily reflecting increased borrowings used to fund portfolio investment growth. The cost of borrowed funds was 6.24% in 2007, compared to 5.69% a year ago, an increase 10%, reflecting increases in the general level of interest rates over the last year, and the adjustable rate nature of much of our borrowings. See page 43 for a table which shows average balances and cost of funds for our funding sources.

Net interest income was $20,689,000 and the net interest margin was 3.40% for 2007, up $5,244,000 or 34% from $15,445,000 a year ago, which represented a net interest margin of 3.01%, all reflecting the items discussed above.

Noninterest income, which is comprised of servicing fee income, prepayment penalties, late charges, and other miscellaneous income was $2,444,000 in 2007, down $202,000 or 8% from $2,646,000 a year ago. Included in 2006 was $629,000 of unusually large prepayment penalties from several large paid-off loans. Excluding those prepayment penalties, noninterest income increased 21% in 2007, reflecting higher servicing fees, other prepayment penalties, and late charges on a larger portfolio base.

Operating expenses were $17,835,000 in 2007, up $2,909,000 or 19% from $14,926,000 in 2006. Salaries and benefits expense was $10,192,000 in the year, up $1,999,000 or 24% from $8,193,000 in 2006, primarily reflecting higher bonus accruals and an increase in headcount and salary levels, partially offset by increased salary deferrals related to loan originations. Professional fees were $2,603,000 in 2007, up $648,000 or 33% from $1,955,000 a year ago. The increase primarily reflected higher investment project-related professional costs, higher accounting costs, including costs related to deconsolidating Medallion Bank and for consultant services for operational reviews, and higher legal expenses. Rent expense was $1,353,000 in the year, up $87,000 or 7% compared to $1,266,000 in 2006, reflecting lease adjustments. Other operating expenses of $3,687,000 in 2007 were up $175,000 or 5% from $3,512,000 a year ago, primarily reflecting higher general office expenses and franchise tax accruals, partially offset by lower directors fees and loan collections costs.

Income tax expense was $0 in 2007 and 2006.

Net unrealized depreciation on investments of $4,034,000 in 2007, compared to appreciation of $6,863,000 in 2006, a decrease of $10,897,000. Net change in unrealized depreciation, net of the net change in unrealized appreciation on Medallion Bank and the other controlled subsidiaries, was $6,326,000 in 2007, compared to $591,000 in 2006, resulting in increased depreciation of $5,735,000 in 2007. Unrealized appreciation (depreciation) arises when we make valuation adjustments to the investment portfolio. When investments are sold or written off, any resulting realized gain (loss) is grossed up to reflect previously recorded unrealized components. As a result, movement between periods can appear distorted. The 2007 activity resulted from reversals of unrealized appreciation associated with equity investments that were sold of $11,647,000, net unrealized depreciation on loans of $4,246,000, and reversals of unrealized appreciation associated with foreclosed properties that were sold of $1,336,000, partially offset by net unrealized appreciation on foreclosed property of $8,076,000, net appreciation on Medallion Bank and other controlled subsidiaries of $2,292,000, net unrealized appreciation on equity investments of $1,994,000, and by reversals of unrealized depreciation associated with fully depreciated loans which were charged off of $833,000. The net appreciation on Medallion Bank and other controlled subsidiaries described above is net of the $5,750,000 of dividends declared by them to Medallion Financial in 2007. The 2006 activity resulted from net appreciation on Medallion Bank and other controlled subsidiaries of $7,454,000, net unrealized appreciation on equity investments of $4,236,000, reversals of unrealized depreciation associated with fully depreciated loans which were charged off of $4,016,000, and net unrealized appreciation on foreclosed property of $921,000, partially offset by net unrealized depreciation on loans of $7,185,000 and reversals of unrealized appreciation associated with equity investments that were sold of $2,579,000. See Notes 3 and 4 to the consolidated financial statements for more information about Medallion Bank and other controlled subsidiaries.

Our net realized gains on investments were $14,172,000 in 2007, compared to $3,080,000 in 2006. The 2007 activity reflected the reversals described in the unrealized paragraph above and by net direct gains on sales of equity and other investments of $1,999,000 and net direct recoveries of $23,000. The 2006 activity reflected the above and net direct gains on sales of equity and other investments of $5,997,000 and gains on sales of foreclosed property of $4,000, partially offset by net direct chargeoffs $1,484,000.

 

44


Table of Contents

The Company’s net realized/unrealized gains on investments were $10,138,000 in 2007, compared to $9,943,000 in 2006, reflecting the above.

For the Years Ended December 31, 2006 and 2005

Net increase in net assets resulting from operations was $13,108,000 or $0.74 per diluted common share in 2006, up $6,246,000 or 91% from of $6,862,000 or $0.39 in 2005, which included the results of Business Lenders. The increase in 2006 primarily reflected higher net realized/unrealized portfolio gains, mostly representing the net appreciation on our investment in Medallion Bank, and lower operating expenses, partially offset by lower noninterest income and net interest income. Net investment income after taxes was $3,165,000 or $0.18 per diluted common share, down $1,417,000 or 31% from $4,582,000 or $0.26 per share in 2005.

Investment income was $39,635,000 in 2006, up $4,824,000 or 14% from $34,811,000 a year ago, and included $1,556,000 from interest recoveries on certain investments in 2006, compared to $1,480,000 in 2005. Investment income increased reflecting growth in the investment portfolios and higher yields earned. The yield on the investment portfolio was 7.71% in 2006, up 6% from 7.24% in 2005, reflecting the general increase in market interest rates and the refinancing of fixed rate loans at current rates. Average investments outstanding were $513,059,000 in 2006, up 7% from $480,784,000 a year ago, primarily reflecting growth in the medallion loan portfolio.

Medallion loans were $428,249,000 at year end, up $52,986,000 or 14% from $375,263,000 a year ago, representing 72% of the investment portfolio compared to 71% a year ago, and were yielding 6.93% compared to 6.50% a year ago, an increase of 7%. The increase in outstandings primarily reflected efforts to book new business and repurchase certain participations, primarily in the New York City and Boston markets, including the purchase of a $35,703,000 portfolio from Banco Popular, and also reflected the increase in medallion values, partially offset by several large fleet repayments, including reductions in Chicago. The managed medallion portfolio, which includes loans at Medallion Bank, was $527,976,000 at year end, up $70,024,000 or 15% from $457,952,000 a year ago. The commercial loan portfolio was $88,207,000 at year end, compared to $91,486,000 a year ago, a decrease of $3,279,000 or 4%, and represented 15% of the investment portfolio compared to 17% in 2005. The decrease primarily reflected the resolution of several large old nonperforming loans, relatively flat growth in the on-balance sheet asset-based lending portfolio, and the pay down of several large loans in the high-yield mezzanine loan portfolio. Commercial loans yielded 12.21% at year end, compared to 11.79% a year ago, an increase of 4%, reflecting the increases in market interest rates during year and the floating rate nature of much of the portfolio. The managed commercial portfolio, which includes loans at Medallion Bank, was $156,205,000 at year end, up $10,059,000 or 7% from $146,146,000 a year ago, primarily reflecting the increases described above and increased loan participations sold. Investments in Medallion Bank and other controlled subsidiaries was $50,448,000 at year end, up $10,113,000 or 25% from $40,335,000 a year ago, primarily reflecting the increased value of those investments, a large portion of which reflected the earnings of Medallion Bank. See Note 4 of the consolidated financial statements for additional information about Medallion Bank and the other controlled subsidiaries. Equity investments were $16,068,000, down $7,070,000 or 31% from $23,138,000 a year ago, primarily reflecting the sale of a portion of the Clear Channel common stock received for our ownership interest in Media and losses taken on certain mezzanine investments, partially offset by portfolio appreciation, and represented 3% of the investment portfolio and had a dividend yield of 2.23%, compared to 4% and 1.59% a year ago. Investment securities of $9,961,000 were up from zero a year ago, and represented 2% of the investment portfolio and yielded 5.09%. See page 36 for a table that shows balances and yields by type of investment.

Interest expense was $24,190,000 in 2006, up $6,193,000 or 34% from $17,997,000 in 2005. The increase in interest expense was due to the higher cost of borrowed funds compounded by increased levels of borrowings. The cost of borrowed funds was 5.69%, compared to 4.76% a year ago, an increase of 20%, reflecting increases in the general level of interest rates over the last year, and the floating rate nature of much of our borrowings. Average debt outstanding was $425,061,000 for 2006, compared to $377,874,000 a year ago, an increase of 12%, primarily reflecting increased borrowings used to fund portfolio investment growth. See page 43 for a table which shows average balances and cost of funds for our funding sources.

Net interest income was $15,445,000 and the net interest margin was 3.01% for 2006, down $1,369,000 or 8% from $16,814,000 a year ago, which represented a net interest margin of 3.50%, all reflecting the items discussed above.

Noninterest income was $2,646,000 in 2006, down $2,092,000 or 44% from $4,738,000 a year ago. Excluding amounts related to the sold Business Lenders loan portfolio, noninterest income, which is comprised of servicing fee income, prepayment fees,

 

45


Table of Contents

late charges, and other miscellaneous income, was down $203,000 or 7%. Included in 2006 were $629,000 of unusually large prepayment penalties from several large paid-off loans, compared to $810,000 a year ago. Excluding those prepayment penalties, noninterest income was relatively flat from year to year.

Operating expenses were $14,926,000 in 2006, compared to $16,984,000 in 2005, a decrease of $2,058,000 or 12%. Excluding the amounts related to the sold Business Lenders loan portfolio, operating expenses were up $840,000 or 6%, primarily reflecting costs of our growth initiatives. Salaries and benefits expense excluding Business Lenders was $8,193,000 in the year, up $519,000 or 7% from $7,674,000 in 2005, primarily reflecting lower amounts of salary deferrals related to loan originations, the costs associated with options granted, and increase in headcount and salary levels, partially offset by lower bonus accruals. Professional fees excluding Business Lenders were $1,955,000 in 2006, up $140,000 or 8% from $1,816,000 a year ago, primarily reflecting higher investment project-related professional costs and costs associated with certain investments. Other operating expenses excluding Business Lenders of $4,778,000 in the year were up $181,000 or 4% from $4,596,000 in 2005, reflecting lower travel and entertainment, depreciation, and advertising, partially offset by higher loan collections and miscellaneous tax expenses.

Income tax expense was $0 in 2006, compared to a tax benefit of $14,000 a year ago.

Net unrealized appreciation on investments was $6,863,000 in 2006, compared to depreciation of $1,327,000 in 2005, an increase of $8,189,000. Net unrealized depreciation net of the net unrealized appreciation on Medallion Bank and the other controlled subsidiaries was $591,000 in 2006 and $6,339,000 in 2005, resulting in decreased depreciation of $5,748,000 in 2006. Unrealized appreciation (depreciation) arises when we make valuation adjustments to the investment portfolio. When investments are sold or written off, any resulting realized gain (loss) is grossed up to reflect previously recorded unrealized components. As a result, movement between periods can appear distorted. The 2006 activity resulted from net appreciation on Medallion Bank and other controlled subsidiaries of $7,454,000, net unrealized appreciation on equity investments of $4,236,000, reversals of unrealized depreciation associated with fully depreciated loans which were charged off of $4,016,000, and net unrealized appreciation on foreclosed property of $921,000, partially offset by net unrealized depreciation on loans of $7,185,000 and reversals of unrealized appreciation associated with equity investments that were sold of $2,579,000. The 2005 activity resulted from reversals of unrealized appreciation associated with equity investments that were sold of $5,514,000, net unrealized depreciation on foreclosed property of $1,123,000, and net unrealized depreciation on loans of $1,011,000, partially offset by net appreciation on Medallion Bank and other controlled subsidiaries of $5,012,000, net unrealized appreciation on equity investments of $827,000, and reversals of unrealized depreciation associated with fully depreciated loans which were charged off of $482,000.

Also included in unrealized appreciation (depreciation) on investments was the net unrealized appreciation on Medallion Bank and other controlled subsidiaries of $7,454,000 in 2006 and $5,012,000 in 2005. Both years primarily reflected the results of operations of Medallion Bank. See notes 3 and 4 to the consolidated financial statements for information about these controlled subsidiaries.

Our net realized gains on investments were $3,080,000 in 2006, compared to $3,606,000 in 2005. The 2006 activity reflected the reversals described in the unrealized paragraph above and net direct gains on sales of equity and other investments of $5,997,000 and gains on sales of foreclosed property of $4,000, partially offset by net direct chargeoffs $1,484,000. The 2005 activity reflected the above and net direct gains on sales of equity investments of $2,439,000, partially offset by net direct chargeoffs of $3,864,000.

The Company’s net realized/unrealized gains on investments were $9,943,000 in 2006, compared to $2,280,000 in 2005, reflecting the above.

ASSET/LIABILITY MANAGEMENT

Interest Rate Sensitivity

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

Having interest-bearing liabilities that mature or reprice more frequently on average than assets may be beneficial in times of declining interest rates, although such an asset/liability structure may result in declining net earnings during periods of rising interest rates. Abrupt increases in market rates of interest may have an adverse impact on our earnings until we are able to originate new loans

 

46


Table of Contents

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, we anticipate that approximately 40% of the taxicab medallion portfolio will mature or be prepaid each year. We believe that the average life of our loan portfolio varies to some extent as a function of changes in interest rates. Borrowers are more likely to exercise prepayment rights in a decreasing interest rate environment because the interest rate payable on the borrower’s loan is high relative to prevailing interest rates. Conversely, borrowers are less likely to prepay in a rising interest rate environment. However, borrowers may prepay for a variety of other reasons, such as to monetize increases in the underlying collateral values, particularly in the medallion loan portfolio.

In addition, we manage our exposure to increases in market rates of interest by incurring fixed-rate indebtedness, such as ten year subordinated SBA debentures, and by setting repricing intervals or the maturities of tranches drawn under the revolving lines of credit or issued as certificates of deposit, for terms of up to five years. We had outstanding SBA debentures of $77,250,000 with a weighted average interest rate of 6.05%, constituting 14% of our total indebtedness as of December 31, 2007. Also, as of December 31, 2007, portions of the adjustable rate debt with banks repriced at intervals of as long as 57 months, and certain of the certificates of deposit were for terms of up to 34 months, further mitigating the immediate impact of changes in market interest rates.

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

The following table presents our interest rate sensitivity gap at December 31, 2007, compared to the respective positions at the end of 2006 and 2005. The principal amount of interest earning assets are assigned to the time frames in which such principal amounts are contractually obligated to be repriced. We have not reflected an assumed annual prepayment rate for such assets in this table.

 

     December 31, 2007 Cumulative Rate Gap (1)

(Dollars in thousands)

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

Earning assets

                  

Floating-rate

   $ 24,801     $ —       $ —       $ —      $ —      $ —       $ —       $ 24,801

Adjustable rate

     19,078       1,641       2,132       26,979      11,314      —         —         61,144

Fixed-rate

     69,864       92,373       167,235       90,628      65,744      7,531       17,080       510,455

Cash

     33,454       —         —         —        —        —         —         33,454
                                                            

Total earning assets

   $ 147,197     $ 94,014     $ 169,367     $ 117,607    $ 77,058    $ 7,531     $ 17,080     $ 629,854
                                                            

Interest bearing liabilities

                  

Revolving line of credit

   $ 411,449     $ —       $ —       $ —      $ —      $ —       $ —       $ 411,449

Notes payable to banks

     14,000       1,728       5,122       —        33,000      —         —         53,850

SBA debentures

     —         —         —         17,985      13,500      19,450       26,315       77,250
                                                            

Total liabilities

   $ 425,449     $ 1,728     $ 5,122     $ 17,985    $ 46,500    $ 19,450     $ 26,315     $ 542,549
                                                            

Interest rate gap

   $ (278,252 )   $ 92,286     $ 164,245     $ 99,622    $ 30,558    $ (11,919 )   $ (9,235 )   $ 87,305
                                                            

Cumulative interest rate gap (2)

   $ (278,252 )   $ (185,966 )   $ (21,721 )   $ 77,901    $ 108,459    $ 96,540     $ 87,305       —  
                                                            

December 31, 2006 (2)

   $ (267,015 )   $ (152,783 )   $ (8,334 )   $ 53,943    $ 127,019    $ 115,046     $ 89,104       —  

December 31, 2005 (2)

     (99,581 )     (118,589 )     43,224       105,049      153,469      139,543       96,083       —  
                                                            

 

(1)

The ratio of the cumulative one year gap to total interest rate sensitive assets was (44%), (49%), and (20%), as of December 31, 2007, 2006, and 2005, and was (34%), (34%), and (11%), on a combined basis with Medallion Bank.

(2)

Adjusted for the medallion loan 40% prepayment assumption results in a cumulative one year negative interest rate gap and related ratio of ($127,292) or (20%) for December 31, 2007, compared to a negative rate gap of ($127,184) or ( 23%) and a positive rate gap of $10,768 or 2% for December 31, 2006 and 2005, respectively, and was ($156,202) or (16%), ($117,151) or (14%), and $47,912 or 6% on a combined basis with Medallion Bank.

 

47


Table of Contents

Our interest rate sensitive assets were $629,854,000 and interest rate sensitive liabilities were $542,549,000 at December 31, 2007. The one-year cumulative interest rate gap was a negative $278,252,000 or 44% of interest rate sensitive assets, compared to a negative $267,015,000 or 49% at December 31, 2006 and $99,581,000 or 20% at December 31, 2005. However, using our estimated 40% prepayment/refinancing rate for medallion loans to adjust the interest rate gap resulted in a negative gap of $127,292,000 or 20% at December 31, 2007. We seek to manage interest rate risk by originating adjustable-rate loans, by incurring fixed-rate indebtedness, by evaluating appropriate derivatives, pursuing securitization opportunities, and by other options consistent with managing interest rate risk.

On a combined basis with Medallion Bank, our interest rate sensitive assets were approximately $985,233,000 and interest rate sensitive liabilities were $841,632,000 at December 31, 2007. The one-year cumulative interest rate gap was a negative $333,855,000 or 34% of interest rate sensitive assets, compared to a negative $287,680,000 or 34% and $82,358,000 or 11% at December 31, 2006 and 2005. Using our estimated 40% prepayment/refinancing rate for medallion loans to adjust the interest rate gap resulted in a negative gap of $156,202,000 or 16% at December 31, 2007.

Interest Rate Cap Agreements

From time-to time, we enter into interest rate cap agreements to manage the exposure of the portfolio to increases in market interest rates by hedging a portion of our variable-rate debt against increases in interest rates. There were no interest rate caps outstanding during 2007, 2006, and 2005.

Liquidity and Capital Resources

Our sources of liquidity are the revolving lines of credit with Merrill Lynch and Citibank, unfunded commitments from the SBA for long-term debentures that are issued to or guaranteed by the SBA, loan amortization and prepayments, private issuances of debt securities and participations or sales of loans to third parties. As a RIC, we are required to distribute at least 90% of our investment company taxable income; consequently, we have primarily relied upon external sources of funds to finance growth. The Trust’s $375,000,000 revolving line of credit with Merrill Lynch had availability of $84,210,000, and Trust II’s $250,000,000 line had availability of $129,342,000 as of December 31, 2007. Medallion Capital and Freshstart have $13,500,000 and $6,000,000 of additional funding commitments with the SBA, which requires capital contributions from us of $6,750,000 and $2,000,000, respectively. Since SBA financing subjects its recipients to certain regulations, we will seek funding at the subsidiary level to maximize its benefits. Lastly, $24,000,000 was available under revolving credit agreements with commercial banks, and approximately $347,000 was available under the company’s margin loan.

Additionally, Medallion Bank, our wholly-owned, unconsolidated portfolio company has access to independent sources of funds for our business originated there, primarily through brokered certificates of deposit. At the current required capital levels, it is expected, although there can be no guarantee, that deposits of approximately $4,000,000 could be raised by Medallion Bank to fund future loan origination activity, and Medallion Bank also has $15,000,000 available under Fed Funds lines with several commercial banks. In addition, Medallion Bank as a non-RIC subsidiary of ours is allowed to retain all earnings in the business to fund future growth.

The components of our debt were as follows at December 31, 2007. See note 5 to the consolidated financial statements on page F-21 for details of the contractual terms of our borrowings.

 

(Dollars in thousands)

   Balance    Percentage     Rate (1)  

Revolving lines of credit

   $ 411,449    76 %   5.58 %

SBA debentures

     77,250    14     6.05  

Preferred securities

     33,000    6     7.68  

Notes payable to banks

     20,850    4     6.81  
               

Total outstanding debt

   $ 542,549    100 %   5.83  
                   

Certificates of deposit at Medallion Bank

     299,083    —       4.85 %
           

Total outstanding debt, including Medallion Bank

   $ 841,632    —       5.48  
                   

 

(1)

Weighted average contractual rate as of December 31, 2007.

 

48


Table of Contents

Our contractual obligations expire on or mature at various dates through September 2037. The following table shows all contractual obligations at December 31, 2007.

 

     •        Payments due by period

(Dollars in thousands)

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

Revolving lines of credit

   $ 290,791    $ 120,658    $ —      $ —      $ —      $ —      $ 411,449

SBA debentures

     —        —        —        17,985      13,500      45,765      77,250

Preferred securities

     —        —        —        —        —        33,000      33,000

Notes payable to banks

     14,281      1,855      4,714      —        —        —        20,850
                                                

Total

   $ 305,072    $ 122,513    $ 4,714    $ 17,985    $ 13,500    $ 78,765    $ 542,549
                                                

Certificates of deposit at Medallion Bank

     196,599      91,924      10,560      —        —        —        299,083
                                                

Total, including Medallion Bank

   $ 501,671    $ 214,437    $ 15,274    $ 17,985    $ 13,500    $ 78,765    $ 841,632
                                                

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

In addition, the illiquidity of our loan portfolio and investments may adversely affect our ability to dispose of loans at times when it may be advantageous for us to liquidate such portfolio or investments. In addition, if we were required to liquidate some or all of the investments in the portfolio, the proceeds of such liquidation may be significantly less than the current value of such investments. Because we borrow money to make loans and investments, our net operating income is dependent upon the difference between the rate at which we borrow funds and the rate at which we invest these funds. As a result, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our interest income. In periods of sharply rising interest rates, our cost of funds would increase, which would reduce our net operating income before net realized and unrealized gains. We use a combination of long-term and short-term borrowings and equity capital to finance our investing activities. Our long-term fixed-rate investments are financed primarily with short-term floating-rate debt, and to a lesser extent by term fixed-rate debt. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. Such techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act. We have analyzed the potential impact of changes in interest rates on net interest income. Assuming that the balance sheet were to remain constant and no actions were taken to alter the existing interest rate sensitivity, and including the impact on Medallion Bank, a hypothetical immediate 1% increase in interest rates would have positively impacted net increase in net assets resulting from operations as of December 31, 2007 by approximately $374,000 on an annualized basis, compared to a positive impact of $399,000 at December 31, 2006, and the impact of such an immediate increase of 1% over a one year period would have been ($2,895,000) at December 31, 2007, compared to ($2,334,000) for December 31, 2006. Although management believes that this measure is indicative of our sensitivity to interest rate changes, it does not adjust for potential changes in credit quality, size, and composition of the assets on the balance sheet, and other business developments that could affect net increase in net assets resulting from operations in a particular quarter or for the year taken as a whole. Accordingly, no assurances can be given that actual results would not differ materially from the potential outcome simulated by these estimates.

We continue to work with investment banking firms and other financial intermediaries to investigate the viability of a number of other financing options which include, among others, the sale or spin off certain assets or divisions, the development of a securitization conduit program, and other independent financing for certain subsidiaries or asset classes. These financing options would also provide additional sources of funds for both external expansion and continuation of internal growth.

 

49


Table of Contents

The following table illustrates sources of available funds for us and each of our subsidiaries, and amounts outstanding under credit facilities and their respective end of period weighted average interest rates at December 31, 2007. See note 5 to the consolidated financial statements for additional information about each credit facility.

 

(Dollars in thousands)

   The
Company
    MFC     MCI     MBC   FSVC     UTAH     Total     12/31/06  

Cash

   $ 14,709     $ 4,005     $ 4,346     $ 4,806   $ 5,588     $ —       $ 33,454     $ 15,399  

Bank loans (1)

     20,000       18,000       —         —       —         —         38,000       26,000  

Amounts undisbursed

     6,000       18,000       —         —       —         —         24,000       15,425  

Amounts outstanding

     14,000       6,850       —         —       —         —         20,850       15,210  

Average interest rate

     6.86 %     6.72 %     —         —       —         —         6.81 %     7.41 %

Maturity

     6/08       8/08-6/10       —         —       —         —         6/08-6/10       6/07-12/09  

Preferred Securities(2)

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

Average interest rate

     7.68 %     —         —         —       —         —         7.68 %     —    

Maturity

     09/37       —         —         —       —         —         09/37       —    

Lines of Credit

     —         625,000       —         —       —         —         625,000       500,000  

Amounts undisbursed

     —         213,551       —         —       —         —         213,551       151,251  

Amounts outstanding

     —         411,449       —         —       —         —         411,449       348,749  

Average interest rate

     —         5.58 %     —         —       —         —         5.58 %     5.52 %

Maturity

     —         9/08-12/09       —         —       —         —         9/08-12/09       9/08-12/09  

Margin loan

     —         —         —         —       —         —         —         13,928  

Average interest rate

     —   %     —         —         —       —         —         —   %     6.19 %

Maturity

     N/A       —         —         —       —         —         N/A       N/A  

SBA debentures

     —         —         46,750       —       50,000       —         96,750       96,750  

Amounts undisbursed

     —         —         13,500       —       6,000       —         19,500       19,500  

Amounts outstanding

     —         —         33,250       —       44,000       —         77,250       77,250  

Average interest rate

     —         —         6.02 %     —       6.08 %     —         6.05 %     6.05 %

Maturity

     —         —         9/11-9/15       —       9/11-3/16       —         9/11-3/16       9/11-3/16  
                                                              

Total cash and amounts remaining undisbursed under credit facilities

   $ 20,709     $ 235,556     $ 17,846     $ 4,806   $ 11,588     $ —       $ 290,505     $ 201,575  
                                                              

Total debt outstanding

   $ 47,000     $ 418,299     $ 33,250     $ —     $ 44,000     $ —       $ 542,549     $ 455,137  
                                                              

Including Medallion Bank

                
                                                              

Cash

     —         —         —         —       —       $ 17,025     $ 17,025     $ 14,699  

Certificates of deposit

     —         —         —         —       —         299,083       299,083       261,484  

Average interest rate

     —         —         —         —       —         4.85 %     4.85 %     4.36 %

Maturity

     —         —         —         —       —         1/08-10/10       1/08-10/10       01/07-10/10  
                                                              

Total cash and amounts remaining undisbursed under credit facilities

   $ 20,709     $ 235,556     $ 17,846     $ 4,806   $ 11,588     $ 17,025     $ 307,530     $ 216,274  
                                                              

Total debt outstanding

   $ 47,000     $ 418,299     $ 33,250     $ —     $ 44,000     $ 299,083     $ 841,632     $ 716,620  
                                                              

 

(1)

In September 2007, MFC entered into a $10,000 revolving note agreement with Citibank that matures on June 30, 2008. In March 2007, we amended our revolving secured line of credit with Atlantic Bank, a division of New York Commercial Bank, to increase the line from $6,000 to $8,000.

(2)

In September 2007, the Company under its new Trust “Fin Trust” issued and sold $35,000 of Preferred Securities (Securities) to Merrill Lynch. The Securities bear interest at a fixed rate of 7.68% through September 2012, and thereafter, at a variable rate of 90 day LIBOR plus 2.125%. In December 2007, $2,000 of the Securities were repurchased from a broker for $1,300. The remaining Securities mature in September 2037.

(3)

In November 2007, the line of credit with Citibank was renewed, extended, and increased to $250,000.

Loan amortization, prepayments, and sales also provide a source of funding for us. Prepayments on loans are influenced significantly by general interest rates, medallion loan market values, economic conditions, and competition. We believe that our credit facilities with Merrill Lynch and Citibank, deposits generated at Medallion Bank, other borrowing arrangements, and cash flow from operations (after distributions to shareholders) will be adequate to fund the continuing operations of our loan portfolio. Also, Medallion Bank is not a RIC, and therefore is able to retain earnings to finance growth.

Recently Issued Accounting Standards

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51, which establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and

 

50


Table of Contents

for the deconsolidation of a subsidiary by clarifying that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as a component of equity. It requires that changes in a parent’s ownership interest while the parent retains its controlling interest be accounted for as equity transactions and any retained noncontrolling equity investment upon the deconsolidation of a subsidiary be initially measured at fair value. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008 and shall be applied prospectively, except for the presentation and disclosure requirements which shall be applied retrospectively. We do not believe that this pronouncement will have an impact on our financial condition or results of operations.

In December 2007, the FASB issued SFAS No. 141R (revised 2007), Business Combinations which establishes principles and requirements on how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date fair value, as well as the recognition and measurement of goodwill acquired in a business combination. SFAS No. 141R also requires certain disclosures to enable users of the financial statements to evaluate the nature and financial effects of the business combination. Acquisition costs associated with the business combination will generally be expensed as incurred. SFAS No. 141R is effective prospectively to business combinations in fiscal years beginning on or after December 15, 2008. We do not believe that this pronouncement will have an impact on our financial condition or results of operations.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”, which includes an amendment to SFAS No. 115. This statement permits entities to choose to measure eligible financial instruments and certain other items at fair value at specified election dates. This statement is effective for fiscal years beginning after November 15, 2007. We do not believe that this pronouncement will have an impact on our financial condition or results of operations.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” an amendment of FASB Statements No. 87, 88, 106, and 132(R) (“SFAS 158”). SFAS No. 158 requires an employer to: (a) recognize in its statement of financial position the funded status of a benefit plan; (b) measure defined benefit plan assets and obligations as of the end of the employer’s fiscal year (with limited exceptions); and (c) recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise but are not recognized as components of net periodic benefit costs pursuant to prior existing guidance, any adjustment to amounts recognized in accumulated other comprehensive income. The provisions governing recognition of the funded status of a defined benefit plan and related disclosures are effective as of the end of fiscal years ending after December 15, 2006 and not before June 16, 2007. The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. We do not believe that this pronouncement will have an impact on our financial condition or results of operations.

In September 2006, the FASB issued SFAS No.157, “Fair Value Measurement.” This statement defines fair values, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. We currently follow fair market value accounting in our consolidated financial statements as a RIC; hence we do not expect the adoption of SFAS No.157 to have a material effect on our financial condition and results of operations. This statement is effective for fiscal years beginning after November 15, 2007.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting For Uncertainty in Income Taxes.” The interpretation sets a recognition threshold and measurement attribute for recognizing tax positions in a company’s financial statements based on a determination whether it is likely or not that the tax position would withstand a tax audit, without regard for the likelihood of a tax audit taking place. Assuming a position meets the”more-likely-than-not” threshold, the interpretation also prescribes a measurement attribute requiring determination of how much of the tax position would ultimately be allowed if challenged. The interpretation is effective for fiscal years beginning after December 15, 2006. We do not believe that this pronouncement will have an impact on our financial condition or results of operations.

In February 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments,” an amendment of SFAS Nos. 133 and 140. This statement permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133, establishes a requirement to evaluate interests in securitized financial assets to identify interests that are free standing derivatives or that are hybrid financial instruments that contain an embedded derivative that require bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends SFAS No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. This statement is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006, as defined. The adoption of SFAS No. 155 does not have a material impact on our consolidated financial position or results of operations.

 

51


Table of Contents
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our business activities contain elements of risk. We consider the principal types of risk to be fluctuations in interest rates and portfolio valuations. We consider the management of risk essential to conducting our businesses. Accordingly, our risk management systems and procedures are designed to identify and analyze our risks, to set appropriate policies and limits, and to continually monitor these risks and limits by means of reliable administrative and information systems and other policies and programs.

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

In addition, the illiquidity of our loan portfolio and investments may adversely affect our ability to dispose of loans at times when it may be advantageous for us to liquidate such portfolio or investments. In addition, if we were required to liquidate some or all of the investments in the portfolio, the proceeds of such liquidation may be significantly less than the current value of such investments. Because we borrow money to make loans and investments, our net operating income is dependent upon the difference between the rate at which we borrow funds and the rate at which we invest these funds. As a result, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our interest income. In periods of sharply rising interest rates, our cost of funds would increase, which would reduce our net operating income before net realized and unrealized gains. We use a combination of long-term and short-term borrowings and equity capital to finance our investing activities. Our long-term fixed-rate investments are financed primarily with short-term floating-rate debt, and to a lesser extent by term fixed-rate debt. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. Such techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act. We have analyzed the potential impact of changes in interest rates on net interest income. Assuming that the balance sheet were to remain constant and no actions were taken to alter the existing interest rate sensitivity, and including the impact on Medallion Bank, a hypothetical immediate 1% increase in interest rates would have positively impacted net increase in net assets resulting from operations as of December 31, 2007 by approximately $374,000 on an annualized basis, compared to a positive impact of $399,000 at December 31, 2006, and the impact of such an immediate increase of 1% over a one year period would have been ($2,895,000) at December 31, 2007, compared to ($2,334,000) for December 31, 2006. Although management believes that this measure is indicative of our sensitivity to interest rate changes, it does not adjust for potential changes in credit quality, size, and composition of the assets on the balance sheet, and other business developments that could affect net increase in net assets resulting from operations in a particular quarter or for the year taken as a whole. Accordingly, no assurances can be given that actual results would not differ materially from the potential outcome simulated by these estimates.

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Reference is made to the financial statements set forth under Item 15 (A) (1) in this Annual Report on Form 10-K, which financial statements are incorporated herein by reference in response to this Item 8.

 

52


Table of Contents
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES

None.

 

ITEM 9A. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

As required by Rule 13a-15(b) under the Exchange Act, our management, including our Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of our disclosure controls and procedures as of the end of the fiscal year covered by this annual report. As a result of this evaluation, we have concluded that our disclosure controls and procedures were effective as of December 31, 2007.

Changes in Internal Control Over Financial Reporting

As required by Rule 13a-15(d) under the Exchange Act, our management, including our Chief Executive Officer and Chief Financial Officer, have evaluated our internal control over financial reporting to determine whether any changes occurred during the fourth quarter of 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

In 2006, management determined that there was a material weakness relating to the documentation and oversight of the monitoring of certain of the loans and/or investments included in the portfolio of one of our subsidiaries, Medallion Capital. This deficiency resulted in more than a remote likelihood that a material misstatement to the annual or interim consolidated financial statements would not be prevented or detected. We took action to remediate the material weakness described above, which was completed during the 2007 fourth quarter. The actions taken to remediate that material weakness were as follows:

 

   

Implemented an enhanced review, monitoring, and reporting process to include additional documentation requirements to ensure that early detection and prevention of a potential impairment in value of an investment and changes in investment value, if any, are properly documented and reviewed;

 

   

Formalized communication channels between the management of Medallion Capital and us relating to the monitoring of loans and/or investments included in the Medallion Capital portfolio.

Except for the changes discussed above, there have been no changes that occurred during the 2007 fourth quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Management’s Annual Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) and 15d-15(f) promulgated under the Exchange Act as a process designed by, or under the supervision of, our principal executive and principal financial officers and effected our Board of Directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles, and includes those policies and procedures that:

 

   

Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;

 

   

Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and

 

   

Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

53


Table of Contents

Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2007. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. Based on its assessment and those criteria, management believes that we maintained effective internal control over financial reporting as of December 31, 2007.

We believe that the consolidated financial statements included in this report fairly represent our consolidated financial position and consolidated results of operations for all periods presented.

Our Independent Registered Public Accounting Firm, Weiser LLP, has audited and issued a report on management’s assessment of our internal control over financial reporting. The report of Weiser LLP appears below.

 

54


Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Medallion Financial Corp.

We have audited Medallion Financial Corp. and subsidiaries’ (the “Company”) internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A Company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company including the consolidated schedule of investments, as of December 31, 2007 and 2006, and the related consolidated statements of operations, changes in net assets, cash flows, and the selected financial ratios and other data for each of the three years in the three-year period ended December 31, 2007, and our report dated March 13, 2008 expressed an unqualified opinion on those consolidated financial statements.

 

Weiser LLP

New York, New York

March 13, 2008

 

55


Table of Contents
ITEM 9B. OTHER INFORMATION

None.

PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE

Incorporated by reference from our Definitive Proxy Statement expected to be filed by April 29, 2008 for its fiscal year 2008 Annual Meeting of Shareholders under the captions “Our Directors and Executive Officers” and “Corporate Governance.”

 

ITEM 11. EXECUTIVE COMPENSATION

Incorporated by reference from our Definitive Proxy Statement expected to be filed by April 29, 2008 for our fiscal year 2008 Annual Meeting of Shareholders under the caption “Executive Compensation.”

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Incorporated by reference from our Definitive Proxy Statement expected to be filed by April 29, 2008 for our fiscal year 2008 Annual Meeting of Shareholders under the captions “Stock Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information.”

 

ITEM 13. CERTAIN RELATIONSHIPS, RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

Incorporated by reference from our Definitive Proxy Statement expected to be filed by April 29, 2008 for our fiscal year 2008 Annual Meeting of Shareholders under the caption “Certain Relationships and Related Party Transactions.”

 

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

Incorporated by reference from our Definitive Proxy Statement expected to be filed by April 29, 2008 for our fiscal year 2008 Annual Meeting of Shareholders under the caption “Principal Accountant Fees and Services.”

PART IV

 

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(A) 1. FINANCIAL STATEMENTS

The consolidated financial statements of Medallion Financial Corp. and the Report of Independent Public Accountants thereon are included as set forth on the Index to Financial Statements on F-1.

       2. FINANCIAL STATEMENT SCHEDULES

See Index to Financial Statements on F-1.

       3. EXHIBITS

 

Number

  

Description

  2.1    Agreement and Plan of Merger, dated September 3, 2004, between Medallion Financial Corp., Medallion Taxi Media, Inc., Clear Channel Communications, Inc., and Checker Acquisition Corp. Filed as Exhibit 2.1 to the Current Report on Form 8-K, filed on September 10, 2004 (File No. 814-00188) and incorporated by reference herein.

 

56


Table of Contents
  2.2    Amended and Restated Asset Purchase Agreement, dated October 17, 2005, by and among Medallion Financial Corp., Business Lenders, LLC, and BLL Acquisition LLC. Filed as Exhibit 2.1 to the Current Report on Form 8-K, filed on October 18, 2005 (File No. 814-00188) and incorporated by reference herein.
  3.1(a)    Restated Medallion Financial Corp. Certificate of Incorporation. Filed as Exhibit 2(a) to the Company’s Registration Statement on Form N-2 (File No. 333-1670) and incorporated by reference herein.
  3.1(b)    Amendment to Restated Certificate of Incorporation. Filed as Exhibit 3.1.1 to the Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1998 (File No. 814-00188) and incorporated by reference herein.
  3.2    Restated By-Laws. Filed as Exhibit (b) to the Company’s Registration Statement on Form N-2 (File No. 333-1670) and incorporated by reference herein.
  4.1    Third Amended and Restated Promissory Note, dated September 5, 2006, by Taxi Medallion Loan Trust I, in favor of Merrill Lynch Commercial Finance Corp. Filed as Exhibit 4.1 to the Current Report on Form 8-K filed on September 8, 2006 (File No. 814-00188) and incorporated by reference herein.
  4.2    Amended and Restated Revolving Secured Line of Credit Promissory Note, dated March 6, 2006, by Medallion Funding Corp., in favor of Atlantic Bank of New York. Filed as Exhibit 4.1 to the Current Report on Form 8-K filed on March 9, 2006 (File No. 814-00188) and incorporated by reference herein.
  4.3    Amendment to Amended and Restated Revolving Secured Line of Credit Promissory Note, dated August 1, 2006, by Medallion Funding Corp., in favor of Atlantic Bank of New York. Filed as Exhibit 4.1 to the Current Report on Form 8-K filed on August 4, 2006 (File No. 814-00188) and incorporated by reference herein.
  4.4    Amendment No. 2 to Amended and Restated Revolving Secured Line of Credit Promissory Note, dated January 16, 2007, by Medallion Funding Corp., in favor of New York Commercial Bank, formerly known as Atlantic Bank of New York. Filed as Exhibit 4.1 to the Current Report on Form 8-K filed on January 17, 2007 (File No. 814-00188) and incorporated by reference herein.
  4.5    Amendment to Amended and Restated Revolving Secured Line of Credit Promissory Note, dated March 22, 2007, by Medallion Funding Corp., in favor of Atlantic Bank. Filed as Exhibit 4.1 to the Current Report on Form 8-K filed on April 18, 2007 (File No. 814-00188) and incorporated by reference herein.
  4.6    Amendment to Amended and Restated Revolving Secured Line of Credit Promissory Note, dated as of July 26, 2007, by Medallion Funding Corp., in favor of Atlantic Bank. Filed as Exhibit 4.2 to the Current Report on Form 8-K filed on August 3, 2007 (File No. 814-00188) and incorporated by reference herein.
  4.7    Amendment to Amended and Restated Revolving Secured Line of Credit Promissory Note, dated as of September 26, 2007, by Medallion Funding Corp., in favor of Atlantic Bank. Filed as Exhibit 4.1 to the Current Report on Form 8-K filed on September 27, 2007 (File No. 814-00188) and incorporated by reference herein.
  4.8    Substitute Revolving Credit Note, dated December 31, 2007, by Medallion Financial Corp., in favor of Sterling National Bank. Filed as Exhibit 4.1 to the Current Report on Form 8-K filed on January 3, 2008 (File No. 814-00188) and incorporated by reference herein.
  4.9    Amended and Restated Promissory Note, dated November 29, 2007, by Taxi Medallion Loan Trust II, in favor of Citicorp North America, Inc. (the “Managing Agent”) for the benefit of the lenders in the Managing Agent’s related lender group. Filed as Exhibit 4.1 to the Current Report on Form 8-K filed on December 4, 2007 (File No. 814-00188) and incorporated by reference herein.
  4.10    Fixed/Floating Rate Junior Subordinated Note, dated June 7, 2007, by Medallion Financial Corp., in favor of Medallion Financing Trust I. Filed as Exhibit 4.1 to the Current Report on Form 8-K filed on June 11, 2007 (File No. 814-00188) and incorporated by reference herein.

 

57


Table of Contents
  4.11    Master Note, dated September 19, 2007, by Medallion Funding Corp., in favor of Citibank, N.A. Filed as Exhibit 4.1 to the Current Report on Form 8-K filed on September 21, 2007 (File No. 814-00188) and incorporated by reference herein.
10.1    First Amended and Restated Employment Agreement, between Medallion Financial Corp. and Alvin Murstein dated May 29, 1998. Filed as Exhibit 10.19 to the Annual Report on Form 10-K for the fiscal year ended December 31, 1998 (File No. 814-00188) and incorporated by reference herein.*
10.2    First Amended and Restated Employment Agreement, between Medallion Financial Corp. and Andrew Murstein dated May 29, 1998. Filed as Exhibit 10.20 to the Annual Report on Form 10-K for the fiscal year ended December 31, 1998 (File No. 814-00188) and incorporated by reference herein.*
10.3    Employment Agreement, dated August 3, 2006, by and between Medallion Financial Corp. and Michael Kowalsky. Filed as Exhibit 10.1 to the Current Report on Form 8-K filed on August 4, 2006 (File No. 814-00188) and incorporated by reference herein.*
10.4    Medallion Financial Corp. Amended and Restated 1996 Stock Option Plan. Filed as Exhibit 10.1 to the Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2002 (File No. 814-00188) and incorporated by reference herein.*
10.5    Medallion Financial Corp. Amended and Restated 1996 Non-Employee Directors Stock Option Plan. Filed as Exhibit A to the Company’s Request Form on Amendment and the Order by the Commission approving the plan as of April 3, 2000 (File No. 812-11800) and incorporated by reference herein.*
10.6    2006 Employee Stock Option Plan. Filed as Exhibit II to our definitive proxy statement for our 2006 Annual Meeting of Shareholders filed on April 28, 2006 (File No. 814-00188) and incorporated by reference herein.*
10.7    2006 Non-Employee Director Stock Option Plan. Filed as Exhibit I to our definitive proxy statement for our 2006 Annual Meeting of Shareholders filed on April 28, 2006 (File No. 814-00188) and incorporated by reference herein.*
10.8    Non-Employee Director Compensation Summary Sheet. Filed herewith.*
10.9    Indenture of Lease, dated October 31, 1997, by and between Sage Realty Corporation, as Agent and Landlord, and Medallion Financial Corp., as Tenant. Filed as Exhibit 10.64 to the Annual Report on Form 10-K for the fiscal year ended December 31, 1997 (File No. 814-00188) and incorporated by reference herein.
10.10    First Amendment of Lease, dated September 6, 2005, by and between Medallion Financial Corp. and Sage Realty Corporation. Filed as Exhibit 10.1 to the Current Report on Form 8-K filed on September 12, 2005 (File No. 814-00188) and incorporated by reference herein.
10.11    Amended and Restated Loan and Security Agreement dated as of September 13, 2003, by and among Taxi Medallion Loan Trust I and Merrill Lynch Commercial Finance Corp. Filed as Exhibit 10.1 to the Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2003 (File No. 814-00188) and incorporated by reference herein.
10.12    Amendment No. 1 to Amended and Restated Loan and Security Agreement, dated August 12, 2004, by and between Taxi Medallion Loan Trust I and Merrill Lynch Commercial Finance Corp. Filed as Exhibit 10.9 to the Annual Report on Form 10-K for the fiscal year ended December 31, 2005 (File No. 814-00188) and incorporated by reference herein.
10.13    Amendment No. 2 to Amended and Restated Loan and Security Agreement, dated January 7, 2005, by and between Taxi Medallion Loan Trust I and Merrill Lynch Commercial Finance Corp. Filed as Exhibit 10.1 to the Current Report on Form 8-K filed on January 11, 2005 (File No. 814-00188) and incorporated by reference herein.
10.14    Amendment No. 3 to Amended and Restated Loan and Security Agreement, dated January 9, 2006, by and between Taxi Medallion Loan Trust I and Merrill Lynch Commercial Finance Corp. Filed as Exhibit 10.1 to the Current Report on Form 8-K filed on January 11, 2006 (File No. 814-00188) and incorporated by reference herein.

 

58


Table of Contents
10.15    Amendment No. 4 to Amended and Restated Loan and Security Agreement, dated September 5, 2006, by and between Taxi Medallion Loan Trust I and Merrill Lynch Commercial Finance Corp. Filed as Exhibit 10.1 to the Current Report on Form 8-K filed on September 8, 2006 (File No. 814-00188) and incorporated by reference herein.
10.16    Amendment No. 5 to Amended and Restated Loan and Security Agreement, dated December 19, 2006, by and between Taxi Medallion Loan Trust I and Merrill Lynch Commercial Finance Corp. Filed as Exhibit 10.1 to the Current Report on Form 8-K filed on December 21, 2006 (File No. 814-00188) and incorporated by reference herein.
10.17    Loan and Sale Contribution Agreement, dated as of September 13, 2002, between Medallion Financial Corp. and Taxi Medallion Loan Trust I. Filed as Exhibit 10.5 to the Current Report on Form 8-K filed on September 18, 2002 (File No. 814-00188) and incorporated by reference herein.
10.18    Loan Sale and Exchange Agreement, dated as of September 13, 2002, between Medallion Financial Corp. and Medallion Funding Corp. Filed as Exhibit 10.6 to the Current Report on Form 8-K filed on September 18, 2002 (File No. 814-00188) and incorporated by reference herein.
10.19    Servicing Agreement, by and among Taxi Medallion Loan Trust I, Medallion Funding Corp., and Merrill Lynch Bank USA, dated as of September 13, 2002. Filed as Exhibit 10.7 to the Current Report on Form 8-K filed on September 18, 2002 (File No. 814-00188) and incorporated by reference herein.
10.20    Amendment to Servicing Agreement, by and among Taxi Medallion Loan Trust I, Medallion Funding Corp. and Merrill Lynch Commercial Finance Corp. as successor in interest to Merrill Lynch Bank USA, dated as of September 12, 2003. Filed as Exhibit 10.1 to the Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2003 (File No. 814-00188) and incorporated by reference herein.
10.21    Amendment No. 2 to Servicing Agreement, by and among Taxi Medallion Loan Trust I, Medallion Funding Corp., and Merrill Lynch Commercial Finance Corp. as successor in interest to Merrill Lynch Bank USA, dated as of September 1, 2004. Filed as Exhibit 10.15 to the Annual Report on Form 10-K for the fiscal year ended December 31, 2005 (File No. 814-00188) and incorporated by reference herein.
10.22    Custodial Agreement, dated as of September 13, 2002, among the lenders thereto, Taxi Medallion Loan Trust I, Medallion Funding Corp., and Wells Fargo Bank Minnesota, N.A. Filed as Exhibit 10.8 to the Current Report on Form 8-K filed on September 18, 2002 (File No. 814-00188) and incorporated by reference herein.
10.23    Amended and Restated Trust Agreement, dated as of September 13, 2002, by and between Medallion Funding Corp. and Wachovia Trust Company, N.A. Filed as Exhibit 10.9 to the Current Report on Form 8-K filed on September 18, 2002 (File No. 814-00188) and incorporated by reference herein.
10.24    Loan and Security Agreement, dated April 26, 2004, by and between Medallion Financial Corp. and Sterling National Bank. Filed herewith. Filed as Exhibit 10.18 to the Annual Report on Form 10-K for the fiscal year ended December 31, 2005 (File No. 814-00188) and incorporated by reference herein.
10.25    First Amendment to Loan and Security Agreement, dated as of July 28, 2005, by and between Medallion Financial Corp. and Sterling National Bank. Filed as Exhibit 10.2 to the Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005 (File No. 814-00188) and incorporated by reference herein.
10.26    Second Amendment to Loan and Security Agreement, dated August 14, 2006, by and between Medallion Financial Corp. and Sterling National Bank. Filed as Exhibit 10.1 to the Current Report on Form 8-K filed on August 16, 2006 (File No. 814-00188) and incorporated by reference herein.
10.27    Third Amendment to Loan and Security Agreement, dated July 31, 2007, by and between Medallion Financial Corp. and Sterling National Bank. Filed as Exhibit 10.1 to the Current Report on Form 8-K filed on August 3, 2007 (File No. 814-00188) and incorporated by reference herein.

 

59


Table of Contents
10.28    Fourth Amendment to Loan and Security Agreement, dated December 31, 2007, by and between Medallion Financial Corp. and Sterling National Bank. Filed as Exhibit 10.1 to the Current Report on Form 8-K filed on January 3, 2008 (File No. 814-00188) and incorporated by reference herein.
10.29    Commitment Letter, dated March 1, 2006, by the Small Business Administration to Medallion Capital, Inc., accepted and agreed to by Medallion Capital, Inc. on March 8, 2006. Filed as Exhibit 10.1 to the Current Report on Form 8-K filed on March 9, 2006 (File No. 814-00188) and incorporated by reference herein.
10.30    Commitment Letter, dated September 20, 2006, by the Small Business Administration to Freshstart Venture Capital Corp., accepted and agreed to by Freshstart Venture Capital Corp. on October 10, 2006. Filed as Exhibit 10.1 to the Current Report on Form 8-K filed on October 11, 2006 (File No. 814-00188) and incorporated by reference herein.
10.31    Loan And Security Agreement, dated as of December 19, 2006, among Taxi Medallion Loan Trust II, the persons from time to time party thereto as Conduit Lenders, the financial institutions from time to time party thereto as Committed Lenders, the financial institutions from time to time party thereto as Managing Agents, and Citicorp North America, Inc., as Administrative Agent. Filed as Exhibit 10.2 to the Current Report on Form 8-K filed on December 21, 2006 (File No. 814-00188) and incorporated by reference herein.
10.32    Amendment No. 1 to Loan And Security Agreement, dated as of November 29, 2007, among Taxi Medallion Loan Trust II, the persons from time to time party thereto as Conduit Lenders, the financial institutions from time to time party thereto as Committed Lenders, the financial institutions from time to time party thereto as Managing Agents, and Citicorp North America, Inc., as Administrative Agent. Filed as Exhibit 10.1 to the Current Report on Form 8-K filed on December 4, 2007 (File No. 814-00188) and incorporated by reference herein.
10.33    Servicing Agreement, dated as of December 19, 2006, among Medallion Funding Corp., Taxi Medallion Loan Trust II, and Citicorp North America, Inc. Filed as Exhibit 10.3 to the Current Report on Form 8-K filed on December 21, 2006 (File No. 814-00188) and incorporated by reference herein.
10.34    Loan Sale and Contribution Agreement, dated December 19, 2006, by and between Medallion Funding Corp. and Taxi Medallion Loan Trust II. Filed as Exhibit 10.4 to the Current Report on Form 8-K filed on December 21, 2006 (File No. 814-00188) and incorporated by reference herein.
10.35    Amended and Restated Trust Agreement, dated as of December 19, 2006, by and between Medallion Funding Corp. and U.S. Bank Trust, N.A. Filed as Exhibit 10.5 to the Current Report on Form 8-K filed on December 21, 2006 (File No. 814-00188) and incorporated by reference herein.
10.36    Junior Subordinated Indenture, dated as of June 7, 2007, between Medallion Financing Trust I and Wilmington Trust Company as trustee. Filed as Exhibit 10.1 to the Current Report on Form 8-K filed on June 11, 2007 (File No. 814-00188) and incorporated by reference herein.
10.37    Amended and Restated Trust Agreement, dated as of June 7, 2007, among Medallion Financial Corp. as depositor, Wilmington Trust Company as property trustee and Delaware trustee and the Administrative Trustees named therein. Filed as Exhibit 10.2 to the Current Report on Form 8-K filed on June 11, 2007 (File No. 814-00188) and incorporated by reference herein.
10.38    Purchase Agreement, dated as of June 7, 2007, among Medallion Financial Corp., Medallion Financing Trust I, and Merrill Lynch International. Filed as Exhibit 10.3 to the Current Report on Form 8-K filed on June 11, 2007 (File No. 814-00188) and incorporated by reference herein.
10.39    Security Agreement, dated September 19, 2007, by Medallion Funding Corp., in favor of Citibank, N.A. Filed as Exhibit 10.1 to the Current Report on Form 8-K filed on September 21, 2007 (File No. 814-00188) and incorporated by reference herein.
12.1    Computation of ratio of debt to equity. Filed herewith.

 

60


Table of Contents
16.1    Letter, dated June 3, 2005, from Eisner LLP to the Securities and Exchange Commission, regarding change in certifying accountant of Medallion Financial Corp. Filed as Exhibit 16.1 to the Current Report on Form 8-K filed on June 3, 2005 (File No. 814-00188) and incorporated by reference herein.
21.1    List of Subsidiaries of Medallion Financial Corp. Filed herewith.
23.1    Consent of Weiser LLP, independent registered public accounting firm, related to reports on financial statements of Medallion Financial Corp. and Medallion Bank. Filed herewith.
31.1    Certification of Alvin Murstein pursuant to Rule 13a-14(a) and 15d-14(a) as adopted pursuant to section 302 of The Sarbanes-Oxley Act of 2002. Filed herewith.
31.2    Certification of Larry D. Hall pursuant to Rule 13a-14(a) and 15d-14(a) as adopted pursuant to section 302 of The Sarbanes-Oxley Act of 2002. Filed herewith.
32.1    Certification of Alvin Murstein pursuant to 18 USC. Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Filed herewith.
32.2    Certification of Larry D. Hall pursuant to 18 USC. Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Filed herewith.

 

* Compensatory plan or arrangement required to be identified pursuant to Item 15(a)(3) of this Annual Report on Form 10-K.

IMPORTANT INFORMATION RELATING TO FORWARD-LOOKING STATEMENTS

The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those projected in such statements. In connection with certain forward-looking statements contained in this Form 10-K and those that may be made in the future by us or on our behalf, we note that there are various factors that could cause actual results to differ materially from those set forth in any such forward-looking statements. The forward-looking statements contained in this Form 10-K were prepared by management and are qualified by, and subject to, significant business, economic, competitive, regulatory, and other uncertainties and contingencies, all of which are difficult or impossible to predict, and many of which are beyond our control. Accordingly, there can be no assurance that the forward-looking statements contained in this Form 10-K will be realized or that actual results will not be significantly higher or lower. The statements have not been audited by, examined by, compiled by, or subjected to agreed-upon procedures by independent accountants, and no third-party has independently verified or reviewed such statements. Readers of this Form 10-K should consider these facts in evaluating the information contained herein. In addition, our business and operations are subject to substantial risks which increase the uncertainty inherent in the forward-looking statements contained in this Form 10-K. The inclusion of the forward-looking statements contained in this Form 10-K should not be regarded as a representation by us or any other person that the forward-looking statements contained in this Form 10-K will be achieved. In light of the foregoing, readers of this Form 10-K are cautioned not to place undue reliance on the forward-looking statements contained herein. These risks and others that are detailed in this Form 10-K and other documents that we file from time to time with the Securities and Exchange Commission, including quarterly reports on Form 10-Q and any current reports on Form 8-K must be considered by any of our investors or potential investors.

 

61


Table of Contents

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange of Act of 1934, registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

MEDALLION FINANCIAL CORP.
Date:   March 13, 2008
By:  

/s/ Alvin Murstein

  Alvin Murstein
  Chairman and Chief Executive Officer

 

62


Table of Contents

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

 

Signatures

  

Title

  

Date

/s/ Alvin Murstein

  

Chairman of the Board of Directors

and Chief Executive Officer

(Principal Executive Officer)

   March 13, 2008
Alvin Murstein      

/s/ Larry D. Hall

  

Senior Vice President and Chief Financial Officer

(Principal Financial and Accounting Officer)

   March 13, 2008
Larry D. Hall      

/s/ Andrew M. Murstein

   President and Director    March 13, 2008
Andrew M. Murstein      

/s/ Henry L. Aaron

   Director    March 13, 2008
Henry L. Aaron      

/s/ Mario M. Cuomo

   Director    March 13, 2008
Mario M. Cuomo      

/s/ Henry D. Jackson

   Director    March 13, 2008
Henry D. Jackson      

/s/ Stanley Kreitman

   Director    March 13, 2008
Stanley Kreitman      

/s/ Frederick A. Menowitz

   Director    March 13, 2008
Frederick A. Menowitz      

/s/ David L. Rudnick

   Director    March 13, 2008
David L. Rudnick      

/s/ Lowell P. Weicker, Jr.

   Director    March 13, 2008
Lowell P. Weicker, Jr.      

 

63


Table of Contents

MEDALLION FINANCIAL CORP.

INDEX TO FINANCIAL STATEMENTS

 

     Page

Report of Independent Registered Public Accounting Firm

   F-2

Consolidated Statements of Operations for the Years ended December 31, 2007, 2006, and 2005

   F-3

Consolidated Balance Sheets as of December 31, 2007 and 2006

   F-4

Consolidated Statements of Changes in Net Assets for the Years ended December 31, 2007, 2006, and 2005

   F-5

Consolidated Statements of Cash Flows for the Years ended December 31, 2007, 2006, and 2005

   F-6

Notes to Consolidated Financial Statements

   F-7

Consolidated Schedules of Investments as of December 31, 2007 and 2006

   F-28

Medallion Bank Financial Statements

   F-32

Report of Independent Registered Public Accounting Firm

   F-33

Statements of Operations for the Years ended December 31, 2007, 2006, and 2005

   F-34

Balance Sheets as of December 31, 2007 and 2006

   F-35

Statements of Changes in Shareholders’ Equity for the Years ended December 31, 2007, 2006, and 2005

   F-36

Statements of Cash Flows for the Years ended December 31, 2007, 2006, and 2005

   F-37

Notes to Financial Statements

   F-38

 

F-1


Table of Contents

Report of Independent Registered Public Accounting Firm

Board of Directors and Shareholders

Medallion Financial Corp.

We have audited the accompanying consolidated balance sheets of Medallion Financial Corp. and subsidiaries (the “Company”), including the schedule of investments, as of December 31, 2007 and 2006, and the related consolidated statements of operations, changes in net assets, cash flows and the selected financial ratios and other data (see note 14) for each of the three years in the three-year period ended December 31, 2007. These financial statements and selected financial ratios and other data are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and selected financial ratios and other data based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements and the selected financial ratios and other data referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2007 and 2006, and the consolidated results of their operations, changes in net assets, cash flows, and selected financial ratios and other data for each of the three years in the three-year period ended December 31, 2007, in conformity with US generally accepted accounting principles.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2007, based on the criteria established in Internal Control-Integrated Framework Issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), and our report dated March 13, 2008 expressed an unqualified opinion thereon.

 

Weiser LLP

New York, New York

March 13, 2008

 

F-2


Table of Contents

MEDALLION FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF OPERATIONS

 

     Year Ended December 31,  

(Dollars in thousands, except per share data)

   2007     2006     2005  

Interest income on investments

   $ 44,176     $ 38,032     $ 33,650  

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

     6,312       1,059       696  

Medallion lease income

     905       544       465  
                        

Total investment income

     51,393       39,635       34,811  
                        

Total interest expense(2)

     30,704       24,190       17,997  
                        

Net interest income

     20,689       15,445       16,814  
                        

Gain on sales of loans

     —         —         885  

Other income

     2,444       2,646       3,853  
                        

Total noninterest income

     2,444       2,646       4,738  
                        

Salaries and benefits

     10,192       8,193       9,554  

Professional fees

     2,603       1,955       1,945  

Rent expense

     1,353       1,266       1,339  

Other operating expenses

     3,687       3,512       4,146  
                        

Total operating expenses

     17,835       14,926       16,984  
                        

Net investment income before income taxes(1) (3)

     5,298       3,165       4,568  

Income tax benefit

     —         —         14  
                        

Net investment income after income taxes

     5,298       3,165       4,582  
                        

Net realized gains on investments

     14,172       3,080       3,606  
                        

Net change in unrealized depreciation on investments

     (6,326 )     (591 )     (6,339 )

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

     2,292       7,454       5,012  
                        

Net unrealized appreciation (depreciation) on investments

     (4,034 )     6,863       (1,327 )
                        

Net realized/unrealized gains on investments

     10,138       9,943       2,279  
                        

Net increase in net assets resulting from operations

   $ 15,436     $ 13,108     $ 6,861  
                        

Net increase in net assets resulting from operations per common share

      

Basic

   $ 0.88     $ 0.76     $ 0.40  

Diluted

     0.87       0.74       0.39  
                        

Dividends declared per share

   $ 0.76     $ 0.70     $ 0.54  
                        

Weighted average common shares outstanding

      

Basic

     17,480,523       17,293,665       17,087,034  

Diluted

     17,786,310       17,761,039       17,552,228  
                        

 

(1)

Includes $5,750 of dividend income in 2007 from Medallion Bank.

(2)

Average borrowings outstanding were $492,022, $425,062, and $377,874, and the related average borrowing costs were 6.25%, 5.69%, and 4.76% for the years ended December 31, 2007, 2006, and 2005.

(3)

Includes $2,027, $1,891, and $1,753 of net revenues received from Medallion Bank for the years ended December 31, 2007, 2006, and 2005 primarily for servicing fees, loan origination fees, and expense reimbursements. See notes 4 and 11 for additional information.

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

 

F-3


Table of Contents

MEDALLION FINANCIAL CORP.

CONSOLIDATED BALANCE SHEETS

 

(Dollars in thousands, except per share data)

   December 31, 2007     December 31, 2006  

Assets

    

Medallion loans, at fair value

   $ 498,883     $ 428,249  

Commercial loans, at fair value (1)

     91,782       88,207  

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

     57,501       50,448  

Investment securities, at fair value

     —         9,961  

Equity investments, at fair value

     4,880       16,068  
                

Net investments ($458,102 at December 31, 2007 and $406,817 at December 31, 2006 pledged as collateral under borrowing arrangements)

     653,046       592,933  

Cash and cash equivalents ($852 at December 31, 2007 and $865 at December 31, 2006 restricted as to use by lender)

     33,454       15,399  

Accrued interest receivable

     2,449       2,178  

Fixed assets, net

     558       525  

Goodwill, net

     5,007       5,007  

Other assets, net

     26,748       15,563  
                

Total assets

   $ 721,262     $ 631,605  
                

Liabilities

    

Accounts payable and accrued expenses

   $ 4,203     $ 5,057  

Accrued interest payable

     2,087       1,783  

Funds borrowed

     542,549       455,137  
                

Total liabilities

     548,839       461,977  
                

Commitments and contingencies

     —         —    

Shareholders’ equity (net assets)

    

Preferred stock (1,000,000 shares of $0.01 par value stock authorized - none outstanding)

     —         —    

Common stock (50,000,000 shares of $0.01 par value stock authorized – 18,902,416 shares at December 31, 2007 and 18,799,766 shares at December 31, 2006 issued)

     189       188  

Treasury stock at cost (1,406,551 shares at December 31, 2007 and 1,373,351 at December 31, 2006)

     (12,938 )     (12,611 )

Capital in excess of par value

     177,819       176,849  

Accumulated undistributed net investment income

     2,739       5,198  

Accumulated undistributed net realized gains on investments

     —         —    

Net unrealized appreciation on investments

     4,614       4  
                

Total shareholders’ equity (net assets)

     172,423       169,628  
                

Total liabilities and shareholders’ equity

   $ 721,262     $ 631,605  
                

Number of common shares outstanding

     17,495,865       17,426,415  

Net asset value per share

   $ 9.86     $ 9.73  
                

 

(1)

Includes a $3,100 loan to an entity which is majority owned by one of our controlled subsidiaries.

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

 

F-4


Table of Contents

MEDALLION FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS

 

     Year Ended December 31,  

(Dollars in thousands, except per share data)

   2007     2006     2005  

Net investment income after income taxes

   $ 5,298     $ 3,165     $ 4,582  

Net realized gains on investments

     14,172       3,080       3,606  

Net unrealized gains (losses) on investments

     (4,034 )     6,863       (1,327 )
                        

Net increase in net assets resulting from operations

     15,436       13,108       6,861  
                        

Investment income, net

     (6,085 )     (6,049 )     (4,894 )

Realized gain from investment transactions, net

     (7,200 )     (5,377 )     (3,633 )
                        

Dividends and distributions to shareholders’ (1)

     (13,285 )     (11,426 )     (8,527 )
                        

Exercise of stock options

     971       1,592       1,167  

Treasury stock acquired

     (327 )     —         (3,608 )
                        

Capital share transactions

     644       1,592       (2,441 )
                        

Total increase (decrease) in net assets

     2,795       3,274       (4,107 )

Net assets at the beginning of the year

     169,628       166,354       170,461  
                        

Net assets at the end of the year(2)

   $ 172,423     $ 169,628     $ 166,354  
                        

Capital share activity

      

Common stock issued, beginning of year

     18,799,766       18,546,648       18,328,450  

Exercise of stock options

     102,650       253,118       218,198  
                        

Common stock issued, end of year

     18,902,416       18,799,766       18,546,648  
                        

Treasury stock, beginning of year

     (1,373,351 )     (1,373,351 )     (983,451 )

Treasury stock acquired

     (33,200 )     —         (389,900 )
                        

Treasury stock, end of year

     (1,406,551 )     (1,373,351 )     (1,373,351 )
                        

Common stock outstanding

     17,495,865       17,426,415       17,173,297  
                        

 

(1)

Dividends paid were $0.76, $0.66, and $0.50 per share for the years ended December 31, 2007, 2006, and 2005.

(2)

Includes $2,739 of undistributed net investment income and $0 of undistributed net realized gains on investments at December 31, 2007.

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

 

F-5


Table of Contents

MEDALLION FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     Year ended December 31,  

(Dollars in thousands)

   2007     2006     2005  

CASH FLOWS FROM OPERATING ACTIVITIES

      

Net increase in net assets resulting from operations

   $ 15,436     $ 13,108     $ 6,861  

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

      

Depreciation and amortization

     1,421       415       579  

Amortization of origination costs

     495       510       1,481  

Increase in net unrealized depreciation on investments

     6,326       591       6,339  

Increase in unrealized appreciation on Medallion Bank and other controlled subsidiaries

     (2,292 )     (7,454 )     (5,012 )

Net realized gains on investments

     (14,172 )     (3,080 )     (3,606 )

Stock-based compensation expense

     323       342       —    

(Increase) decrease in accrued interest receivable

     (272 )     205       (763 )

(Increase) decrease in other assets, net

     (4,072 )     (2,019 )     881  

Increase (decrease) in accounts payable and accrued expenses

     (854 )     732       (3,825 )

Increase in accrued interest payable

     312       24       3  

Gain on sales of loans

     —         —         (885 )

Decrease in servicing fee receivable

     —         —         183  
                        

Net cash provided by operating activities

     2,651       3,374       2,236  
                        

CASH FLOWS USED FOR INVESTING ACTIVITIES

      

Investments originated

     (329,955 )     (309,761 )     (279,545 )

Proceeds from principal receipts, sales, and maturities of investments

     275,468       293,920       212,094  

Banco portfolio acquisition

     —         (35,703 )     —    

Investments in Medallion Bank and other controlled subsidiaries, net

     (4,761 )     (2,658 )     (902 )

Capital expenditures

     (488 )     (486 )     (350 )

Cash received for sold BLL SBA Section 7 (a) loans

     —         —         20,472  
                        

Net cash used for investing activities

     (59,736 )     (54,688 )     (48,231 )
                        

CASH FLOWS FROM FINANCING ACTIVITIES

      

Proceeds from funds borrowed

     361,881       269,656       143,246  

Repayments of funds borrowed

     (308,777 )     (215,434 )     (81,728 )

Proceeds from Trust Preferred Securities issued

     35,000       —         —    

Proceeds from exercise of stock options

     648       1,244       1,167  

Payments of declared dividends

     (13,285 )     (11,426 )     (8,527 )

Purchase of treasury stock at cost

     (327 )     —         (3,608 )

Commitment fees on SBA leverage

     —         (135 )     —    
                        

Net cash provided by financing activities

     75,140       43,905       50,550  
                        

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     18,055       (7,409 )     4,555  

CASH and cash equivalents, beginning of year

     15,399       22,808       18,253  
                        

CASH and cash equivalents, end of year

   $ 33,454     $ 15,399     $ 22,808  
                        

SUPPLEMENTAL INFORMATION

      

Cash paid during the year for interest

   $ 29,435     $ 23,713     $ 16,802  

Cash paid during the year for income taxes

     —         —         —    

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

     —         —         3,582  
                        

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

 

F-6


Table of Contents

MEDALLION FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2007

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

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

The Company also conducts business through Medallion Capital, Inc. (MCI), an SBIC which conducts a mezzanine financing business; and Freshstart Venture Capital Corp. (FSVC), an SBIC which originates and services taxicab medallion and commercial loans. MFC, MCI, and FSVC, as SBICs, are regulated and financed in part by the SBA. The Company also conducts business through our asset-based lending division, Medallion Business Credit (MBC), an originator of loans to small businesses for the purpose of financing inventory and receivables, which prior to December 31, 2007, was a wholly-owned investment company subsidiary. On December 31, 2007, Medallion Business Credit was merged into the Company and ceased to exist as a separate legal entity. Until October 2005, the Company also conducted business through Business Lenders, LLC (BLL), licensed under the Small Business Administration (SBA) Section 7(a) program. On October 17, 2005, the Company completed the sale of the loan portfolio and related assets of BLL. In connection with this transaction, the Company sold assets in the amount of $22,799,000, less liabilities assumed by the buyer in the amount of $2,327,000. The assets were sold at book value, and therefore no gain or loss, excluding transaction costs, was recognized as a result of this transaction. For 2005, BLL generated net decease in net assets resulting from operations of $1,003,000, and net investment loss after taxes of $696,000.

In June 2007, the Company established a wholly-owned subsidiary, Medallion Financing Trust I (Fin Trust) for the purpose of issuing unsecured preferred securities to investors. Fin Trust is a separate legal and corporate entity with its own creditors who, in any liquidation of Fin Trust, will be entitled to be satisfied out of Fin Trust’s assets prior to any value in Fin Trust becoming available to Fin Trust’s equity holders. The assets of Fin Trust, aggregating $35,020,000 at December 31, 2007, are not available to pay obligations of its affiliates or any other party, and the assets of affiliates or any other party are not available to pay obligations of Fin Trust.

In December 2006, MFC established a wholly-owned subsidiary, Taxi Medallion Loan Trust II (Trust II), for the purpose of owning medallion loans originated by MFC or others. Trust II is a separate legal and corporate entity with its own creditors who, in any liquidation of Trust II, will be entitled to be satisfied out of Trust II’s assets prior to any value in Trust II becoming available to Trust II’s equity holders. The assets of Trust II, aggregating $132,576,000 at December 31, 2007 and $71,884,000 at December 31, 2006, are not available to pay obligations of its affiliates or any other party, and the assets of affiliates or any other party are not available to pay obligations of Trust II. Trust II’s loans are serviced by MFC.

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

A wholly-owned portfolio investment of ours, Medallion Bank (MB), a Federal Deposit Insurance Corporation (FDIC) insured industrial bank that originates medallion loans, commercial loans, and consumer loans, raises deposits, and conducts other banking activities (see notes 3 and 4). MB was capitalized on December 16, 2003, with $22,000,000 from the Company. On December 22, 2003, upon satisfaction of the conditions set forth in the FDIC’s order of October 2, 2003 approving MB’s application for federal deposit insurance, the FDIC certified that the deposits of each depositor in MB were insured to the maximum amount provided by the Federal Deposit Insurance Act and MB opened for business. MB is subject to competition from other financial institutions and to the regulations of certain federal and state agencies, and undergoes examinations by those agencies.

MB is not an investment company, and therefore, is not consolidated with the Company, but instead is treated as a portfolio investment. It was initially formed for the primary purpose of originating commercial loans in three categories: 1) loans to finance the purchase of taxicab medallions (licenses), 2) asset-based commercial loans, and 3) SBA 7(a) loans. The loans are marketed and serviced by MB’s affiliates who have extensive prior experience in these asset groups. The Company sold substantially all of the Section 7(a) loans in its portfolio in connection with the sale of the assets of BLL to a subsidiary of Merrill Lynch in October 2005.

 

F-7


Table of Contents

Additionally, MB began issuing brokered certificates of deposit in January 2004, and purchased over $84,150,000 of taxicab medallion and asset-based loans from affiliates of the Company. On April 1, 2004, MB purchased a consumer loan portfolio from an unrelated financial institution for consideration of $86,309,000. The purchase was funded with $7,700,000 of additional capital contributed by the Company and with deposits raised by MB. In the 2004 third quarter, Medallion Bank began originating consumer loans similar to the acquired portfolio, which are serviced by a third party.

In September 2002, MFC established a wholly-owned subsidiary, Taxi Medallion Loan Trust I (Trust), for the purpose of owning medallion loans originated by MFC or others. The Trust is a separate legal and corporate entity with its own creditors who, in any liquidation of the Trust, will be entitled to be satisfied out of the Trust’s assets prior to any value in the Trust becoming available to the Trust’s equity holders. The assets of the Trust, aggregating $337,728,000 at December 31, 2007 and $327,202,000 at December 31, 2006, are not available to pay obligations of its affiliates or any other party, and the assets of affiliates or any other party are not available to pay obligations of the Trust. The Trust’s loans are serviced by MFC.

(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates

The accounting and reporting policies of the Company conform with accounting principles generally accepted in the US and general practices in the investment company industry. The preparation of financial statements in conformity with generally accepted accounting principles in the US 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. Such estimates are subject to change over time, and actual results could differ from those estimates. The determination of fair value of the Company’s investments is subject to significant change within one year.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, except for MB and other portfolio investments. All significant intercompany transactions, balances, and profits have been eliminated in consolidation. As non-investment companies, MB is not consolidated with the Company, which is an investment company under the 1940 Act. See Note 3 regarding our change in reporting entity in 2006, and note 4 for the presentation of financial information for MB.

Cash and Cash Equivalents

The Company considers all highly liquid instruments with an original purchased maturity of three months or less to be cash equivalents.

Investment Valuation

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

Equity investments (common stock and stock warrants, including certain controlled subsidiary portfolio investments) and investment securities (US Treasuries and mortgage backed bonds), in total representing 10% and 13% of the investment portfolio at December 31, 2007 and 2006, are recorded at fair value, represented as cost, plus or minus unrealized appreciation or depreciation. The fair value of investments that have no ready market are determined in good faith by management, and approved by the Board of Directors, based upon assets and revenues of the underlying investee companies as well as general market trends for businesses in the same industry. Included in equity investments were marketable securities of $4,263,000 and $15,969,000 at December 31, 2007 and 2006, and non-marketable securities of $617,000 and $99,000 in the comparable periods. The $57,501,000 and $50,448,000 related to portfolio investments in controlled subsidiaries at December 31, 2007 and 2006 were all non-marketable in each period. Because of the inherent uncertainty of valuations, management’s estimates of the values of the investments may differ significantly from the values that would have been used had a ready market for the investments existed, and the differences could be material.

 

F-8


Table of Contents

Our investment in Medallion Bank, as a wholly owned portfolio investment, is also subject to quarterly assessments of fair value. We conduct a thorough valuation analysis as described previously, and determine whether any factors give rise to a valuation different than recorded book value, including various regulatory restrictions that were established at Medallion Bank’s inception, by the FDIC and State of Utah, and also by additional marketplace restrictions, such as on the ability to transfer industrial bank charters. As a result of this valuation process, we used Medallion Bank’s actual results of operations as the best estimate of changes in fair value, and recorded the results as a component of unrealized appreciation (depreciation) on investments, although changes in these restrictions and other applicable factors could change these conclusions in the future. See Note 4 for additional information about Medallion Bank.

A majority of the Company’s investments consist of long-term loans to persons defined by SBA regulations as socially or economically disadvantaged, or to entities that are at least 50% owned by such persons. Approximately 76% and 72% of the Company’s investment portfolio at December 31, 2007 and 2006 had arisen in connection with the financing of taxicab medallions, taxicabs, and related assets, of which 80% and 79% were in New York City at December 31, 2007 and 2006. These loans are secured by the medallions, taxicabs, and related assets, and are personally guaranteed by the borrowers, or in the case of corporations, are generally guaranteed personally by the owners. A portion of the Company’s portfolio (14% and 15% at December 31, 2007 and 2006) represents loans to various commercial enterprises, in a wide variety of industries, including manufacturing, food services, wholesaling, real estate, business services, transportation and warehousing, and various other industries. These loans are made primarily in the metropolitan New York City area, and historically included loans guaranteed by the SBA under its Section 7(a) program, less the sale of the guaranteed portion of those loans. The Company sold substantially all of the Section 7(a) loans in its portfolio in connection with the sale of the assets of BLL to a subsidiary of Merrill Lynch in October 2005. Investments in unconsolidated controlled subsidiaries, equity investments, and investment securities were 9%, 1%, and 0% at December 31, 2007, compared to 8%, 3%, and 2% at December 31, 2006.

On a managed basis, which includes the investments of MB after eliminating the Company’s investment in MB and other controlled subsidiaries, medallion loans were 63% at both December 31, 2007 and 2006 (83% and 82% in New York City), commercial loans were 19% and 18%, and 15% and 13% were consumer loans in all 50 states collateralized by recreational vehicles, boats, and trailers. Investment securities were 2% and 4% at December 31, 2007 and 2006, and equity investments were 1% and 2%.

Investment Transactions and Income Recognition

Loan origination fees and certain direct origination costs are deferred and recognized as an adjustment to the yield of the related loans. At December 31, 2007, and 2006, net origination costs totaled approximately $734,000 and $631,000. Amortization expense for the years ended December 31, 2007, 2006, and 2005 was $495,000, $510,000, and $1,480,000.

Investment securities are purchased from time-to-time in the open market at prices that are greater or lesser than the par value of the investment. The resulting premium or discount is deferred and recognized as an adjustment to the yield of the related investment. At December 31, 2007 and 2006, there were no premiums or discounts on investment securities, and their related income accretion or amortization was immaterial for 2007, 2006, and 2005.

Interest income is recorded on the accrual basis. Taxicab medallion and commercial loans are placed on nonaccrual status, and all uncollected accrued interest is reversed, when there is doubt as to the 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 nonaccrual loans is generally recognized when cash is received, unless a determination has been made to apply all cash receipts to principal. At December 31, 2007, 2006, and 2005, total non-accrual loans were approximately $21,968,000, $13,670,000, and $22,641,000, and represented 4%, 3%, and 4% of the gross medallion and commercial loan portfolio at each yearend. The amount of interest income on nonaccrual loans that would have been recognized if the loans had been paying in accordance with their original terms was approximately $6,856,000, $5,281,000, and $6,744,000 as of December 31, 2007, 2006, and 2005, of which $2,892,000, $2,103,000, and $2,904,000 would have been recognized in the years ended December 31, 2007, 2006, and 2005.

Loan Sales and Servicing Fee Receivable

The Company accounts for its sales of loans in accordance with Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a Replacement of FASB Statement

 

F-9


Table of Contents

No. 125” (SFAS 140). In addition, we are in compliance with Statement of Financial Accounting Standards No. 156 “Accounting for Servicing of Financial Assets – an Amendment of FASB Statement No. 140” (SFAS 156). SFAS 156 provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. In accordance with SFAS 156, we have elected the fair value measurement method for our servicing assets and liabilities. The principal portion of loans serviced for others by the Company was $168,781,000 and $168,463,000 at December 31, 2007 and 2006, and included $163,816,000 and $153,271,000 of loans serviced for MB. The Company has evaluated the servicing aspect of its business in accordance with SFAS 156, substantially all of which relates to servicing assets held by MB, and determined that no material servicing asset or liability exists as of December 31, 2007 and 2006.

Gains or losses on loan sales were primarily attributable to the sale of commercial loans which had been at least partially guaranteed by the SBA, and was conducted by the Company’s BLL subsidiary. The Company sold all of the SBA Section 7(a) loans in its portfolio in connection with the sale of the assets of BLL to a subsidiary of Merrill Lynch in October 2005. The Company recognized 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 was surrendered. The gains were calculated in accordance with SFAS 140, which required that the gain on the sale of a portion of a loan be based on the relative fair values of the loan portion sold and the loan portion retained. The gain on loan sales was due to the differential between the carrying amount of the portion of loans sold and the sum of the cash received and the servicing fee receivable.

The servicing fee receivable represented the present value of the difference between the servicing fee received by the Company (generally 100 to 400 basis points) and the Company’s servicing costs and normal profit, after considering the estimated effects of prepayments and defaults over the life of the servicing agreement. In connection with calculating the servicing fee receivable, the Company made certain assumptions including the cost of servicing a loan including a normal profit, the estimated life of the underlying loan that would be serviced, and the discount rate used in the present value calculation. The Company considered 40 basis points to be its cost plus a normal profit and used the note rate plus 100 basis points for loans with an original maturity of ten years or less, and the note rate plus 200 basis points for loans with an original maturity of greater than ten years as the discount rate. The note rate was generally the prime rate plus 2.75%.

The servicing fee receivable was amortized as a charge to loan servicing fee income over the estimated lives of the underlying loans using the effective interest rate method. The Company reviewed the carrying amount of the servicing fee receivable for possible impairment by stratifying the receivables based on one or more of the predominant risk characteristics of the underlying financial assets. The Company stratified its servicing fee receivable into pools, generally by the year of creation, and within those pools, by the term of the loan underlying the servicing fee receivable. If the estimated present value of the future servicing income was less than the carrying amount, the Company established an impairment reserve and adjusted future amortization accordingly. If the fair value exceeded the carrying value, the Company may have reduced future amortization. The servicing fee receivable was carried at the lower of amortized cost or fair value.

The estimated net servicing income was based, in part, on management’s estimate of prepayment speeds, including default rates, and accordingly, there was no assurance of the accuracy of these estimates. If the prepayment speeds occurred at a faster rate than anticipated, the amortization of the servicing asset would have been accelerated and its value would have declined; and as a result, servicing income during that and subsequent periods would have declined. If prepayments occurred slower than anticipated, cash flows would have exceeded estimated amounts and servicing income would have increased. The constant prepayment rates utilized by the Company in estimating the lives of the loans depended on the original term of the loan, industry trends, and the Company’s historical data on prepayments and delinquencies, and ranged from 15% to 35%. The Company evaluated the temporary impairment to determine if any such temporary impairment would be considered to be permanent in nature. The prepayment rate of loans may have been affected by a variety of economic and other factors, including prevailing interest rates and the availability of alternative financing to borrowers.

The activity in the reserve for servicing fee receivable follows:

 

     Year Ended December 31,  

(Dollars in thousands)

   2007    2006    2005  

Beginning Balance

   $ —      $ —      $ 1,037  

Reversal related to sale of servicing asset

     —        —        (1,063 )

Increases (decreases) charged to operations

     —        —        27  
                      

Ending Balance

   $ —      $ —      $ —    
                      

 

F-10


Table of Contents

The Company also had the option to sell the unguaranteed portions of loans to third party investors. The gain or loss on such sales was calculated in accordance with SFAS No. 140. The Company had no sales of unguaranteed portions of loans to third party investors for the years ended December 31, 2007, 2006, and 2005. The Company sold substantially all of the Section 7(a) loans in its portfolio in connection with the sale of the assets of BLL to a subsidiary of Merrill Lynch in October 2005.

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

The change in unrealized appreciation (depreciation) on investments is the amount by which the fair value estimated by the Company is greater (less) than the cost basis of the investment portfolio. Realized gains or losses on investments are generated through sales of investments, foreclosure on specific collateral, and writeoffs of loans or assets acquired in satisfaction of loans, net of recoveries. Unrealized appreciation (depreciation) on net investments was $4,614,000, $4,000, and ($8,664,000) as of December 31, 2007, 2006, and 2005. Our investment in Medallion Bank, a wholly owned portfolio investment, is a also subject to quarterly assessments of fair value. We conduct a thorough valuation analysis as described previously, and determine whether any factors give rise to valuation different than recorded book value, including various regulatory restrictions that were established at Medallion Bank’s inception, by the FDIC and State of Utah, and also by additional marketplace restrictions, such as on the ability to transfer industrial bank charters. As a result of this valuation process, we used Medallion Bank’s actual results of operations as the best estimate of changes in fair value, and recorded the results as a component of unrealized appreciation (depreciation) on investments, although changes in these restrictions and other applicable factors could change these conclusions in the future. See note 3 for change in the reporting entity and note 4 for the presentation of financial information for Medallion Bank.

The following table sets forth the changes in our unrealized appreciation (depreciation) on investments, other than investments in controlled subsidiaries, for the years ended December 31, 2007, 2006, and 2005.

 

(Dollars in thousands)

   Loans     Equity
Investments
    Foreclosed
Properties
    Total  

Balance December 31, 2004

   $ (7,791 )   $ 685     $ (512 )   $ (7,618 )

Increase in unrealized

        

Appreciation on investments

     158       (520 )     —         (362 )

Depreciation on investments

     (1,925 )     (1,022 )     (1,123 )     (4,070 )

Reversal of unrealized appreciation (depreciation) related to realized

        

Gains on investments

     —         1,486       —         1,486  

Losses on investments

     309       —         238       547  

Reversal of reserves on sold SBA Section 7(a) loans

     1,340       —         —         1,340  

Other

     13       —         —         13  
                                

Balance December 31, 2005

     (7,896 )     629       (1,397 )     (8,664 )

Increase in unrealized

        

Appreciation on investments

     —         4,236       921       5,157  

Depreciation on investments

     824       (173 )     —         651  

Reversal of unrealized appreciation (depreciation) related to realized

        

Gains on investments

     —         (2,579 )     —         (2,579 )

Losses on investments

     4,016       —         1,423       5,439  
                                

Balance December 31, 2006

     (3,056 )     2,113       947       4  

Increase in unrealized

        

Appreciation on investments

     —         2,127       8,245       10,372  

Depreciation on investments

     (4,246 )     (133 )     (159 )     (4,538 )

Reversal of unrealized appreciation (depreciation) related to realized

        

Gains on investments

     —         (1,361 )     (571 )     (1,932 )

Losses on investments

     833       —         —         833  

Other

     —         (4 )     (121 )     (125 )
                                

Balance December 31, 2007

   ($ 6,469 )   $ 2,742     $ 8,341     $ 4,614  
                                

 

F-11


Table of Contents

The table below summarizes components of unrealized and realized gains and losses in the investment portfolios for the years ended December 31, 2007, 2006, and 2005.

 

(Dollars in thousands)

   2007     2006     2005  

Net change in unrealized appreciation (depreciation) on investments

      

Unrealized appreciation

   $ 2,127     $ 4,236     $ 1,136  

Unrealized depreciation

     (4,379 )     (7,185 )     (1,320 )

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

     2,292       7,454       5,012  

Realized gains

     (11,647 )     (2,579 )     (5,514 )

Realized losses

     833       4,016       482  

Unrealized gains (losses) on foreclosed properties

     6,740       921       (1,123 )
                        

Total

   $ (4,034 )   $ 6,863     $ (1,327 )
                        

Net realized gains on investments

      

Realized gains

   $ 2,914     $ 2,579     $ 5,514  

Realized losses

     (833 )     (4,016 )     (919 )

Other gains

     10,732       5,997       2,533  

Direct recoveries (charge-offs)

     23       (1,484 )     (3,522 )

Realized gains on foreclosed properties

     1,336       4       —    
                        

Total

   $ 14,172     $ 3,080     $ 3,606  
                        

Goodwill

Effective January 1, 2002, coincident with the adoption of SFAS No.142, “Goodwill and Intangible Assets,” the Company tests its goodwill for impairment, and engages a consultant to help management evaluate its carrying value. The results of this evaluation demonstrated no impairment in goodwill for 2007, 2006, and 2005. The Company conducts annual appraisals of its goodwill, and will recognize any impairment in the period any impairment is identified as a charge to operating expenses.

Fixed Assets

Fixed assets are carried at cost less accumulated depreciation and amortization, and are depreciated on a straight-line basis over their estimated useful lives of 3 to 10 years. Leasehold improvements are amortized on a straight-line basis over the shorter of the lease term or the estimated economic useful life of the improvement. Depreciation and amortization expense was $457,000, $415,000, and $579,000 for the years ended December 31, 2007, 2006, and 2005.

Deferred Costs

Deferred financing costs, included in other assets, represents costs associated with obtaining the Company’s borrowing facilities, and is amortized on a straight line basis over the lives of the related financing agreements. Amortization expense was $964,000, $634,000, and $1,192,000 for the years ended December 31, 2007, 2006, and 2005. In addition, the Company capitalizes certain costs for transactions in the process of completion, including those for acquisitions and the sourcing of other financing alternatives. Upon completion or termination of the transaction, any accumulated amounts will be amortized against income over an appropriate period, capitalized as goodwill, or written off. The amounts on the balance sheet for all of these purposes were $3,918,000 and $2,747,000 as December 31, 2007 and 2006.

Federal Income Taxes

The Company and each of its major subsidiaries other than MB (the RIC subsidiaries) have qualified to be treated for federal income tax purposes as regulated investment companies (RICs) under the Internal Revenue Code of 1986, as amended (the Code). As RICs, the Company and each of the RIC subsidiaries are not subject to US federal income tax on any gains or investment company taxable income (which includes, among other things, dividends and interest income reduced by deductible expenses) that it distributes to its shareholders, if at least 90% of its investment company taxable income for that taxable year is distributed. It is the Company’s and the RIC subsidiaries’ policy to comply with the provisions of the Code. The Company’s RIC qualification is determined on an annual basis, and it qualified and filed its federal tax returns as a RIC for 2006 and 2005, and anticipates qualifying and filing as a RIC for 2007. Income tax (provision) benefit reported on the consolidated statements of operations were $0, $0, and $14,000 for the years ended December 31, 2007, 2006, and 2005, and primarily related to the taxes owed by or refunds due from a limited partnership investment of MCI.

 

F-12


Table of Contents

MB is not a RIC and is taxed as a regular corporation. Fin Trust, Trust, and Trust II are not subject to federal income taxation instead their taxable income is treated as having been earned by MFC.

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

Basic earnings per share are computed by dividing net increase in net assets resulting from operations available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution that could occur if option contracts to issue common stock were exercised, and has been computed after giving consideration to the weighted average dilutive effect of the Company’s common stock and stock options. The Company uses the treasury stock method to calculate diluted EPS, which is a method of recognizing the use of proceeds that could be obtained upon exercise of options and warrants in computing diluted EPS. It assumes that any proceeds would be used to purchase common stock at the average market price during the period.

The table below shows the calculation of basic and diluted EPS.

 

     Years Ended December 31,

(Dollars in thousands)

   2007    2006    2005

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

   $ 15,436    $ 13,108    $ 6,861
                    

Weighted average common shares outstanding applicable to basic EPS

     17,480,523      17,293,665      17,087,034

Effect of dilutive stock options

     305,787      467,374      465,194
                    

Adjusted weighted average common shares outstanding applicable to diluted EPS

     17,786,310      17,761,039      17,552,228
                    

Basic earnings per share

   $ 0.88    $ 0.76    $ 0.40

Diluted earnings per share

     0.87      0.74      0.39
                    

Potentially dilutive common shares excluded from the above calculations aggregated 795,936, 611,762, and 585,677 shares as of December 31, 2007, 2006, and 2005.

Dividends to Shareholders

The table below shows the tax character of distributions for tax reporting purposes.

 

     Years Ended December 31,

(Dollars in thousands)

   2007    2006    2005

Dividends paid from

        

Investment income, net

   $ 6,085    $ 6,049    $ 4,894

Realized gain from investment transactions, net

     7,200      5,377      3,633
                    

Total dividends

   $ 13,285    $ 11,426    $ 8,527
                    

Our ability to make dividend payments is restricted by SBA regulations and under the terms of the SBA debentures. As of December 31, 2007, the Company anticipates paying an estimated $1,782,000 of ordinary income dividends for tax purposes by September 15, 2008.

Stock Compensation

The Company applies SFAS No. 123 (Revised), “Share-Based Payment” (SFAS No. 123R), and related interpretations in accounting for its stock option plans effective January 1, 2006, and accordingly, the Company recognizes the expense of these grants as required. Stock-based employee compensation costs pertaining to stock options is reflected in net increase in net assets resulting from operations, for both any new grants, as well as for all unvested options outstanding at December 31, 2005, in both cases using the fair values established by usage of the Black-Scholes option pricing model, expensed over the vesting period of the underlying option. Previously, the Company applied APB Opinion No. 25 and related Interpretations in accounting for all the plans. Accordingly, no compensation cost was recognized under these plans, and the Company followed the disclosure-only provisions of SFAS No. 123 and SFAS No. 148, Accounting for Stock-Based Compensation Transition and Disclosure.

 

F-13


Table of Contents

The Company elected the modified prospective transition method for adopting SFAS No. 123R. Under this method, the provisions of SFAS 123R apply to all awards granted or modified after the date of adoption, as well as for all unvested options outstanding at December 31, 2005. During 2007 and 2006, the Company issued 209,674 and 207,162 shares of stock-based compensation awards, and recognized $323,000 and $342,000, or $0.02 per diluted common share for each year, of non-cash stock-based compensation expense related to the option grants. During 2005, the Company issued 38,000 shares of stock-based compensation awards, and would have recognized $319,100 or $0.02 per share of non-cash stock-based compensation expense. As of December 31, 2007, the total remaining unrecognized compensation cost related to unvested stock options was $348,000, which is expected to be recognized over the next thirteen quarters (see note 6).

Had the compensation cost for the Company’s stock-based compensation plan been determined under the fair value recognition provisions in SFAS No. 123 prior to the date of adopting SFAS No. 123R, the Company’s net income and earnings per share would have been adjusted to the pro forma amounts below for the year ended December 31 2005.

 

(Dollars in thousands)

   2005  

Net increase in net assets resulting from operations

   $ 6,861  

Add: stock-based employee compensation expense determined under APB No.25, included in net increase in net assets resulting from operations

     —    

Less: stock-based employee compensation expense determined under fair value method

     (319 )
        

Net increase in net assets resulting from operations, pro forma

   $ 6,542  
        

Net value per share

  

Basic-as reported

   $ 0.40  

Basic-pro forma

     0.38  

Diluted-as reported

     0.39  

Diluted-pro forma

     0.37  
        

Derivatives

The Company had no interest rate cap agreements or other derivative investments outstanding during 2007, 2006, and 2005.

Reclassifications

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

(3) CHANGE IN THE REPORTING ENTITY

Since MB commenced operations in December 2003, the Company had historically consolidated MB’s financial statements with those of its own. Although MB is not an investment company, and SEC rules generally do not permit investment companies such as the Company to consolidate the financial statements of non-investment companies, such as MB, the Company had sought and obtained a letter from the SEC in March 2004 permitting such consolidation. The Company believed that consolidating MB provided a more complete and accurate representation of the Company’s full scope of operations, and its complete financial position and results of operations.

During August 2006, the Company filed a registration statement on Form N-2 which the SEC staff reviewed and on which they provided comments, including those relating to the consolidation of the accounts of MB which have evolved since 2004. Based on discussions with the SEC staff, the Company determined during the 2006 fourth quarter to voluntarily not consolidate MB and present MB as a portfolio company. The Company determined that this change represents a change in the reporting entity as described in SFAS No. 154, “Accounting Changes and Error Corrections.” Accordingly the Company retrospectively applied this change to the financial statements of all prior periods presented, including previously issued interim periods presented, included in its 2006 Form 10-K. The effect of this retrospective application was to present the Company’s financial position and results of operations as if MB had not been consolidated for all periods presented and to present MB as an unconsolidated portfolio investment. Although this created changes in the reported levels of assets, liabilities, revenues, and expenses, our net increase in net assets resulting from operations, shareholders’ equity, and the related amounts per common share were unchanged.

 

F-14


Table of Contents

(4) INVESTMENT IN MEDALLION BANK AND OTHER CONTROLLED SUBSIDIARIES

The following table presents MB’s statement of operations and other valuation adjustments on other controlled subsidiaries for the years ended December 31, 2007, 2006, and 2005.

 

     Year ended December 31,  

(Dollars in thousands)

   2007     2006     2005  

Statement of operations

      

Investment income

   $ 36,564     $ 29,975     $ 22,403  

Interest expense

     13,804       10,453       6,414  
                        

Net interest income

     22,760       19,522       15,989  

Noninterest income

     337       490       408  

Operating expenses

     7,190       6,289       5,543  
                        

Net investment income before income taxes

     15,907       13,723       10,854  

Income tax provision

     4,059       4,388       1,973  
                        

Net investment income after income taxes

     11,848       9,335       8,881  

Net realized/unrealized losses of MB and other controlled subsidiaries (1)

     (9,556 )     (1,881 )     (3,869 )
                        

Net increase in net assets resulting from operations of MB and other controlled subsidiaries

   $ 2,292     $ 7,454     $ 5,012  
                        

 

(1)

Includes $890, $1,450, and ($231) of net realized/unrealized gains (losses) of controlled subsidiaries other than Medallion Bank for the years ended December 31, 2007, 2006, and 2005. Also reflects $5,750 of unrealized depreciation on Medallion Bank in 2007 to adjust the investment carrying amount to reflect the dividend paid to the parent.

The following table presents MB’s balance sheets and the net investment in other controlled subsidiaries as of December 31, 2007 and 2006.

 

(Dollars in thousands)

   2007    2006

Loans

   $ 315,108    $ 267,840

Investment securities, at fair value

     21,838      21,683
             

Net investments ($0 pledged as collateral under borrowing arrangements at December 31, 2007 and 2006)

     336,946      289,523

Cash ($0 at December 31, 2007 and 2006 restricted as to use by lender)

     17,025      14,699

Receivable from parent

     1,059      —  

Other assets, net

     6,743      5,209
             

Total assets

   $ 361,773    $ 309,431
             

Other liabilities

   $ 4,080    $ 832

Payable to parent

     —        267

Deposits and federal funds purchased, including accrued interest payable

     302,800      261,484
             

Total liabilities

     306,880      262,583

Medallion Bank equity

     54,893      46,848
             

Total liabilities and equity

   $ 361,773    $ 309,431
             

Investment in other controlled subsidiaries

   $ 3,667    $ 3,373

Total investment in MB and other controlled subsidiaries

     57,501      50,488
             

 

(1)

Included in MB’s net investments is $1,203 and $1,859 for purchased loan premium and facility fees at December 31, 2007 and 2006.

The following paragraphs summarize the accounting and reporting policies of MB, and provide additional information relating to the table presented above.

Investment securities are purchased from time-to-time in the open market at prices that are greater or lesser than the par value of the investment. The resulting premium or discount is deferred and recognized on a level yield basis as an adjustment to the yield of the related investment. At December 31, 2007 and 2006, the net premium on investment securities totaled $92,000 and $245,000, and amortization expense was $140,000, $160,000, and $177,000 for 2007, 2006, and 2005.

 

F-15


Table of Contents

MB’s policies regarding nonaccrual of medallion and commercial loans are similar to those of the Company. The consumer portfolio has different characteristics compared to commercial loans, typified by a larger number of lower dollar loans that have similar characteristics. As a result, these loans are not typically placed on nonaccrual, but are charged off in their entirety when deemed uncollectible, or when they become 120 days past due, whichever occurs first, at which time appropriate collection and recovery efforts against both the borrower and the underlying collateral are initiated. At December 31, 2007, $623,000 of consumer loans to individuals in bankruptcy, representing less than 1% of consumer loans, were on nonaccrual. The amount of interest income on nonaccrual loans that would have been recognized if the loans had been paying in accordance with their original terms was immaterial for all periods presented. None of MB’s medallion or commercial loans were on nonaccrual as of December 31, 2007 and 2006.

MB’s loan and investment portfolios are assessed for collectability on a monthly basis, and a loan loss allowance is established for any realizability concerns on specific investments, and general reserves have also been established for any unknown factors. The consumer portfolio purchase in 2004 was net of unrealized depreciation of $4,244,000, or 5.0% of the balances outstanding, and included a purchase premium of approximately $5,678,000 of which $654,000, $986,000 and $1,511,000 was amortized into interest income during 2007, 2006, and 2005. The premium amounts on the balance sheet were $1,239,000 and $1,893,000 as of December 2007 and 2006. Adjustments to the fair value of this portfolio are based on the historical loan loss data obtained from the seller, adjusted for changes in delinquency trends and other factors as described previously in note 2.

In January 2004, MB commenced raising deposits to fund the purchase of various affiliates’ loan portfolios. The deposits were raised through the use of investment brokerage firms who package deposits qualifying for FDIC insurance into pools that are sold to MB. The rates paid on the deposits are highly competitive with market rates paid by other financial institutions, and include a brokerage fee of 0.25% to 0.55%, depending on the maturity of the deposit, which is capitalized and amortized to interest expense over the life of the respective pool. The total amount capitalized at December 31, 2007 and 2006 was $645,000 and $999,000, and $795,000 $699,000, and $585,000 was amortized to interest expense during 2007, 2006, and 2005. Interest on the deposits is accrued daily and paid monthly, semiannually, or at maturity.

The outstanding balances of fixed rate borrowings were as follows:

 

     Payments Due for the Fiscal Year Ending December 31,    December 31,
2007
   December 31,
2006
   Interest
Rate (1)
 

(Dollars in thousands)

   2008    2009    2010    2011    2012    Thereafter         

Deposits and fed funds purchased

   $ 200,316    $ 91,924    $ 10,560    $ —      $ —      $ —      $ 302,800    $ 261,484    4.85 %
                                                              

 

(1)

Weighted average contractual rate as of December 31, 2007.

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

FDIC-insured banks, including MB, are subject to certain federal laws, which impose various legal limitations on the extent to which banks may finance or otherwise supply funds to certain of their affiliates. In particular, MB is subject to certain restrictions on any extensions of credit to, or other covered transactions, such as certain purchases of assets, with the Company or its affiliates.

Quantitative measures established by regulation to ensure capital adequacy require MB to maintain minimum amounts and ratios as defined in the regulations (set forth in the table below). Additionally, as conditions of granting MB’s application for federal deposit insurance, the FDIC ordered that beginning paid-in-capital funds of not less than $22,000,000 be provided, and that the Tier I Leverage Capital to total assets ratio, as defined, be not less than 15%, and that an adequate allowance for loan losses be maintained. As a result, to facilitate maintenance of MB’s capital ratio requirement and to provide the necessary capital for continued growth, the Company periodically makes capital contributions to Medallion Bank, including an aggregate of $6,800,000 contributed over various months in 2007 and an aggregate of $1,550,000 contributed similarly in 2006. Separately, Medallion Bank paid dividends to the Company of $5,750,000 in 2007 and $0 in 2006. Without the capital infusions by the Company, a portion of the Medallion Bank

 

F-16


Table of Contents

dividends would have been retained to ensure Medallion Bank met its capital ratio requirements, and in such circumstance, if the Company maintained its dividend at the existing levels, a portion of those dividends could have represented a tax-free return of capital.

The following table represents MB’s actual capital amounts and related ratios as of December 31, 2007 and 2006, compared to required regulatory minimum capital ratios and the ratio required to be considered well capitalized. As of December 31, 2007, MB meets all capital adequacy requirements to which it is subject, and is well-capitalized.

 

     Regulatory     December 31,
2007
    December 31,
2006
 

(Dollars in Thousands)

   Minimum     Well-capitalized      

Tier I capital

   $ 13,884     $ 17,356     $ 54,869     $ 47,093  

Total capital

     26,888       33,610       59,109       50,680  

Average assets

     —         —         347,111       299,479  

Risk-weighted assets

     —         —         336,103       284,524  

Leverage ratio (1)

     4 %     5 %     15.8 %     15.7 %

Tier I capital ratio (2)

     4       6       16.3       16.6  

Total capital ratio (2)

     8       10       17.6       17.8  
                                

 

(1)

Calculated by dividing Tier I capital by average assets.

(2)

Calculated by dividing Tier I or total capital by risk-weighted assets.

(5) FUNDS BORROWED

The outstanding balances of funds borrowed were as follows:

 

     Payments Due for the Fiscal Year Ending December 31,    December 31,
2007
   December 31,
2006
   Interest
Rate (1)
 

(Dollars in thousands)

   2008    2009    2010    2011    2012    Thereafter         

Revolving lines of credit

   $ 290,791    $ 120,658    $ —      $ —      $ —      $ —      $ 411,449    $ 348,749    5.58 %

SBA debentures

     —        —        —        17,985      13,500      45,765      77,250      77,250    6.05  

Preferred securities

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

Notes payable to banks

     14,281      1,855      4,714      —        —        —        20,850      15,210    6.81  

Margin loans

     —        —        —        —        —        —        —        13,928    —    
                                                          

Total

   $ 305,072    $ 122,513    $ 4,714    $ 17,985    $ 13,500    $ 78,765    $ 542,549    $ 455,137    5.83  
                                                              

 

(1)

Weighted average contractual rate as of December 31, 2007.

(A) REVOLVING LINES OF CREDIT

In December 2006, and as renegotiated in December 2007, Trust II entered into a revolving line of credit agreement with Citibank N.A., to provide up to $250,000,000 of financing through a commercial paper conduit to acquire medallion loans from MFC (Citi line), of which $120,658,000 was outstanding at December 31, 2007. Borrowings under Trust II’s revolving line of credit are collateralized by Trust II’s assets. MFC is the servicer of the loans owned by Trust II. The Citi line includes a borrowing base covenant and rapid amortization in certain circumstances. In addition, if certain financial tests are not met, MFC can be replaced as the servicer. The Citi line matures in November 2008 with a term-out to December 2009. The interest rate is a pooled short-term commercial paper rate, which approximates LIBOR (4.60% at December 31, 2007), plus 0.47% with a facility fee of 0.15% on the aggregate Citi line, and prior to December 2007 was plus 0.35% with a facility fee of 0.125%.

In September 2002, and as renegotiated in September 2003, January 2005, January 2006, September 2006, and December 2006, the Trust entered into a revolving line of credit agreement (amended) with Merrill Lynch Commercial Finance Corp., as successor to Merrill Lynch Bank, USA (MLB) to provide up to $375,000,000 of financing to acquire medallion loans from MFC (MLB line), of which $290,791,000 was outstanding at December 31, 2007. Borrowings under the Trust’s revolving line of credit are collateralized by the Trust’s assets. MFC is the servicer of the loans owned by the Trust. The MLB line includes a borrowing base covenant and rapid amortization in certain circumstances. In addition, if certain financial tests are not met, MFC can be replaced as

 

F-17


Table of Contents

the servicer. The MLB line matures in September 2008. Effective January 2005, the interest rate was generally LIBOR (4.60% at December 31, 2007) plus 0.75% with an unused facility fee of 0.375% on unused amounts up to $250,000,000. The facility fees were $500,000 in September 2006, $200,000 in February 2006, $200,000 in January 2006, $300,000 in September 2005; and $94,000 remains to be paid pro rata over the next 3 quarters.

(B) SBA DEBENTURES

In September 2006, the SBA approved a $6,000,000 commitment for FSVC to issue additional debentures to the SBA during a four year period upon payment of a 1% fee and the infusion of $2,000,000 of additional capital. In March 2006, the SBA approved a $13,500,000 commitment for MCI to issue additional debentures to the SBA during a four year period upon payment of a 1% fee and the infusion of $6,750,000 of additional capital. In November 2003, the SBA approved an $8,000,000 commitment for FSVC, and during 2001, the SBA approved $36,000,000 each in commitments for FSVC and MCI. As of December 31, 2007, $80,000,000 of commitments had been fully utilized, and $19,500,000 was available for borrowing.

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

(C) PREFERRED SECURITIES, NOTES PAYABLE TO BANKS, AND MARGIN LOANS

On September 19, 2007, MFC entered into a $10,000,000 revolving note agreement with Citibank that matures on June 30, 2008. The line is secured by medallion loans of MFC that are in process of being sold to Trust II, any draws being payable from the receipt of proceeds from the sale. The line bears interest at the prime rate (7.25% at December 31, 2007) minus 1.00%, payable monthly. As of December 31, 2007, $0 had been drawn down under this line.

In June 2007, the Company issued and sold $36,083,000 aggregate principal amount of unsecured junior subordinated notes to Fin Trust which, in turn, sold $35,000,000 of preferred securities to Merrill Lynch International and issued 1,083 shares of common stock to the Company. The notes bear a fixed rate of interest of 7.68% to September 2012, and thereafter a variable rate of interest of 90 day LIBOR plus 2.125%. The notes mature in September 2037, and are prepayable at par on or after September 6, 2012. Interest is payable quarterly in arrears. The terms of the preferred securities and the notes are substantially identical. In December 2007, the Company was able to acquire $2,000,000 of the preferred securities for $1,300,000, realizing a gain of $700,000 in a transaction with a third party investor. At December 31, 2007, $33,000,000 was outstanding on the preferred securities.

In March 2007, the Company entered into a margin loan agreement with Smith Barney. The margin loan is secured by the pledge of short-term, high-quality investment securities held by the Company, and is generally available at 99% of the current fair market value of the securities. The margin loan bears interest at LIBOR (4.60% at December 31, 2007) plus 0.35%. As of December 31, 2007, $0 had been drawn down under this margin loan.

In December 2006, the Company entered into a margin loan agreement with Bear Stearns & Co. Inc. The margin loan is secured by the pledge of short-term, high-quality investment securities held by the Company, and is generally available at 99% of the current fair market value of the securities. The margin loan bears interest at LIBOR (4.60% at December 31, 2007) plus 0.50%. As of December 31, 2007, $0 had been drawn down under this margin loan.

In December 2006, certain operating subsidiaries of MFC entered into an aggregate $966,000 of note agreements with New York Commercial Bank, which was increased by $756,000 in January 2007, and by $2,250,000 in May 2007, to an aggregate of $3,972,000. These agreements are collateralized by certain taxicab medallions owned by Medallion Chicago of which $3,848,000 was outstanding at December 31, 2007. The note agreements bear interest at 6.50% or 6.74%, payable monthly. The notes mature December 4, 2009, January 5, 2010 and May 22, 2010, and are guaranteed by the Company. Principal and interest payments of $35,000 are due monthly, with the balance due at maturity.

In October 2006, certain operating subsidiaries of MFC entered into an aggregate $840,000 of note agreements with Metropolitan Bank of New York, which was increased by $2,250,000 in May 2007 to an aggregate of $3,090,000. These agreements are collateralized by certain taxicab medallions owned by Medallion Chicago of which $3,002,000 was outstanding at December 31, 2007. The note agreements bear interest at 6.75% or 6.85%, payable monthly. The notes mature October 30, 2009 and June 1, 2010 and are guaranteed by MFC. Principal and interest payments of $24,000 are due monthly, with the balance due at maturity.

 

F-18


Table of Contents

On January 25, 2005, MFC entered into a $4,000,000 revolving note agreement with New York Commercial Bank, formerly known as Atlantic Bank of New York that matured on December 1, 2005, and which maturity was extended by New York Commercial Bank to August 1, 2008. On March 6, 2006, the line of credit was increased to $6,000,000, and was further increased to $8,000,000 in March 2007. The line is secured by medallion loans of MFC that are in process of being sold to the Trust, any draws being payable from the receipt of proceeds from the sale. The line bears interest at the prime rate (7.25% at December 31, 2007) minus 0.25%, payable monthly. As of December 31, 2007, $0 had been drawn down under this line.

On April 26, 2004, the Company entered into a $15,000,000 revolving note agreement with Sterling National Bank that was further extended to June 30, 2008 and was increased to $20,000,000. The line is secured by certain pledged assets of the Company and MBC, and is subject to periodic borrowing base requirements. Effective August 2006, the line bears interest, payable monthly, at LIBOR (4.60% at December 31, 2007) plus 2.0% with no unused fee, and prior to that was at the prime rate, and was subject to an unused fee of 0.125%. As of December 31, 2007, $14,000,000 had been drawn down under this line.

(D) COVENANT COMPLIANCE

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

(6) STOCK OPTIONS

The Company has a stock option plan (2006 Stock Option Plan) available to grant both incentive and nonqualified stock options to employees. The 2006 Stock Option Plan, which was approved by the Board of Directors on February 15, 2006 and shareholders on June 16, 2006, provides for the issuance of a maximum of 800,000 shares of common stock of the Company. At December 31, 2007, 652,384 shares of the Company’s common stock remained available for future grants. The 2006 Stock Option Plan is administered by the Compensation Committee of the Board of Directors. The option price per share may not be less than the current market value of the Company’s common stock on the date the option is granted. The term and vesting periods of the options are determined by the Compensation Committee, provided that the maximum term of an option may not exceed a period of ten years.

The Company’s Board of Directors approved a new non-employee director stock option plan (the 2006 Director Plan) on February 15, 2006, which was approved by shareholders on June 16, 2006, and on which exemptive relief to implement the 2006 Director Plan was received from the SEC on August 28, 2007. The 2006 Director Plan provides for an automatic grant of options to purchase 9,000 shares of the Company’s common stock to an Eligible Director upon election to the Board, with an adjustment for directors who are elected to serve less than a full term. A total of 100,000 shares of the Company’s common stock is issuable under the 2006 Director Plan. At December 31, 2007, 55,000 shares of the Company’s common stock remained available for future grants. The option price per share may not be less than the current market value of the Company’s common stock on the date the option is granted. Options granted under the 2006 Director Plan are exercisable annually, as defined in the 2006 Director Plan. The term of the options may not exceed ten years.

The Company’s 1996 Stock Option Plan and 1996 Director Plan terminated on May 21, 2006 and no additional shares are available for future issuance. At December 31, 2007, 1,468,055 shares of the Company’s common stock were outstanding under the 1996 and 2006 plans, of which 1,206,190 shares were exercisable.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The weighted average fair value of options granted was $1.93, $2.25, and $2.05 per share for the years ended December 31, 2007, 2006, and 2005. The following assumptions were used for the shares granted during 2007, 2006, and 2005.

 

     Year ended December 31,  
     2007     2006     2005  

Risk free interest rate

   4.92 %   4.75 %   4.32 %

Expected dividend yield

   8.00     8.00     8.00  

Expected life of option in years

   5.88     7.00     7.00  

Expected volatility (1)

   35.00     35.00     44.00  
                  

 

(1)

We determine our expected volatility using the Black-Scholes option pricing model based on our historical volatility.

 

F-19


Table of Contents

The following table presents the activity for the stock option program under the 1996 and 2006 Stock Option Plans and the 1996 and 2006 Director Plans for the years ended December 31, 2007, 2006, and 2005.

 

     Number of
Options
    Exercise Price
Per Share
   Weighted
Average
Exercise Price

Outstanding at December 31, 2004

   1,883,209     $ 3.50-29.25    $ 9.75

Granted

   38,000       9.27-9.60      9.44

Cancelled

   (48,607 )     4.85-18.75      13.61

Exercised (1)

   (218,198 )     3.87-8.72      5.30
                   

Outstanding at December 31, 2005

   1,654,404       3.50-29.25      10.21

Granted

   207,162       13.06-13.06      13.06

Cancelled

   (151,918 )     4.85-29.25      17.03

Exercised (1)

   (253,118 )     3.70-8.40      4.94
                   

Outstanding at December 31, 2006

   1,456,530       3.50-29.25      10.82

Granted

   209,674       10.76-11.24      11.11

Cancelled

   (95,499 )     8.51-13.06      11.78

Exercised (1)

   (102,650 )     3.87-8.51      6.30
                   

Outstanding at December 31, 2007 (2)

   1,468,055     $ 3.50-29.25    $ 11.12
                   

Options exercisable at

       

December 31, 2005

   1,505,067     $ 3.50-29.25    $ 10.10

December 31, 2006

   1,233,512       3.50-29.25      10.79

December 31, 2007 (2)

   1,206,190       3.50-29.25      11.13
                   

 

(1)

The aggregate intrinsic value, which represents the difference between the price of the Company’s common stock at the exercise date and the related exercise price of the underlying options, was $523,000, $1,186,000, and $1,011,000 for 2007, 2006, and 2005.

(2)

The aggregate intrinsic value, which represents the difference between the price of the Company’s common stock at December 31, 2007 and the related exercise price of the underlying options, was $2,518,292 for outstanding options and $2,453,392 for exercisable options as of December 31, 2007.

The following table presents the activity for the unvested options outstanding under the plan for the year ended December 31, 2007.

 

     Number of
Options
    Exercise Price
Per Share
   Weighted
Average
Exercise Price

Outstanding at December 31, 2006

   223,018     $ 6.89-13.06    $ 8.66

Granted

   209,674       10.76-11.24      11.11

Cancelled

   (50,502 )     8.51-13.06      10.99

Vested

   (120,325 )     6.89-13.06      11.08
                   

Outstanding at December 31, 2007

   261,865     $ 8.51-13.06    $ 11.08
                   

The fair value of the options vested was $510,000, $1,665,000, and $3,709,000 in 2007, 2006, and 2005.

The following table summarizes information regarding options outstanding and options exercisable at December 31, 2007 under the 1996 and 2006 Stock Option Plans and the 1996 and 2006 Director Plans.

 

     Options Outstanding    Options Exercisable
     Weighted average    Weighted average

Range of Exercise
Prices

   Shares at
December 31,
2007
   Remaining
contractual life
in years
   Exercise price    Shares at
December 31,
2007
   Remaining
contractual life
in years
   Exercise price

$    3.50-5.51

   403,200    4.55    $ 4.88    403,200    4.55    $ 4.88

      6.50-13.75

   682,073    6.67      10.58    420,208    5.55      10.27

    14.25-15.56

   42,848    2.20      14.71    42,848    2.20      14.71

    17.25-18.75

   289,934    1.43      17.41    289,934    1.43      17.41

    29.25-29.25

   50,000    0.34      29.25    50,000    0.34      29.25
                     

$  3.50-29.25

   1,468,055    4.70      11.12    1,206,190    3.89      11.13
                                 

 

F-20


Table of Contents

(7) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

The following table presents the Company’s quarterly results of operations for the years ended December 31, 2007, 2006, and 2005.

 

(Dollars in thousands except per share data)

   March 31     June 30    September 30    December 31

2007 Quarter Ended

          

Investment income

   $ 10,439     $ 13,157    $ 13,555    $ 14,242

Net investment income (loss) after income taxes

     (395 )     1,618      1,555      2,520

Net increase in net assets resulting from operations

     3,780       4,272      3,602      3,782

Net increase in net assets resulting from operations per common share

          

Basic

   $ 0.22     $ 0.24    $ 0.21    $ 0.22

Diluted

     0.21       0.24      0.20      0.21
                            

2006 Quarter Ended

          

Investment income

   $ 10,014     $ 9,338    $ 9,630    $ 10,653

Net investment income after income taxes

     1,727       329      144      965

Net increase in net assets resulting from operations

     1,787       4,076      1,401      5,844

Net increase in net assets resulting from operations per common share

          

Basic

   $ 0.10     $ 0.24    $ 0.08    $ 0.34

Diluted

     0.10       0.23      0.08      0.33
                            

2005 Quarter Ended

          

Investment income

   $ 8,195     $ 8,763    $ 8,863    $ 8,990

Net investment income after income taxes

     1,020       1,854      668      1,040

Net increase in net assets resulting from operations

     2,236       447      3,575      603

Net increase in net assets resulting from operations per common share

          

Basic

   $ 0.13     $ 0.03    $ 0.21    $ 0.04

Diluted

     0.13       0.03      0.20      0.03
                            

(8) RECENTLY ISSUED ACCOUNTING STANDARDS

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51, which establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary by clarifying that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as a component of equity. It requires that changes in a parent’s ownership interest while the parent retains its controlling interest be accounted for as equity transactions and any retained noncontrolling equity investment upon the deconsolidation of a subsidiary be initially measured at fair value. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008 and shall be applied prospectively, except for the presentation and disclosure requirements which shall be applied retrospectively. We do not believe that this pronouncement will have an impact on our financial condition or results of operations.

In December 2007, the FASB issued SFAS No. 141R (revised 2007), Business Combinations which establishes principles and requirements on how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date fair value, as well as the recognition and measurement of goodwill acquired in a business combination. SFAS No. 141R also requires certain disclosures to enable users of the financial statements to evaluate the nature and financial effects of the business combination. Acquisition costs associated with the business combination will generally be expensed as incurred. SFAS No. 141R is effective prospectively to business combinations in fiscal years beginning on or after December 15, 2008. We do not believe that this pronouncement will have an impact on our financial condition or results of operations.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”, which includes an amendment to SFAS No. 115. This statement permits entities to choose to measure eligible financial instruments and certain other items at fair value at specified election dates. This statement is effective for fiscal years beginning after November 15, 2007. We do not believe that this pronouncement will have an impact on our financial condition or results of operations.

 

F-21


Table of Contents

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” an amendment of FASB Statements No. 87, 88, 106, and 132(R) (“SFAS 158”). SFAS No. 158 requires an employer to: (a) recognize in its statement of financial position the funded status of a benefit plan; (b) measure defined benefit plan assets and obligations as of the end of the employer’s fiscal year (with limited exceptions); and (c) recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise but are not recognized as components of net periodic benefit costs pursuant to prior existing guidance, any adjustment to amounts recognized in accumulated other comprehensive income. The provisions governing recognition of the funded status of a defined benefit plan and related disclosures are effective as of the end of fiscal years ending after December 15, 2006 and not before June 16, 2007. The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. We do not believe that this pronouncement will have an impact on our financial condition or results of operations.

In September 2006, the FASB issued SFAS No.157, “Fair Value Measurement.” This statement defines fair values, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. We currently follow fair market value accounting in our consolidated financial statements as a RIC; hence we do not expect the adoption of SFAS No.157 to have a material effect on our financial condition and results of operations. This statement is effective for fiscal years beginning after November 15, 2007.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting For Uncertainty in Income Taxes.” The interpretation sets a recognition threshold and measurement attribute for recognizing tax positions in a company’s financial statements based on a determination whether it is likely or not that the tax position would withstand a tax audit, without regard for the likelihood of a tax audit taking place. Assuming a position meets the ”more-likely-than-not” threshold, the interpretation also prescribes a measurement attribute requiring determination of how much of the tax position would ultimately be allowed if challenged. The interpretation is effective for fiscal years beginning after December 15, 2006. We do not believe that this pronouncement will have an impact on our financial condition or results of operations.

In February 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments,” an amendment of SFAS Nos. 133 and 140. This statement permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133, establishes a requirement to evaluate interests in securitized financial assets to identify interests that are free standing derivatives or that are hybrid financial instruments that contain an embedded derivative that require bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends SFAS No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. This statement is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006, as defined. The adoption of SFAS No. 155 does not have a material impact on our consolidated financial position or results of operations.

(9) SEGMENT REPORTING

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

(10) COMMITMENTS AND CONTINGENCIES

(a) Employment Agreements

The Company has employment agreements with certain key officers for either a three or five-year term. Annually, the contracts with a five-year term will renew for new five-year terms unless prior to the end of the first year, either the Company or the executive provides notice to the other party of its intention not to extend the employment period beyond the current five-year term. In the event of a change in control, as defined, during the employment period, the agreements provide for severance compensation to the executive in an amount equal to the balance of the salary, bonus, and value of fringe benefits which the executive would be entitled to receive for the remainder of the employment period.

 

F-22


Table of Contents

Employment agreements expire at various dates through 2012. At December 31, 2007, minimum payments under employment agreements are as follows:

 

(Dollars in thousands)

    

2008

   $ 2,198

2009

     1,263

2010

     773

2011

     638

2012

     266

2013 and thereafter

     —  
      

Total

   $ 5,138
      

(b) Other Commitments

The Company had portfolio commitments outstanding of $1,760,000 at December 31, 2007 that are generally on the same terms as those to existing borrowers or investees. Commitments generally have fixed expiration dates. Since some commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. In addition, the Company had approximately $37,162,000 of undisbursed funds relating to revolving credit facilities with borrowers. These amounts may be drawn upon at the customer’s request if they meet certain credit requirements.

Commitments for leased premises expire at various dates through June 30, 2016. At December 31, 2007, minimum rental commitments for non-cancelable leases are as follows:

 

(Dollars in thousands)

    

2008

   $ 1,207

2009

     1,169

2010

     1,114

2011

     1,114

2012

     1,039

2013 and thereafter

     3,173
      

Total

   $ 8,816
      

Rent expense was $1,353,000, $1,266,000, and $1,339,000 for the years ended December 31, 2007, 2006, and 2005.

(c) Litigation

The Company and its subsidiaries become defendants to various legal proceedings arising from the normal course of business. In the opinion of management, based on the advice of legal counsel, there is no proceeding pending, or to the knowledge of management threatened, which in the event of an adverse decision would result in a material adverse impact on the financial condition or results of operations of the Company.

(11) RELATED PARTY TRANSACTIONS

Certain directors, officers, and shareholders of the Company are also directors and officers of its wholly-owned subsidiaries, MFC, MCI, FSVC, and MB, as well as of certain portfolio investment companies. Officer salaries are set by the Board of Directors of the Company.

A member of the Board of Directors of the Company since 1996 was also senior counsel in the Company’s primary law firm. Amounts paid to the law firm were approximately $837,000, $542,000, and $198,000 in 2007, 2006, and 2005.

 

F-23


Table of Contents

During 2007, 2006, and 2005 we serviced $163,816,000, $155,099,000 and $129,391,000 in loans for MB. Included in net investment income were amounts as described below that were received from MB for services rendered in originating and servicing loans, and also for reimbursement of certain expenses incurred on their behalf:

 

      Year ended December 31,

(Dollars in thousands)

   2007    2006    2005

Servicing fees

   $ 1,395    $ 1,327    $ 1,292

Loan origination fees

     452      381      276

Reimbursement of operating expenses

     173      167      170

Interest income

     7      16      15
                    

Total other income

   $ 2,027    $ 1,891    $ 1,753
                    

SPAC

Included in deferred costs in other assets is $642,000 of investments in and loans to a special purpose acquisition company (the SPAC), 91%-owned by the Company which is currently in registration with the SEC to register units for sale in an initial public offering. Of this amount, $445,000 was repaid upon completion of the offering, which occurred after year end, see note 17. Prior to the consummation of the offering, the Company purchased warrants for $5,900,000 from the SPAC in a private placement which will allow it to acquire 5,900,000 additional shares of common stock. After the offering, the Company owned approximately 18% of the SPAC’s outstanding shares. If the SPAC is unable consummate an approved business combination within 24 months of its offering, the Company’s entire investment in the SPAC will become worthless as all of the assets of the SPAC will be used to repay the public stockholders.

The Company has entered into consulting agreements with ProEminent Sports, LLC and GamePlan, LLC, whose principals act as consultants to the Company for sports related investments and, included within the scope of their duties, also provide services to the SPAC, including serving as its Chief Executive Officer, and assisting generally with the SPAC’s offering and business combination. The Company pays ProEminent Sports a monthly fee of $20,000, and pays Game Plan a monthly fee of $10,000. Following a business combination, in the event the CEO is not offered employment or a board position with the SPAC, the Company has agreed to continue the consulting arrangement for at least an additional twelve months.

The Company will also agree to indemnify the SPAC in the event of the SPAC’s liquidation for all claims of any vendors, service providers, or other entities that are owed money by the SPAC for services or financing provided or contracted for, or for products sold to the SPAC, including claims of any prospective acquisition targets. In addition, the Company, as the majority owner of the SPAC, may advance additional funds for operational and acquisition-related purposes, which may be repaid from the proceeds of the offering or the ultimate disposition of the Company’s equity investment in the SPAC.

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

SPAC 2

Included in deferred costs in other assets is $504,000 of investments in and loans to a special purpose acquisition company (SPAC 2), 74%-owned by the Company which is currently in organization prior to registration with the SEC to register units for sale in an initial public offering. Up to $375,000 of this may be repayable upon completion of the offering or December 26, 2008, whichever is first. Prior to the offering, the Company will purchase warrants for $4,125,000 from SPAC 2 in a private placement which will allow it to acquire 4,125,000 additional shares of common stock. After the offering, the Company will own approximately 17% of SPAC 2’s outstanding shares. If SPAC 2 is unable consummate an approved business combination within 24 months of its offering, the Company’s entire investment in SPAC 2 will become worthless as all of the assets of SPAC 2 will be used to repay the public stockholders.

The Company will also agree to indemnify SPAC 2 in the event of SPAC 2’s liquidation for all claims of any vendors, service providers, or other entities that are owed money by SPAC 2 for services rendered or contracted for, or for products sold to SPAC 2, including claims of any prospective acquisition targets. In addition, the Company, as the majority owner of SPAC 2, may advance additional funds for operational and acquisition-related purposes, which may be repaid from the proceeds of the offering or the ultimate disposition of the Company’s equity investment in SPAC 2.

 

F-24


Table of Contents

Certain of the Company’s officers and directors also serve as officers and directors of SPAC 2, and in that role will enter into agreements with SPAC 2 and its underwriter(s) to present to SPAC 2, prior to presentation to any other person or entity, opportunities to acquire entities, until the earlier of SPAC 2’s consummation of a business combination, SPAC 2’s liquidation, or until such time as they cease to be an officer or director of SPAC 2. The Company will also enter into a similar agreement.

(12) SHAREHOLDERS’ EQUITY

In November 2003, the Company announced a stock repurchase program which authorized the repurchase of up to $10,000,000 of common stock during the following six months, with an option for the Board of Directors to extend the time frame for completing the purchases. In November 2004, the repurchase program was increased by an additional $10,000,000. As of December 31, 2007, 1,386,433 shares were repurchased for $12,606,000.

(13) NONINTEREST INCOME AND OTHER OPERATING EXPENSES

The major components of noninterest income were as follows:

 

      Year ended December 31,

(Dollars in thousands)

   2007    2006    2005

Servicing fees

   $ 1,436    $ 1,327    $ 1,879

Prepayment penalties

     460      782      874

Late charges

     277      228      332

Accretion of discount

     —        —        350

Other

     271      309      418
                    

Total noninterest income

   $ 2,444    $ 2,646    $ 3,853
                    

Included in prepayment penalties in 2006 and 2005 was $629,000 and $810,000 related to the early payoff of several large loans. The decrease in servicing fees, late charges, accretion of discount, and other income from 2005 primarily reflects the sale of BLL’s loan portfolio in October 2005.

The major components of other operating expenses were as follows:

 

      Year ended December 31,

(Dollars in thousands)

   2007    2006    2005

Travel, meals, and entertainment

   $ 548    $ 491    $ 652

Office expense

     535      294      329

Depreciation and amortization

     457      415      579

Miscellaneous taxes

     436      274      221

Directors fees

     345      492      426

Insurance

     308      302      396

Loan collection costs

     254      372      237

Telephone

     205      194      258

Other expenses

     599      678      1,048
                    

Total other operating expenses

   $ 3,687    $ 3,512    $ 4,146
                    

Operating expenses decreased as a whole primarily due to the sale of BLL in October 2005. Travel, meals, and entertainment increased due to an increase in investment development activities in 2007. Office expenses increased in 2007 due to office repairs and maintenance expenses, and the disposal and writeoffs of certain assets. Miscellaneous taxes increased due to $325,000 of franchise tax expense incurred in 2007 , partially offset by a $113,000 tax refund. Directors fees decreased due to additional fees recorded in 2006 due to increases in the amounts paid to directors and in the number of board meetings held. Loan collection costs were down from unusually high levels in 2006. Other expenses decreased from 2006 primarily reflecting lower other operating expenses and operating losses.

 

F-25


Table of Contents

(14) SELECTED FINANCIAL RATIOS AND OTHER DATA

The following table provides selected financial ratios and other data:

 

      Year ended December 31,  

(Dollars in thousands, except per share data)

   2007     2006     2005     2004     2003  

Net share data

          

Net asset value at the beginning of the year

   $ 9.73     $ 9.69     $ 9.83     $ 8.89     $ 8.87  

Net investment income

     0.30       0.18       0.26       0.01       0.13  

Income tax (provision) benefit

     0.00       0.00       0.00       (0.01 )     (0.00 )

Net realized gains on investments

     0.80       0.17       0.21       0.13       0.63  

Net change in unrealized appreciation (depreciation) on investments

     (0.23 )     0.39       (0.08 )     1.09       (0.65 )
                                        

Net increase in net assets resulting from operations

     0.87       0.74       0.39       1.22       0.11  

Issuance of common stock

     (0.01 )     (0.04 )     (0.06 )     0.00       0.00  

Repurchase of common stock

     0.01       —         0.03       0.05       —    

Distribution of net investment income

     (0.45 )     (0.44 )     (0.29 )     (0.14 )     (0.09 )

Distribution of net realized gains on investments

     (0.31 )     (0.22 )     (0.21 )     (0.19 )     —    

Other

     0.02       —         —         —         —    
                                        

Total increase (decrease) in net asset value

     0.13       0.04       (0.14 )     0.94       0.02  
                                        

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

   $ 9.86     $ 9.73     $ 9.69     $ 9.83     $ 8.89  
                                        

Per share market value at beginning of year

   $ 12.37     $ 11.26     $ 9.70     $ 9.49     $ 3.90  

Per share market value at end of year

     10.02       12.37       11.26       9.70       9.49  

Total return (2)

     (13 )%     16 %     21 %     6 %     146 %
                                        

Ratios/supplemental data

          

Average net assets

   $ 171,503     $ 167,528     $ 167,909     $ 162,843     $ 162,265  

Total expense ratio (3)

     28 %     23 %     21 %     18 %     17 %

Operating expenses to average net assets

     10.40       8.91       10.11       9.97       9.97  

Net investment income (loss) after taxes to average net assets

     3.09       1.89       2.73       (0.01 )     1.44  
                                        

 

(1)

Includes $0.16, $0.08, $0.12, $0.07, and $0.00 of undistributed net investment income per share as of December 31, 2007, 2006, 2005, 2004, and 2003, and $0.00 of undistributed net realized gains per share for all years presented.

(2)

Total return is calculated by dividing the change in market value of a share of common stock during the year, assuming the reinvestment of dividends on the payment date, by the per share market value at the beginning of the year.

(3)

Total expense ratio represents total expenses (interest expense, operating expenses, and income taxes) divided by average net assets.

(15) EMPLOYEE BENEFIT PLANS

The Company has a 401(k) Investment Plan (the 401(k) Plan) which covers all full-time and part-time employees of the Company who have attained the age of 21 and have a minimum of one year of service, including the employees of MB. Under the 401(k) Plan, an employee may elect to defer not less than 1% and no more than 15% of the total annual compensation that would otherwise be paid to the employee, provided, however, that employee’s contributions may not exceed certain maximum amounts determined under the Code. Employee contributions are invested in various mutual funds according to the directions of the employee. Beginning September 1, 1998, the Company elected to match employee contributions to the 401(k) Plan in an amount per employee up to one-third of such employee’s contribution but in no event greater than 2% of the portion of such employee’s annual salary eligible for 401(k) Plan benefits. The Company’s 401(k) plan expense, which including amounts for the employees of MB, was approximately $98,000, $59,000, and $67,000 for the years ended December 31, 2007, 2006, and 2005.

(16) FAIR VALUE OF FINANCIAL INSTRUMENTS

Statement of Financial Accounting Standard No. 107, “Disclosures About Fair Value of Financial Instruments” (SFAS 107) requires disclosure of fair value information about certain financial instruments, whether assets, liabilities, or off-balance-sheet commitments, if practicable. The following methods and assumptions were used to estimate the fair value of each class of financial instrument. Fair value estimates that were derived from broker quotes cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument.

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

 

F-26


Table of Contents

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

(c) Commitments to extend credit - The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and present creditworthiness of the counter parties. For fixed rate loan commitments, fair value also includes a consideration of the difference between the current levels of interest rates and the committed rates. At December 31, 2007 and 2006, the estimated fair value of these off-balance-sheet instruments was not material.

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

 

      December 31, 2007    December 31, 2006

(Dollars in thousands)

   Carrying
Amount
   Fair Value    Carrying
Amount
   Fair Value

Financial Assets

           

Investments

   $ 653,046    $ 653,046    $ 592,933    $ 592,933

Cash

     33,454      33,454      15,399      15,399

Financial Liabilities

           

Funds borrowed

     542,549      542,549      455,137      455,137
                           

(17) SUBSEQUENT EVENTS

On February 13, 2008, the Company’s board of directors declared a $0.19 per share common stock dividend, payable on March 31, 2008 to shareholders of record on March 14, 2008.

On January 24, 2008, the SPAC consummated its initial public offering (IPO), the results of which reduced the Company’s ownership to 20%. Immediately prior to the IPO, the Company purchased 5,900,000 warrants of the SPAC, to acquire common stock in the future under various conditions and restrictions, for $5,900,000. At closing, the SPAC repaid the $200,000 note due to the Company and reimbursed the Company for $245,000 of expenses incurred on its behalf.

 

F-27


Table of Contents

Medallion Financial Corp.

Consolidated Schedule of Investments

December 31, 2007

 

(Dollars in thousands)

   Industry    State    Security Type    % Held    # of
Invest.
   % of Total     Interest
Rate (1)
    Investment
Balances
 

Medallion loans

                     

New York

               1,166    61 %   6.91 %   $ 399,955  

Chicago

               286    5     7.43       33,008  

Boston

               161    5     8.44       32,446  

Newark

               159    3     8.40       22,058  

Cambridge

               25    1     8.41       5,174  

Other

               29    1     7.58       5,481  
                                 

Total

               1,826    76 %   7.13 %     498,122  

Deferred loan acquisition costs

                        798  

Unrealized depreciation on loans

                        (37 )
                           

Medallion loans, net

                      $ 498,883  
                           

Commercial loans

                     

Secured mezzanine (22% Minnesota, 15% Wisconsin, 11% Indiana, 10% Texas, 7% Iowa, 7% Florida, and 28% all other states)

         

Manufacturing

   21    5 %   14.32 %   $ 32,258  

Accommodation and food services

   4    1     11.40       6,442  

Administrative and support services

   3    1     17.01       6,265  

Wholesale trade

   1    1     13.00       4,000  

Transportation and warehousing

   1      *   14.00       2,850  

Professional, scientific, and technical services

   2      *   18.81       2,619  

Health care and social assistance

   1      *   7.00       1,906  

Information

   3      *   17.67       1,808  

Retail trade

   1      *   10.88       1,004  
                                 

Total

   37    9 %   14.19     $ 59,152  

Asset-based (77% New York, 21% New Jersey, and 2% all other states)

         

Wholesale trade

   10    1 %   8.45 %   $ 7,505  

Retail trade

   7    1     8.87       3,333  

Administrative and support services

   3      *   8.65       2,879  

Transportation and warehousing

   5      *   9.51       2,425  

Construction

   2      *   9.25       1,159  

Manufacturing

   10      *   10.14       1,111  

Arts, entertainment, and recreation

   1      *   9.75       569  

Finance and insurance

   5      *   10.10       506  

Professional, scientific, and technical services

   1      *   9.25       264  

Health care and social assistance

   1      *   9.50       89  

Real estate and rental and leasing

   1      *   9.50       30  
                                 

Total

   46    3 %   8.91     $ 19,870  

Other secured commercial (91% New York, 7% New Jersey, and 2% Illinois)

         

Transportation and warehousing

   132    1 %   7.25 %   $ 5,152  

Accommodation and food services

   10    1     9.05       4,763  

Retail trade

   13    1     11.61       3,843  

Other services (except public administration)

   18    1     9.56       3,789  

Real estate and rental and leasing

   6      *   7.39       1,144  

Arts, entertainment, and recreation

   2      *   8.59       413  

Construction

   1      *   7.25       148  

Manufacturing

   1      *   8.00       4  
                                 

Total

   183    3 %   9.05     $ 19,256  

Total

   266    15 %   12.12 %   $ 98,278  

Deferred loan acquisition costs

            (64 )

Unrealized depreciation on loans

            (6,432 )
                           

Commercial loans, net

          $ 91,782  
                           

 

(1)

Represents the weighted average interest rate of the respective portfolio as of the date indicated.

 

F-28


Table of Contents

Medallion Financial Corp.

Consolidated Schedule of Investments

December 31, 2007

 

(Dollars in thousands)

  

Industry

   State   

Security Type

   % Held     # of
Invest.
   % of Total     Interest
Rate (1)
    Investment
Balances
 

Investment in Medallion Bank and other controlled subsidiaries

 

        

Medallion Bank**

   Commercial banking    Utah    Common stock    100 %   1    8 %   14.24 %   $ 53,834  

Salt Lake City, Utah

                 

Medallion Hamptons Holding, LLC

   Real Estate    NY    Membership Interests    100 %   1      *   0.00       1,730  

437 Madison Avenue

                    

New York, NY 10022

                    

Generation Outdoors, LLC

   Advertising    NY    Common stock    100 %   1      *   0.00       17  

437 Madison Avenue

                    

New York, NY 10022

                    
                              

Total

              3    9 %   13.79 %   $ 55,581  

Unrealized appreciation on investments in Medallion Bank and other controlled subsidiaries

  

           1,920  
                          

Investment in Medallion Bank and other controlled subsidiaries, net

            $ 57,501  
                          

Equity investments

              

PMC Commercial Trust **

   Real Estate Investment Trust       Common Stock      *   1      *%   11.2 %   $ 901  

17950 Preston Road, Suite 600

                    

Dallas, TX 75252

                    

Restaurant Technologies

   Restaurant Service Provider       Common Stock      *   1      *   0.00       620  

940 Apollo Rd. Suite 110

                    

Eagan, MN 55121

                    

Clear Source

   Bottled Water Manufacturer       Warrants      *   1      *   0.00       278  

2281 Vermont Rte. 66

                    

Randolph, VT 05060

                    

Convergent Capital, Ltd

   Commercial Finance      

Limited Partnership

Interest

   7 %   1      *   0.00       240  

505 N. Highway 169

                    

Minneapolis MN 35441

                    

Micromedics, Inc.

   Medical Device Manufacturer       Common Stock      *   1      *   0.00       59  

1270 Eagan Industrial Road

                    

St. Paul, MN 55121-1385

                    

Star Concessions, Ltd.

   Airport Food and Retail      

Limited Partnership

Interest

   45 %   1      *   0.00       40  

8008 Cedar Springs Road, Terminal Building LB

                    

Dallas, TX 75235

                    

Appliance Recycling Centers of America, Inc.**

   Appliance Recycler       Common Stock      *   1      *   0.00       —    

7400 Excelsior Boulevard

                    

Minneapolis, MN 55426-4516

                    
                                

Total

              7      *%   4.70 %   $ 2,138  

Unrealized appreciation on equities

                    2,742  
                          

Equity investments, net

                  $ 4,880  
                          

Investment securities

                 
                                

Total

              —      —   %   —   %   $ —    

Unrealized appreciation on investment securities

              —    

Investment securities, net

                  $ —    
                                    

Total investments at cost

     2,102    100 %   8.45 %   $ 654,119  
                              

Deferred loan acquisition costs

              734  

Unrealized appreciation on investments in Medallion Bank and other controlled subsidiaries

              1,920  

Unrealized appreciation on equities

              2,742  

Unrealized depreciation on loans

              (6,469 )
                          

Net Investments ($458,102 pledged as collateral under borrowing arrangements)

            $ 653,046  
                          

 

* Less than 1.0%
** Not an eligible portfolio company as such term is defined in Section 2(a)(46) of the 1940 Act.

(1)

Represents the weighted average interest rate of the respective portfolio as of the date indicated.

 

F-29


Table of Contents

Medallion Financial Corp.

Consolidated Schedule of Investments

December 31, 2006

 

(Dollars in thousands)

   Industry    State    Security
Type
   % Held    # of
Invest.
   % of Total     Interest
Rate (1)
    Investment
Balances
 

Medallion loans

                     

New York

               1,187    57 %   6.74 %   $ 340,110  

Boston

               195    6     8.12       32,787  

Chicago

               335    5     6.88       31,077  

Newark

               102    2     8.32       10,233  

Cambridge

               38    1     7.93       8,184  

Other

               37    1     7.55       5,586  
                                 

Total

               1,894    72 %   6.93       427,977  

Deferred loan acquisition costs

                        729  

Unrealized depreciation on loans

                        (457 )
                           

Medallion loans, net

                      $ 428,249  
                           

Commercial loans

                     

Secured mezzanine (24% Minnesota, 13% Wisconsin, 12% Texas, 8% Indiana, 8% Iowa, and 35% all other states)

         

Manufacturing

   18    5 %   13.19 %   $ 28,699  

Accommodation and food services

   4    1     11.50       7,505  

Administrative and support services

   3    1     16.96       5,939  

Transportation and warehousing

   1      *   14.00       2,700  

Professional, scientific, and technical services

   2      *   18.81       2,619  

Information

   2      *   17.50       2,407  

Health care and social assistance

   2      *   12.00       2,252  

Retail trade

   1      *   10.88       1,121  

Wholesale trade

   1      *   13.75       293  

Other services (except public administration)

   1      *   12.50       197  
                                 

Total

   35    9 %   13.78     $ 53,732  

Asset-based (75% New York, 16% New Jersey, and 9% all other states)

         

Wholesale trade

   8    1 %   9.66 %   $ 7,186  

Transportation and warehousing

   4      *   10.52       3,302  

Retail trade

   7      *   10.24       2,698  

Manufacturing

   8      *   11.44       2,145  

Administrative and support services

   2      *   10.76       1,071  

Construction

   2      *   10.25       1,030  

Real estate and rental and leasing

   2      *   10.49       559  

Finance and insurance

   5      *   11.77       352  

Arts, entertainment, and recreation

   1      *   11.48       192  

Professional, scientific, and technical services

   1      *   10.25       133  
                                 

Total

   40    3 %   10.28     $ 18,668  

Other secured commercial (75% New York, 10% New Jersey, 8% Arizona, and 7% all other states)

         

Retail trade

   19      *   11.79 %   $ 3,959  

Transportation and warehousing

   55      *   7.09       3,723  

Other services (except public administration)

   26      *   9.66       3,712  

Real estate and rental and leasing

   10      *   8.53       3,047  

Accommodation and food services

   21      *   10.46       2,795  

Information

   1      *   11.70       828  

Construction

   1      *   8.25       305  

Arts, entertainment, and recreation

   1      *   9.00       97  

Manufacturing

   2      *   8.95       24  

Wholesale trade

   1      *   8.50       14  
                                 

Total

   137    3 %   9.59     $ 18,504  

Total

   212    15 %   12.21 %   $ 90,904  

Deferred loan acquisition costs

            (98 )

Unrealized depreciation on loans

            (2,599 )
                           

Commercial loans, net

          $ 88,207  
                           

 

(1)

Represents the weighted average interest rate of the respective portfolio as of the date indicated.

 

F-30


Table of Contents

Medallion Financial Corp.

Consolidated Schedule of Investments

December 31, 2006

 

(Dollars in thousands)

  

Industry

  

State

  

Security Type

   % Held     # of
Invest.
   % of Total     Interest
Rate (1)
    Investment
Balances
 

Investment in Medallion Bank and other controlled subsidiaries

           

Medallion Bank**

   Commercial banking    Utah    Common stock      100 %   1    8 %   0.00 %   $ 46,958  

Salt Lake City, Utah

                    

Medallion Hamptons Holding, LLC

   Real Estate    NY    Membership Interests      100 %   1      *   0.00       1,466  

437 Madison Avenue

                    

New York, NY 10022

                    

Generation Outdoors, LLC

   Advertising    NY    Common stock      100 %   1      *   0.00       774  

437 Madison Avenue

                    

New York, NY 10022

                    
                              

Total

              3    8 %   0.00 %     49,198  

Unrealized appreciation on investments in Medallion Bank and other controlled subsidiaries

  

           1,250  
                          

Investment in Medallion Bank and other controlled subsidiaries, net

 

         $ 50,448  
                          

Equity investments

                    

Clear Channel Communications, Inc.**

   Broadcasting - Radio       Common Stock        *   1    2 %   2.12 %   $ 12,335  

200 East Basse Road

                    

San Antonio, TX 78209

                 

PMC Commercial Trust **

   Real Estate Investment Trust       Common Stock        *   1      *   10.7       901  

17950 Preston Road, Suite 600

                    

Dallas, TX 75252

                    

Restaurant Technologies

   Restaurant Service Provider       Common Stock        *   1      *   0.00       620  

940 Apollo Rd. Suite 110

                    

Eagan, MN 55121

                    

Micromedics, Inc.

   Medical Device Manufacturer       Common Stock        *   1      *   0.00       59  

1270 Eagan Industrial Road

                 

St. Paul, MN 55121-1385

                 

Star Concessions, Ltd.

   Airport Food and Retail       Limited Partnership Interest      45 %   1      *   0.00       40  

8008 Cedar Springs Road, Terminal Building LB

                    

Dallas, TX 75235

                    

Appliance Recycling Centers of America, Inc.**

   Appliance Recycler       Common Stock        *   1      *   0.00       —    

7400 Excelsior Boulevard

                 

Minneapolis, MN 55426-4516

                 
                                

Total

              7    2 %   0.91 %     13,955  

Unrealized appreciation on equities

                    2,113  
                          

Equity investments, net

                  $ 16,068  
                          

Investment securities

                 

Federal National Mortgage Association**

   Finance       Bonds        *   1    2 %   4.59 %   $ 9,961  

3900 Wisconsin Avenue NW

                    

Washington, DC 20016

                 
                                

Total

              1    2 %   4.59 %     9,961  

Unrealized appreciation on investment securities

                 0  

Investment securities, net

               $ 9,961  
                                    

Total investments at cost

     2,114    100 %   6.90 %   $ 591,995  
                              

Deferred loan acquisition costs

              631  

Unrealized appreciation on investments in Medallion Bank and other controlled subsidiaries

  

           1,250  

Unrealized appreciation on equities

              2,113  

Unrealized depreciation on loans

              (3,056 )
                          

Net Investments ($405,817,000 pledged as collateral under borrowing arrangements)

 

         $ 592,933  
                          

 

* Less than 1.0%
** Not an eligible portfolio company as such term is defined in Section 2(a)(46) of the 1940 Act.

(1)

Represents the weighted average interest rate of the respective portfolio as of the date indicated.

 

F-31


Table of Contents

Medallion Bank

(A wholly owned subsidiary of Medallion Financial Corp.)

Financial Statements for the years ended December 31, 2007, 2006, and, 2005

 

F-32


Table of Contents

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholder of Medallion Bank

We have audited the accompanying balance sheets of Medallion Bank (the “Bank”) (a wholly owned subsidiary of Medallion Financial Corp.) as of December 31, 2007 and 2006, and the related statements of operations, changes in shareholder’s equity, and cash flows for each of the three years in the three-year period ended December 31,2007. These financial statements are the responsibility of the Bank’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Bank as of December 31, 2007 and 2006, and the results of its operations and its cash flows for each of the three years in the three-year period ended December 31,2007, in conformity with US generally accepted accounting principles.

 

Weiser LLP
New York, New York
March 13, 2008

 

F-33


Table of Contents

Medallion Bank

Statement of Operations

For the years ended December 31,

 

     2007    2006    2005  

Interest income

        

Investments

   $ 1,654,465    $ 1,589,039    $ 1,003,954  

Loan interest including fees

     34,909,582      28,386,375      21,399,022  
                      

Total interest income

     36,564,047      29,975,414      22,402,976  

Interest expense

     13,803,604      10,453,732      6,413,604  
                      

Net interest income

     22,760,443      19,521,682      15,989,372  

Provision for loan losses

     5,177,823      3,197,752      3,279,713  
                      

Net interest income after provision for loan losses

     17,582,620      16,323,930      12,709,659  

Non-interest income

     336,719      490,128      408,047  

Gain/(loss) on sale of assets

     55,423      26,378      (164,103 )

Non-interest expense

        

Loan servicing

     3,520,906      2,951,525      2,505,815  

Salaries and benefits

     2,174,839      1,953,858      1,655,117  

Professional fees

     357,477      497,368      311,369  

Occupancy and equipment

     177,367      154,392      203,956  

Credit reports

     160,909      124,818      117,878  

Regulatory fees

     137,059      45,287      51,215  

Other

     661,324      561,761      698,384  
                      

Total non-interest expense

     7,189,881      6,289,009      5,543,734  
                      

Income before income taxes

     10,784,881      10,551,427      7,409,869  

Provision for income taxes

     4,058,745      4,387,959      1,972,920  
                      

Net income

   $ 6,726,136    $ 6,163,468    $ 5,436,949  
                      

The accompanying notes are an integral part of these financial statements.

 

F-34


Table of Contents

Medallion Bank

Balance Sheets

December 31,

 

     2007     2006  

Assets

    

Cash and cash equivalents, substantially all of which are federal funds sold

   $ 17,024,801     $ 14,698,919  

Investment securities available-for-sale

     21,837,833       21,682,923  

Loans, net of deferred loan acquisition costs

     322,419,804       273,896,578  

Allowance for loan losses

     (7,311,430 )     (6,056,785 )
                

Loans, net of allowance for loan losses

     315,108,374       267,839,793  

Due from affiliates

     1,120,371       —    

Repossessed inventory

     978,057       772,845  

Fixed assets, net

     198,304       184,091  

Deferred tax asset

     931,165       —    

Taxes receivable

     —         19,408  

Other assets

     4,635,517       4,232,671  
                

Total assets

   $ 361,834,422     $ 309,430,650  
                

Liabilities and shareholder’s equity

    

Liabilities

    

Time deposits, including accrued interest payable of $3,717,323 in 2007 and $3,227,540 in 2006

   $ 302,800,323     $ 261,483,540  

Subordinated debt

     105,553       105,553  

Other liabilities

     3,136,500       485,339  

Deferred tax liability, net

     —         347,057  

Due to affiliates

     —         161,694  

Taxes payable

     898,925       —    
                

Total liabilities

     306,941,301       262,583,183  
                

Commitments and contingencies

     —         —    

Shareholder’s equity

    

Common stock, $1 par value, 1,000,000 shares authorized, 1,000,000 issued and outstanding

     1,000,000       1,000,000  

Additional paid in capital

     39,000,000       32,200,000  

Accumulated other comprehensive loss

     24,108       (245,410 )

Retained earnings

     14,869,013       13,892,877  
                

Total shareholder’s equity

     54,893,121       46,847,467  
                

Total liabilities and shareholder’s equity

   $ 361,834,422     $ 309,430,650  
                

The accompanying notes are an integral part of these financial statements.

 

F-35


Table of Contents

Medallion Bank

Statement of Changes in Shareholder’s Equity

For the years ended December 31, 2007, 2006, and 2005

 

     Common
Stock
   Additional
Paid in
Capital
   Accumulated
Other
Comprehensive
Loss
    Retained
Earnings
    Total
Shareholder’s
Equity
 

Balance at December 31, 2004

   $ 1,000,000    $ 30,200,000    $ (49,219 )   $ 2,292,360     $ 33,443,141  

Capital Contributions

     —        450,000      —         —         450,000  

Net income

     —        —        —         5,436,949       5,436,949  

Unrealized losses on investment securities

     —        —        (193,878 )     —         (193,878 )

Other

     —        —        —         100       100  
                                      

Balance at December 31, 2005

     1,000,000      30,650,000      (243,097 )     7,729,409       39,136,312  

Capital Contributions

     —        1,550,000      —         —         1,550,000  

Net income

     —        —        —         6,163,468       6,163,468  

Unrealized losses on investment securities

     —        —        (2,313 )     —         (2,313 )
                                      

Balance at December 31, 2006

     1,000,000      32,200,000      (245,410 )     13,892,877       46,847,467  

Capital Contributions

     —        6,800,000      —         —         6,800,000  

Net income

     —        —        —         6,726,136       6,726,136  

Dividends paid to parent

     —        —        —         (5,750,000 )     (5,750,000 )

Unrealized gains on investment securities

     —        —        269,518       —         269,518  
                                      

Balance at December 31, 2007

   $ 1,000,000    $ 39,000,000    $ 24,108     $ 14,869,013     $ 54,893,121  
                                      

The accompanying notes are an integral part of these financial statements.

 

F-36


Table of Contents

Medallion Bank

Statement of Cash Flows

For the years ended December 31,

 

     2007     2006     2005  

Cash flows from operating activities

      

Net income from operations

   $ 6,726,136     $ 6,163,468     $ 5,436,949  

Adjustments to reconcile net income to net cash flows provided by operating activities:

      

Depreciation and amortization

     71,136       47,208       126,677  

Provision for loan losses

     5,177,823       3,197,752       3,279,713  

Amortization of premium on investments

     139,868       276,737       176,767  

Changes in operating assets and liabilities:

      

Interest receivable

     (447,701 )     (733,748 )     (448,210 )

Repossessed inventory

     (205,212 )     (291,947 )     52,535  

Deferred tax asset

     (1,449,586 )     730,159       (226,201 )

Other assets

     44,855       (185,224 )     (650,273 )

Interest payable

     489,783       1,137,326       773,179  

Taxes payable

     918,333       (125,084 )     82,819  

Other liabilities

     2,651,161       144,652       95,344  
                        

Net cash provided by operating activities

     14,116,596       10,361,299       8,699,299  
                        

Cash flows from investing activities

      

Increase in loans, net

     (52,446,405 )     (54,329,607 )     (35,305,845 )

Purchase of investments

     (6,166,975 )     (8,305,414 )     (8,769,496 )

Proceeds from maturity of investments

     6,313,080       4,279,379       4,904,850  

Purchase of premises and equipment

     (101,900 )     (71,100 )     (103,106 )

Loss on sale of premises and equipment

     11,551       —         —    

Proceeds from disposal of premises and equipment

     5,000       —         —    
                        

Net cash used in investing activities

     (52,385,649 )     (58,426,742 )     (39,273,597 )
                        

Cash flows from financing activities

      

Issuance of time deposits

     216,633,000       297,782,000       179,542,000  

Payments made at maturity of time deposits

     (175,806,000 )     (256,543,000 )     (147,746,000 )

Federal funds purchased

     16,245,000       —         —    

Payments made at maturity of federal funds purchased

     (16,245,000 )     —         —    

Change in due to parent/affiliates

     (1,282,065 )     (51,756 )     (458,824 )

Proceeds from capital contributions

     6,800,000       1,550,000       450,000  

Dividends paid

     (5,750,000 )     —         —    

Proceeds from payment of subordinated debt

     —         (200,000 )     —    
                        

Net cash provided by financing activities

     40,594,935       42,537,244       31,787,176  
                        

Net change in cash and cash equivalents

     2,325,882       (5,528,199 )     1,212,878  

Cash and cash equivalents, beginning of the year

     14,698,919       20,227,118       19,014,240  
                        

Cash and cash equivalents, end of the year

   $ 17,024,801     $ 14,698,919     $ 20,227,118  
                        

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

      

Cash paid for interest

   $ 12,518,703     $ 8,617,151     $ 5,055,254  

Cash paid for income taxes

     4,590,000       3,782,883       2,138,000  

Loans transferred to repossessed inventory

     5,391,666       3,664,350       3,161,576  
                        

The accompanying notes are an integral part of these financial statements.

 

F-37


Table of Contents

Medallion Bank

Notes To Financial Statements

For the year ended December 31, 2007

1. Organization and summary of significant accounting policies

Description of business – Medallion Bank (the Bank) is a limited service industrial bank headquartered in Salt Lake City, Utah. The Bank was formed in May 2002 for the purpose of obtaining an industrial bank (IB) charter pursuant to the laws of the State of Utah. The Bank is a wholly owned subsidiary of Medallion Financial Corp. (Medallion). The Bank originates asset-based commercial loans and commercial loans to finance the purchase of taxi medallions (licenses), both of which are marketed and serviced by the Bank’s affiliates who have extensive prior experience in these asset groups. The Bank also originates consumer loans on a national basis that are secured by marine, recreational vehicle, and trailer products to customers with prior credit blemishes. Time certificates of deposits are originated nationally through a variety of brokered deposit relationships.

Basis of presentation – The Bank’s financial statements are presented in accordance with accounting principles generally accepted in the US and prevailing industry practices, which require management to make estimates that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities. Estimates, by their nature, are based upon judgment and available information. Actual results could differ materially from those estimates.

Cash and cash equivalents – The Bank considers all highly liquid instruments with an original purchased maturity of three months or less to be cash equivalents.

Investment securities –Statement of Financial Accounting Standard No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” requires that all applicable investments be classified as trading securities, available-for-sale securities, or held-to-maturity securities. The Bank had $21,838,000 and $21,683,000 of investments at fair value as of December 31, 2007 and 2006. The statement further requires that held-to-maturity securities be reported at amortized cost and available-for-sale securities be reported at fair value, with unrealized gains and losses excluded from earnings, at the date of the financial statements and reported in accumulated other comprehensive income (loss) as a separate component of shareholder’s equity, net of the effect of income taxes, until they are sold. The Bank had $39,000 of net unrealized gains and $402,000 net unrealized losses on available-for-sale securities as of December 31, 2007 and 2006. At the time of sale, any gains or losses, calculated by the specific identification method, will be recognized as a component of operating results and any amounts previously included in shareholder’s equity, which were recorded net of the income tax effect, will be reversed.

Loans – Loans are reported at the principal amount outstanding, net of deferred loan acquisition costs, which primarily includes deferred fees paid to loan originators, and which is amortized to interest income over the life of the loan. Interest income is recognized on an accrual basis. Loans are usually charged-off when they are 120 days contractually past due unless the loan is both well secured and in the process of collection or bankruptcy, or when, in the opinion of management, full collection of principal and interest is unlikely. All interest accrued but not collected for loans that are charged off is reversed against interest income. For the consumer loan portfolio, the process to repossess the collateral is started at 60 days past due. If the collateral is not located and the account reaches 120 days delinquent, the account is charged off. If the collateral is repossessed, a loss is recorded to write the loan down to its fair value less selling costs, and the collateral is sent to auction. When the collateral is sold, the net auction proceeds are applied to the account, and any remaining balance is written off, and any excess proceeds are recorded as a realized gain. Proceeds collected on charged off accounts are recorded as a recovery. Total loans 90 days or more past due were $1,077,381, $631,109, and $694,679 at December 31, 2007, 2006, and 2005.

A loan is considered to be impaired when, based on current information and events, it is likely the Bank will be unable to collect all amounts due according to the contractual terms of the original loan agreement. Management considers loans that are in bankruptcy status, but have not been charged-off, to be impaired. These loans are charged-down to fair value and placed on nonaccrual status. All interest accrued but not collected for loans that are placed on nonaccrual is reversed against interest income. The interest on these loans is accounted for on the cash basis until qualifying for return to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. At December 31, 2007, $623,000 of consumer loans to individuals in bankruptcy, representing less than 1% of consumer loans, were placed on nonaccrual. The amount of interest income on nonaccrual loans that would have been recognized if the loans had been paying in accordance with their original terms was immaterial for all periods presented. None of the Bank’s medallion or commercial loans were on nonaccrual as of December 31, 2007 and 2006.

Allowance for loan losses –In analyzing the adequacy of the allowance for loan losses, the Bank uses historical delinquency and actual loss rates acquired from Medallion and the unrelated financial institution from which the consumer portfolio was purchased. The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations

 

F-38


Table of Contents

that may affect the borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions, and excess concentration risks. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. Credit losses are deducted from the allowance and subsequent recoveries are added.

Fixed assets – Fixed assets are stated at cost less accumulated depreciation and amortization. Maintenance and repairs are charged to expense while significant improvements are capitalized. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the related assets. Capitalized leasehold improvements are amortized over the lesser of the estimated useful life of the asset or the remaining lease term.

Income taxes – The Bank uses the asset and liability method in providing income taxes on all transactions that have been recognized in the financial statements. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their existing tax bases. The Bank files its tax returns on a separate company basis.

Other comprehensive loss – The Bank had $270,000, ($2,000), and ($194,000) of net unrealized gains (losses) due to the mark-to-market of available-for-sale securities for the years ended December 31, 2007, 2006, and 2005. The Bank had no other components of comprehensive loss.

Restrictions on dividends, loans, and advances – Banking regulations place certain restrictions on dividends paid and loans or advances made by the Bank to Medallion. The total amount of dividends that may be paid at any date is generally limited to the retained earnings of the Bank. However, dividends paid by the Bank would be prohibited if the effect thereof would cause the Bank’s capital to be reduced below applicable minimum standards. The Bank was restricted from paying dividends in the first three years of operations.

Fair value of financial instruments – The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. The Financial Accounting Standards Board (FASB) issued SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” which excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements.

Recently issued financial accounting standards – In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51, which establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary by clarifying that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as a component of equity. It requires that changes in a parent’s ownership interest while the parent retains its controlling interest be accounted for as equity transactions and any retained noncontrolling equity investment upon the deconsolidation of a subsidiary be initially measured at fair value. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008 and shall be applied prospectively, except for the presentation and disclosure requirements which shall be applied retrospectively. We do not believe that this pronouncement will have an impact on our financial condition or results of operations.

In December 2007, the FASB issued SFAS No. 141R (revised 2007), Business Combinations which establishes principles and requirements on how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date fair value, as well as the recognition and measurement of goodwill acquired in a business combination. SFAS No. 141R also requires certain disclosures to enable users of the financial statements to evaluate the nature and financial effects of the business combination. Acquisition costs associated with the business combination will generally be expensed as incurred. SFAS No. 141R is effective prospectively to business combinations in fiscal years beginning on or after December 15, 2008. We do not believe that this pronouncement will have an impact on our financial condition or results of operations.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”, which includes an amendment to SFAS No. 115. This statement permits entities to choose to measure eligible financial instruments and certain other items at fair value at specified election dates. This statement is effective for fiscal years beginning after November 15, 2007. We do not believe that this pronouncement will have an impact on our financial condition or results of operations.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” an amendment of FASB Statements No. 87, 88, 106, and 132(R) (“SFAS 158”). SFAS No. 158 requires an employer to: (a) recognize in its statement of financial position the funded status of a benefit plan; (b) measure defined benefit plan assets and obligations as of the end of the employer’s fiscal year (with limited exceptions); and (c) recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise but are not recognized as components of net periodic benefit costs pursuant to prior existing guidance, any adjustment to amounts recognized in accumulated other

 

F-39


Table of Contents

comprehensive income. The provisions governing recognition of the funded status of a defined benefit plan and related disclosures are effective as of the end of fiscal years ending after December 15, 2006 and not before June 16, 2007. The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. We do not believe that this pronouncement will have an impact on our financial condition or results of operations.

In September 2006, the FASB issued SFAS No.157, “Fair Value Measurement.” This statement defines fair values, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. Management is currently assessing the impact this pronouncement will have on our financial condition and results of operations. This statement is effective for fiscal years beginning after November 15, 2007.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting For Uncertainty in Income Taxes”. The interpretation sets a recognition threshold and measurement attribute for recognizing tax positions in a company’s financial statements based on a determination whether it is likely or not that the tax position would withstand a tax audit, without regard for the likelihood of a tax audit taking place. Assuming a position meets the “more-likely-than-not” threshold, the interpretation also prescribes a measurement attribute requiring determination of how much of the tax position would ultimately be allowed if challenged. The interpretation is effective for fiscal years beginning after December 15, 2006. We do not believe that this pronouncement will have an impact on our financial condition or results of operations.

In February 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments,” an amendment of SFAS Nos. 133 and 140. This statement permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133, establishes a requirement to evaluate interests in securitized financial assets to identify interests that are free standing derivatives or that are hybrid financial instruments that contain an embedded derivative that require bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends SFAS No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. This statement is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006, as defined. The adoption of SFAS No. 155 does not have a material impact on our financial position or results of operations.

2. Loans and allowance for loan losses

Loans are summarized as follows at December 31.

 

      2007    2006

Loans

     

Consumer

   $ 141,210,443    $ 115,669,616

Taxi medallion

     88,890,219      94,891,270

Commercial:

     

Asset-based

     72,929,629      56,841,484

Construction

     14,855,725      3,372,624
             

Total commercial

     87,785,354      60,214,108

Deferred loan acquisition costs

     4,533,788      3,121,584
             

Total loans

   $ 322,419,804    $ 273,896,578
             

 

F-40


Table of Contents

Changes in the allowance for loan losses are summarized as follows.

 

Balance at 12/31/04

   $ 4,106,428  

Provision for loan losses

     3,279,713  

Recoveries

     758,377  

Loan charge-offs

     (3,119,387 )
        

Balance at 12/31/05

     5,025,131  

Provision for loan losses

     3,197,752  

Recoveries

     1,132,839  

Loan charge-offs

     (3,298,937 )
        

Balance at 12/31/06

     6,056,785  

Provision for loan losses

     5,177,823  

Recoveries

     1,397,418  

Loan charge-offs

     (5,320,596 )
        

Balance at 12/31/07

   $ 7,311,430  
        

The loan charge-offs resulted from the consumer portfolio.

3. Investment securities

Fixed maturity securities available-for-sale at December 31, 2007 consists of the following.

 

     Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value

Mortgage-backed securities, principally obligations of US federal agencies

   $ 19,149,260    $ 144,982    $ 120,165    $ 19,174,077

State and municipalities

     2,650,000      23,286      9,530      2,663,756
                           

Total

   $ 21,799,260    $ 168,268    $ 129,695    $ 21,837,833
                           

Fixed maturity securities available-for-sale at December 31, 2006 consists of the following.

 

     Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value

Mortgage-backed securities, principally obligations of US federal agencies

   $ 18,905,235    $ 30,784    $ 271,461    $ 18,664,558

State and municipalities

     3,180,000      988      162,623      3,018,365
                           

Total

   $ 22,085,235    $ 31,772    $ 434,084    $ 21,682,923
                           

The amortized cost and estimated market value of investment securities as of December 31, 2007 by contractual maturity are shown below. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

     Amortized Cost    Market Value

Due in one year or less

   $ —      $ —  

Due after one year through five years

     2,779,005      2,861,076

Due after five years through ten years

     2,250,000      2,249,170

Due after ten years

     16,770,255      16,727,587
             

Total

   $ 21,799,260    $ 21,837,833
             

 

F-41


Table of Contents

Information pertaining to securities with gross unrealized losses at December 31, 2007 aggregated by investment category and length of time that individual securities have been in a continuous loss position follows.

 

     Less than Twelve Months    Over Twelve Months
     Gross
Unrealized
Losses
   Fair Value    Gross
Unrealized
Losses
   Fair Value

Mortgage-backed securities, principally obligations of US federal agencies

   $ —      $ —      $ 120,165    $ 8,291,706

State and municipalities

     4,084      495,916      5,446      459,554
                           

Total

   $ 4,084    $ 495,916    $ 125,611    $ 8,751,260
                           

Unrealized losses on securities have not been recognized into income because the issuers’ bonds are of high credit quality, and the Bank has the intent and ability to hold the securities for the foreseeable future. The decline in fair value is primarily due to increased market interest rates. The fair value is expected to recover as the bonds approach the maturity date. There have been no sales of investment securities since the Bank’s inception.

4. Fixed assets

Fixed assets and their related useful lives at December 31 were as following:

 

     Useful lives    2007     2006  

Computer software

   3 years    $ 128,037     $ 99,537  

Furniture and fixtures

   5-10 years      85,376       74,503  

Leasehold improvements

   3-5 years      61,550       55,962  

Equipment

   5 years      40,875       23,104  

Telephone equipment

   3 years      34,347       29,643  

Deposit system

   3 years      13,975       13,975  
        364,160       296,724  

Less accumulated depreciation and amortization

        (165,856 )     (112,633 )
                   

Net fixed assets

      $ 198,304     $ 184,091  
                   

5. Deposits

At December 31, 2007 the scheduled maturities of all time deposits were as follows.

 

2008

   $ 200,316,323

2009

     91,924,000

2010

     10,560,000
      

Total

   $ 302,800,323
      

All time deposits are in denominations of less than $100,000 and have been originated through Certificate of Deposit Broker relationships. The weighted average interest rate of deposits outstanding at December 31, 2007 was 4.85%.

 

F-42


Table of Contents

6. Income taxes

Income taxes are summarized as follows.

 

     2007     2006    2005  

Current

       

Federal

   $ 4,770,556     $ 3,168,568    $ 1,938,554  

State

     737,776       489,231      303,255  

Deferred

       

Federal

     (1,263,743 )     730,160      (37,107 )

State

     (185,844 )     —        (5,580 )
                       

Provision

     4,058,745       4,387,959      2,199,122  

Change in Valuation allowance for tax assets

     —         —        (226,202 )
                       

Net provision for income taxes

   $ 4,058,745     $ 4,387,959    $ 1,972,920  
                       

The following table reconciles the provision for income taxes to the US federal statutory income tax rate for the years ended December 31, 2007, 2006, and 2005.

 

     2007     2006     2005  

US federal statutory tax rate

   34.0 %   34.0 %   34.0 %

State taxes

   4.3     4.6     4.1  

Prior year under (over) accrual

   4.0     7.4     (4.5 )

Change in valuation allowance

   —       —       (3.1 )

Other

   (4.7 )   (4.4 )   (3.9 )
                  

Effective income tax rate

   37.6 %   41.6 %   26.6 %
                  

The difference between the federal statutory income tax rate and the Bank’s effective income tax rate applicable to income from continuing operations for the year ended December 31, 2007 was primarily due to state taxes and adjustments of prior year deferred tax asset.

The Bank files its tax returns on a separate company basis. In 2003, the Bank set up a valuation reserve for a deferred tax asset, as it did not have an operating history to demonstrate that it would realize such net operating losses. The valuation reserve was reversed by $297,000 in 2005.

Deferred tax balances reflected in the balance sheet were as follows.

 

     2007     2006  

Provision for loan losses

   $ 2,727,106     $ 676,194  

Loan origination fees

     (1,768,963 )     (1,215,572 )

Unrealized (gains) losses on investments

     (14,465 )     156,901  

Other

     (12,513 )     35,420  
                

Net deferred tax asset (liability)

   $ 931,165     $ (347,057 )
                

7. Other transactions with affiliates

The Bank’s taxi medallion and asset-based commercial loans aggregated $163,816,000 and $155,099,000 at December 31, 2007 and 2006. These loans are marketed and serviced by the affiliates. The Bank paid $1,395,000, $1,327,000, and $1,292,000 for loan servicing fees to affiliates for 2007, 2006, and 2005. Origination fees of $529,000, $540,000, and $396,000 were capitalized as deferred costs and will be amortized to interest income over the life of the loan for 2007, 2006, and 2005. Amortization costs were $526,000, $567,000, and $350,000 for 2007, 2006, and 2005.

As part of the settlement for the purchase of the taxi medallion loans, the Bank issued a subordinated promissory note to Medallion for $305,553 in 2004. The promissory note is interest bearing at the rate of 3 month Libor (4.97% at December 31, 2007)

 

F-43


Table of Contents

plus 125 basis points, adjustable quarterly, interest paid monthly. The promissory note will be used to cover any loss that may arise in the taxi medallion loan purchased portfolio. The note was paid down to $105,553 in 2006. The remaining balance of the promissory note will be repaid to Medallion after the purchased portfolio has liquidated. Interest expense of $7,000, $16,000, and $15,000 was paid on this note for 2007, 2006, and 2005.

At December 31, 2007, the Bank was owed $1,120,000 from affiliates for payments due the Bank on collection of loan payments by affiliates, partially offset by origination fees, monthly servicing fees on loans, charges for corporate overhead, legal and business development expenses due to the affiliates.

The bank reimbursed the parent for expenses incurred on its behalf of $173,000, $167,000, and $170,000 for 2007, 2006, and 2005.

8. 401(k) plan

The Bank participates in the 401(k) plan offered by Medallion. The 401(k) Plan covers all full and part-time employees of the Bank who have attained the age of 21 and have a minimum of one year of service. Under the 401(k) Plan, an employee may elect to defer not less than 1% and no more than 15% of the total annual compensation that would otherwise be paid to the employee, provided however, that employees’ contributions may not exceed certain maximum amounts determined under the Internal Revenue Code. Employee contributions are invested in various mutual funds according to the directions of the employee. At the discretion of Medallion’s Board of Directors, the Bank can provide for employer matching contributions. Medallion has elected to match employee contributions up to one-third of the employee’s contribution, but not greater than 2% of the portion of the employee’s annual salary eligible for 401(k) benefits. For the years ended December 31, 2007 and 2006 the Bank provided $15,000 and $11,000 in employer matching, which amount is included in salaries and benefits expense on the accompanying statement of operations.

9. Commitments and contingencies

Lines of credit – At December 31, 2007, the Bank had unsecured Federal Funds lines with correspondent banks of $15,000,000.

Loans – At December 31, 2007, the Bank had commitments to extend credit of $26,228,000 to asset-based customers as long as there is no violation of any condition established in the contract. The Bank had commitments to extend credit of $3,486,000 to real estate customers for unfunded amounts.

Leases – The Bank leases office space under a non-cancelable operating lease that expires November 2012. Rental expense related to the lease was $111,000 and $112,000 for the years ended December 31, 2007 and 2006. The Bank has the option to extend the lease term for an additional five years.

Future minimum lease payments under this operating lease as of December 31, 2007 were as follows:

 

2008

   $ 87,815

2009

     90,469

2010

     93,172

2011

     95,967

2012

     90,383
      

Total

   $ 457,806
      

On February 26, 2007 the Bank leased additional office space adjacent to the main office. The future minimum lease payments under this operating lease are as follows:

 

2008

   $ 31,462

2009

     32,412

2010

     32,194

2011

     33,158

2012

     34,154
      

Total

   $ 163,380
      

 

F-44


Table of Contents

10. Capital requirements

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

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios as defined in the regulations (set forth in the table below). Additionally, as conditions of granting the Bank’s application for federal deposit insurance, the FDIC ordered that beginning paid-in-capital funds of not less than $22,000,000 be provided, and that a ratio of Tier 1 Capital as defined in section 325.2 of the FDIC Rules and Regulations (12 C.F.R. § 325.2), to total assets of not less than 15% will be maintained, and an adequate allowance for loan losses shall be maintained and no dividends shall be paid throughout the first three years of operation. Management believes, as of December 31, 2007, that the Bank meets all capital adequacy requirements to which it is subject.

The Bank’s actual and the regulatory minimum capital amounts and ratios are presented in the following table.

 

     Actual     Minimum for Capital
Adequacy Purposes
    Minimum To be Well
Capitalized Under Prompt
Corrective Action
Provisions
 

As of December 31, 2007

   Amount    Ratio     Amount    Ratio     Amount    Ratio  

Tier 1 Capital (to average assets)

   $ 54,869,000    15.8 %   $ 13,884,440    4.0 %   $ 17,355,550    5.0 %

Tier 1 Capital (to risk-weighted assets)

     54,869,000    16.3       13,444,120    4.0       20,166,180    6.0  

Total Capital (to risk-weighted assets)

     59,109,000    17.6       26,888,240    8.0       33,610,300    10.0  
                                       

11. Fair value of financial instruments

Statement of Financial Accounting Standard No. 107, “Disclosures About Fair Value of Financial Instruments” (SFAS 107) requires disclosure of fair value information about certain financial instruments, whether assets, liabilities, or off-balance-sheet commitments, if practicable. The following methods and assumptions were used to estimate the fair value of each class of financial instrument. Fair value estimates that were derived from broker quotes cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument.

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

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

(c) Commitments to extend credit - The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and present creditworthiness of the counter parties. For fixed rate loan commitments, fair value also includes a consideration of the difference between the current levels of interest rates and the committed rates. At December 31, 2007 and 2006, the estimated fair value of these off-balance-sheet instruments was not material.

(d) Fixed rate borrowings - The fair value of time deposits issued is estimated based on current market interest rates for similar debt.

 

      December 31, 2007    December 31, 2006

(Dollars in thousands)

   Carrying
Amount
   Fair Value    Carrying
Amount
   Fair Value

Financial Assets

           

Loans

   $ 315,108    $ 315,108    $ 267,840    $ 267,840

Investment securities

     21,838      21,838      21,683      21,683

Cash

     17,025      17,025      14,699      14,699

Financial Liabilities

           

Funds borrowed

     302,906      302,906      261,589      261,589
                           

 

F-45