MEDALLION FINANCIAL CORP - Quarter Report: 2018 September (Form 10-Q)

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the Quarterly Period Ended September 30, 2018

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 001-37747

 

 

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, 38^th Floor,

NEW YORK, NEW YORK 10022

(Address of principal executive offices) (Zip Code)

(212) 328-2100

(Registrant’s telephone number, including area code)

 

 

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

Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the Registrant was required to submit such files).    YES  ☒    NO  ☐

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer		☐		Accelerated Filer		☐
Non-Accelerated Filer		☒		Smaller Reporting Company		☐
				Emerging growth company		☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

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

The number of outstanding shares of registrant’s Common Stock, par value $0.01, as of November 9, 2018 was 24,440,052.

 

 

 

MEDALLION FINANCIAL CORP.

FORM 10-Q

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION			3
ITEM 1. FINANCIAL STATEMENTS			3
ITEM  2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			59
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			92
ITEM 4. CONTROLS AND PROCEDURES			92
PART II – OTHER INFORMATION			93
ITEM 1. LEGAL PROCEEDINGS			93
ITEM 1A. RISK FACTORS			93
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS			107
ITEM 5. OTHER INFORMATION			107
ITEM 6. EXHIBITS			108
SIGNATURES
CERTIFICATIONS

 

Page 2 of 108

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

BASIS OF PREPARATION

We, Medallion Financial Corp. or the Company, are a finance company, organized as a Delaware corporation, that includes Medallion Bank, our primary operating subsidiary. Effective April 2, 2018, following authorization by our shareholders, we withdrew our previous election to be regulated as a business development company, or BDC, under the Investment Company Act of 1940, as amended, or the 1940 Act. Prior to such time, we were a closed-end, non-diversified management investment company that had elected to be treated as a BDC under the 1940 Act.

As a result of this change in status, commencing with the three months ended June 30, 2018:

 

•

we consolidate the results of Medallion Bank and our other subsidiaries in our financial statements, which, as an investment company, we were previously precluded from doing; and

 

•

with the consolidation of Medallion Bank, given its significance to our overall financial results, we now report as a bank holding company for accounting purposes under Article 9 and Guide 3 of Regulation S-X (but we are not a bank holding company for regulatory purposes).

In accordance with FASB Accounting Standards Codification (ASC) Topic 946 – Financial Services – Investment Company, we are making this change to our financial reporting prospectively, and not restating or revising periods prior to our change in status to a non-investment company effective April 2, 2018. Accordingly, in this report we refer to both accounting in accordance with US generally accepted accounting principles (GAAP) applicable to bank holding companies (Bank Holding Company Accounting), which applies commencing April 2, 2018, and to that applicable to investment companies under the 1940 Act (Investment Company Accounting), which applies to prior periods.

In order to maintain its status as a non-investment company, the Company operates so as to fall outside the definition of an “investment company” or within an applicable exception. The Company expects to continue to fall within the exception from the definition of an “investment company” provided under Section 3(c)(6) of the 1940 Act as a company primarily engaged, directly or through majority-owned subsidiaries, in the business of, among other things, (i) banking, (ii) purchasing and otherwise acquiring notes, drafts, acceptances, open accounts receivable, and other obligations representing part or all of the sales price of merchandise, insurance and services, and (iii) making loans to manufacturers, wholesalers, and retailers of, and to prospective purchasers of, specified merchandise, insurance, and services. The Company is required to monitor its continued compliance with this exception, which it met for the 2018 second and third quarters.

We are a finance company that historically has had a leading position in originating, acquiring, and servicing loans that finance taxicab medallions and various types of commercial businesses. Recently, our strategic growth has been through Medallion Bank, a wholly-owned subsidiary of ours, which originates consumer loans for the purchase of recreational vehicles, boats, and trailers, and to finance small-scale home improvements. 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 16% (20% if there had been no loan sales during 2016, 2017, and 2018). In January 2017, we announced our plans to transform our overall strategy. We are transitioning away from medallion lending and placing our strategic focus on our growing consumer finance portfolio. Total assets under management were $1,598,000,000 as of September 30, 2018, and were $1,593,000,000 and $1,646,000,000 as of December 31, 2017 and September 30, 2017, and have grown at a compound annual growth rate of 10% from $215,000,000 at the end of 1996. Since our initial public offering in 1996, we have paid/declared distributions in excess of $263,060,000 or $14.66 per share.

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

 

•

Medallion Bank, or the Bank, an FDIC-insured industrial bank that originates consumer loans, raises deposits and conducts other banking activity;

 

•

Medallion Funding LLC, or Medallion Funding, a Small Business Investment Company, or SBIC, our primary taxicab medallion lending company;

 

•

Medallion Capital, Inc., or Medallion Capital, an SBIC which conducts a mezzanine financing business;

 

•

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

 

•

Medallion Servicing Corp., or MSC, which provides loan services to the Bank.

 

Page 3 of 108

Our other consolidated subsidiaries are comprised of Medallion Fine Art, Inc., Medallion Taxi Media, Inc., CDI-LP Holdings, Inc., Medallion Motorsports, LLC, and RPAC Racing LLC, or RPAC. In addition, we make both marketable and nonmarketable equity investments, primarily as a function of our mezzanine lending business.

The financial information is divided into two sections. The first section, Item 1, includes our unaudited consolidated financial statements including related footnotes. The second section, Item 2, consists of Management’s Discussion and Analysis of Financial Condition and Results of Operations for the quarter ended September 30, 2018.

Our consolidated balance sheet as of September 30, 2018, and the related consolidated statements of operations, consolidated statements of other comprehensive loss, consolidated statement of stockholders equity, and cash flows for the quarter then ended included in Item 1 have been prepared by us, without audit, pursuant to the rules and regulations of the SEC. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the US have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the accompanying consolidated financial statements include all adjustments, which are of a normal and recurring nature, necessary to present fairly our consolidated financial position and results of operations. The results of operations for the quarter ended September 30, 2018 may not be indicative of future performance. These financial statements should be read in conjunction with the financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2017.

 

Page 4 of 108

MEDALLION FINANCIAL CORP.

CONSOLIDATED BALANCE SHEETS

 

		Bank Holding Company Accounting				Investment Company Accounting
(Dollars in thousands, except share and per share data)		UNAUDITED September 30, 2018				December 31, 2017
Assets
Cash(1)		$	10,678			$	12,690
Federal funds sold			132,882				—
Equity investments			10,752				—
Equity investments, at fair value			—				5,213
Equity investments in affiliated entities, at fair value			—				4,308
Investment securities			45,757				—
Investments in Medallion Bank and other controlled subsidiaries, at fair value			—				302,147
Loans			1,089,545				—
Medallion loans, at fair value			—				208,279
Commercial loans, at fair value			—				53,737
Commercial loans to affiliated entities, at fair value			—				999
Commercial loans to controlled subsidiaries, at fair value			—				35,452
Allowance for losses			(29,484	)			—
Net loans receivable(1)			1,060,061				—
Net investments(1)			—				610,135
Accrued interest receivable(1)			7,005				547
Property and equipment, net			1,093				235
Loan collateral in process of foreclosure(1)			59,761				—
Goodwill and intangible assets			210,761				—
Investments other than securities			—				7,450
Other assets			32,657				4,465
Total assets		$	1,571,407			$	635,522
Liabilities
Accounts payable and accrued expenses(1)		$	17,789			$	4,373
Accrued interest payable(1)			6,118				3,831
Deposits			946,975				—
Short-term borrowings(1)			160,218				—
Deferred tax liabilities and other tax payables			2,011				12,536
Long-term debt			157,881				—
Funds borrowed(1)			—				327,623
Total liabilities			1,290,992				348,363
Commitments and contingencies			—				—
Stockholders’ equity
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 – 27,391,295 shares at September 30, 2018 and 27,294,327 shares at December 31, 2017 issued)			274				273
Additional paid in capital			274,163				273,716
Treasury stock (2,951,243 shares at September 30, 2018 and December 31, 2017)			(24,919	)			(24,919	)
Accumulated undistributed net investment loss			—				(65,592	)
Net unrealized appreciation on investments, net of tax			—				103,681
Accumulated other comprehensive loss			(469	)			—
Retained earnings			3,871				—
Total stockholders’ equity			252,920				287,159

 

Page 5 of 108

		Bank Holding Company Accounting				Investment Company Accounting
(Dollars in thousands, except share and per share data)		UNAUDITED September 30, 2018				December 31, 2017
Non-controlling interest in consolidated subsidiaries			27,495				—
Total equity			280,415				287,159
Total liabilities and equity		$	1,571,407			$	635,522
Number of shares outstanding			24,440,052				24,343,084
Book value per share/net asset value per share		$	10.35			$	11.80

 

(1)	See Note 18 for details of balances related to a consolidated variable interest entity.

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

 

Page 6 of 108

MEDALLION FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

 

		Bank Holding Company Accounting				Combined				Investment Company Accounting
(Dollars in thousands, except per share data)		For the Three Months Ended September 30, 2018				For the Nine Months Ended September 30, 2018 (1)				For the Three Months Ended September 30, 2017				For the Nine Months Ended September 30, 2017
Interest and fees on loans		$	32,692			$	64,718			$	—			$	—
Interest income on investments			—				3,287				3,768				10,153
Dividend income from controlled subsidiaries			—				28				1,256				1,256
Interest income from affiliated investments			—				654				453				1,844
Interest income from controlled subsidiaries			—				10				39				165
Medallion lease income			30				100				40				159
Interest and dividends on investment securities			430				1,032				—				—
Dividends and interest income on short-term investments			—				—				11				27
Total interest income(2)/total investment income(2)			33,152				69,829				5,567				13,604
Interest on deposits			5,064				9,264				—				—
Interest on short-term borrowings			1,698				3,557				—				—
Interest on long-term debt			2,125				3,991				—				—
Interest expense			—				3,551				3,543				10,285
Total interest expense(3)			8,887				20,363				3,543				10,285
Net interest income/net investment income			24,265				49,466				2,024				3,319
Provision for loan losses			18,205				48,781				—				—
Net interest loss after provision for loan losses			6,060				685				2,024				3,319
Other income (loss)
Sponsorship and race winnings			5,371				10,599				—				—
Gain on sale of loans			5,488				5,488				—				—
Impairment of equity investments			(388	)			(862	)			—				—
Writedown of loan collateral in process of foreclosure			(1,265	)			(1,361	)			—				—
Other income			235				515				8				22
Total other income			9,441				14,379				8				22
Other expenses
Salaries and employee benefits			5,999				13,987				2,224				5,086
Race team related expenses			2,876				5,416				—				—
Professional fees			3,951				6,920				567				1,875
Loan servicing fees			1,185				2,313				—				—
Collection costs			1,381				2,218				64				168
Travel, meals and entertainment			313				1,122				126				541
Rent expense			615				1,449				275				802
Regulatory fees			563				1,145				—				—
Amortization of intangible assets			361				722				—				—
Other expenses(4)			2,220				5,206				420				1,111
Total other expenses			19,464				40,498				3,676				9,583
Loss before income taxes/net investment loss before taxes(5)			(3,963	)			(25,434	)			(1,644	)			(6,242	)
Income tax benefit (provision)			117				4,474				(846	)			2,024
Net loss after taxes/net investment loss after taxes			(3,846	)			(20,960	)			(2,490	)			(4,218	)
Net realized gains (losses) on investments(6)			—				(34,745	)			944				3,785

 

Page 7 of 108

		Bank Holding Company Accounting				Combined				Investment Company Accounting
(Dollars in thousands, except per share data)		For the Three Months Ended September 30, 2018				For the Nine Months Ended September 30, 2018 (1)				For the Three Months Ended September 30, 2017				For the Nine Months Ended September 30, 2017
Income tax benefit			—				8,426				—				—
Total net realized gains (losses) on investments			—				(26,319	)			944				3,785
Net change in unrealized appreciation on Medallion Bank and other controlled subsidiaries			—				29,115				2,035				11,089
Net change in unrealized depreciation on investments other than securities			—				(1,915	)			—				—
Net change in unrealized depreciation on investments			—				(4,403	)			(6,871	)			(26,843	)
Income tax (provision) benefit			—				(8,122	)			7,001				13,120
Net unrealized appreciation (depreciation) on investments			—				14,675				2,165				(2,634	)
Net realized/unrealized gains (losses) on investments			—				(11,644	)			3,109				1,151
Net loss after taxes/net increase (decrease) on net assets resulting from operations			(3,846	)			(32,604	)			619				(3,067	)
Less: income attributable to the noncontrolling interest			851				1,614				—				—
Total net income (loss) attributable to Medallion Financial Corp./net increase (decrease) on net assets resulting from operations		$	(4,697	)		$	(34,218	)		$	619			$	(3,067	)
Basic net loss per share		$	(0.19	)		$	(1.41	)		$	0.03			$	(0.13	)
Diluted net loss per share		$	(0.19	)		$	(1.41	)		$	0.03			$	(0.13	)
Distributions declared per share		$	—			$	—				—			$	—
Weighted average common shares outstanding
Basic			24,235,242				24,207,273				23,930,086				23,916,334
Diluted			24,235,242				24,207,273				24,083,919				23,916,334

 

(1)	Balance includes the six months ended September 30, 2018 under Bank Holding Company Accounting and three months ended March 31, 2018 under Investment Company Accounting.

(2)	Included in interest and investment income is $450 and $1,428 of paid in kind interest for the three and nine months ended September 30, 2018 and $939 and $1,650 for the comparable 2017 periods.

(3)	Average borrowings outstanding were $1,255,945 and $1,226,896, and the related average borrowing costs were 2.81% and 2.22% for the three and nine months ended September 30, 2018, and were $330,885 and $335,907 and 4.25% and 4.09% for the comparable 2017 periods.

(4)	See Note 11 for the components of other operating expenses.

(5)	Includes $256 of net revenues received from Medallion Bank for the nine months ended September 30, 2018 and $184 and $641 for the three and nine months ended September 30, 2017, primarily for expense reimbursements. See Notes 6 and 13 for additional information.

(6)	There were no net losses on investment securities of affiliated issuers for the nine months ended September 30, 2018 and for the three and nine months ended September 30, 2017.

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

 

Page 8 of 108

MEDALLION FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE LOSS

(UNAUDITED)

 

		Bank Holding Company Accounting				Combined				Investment Company Accounting
(Dollars in thousands)		For the Three Months Ended September 30, 2018				For the Nine Months Ended September 30, 2018 (1)				For the Three Months Ended September 30, 2017				For the Nine Months Ended September 30, 2017
Net loss after taxes/net increase (decrease) on net assets resulting from operations		$	(3,846	)		$	(32,604	)		$	619			$	(3,067	)
Other comprehensive loss, net of tax			(214	)			(469	)			—				—
Total comprehensive loss			(4,060	)			(33,073	)			619				(3,067	)
Less: comprehensive income attributable to the noncontrolling interest			851				1,614				—				—
Total comprehensive loss attributable to Medallion Financial Corp.		($	4,911	)		($	34,687	)		$	619			($	3,067	)

 

(1)	Balance includes the six months ended September 30, 2018 under Bank Holding Company Accounting and three months ended March 31, 2018 under Investment Company Accounting.

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

 

Page 9 of 108

MEDALLION FINANCIAL CORP.

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY AND CHANGES IN NET ASSETS

(UNAUDITED)

 

		Bank Holding & Investment Company Accounting																								Investment Company Accounting												Bank Holding Company Accounting												Bank Holding & Investment Company Accounting
(Dollars in thousands)		Common Stock Shares				Common Stock				Preferred Stock				Capital in Excess of Par				Treasury Stock Shares				Treasury Stock				Accumulated undistributed net investment loss				Accumulated undistributed net realized gains on investments				Net unrealized appreciation on investments, net of tax				Retained Earnings				Accumulated Other Comprehensive Income				Total Stockholders’ Equity				Noncontrolling Interest				Total Equity
Balance at December 31, 2017			27,294,327			$	273			$	—			$	273,716				(2,951,243	)		($	24,919	)		($	65,592	)		$	—			$	103,681				—			$	—			$	287,159			$	—			$	287,159
Net decrease in net assets resulting from operations			—				—				—				—				—				—				( 38,299	)			—				23,425				—				—				(14,874	)			—				(14,874	)
Stock based compensation expense			—				1				—				151				—				—				—				—				—				—				—				152				—				152
Issuance of restricted stock, net			95,726				—				—				—				—				—				—				—				—				—				—				—				—
Balance at March 31, 2018			27,390,053				274				—				273,867				(2,951,243	)			(24,919	)			(103,891	)			—				127,106				—				—				272,437				—				272,437
Adoption of Bank Holding Company Accounting			—				—				—				—				—				—				103,891				—				(127,106	)			23,215				—				—				—				—
Balance at April 2, 2018			27,390,053				274				—				273,867				(2,951,243	)			( 24,919	)			—				—				—				23,215				—				272,437				27,065				299,502
Net loss			—				—				—				—				—				—				—				—				—				(19,344	)			—				(19,344	)			1,614				(17,730	)
Distributions on noncontrolling interest			—				—				—				—				—				—				—				—				—				—				—				—				(1,184	)			(1,184	)
Stock based compensation			—								—				296				—				—				—				—				—				—				—				296				—				296
Issuance of restricted stock, net			1,242				—				—				—				—				—				—				—				—				—				—				—				—
Net change in unrealized losses on investments, net of tax			—				—				—				—				—				—				—				—				—				—				(469	)			(469	)			—				(469	)
Balance at September 30, 2018			27,391,295			$	274			$	—			$	274,163				(2,951,243	)		($	24,919	)		$	—			$	—			$	—			$	3,871			($	469	)		$	252,920			$	27,495			$	280,415

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

 

Page 10 of 108

MEDALLION FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS

(UNAUDITED)

 

		Investment Company Accounting
(Dollars in thousands, except per share data)		Three Months Ended September 30, 2017				Nine Months Ended September 30, 2017
Net investment loss after income taxes		$	(2,490	)		$	(4,218	)
Net realized gains on investments, net of tax			944				3,785
Net unrealized depreciation on investments, net of tax			2,165				(2,634	)
Net increase (decrease) in net assets resulting from operations			619				(3,067	)
Investment income, net			—				—
Return of capital			—				—
Realized gains from investment transactions, net			—				—
Distributions to shareholders(1)			—				—
Stock-based compensation expense			222				551
Exercise of stock options			—				—
Capital share transactions			222				551
Total increase (decrease) in net assets			841				(2,516	)
Net assets at the beginning of the period			282,739				286,096
Net assets at the end of the period(2)		$	283,580			$	283,580
Capital share activity
Common stock issued, beginning of period			27,227,291				26,976,064
Exercise of stock options			—				—
Issuance of restricted stock, net			(492	)			250,735
Common stock issued, end of period			27,226,799				27,226,799
Treasury stock, beginning of period			(2,951,243	)			(2,951,243	)
Treasury stock acquired			—				—
Treasury stock, end of period			(2,951,243	)			(2,951,243	)
Common stock outstanding			24,275,556				24,275,556

 

(1)	Distributions declared were $0.00 and $0.00 per share for the three and nine months ended September 30, 2017.

(2)	Includes $0 of undistributed net investment income, $0 of undistributed net realized gains on investments, and $0 of capital loss carryforwards at September 30, 2017.

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

 

Page 11 of 108

MEDALLION FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

		Combined				Investment Company Accounting
(Dollars in  thousands)		For the Nine Months Ended September 30, 2018 (1)				For the Nine Months Ended September 30, 2017
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss		$	(32,604	)		$	(3,067	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Provision for loan losses			48,781				—
Loans originated			(8,193	)			(16,775	)
Proceeds from principal receipts, sales, and maturities of loans			13,279				36,922
Paid-in-kind interest			(1,428	)			(1,650	)
Depreciation and amortization			2,995				410
Change in deferred and other tax assets/liabilities, net			8,676				(12,268	)
Amortization of origination fees, net			2,192				55
Net change in loan collateral in process of foreclosure			3,258				—
Capital returned by Medallion Bank and other controlled subsidiaries, net			93				588
Net realized gains on sale of loans and investments			(4,726	)			—
Net change in unrealized depreciation on investments			5,380				26,843
Net change in unrealized depreciation on investment other than securities			1,915				—
Increase in unrealized appreciation on Medallion Bank and other controlled subsidiaries			(29,115	)			(11,089	)
Net realized (gains) losses on investments			34,745				(3,785	)
Stock-based compensation expense			446				551
Decrease in accrued interest receivable			486				209
Increase in other liabilities			3,159				—
(Increase) decrease in other assets			(7,173	)			548
Decrease in accounts payable and accrued expenses			(675	)			(354	)
Increase (decrease) in accrued interest payable			41				255
Net cash provided by operating activities			41,532				17,393
CASH FLOWS FROM INVESTING ACTIVITIES
Loans originated			(256,933	)			—
Proceeds from principal receipts, sales, and maturities of loans			240,915				—
Purchases of investments			(8,304	)			—
Proceeds from principal receipts, sales, and maturities of investments			2,475				—
Net cash (used for) investing activities			(21,847	)			—
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from time deposits and funds borrowed			336,108				—
Repayments of time deposits and funds borrowed			(253,497	)			(18,935	)
Purchase of federal funds			8,000				—
Repayments of federal funds			(8,000	)			—
Distributions to noncontrolling interests			(1,184	)			—
Payments of declared distributions			(65	)			(139	)
Net cash provided by (used for) financing activities			81,362				(19,074	)

 

Page 12 of 108

		Combined				Investment Company Accounting
(Dollars in  thousands)		For the Nine Months Ended September 30, 2018 (1)				For the Nine Months Ended September 30, 2017
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS			101,047				(1,681	)
Cash and cash equivalents, beginning of period(2)			42,513				20,962
Cash and cash equivalents, end of period(3)		$	143,560			$	19,281
SUPPLEMENTAL INFORMATION
Cash paid during the period for interest		$	17,381			$	9,692
Cash paid during the period for income taxes			52				48

 

(1)	Balance includes the six months ended September 30, 2018 under Bank Holding Company Accounting and three months ended March 31, 2018 under Investment Company Accounting.

(2)	Included in the beginning balance for the nine months ended September 30, 2018 was $29,923 of cash, cash equivalents, and federal funds sold as a result of the consolidation of previously unconsolidated subsidiaries and excludes $100 of cash held by the Company on deposit with Medallion Bank.

(3)	Includes federal funds sold for the nine months ended September 30, 2018.

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

 

Page 13 of 108

MEDALLION FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2018

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

Medallion Financial Corp. (the Company) is a commercial finance company organized as a Delaware corporation that reports as a bank holding company (but is not a bank holding company for regulatory purposes). The Company conducts its business through various wholly-owned subsidiaries including its primary operating company, Medallion Bank, a Federal Deposit Insurance Corporation (FDIC) insured industrial bank, that originates consumer loans, raises deposits, and conducts other banking activities. Medallion Bank is subject to competition from other financial institutions and to the regulations of certain federal and state agencies, and undergoes examinations by those agencies. Medallion Bank was initially formed for the primary purpose of originating commercial loans in three categories: 1) loans to finance the purchase of taxicab medallions, 2) asset-based commercial loans, and 3) SBA 7(a) loans. The loans are marketed and serviced by Medallion Bank’s affiliates that have extensive prior experience in these asset groups. Subsequent to its formation, Medallion Bank began originating consumer loans to finance the purchases of RVs, boats, and other related items, and to finance small scale home improvements. The Company also conducts business through Medallion Funding LLC (MFC), a Small Business Investment Company (SBIC) which originates and services taxicab medallion and commercial loans.

The Company also conducts business through its subsidiaries, 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 by the Small Business Administration (SBA). MCI and FSVC are financed in part by the SBA.

The Company has a controlling ownership stake in Medallion Motorsports, LLC, the primary owner of RPAC Racing, LLC (RPAC), a professional car racing team that competes in the Monster Energy NASCAR Cup Series, which is also consolidated with the Company.

The Company formed a wholly-owned subsidiary, Medallion Servicing Corporation (MSC), to provide loan services to Medallion Bank. The Company has assigned all of its loan servicing rights for Medallion Bank, which consists of servicing taxi medallion loans originated by Medallion Bank, to MSC, which bills and collects the related service fee income from Medallion Bank, and is allocated and charged by the Company for MSC’s share of these servicing costs.

Taxi Medallion Loan Trust III (Trust III) was established for the purpose of owning medallion loans originated by MFC or others. Trust III is a variable interest entity (VIE), MFC is the primary beneficiary and as a result the Company consolidated Trust III in its financial results, until consummation of the restructuring subsequent to September 30, 2018. Trust III is a separate legal and corporate entity with its own creditors which, in any liquidation of Trust III, will be entitled to be satisfied out of Trust III’s assets prior to any value in Trust III becoming available to Trust III’s equity holders. The assets of Trust III, aggregating $63,512,000 at September 30, 2018, 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 III. Trust III’s loans are serviced by MFC. As of September 30, 2018, Trust III had liabilities of $98,491,000 and a deficit of $34,979,000, as a result of losses taken on the medallion loans in Trust III. As of September 30, 2018, this amount exceeded the Company’s maximum exposure to Trust III, which is solely due to a limited guaranty by MFC of $5,987,000, by $28,992,000. Refer to Note 19 for a discussion of the restructuring the Company executed subsequent to September 30, 2018.

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 $36,142,000 at September 30, 2018, 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.

MFC, through several wholly-owned subsidiaries (together, Medallion Chicago), purchased $8,689,000 of City of Chicago taxicab medallions out of foreclosure, which are leased to fleet operators while being held for sale. The 159 medallions are carried at a net realizable value of $5,535,000 on the Company’s consolidated balance sheet at September 30, 2018 compared to fair value of $7,450,000 and $9,510,000 at December 31, 2017 and September 30, 2017.

 

Page 14 of 108

(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Change to Bank Holding Company Accounting

As described above, effective April 2, 2018, the Company withdrew its previous election to be regulated as a BDC under the 1940 Act. Prior to such time, the Company was a closed-end, non-diversified management investment company that had elected to be treated as a BDC under the 1940 Act. Accordingly, commencing with the three months ended June 30, 2018, the Company (which now consolidates the results of Medallion Bank and its other subsidiaries) reports in accordance with Bank Holding Company Accounting; periods prior to such change in status are reported in accordance with Investment Company Accounting. Significant accounting policies that differ between such periods are described in more detail below.

Use of Estimates

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the US (GAAP) requires management to make estimates that affect the amounts reported in the consolidated financial statements and the accompanying notes. Accounting estimates and assumptions are those that management considers to be the most critical to an understanding of the consolidated financial statements because they inherently involve significant judgments and uncertainties. All of these estimates reflect management’s best judgment about current economic and market conditions and their effects based on information available as of the date of these consolidated financial statements. If such conditions change, it is reasonably possible that the judgments and estimates could change, which may result in future impairments of loans and other receivables, investments other than securities, loans held for sale, and investments, among other effects.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and all of its wholly-owned and controlled subsidiaries commencing with the three months ended June 30, 2018. All significant intercompany transactions, balances, and profits (losses) have been eliminated in consolidation. Prior to the Company’s election to withdraw from being regulated as a BDC under the 1940 Act effective April 2, 2018, Medallion Bank and various other Company subsidiaries were not consolidated with the Company prior to the three months ended June 30, 2018, and as such see Note 6 for the presentation of financial information for Medallion Bank and other controlled subsidiaries for such prior periods.

The consolidated financial statements have been prepared in accordance with GAAP. The Company consolidates all entities it controls through a majority voting interest, a controlling interest through other contractual rights, or as being identified as the primary beneficiary of VIEs. The primary beneficiary is the party who has both (1) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and (2) an obligation to absorb losses of the entity or a right to receive benefits from the entity that could potentially be significant to the entity. For consolidated entities that are less than wholly owned, the third-party’s holding is recorded as non-controlling interest.

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. Cash balances are generally held in accounts at large national or regional banking organizations in amounts that exceed the federally insured limits.

Fair Value of Assets and Liabilities

The Company follows FASB Accounting Standards Codification Topic 820, Fair Value Measurements and Disclosures, (FASB ASC 820), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. FASB ASC 820 defines fair value as an exit price (i.e. a price that would be received to sell, as opposed to acquire, an asset or transfer a liability), and emphasizes that fair value is a market-based measurement. It establishes a fair value hierarchy that distinguishes between assumptions developed based on market data obtained from independent external sources and the reporting entity’s own assumptions. Further, it specifies that fair value measurement should consider adjustment for risk, such as the risk inherent in the valuation technique or its inputs. See also Notes 14 and 15 to the consolidated financial statements.

Equity Investments

Equity investments of $10,752,000 at September 30, 2018, comprised mainly of nonmarketable stock, equity units and equity warrants, are recorded at cost and are evaluated for impairment periodically. Prior to April 2, 2018, equity investments were recorded at fair value, represented as cost, plus or minus unrealized appreciation or depreciation. The fair value of investments that had no ready market were determined in good faith by the Board of Directors, based upon the financial condition and operating performance of the underlying investee companies as well as general market trends for businesses in the same industry. Included in the equity investments were non-marketable securities of $9,521,000 at December 31, 2017.

 

Page 15 of 108

Investment Securities (Bank Holding Company Accounting)

The Company follows FASB ASC Topic 320, Investments – Debt and Equity Securities (ASC 320), which requires that all applicable investments in equity securities with readily determinable fair values, and debt securities be classified as trading securities, available-for-sale securities, or held-to-maturity securities. 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. The net premium on investment securities totaled $186,000, and $26,000 and $47,000 was amortized to interest income for the three and six months ended September 30, 2018. Medallion Bank, a previously unconsolidated subsidiary under Investment Company Accounting, for the period, had net premium on investment securities of $250,000 as of September 30, 2017, and $21,000 and $61,000 was amortized to interest income for the three and nine months ended September 30, 2017. Refer to Note 3 for more details. ASC 320 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 consolidated 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. 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.

Other Investment Valuation (Investment Company Accounting)

Prior to April 2, 2018, under the 1940 Act, the Company’s investment in Medallion Bank, as a wholly owned portfolio investment, was subject to quarterly assessments of fair value. The Company conducted a thorough valuation analysis, and also received an opinion regarding the valuation from an independent third party to assist the Board of Directors in its determination of the fair value of Medallion Bank on at least an annual basis. The Company’s analysis included factors such as various regulatory restrictions that were established at Medallion Bank’s inception, by the FDIC and State of Utah, and also by additional regulatory restrictions, such as the prior moratorium imposed by the Dodd-Frank Act on the acquisition of control of an industrial bank by a “commercial firm” (a company whose gross revenues are primarily derived from non-financial activities) which expired in July 2013 and the lack of any new charter issuances since the moratorium’s expiration. Because of these restrictions and other factors, the Company’s Board of Directors had previously determined that Medallion Bank had little value beyond its recorded book value. As a result of this valuation process, the Company had previously used Medallion Bank’s actual results of operations as the best estimate of changes in fair value, and recorded the results as a component of unrealized appreciation (depreciation) on investments. In the 2015 second quarter, the Company first became aware of external interest in Medallion Bank and its portfolio assets at values in excess of their book value. Expression of interest in Medallion Bank from both investment bankers and interested parties has continued. The Company incorporated these new factors in the Medallion Bank’s fair value analysis and the Board of Directors determined that Medallion Bank had a fair value in excess of book value. In addition, in the 2016 third quarter there was a court ruling involving a marketplace lender that the Company believes heightens the interest of marketplace lenders to acquire or merge with Utah industrial banks. The Company also engaged a valuation specialist to assist the Board of Directors in their determination of Medallion Bank’s fair value, and this appreciation of $15,500,000 was thereby recorded in 2015, and additional appreciation of $128,918,000 was recorded in 2016, $7,849,000 was recorded in 2017, and $39,826,000 was recorded in the first quarter of 2018. Refer to Note 6 for additional details.

At December 31, 2017, there were non-marketable securities of $302,147,000 related to portfolio investments in controlled subsidiaries that were not consolidated with the Company. Because of the inherent uncertainty of valuations, the Board of Directors’ estimates of the values of the investments may differ significantly from the values that would have been used had a ready market for the investments existed, and the differences could be material.

Loans

The Company’s loans are currently reported at the principal amount outstanding, inclusive 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. Effective April 2, 2018, the existing loan balances were recharged at fair value in connection with the change in reporting, and balances, net of reserves, became the fair value opening balances.

Loan origination fees and certain direct origination costs are deferred and recognized as an adjustment to the yield of the related loans. At September 30, 2018 and December 31, 2017, net loan origination costs were $14,041,000 and $90,000 ($11,187,000 when combined with Medallion Bank). The majority of these loan origination costs were capitalized into the loan balances on April 2, 2018 in connection with the change in reporting status. Net amortization (accretion) to income for the three months ended September 30, 2018 and 2017 was $1,147,000 and ($17,000) ($901,000 when combined with Medallion Bank), and was $2,192,000 ($3,065,000 when combined with Medallion Bank) and ($55,000) ($2,526,000 when combined with Medallion Bank) for the comparable nine month periods.

 

Page 16 of 108

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 collectability 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. The consumer portfolio has different characteristics, typified by a larger number of lower dollar loans that have similar characteristics. A loan is considered to be impaired, or nonperforming, when based on current information and events, it is likely the Company 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 placed on nonaccrual, when they become 90 days past due, or earlier if they enter bankruptcy, and 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. For the recreational 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 collateral 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. Proceeds collected on charged off accounts are recorded as a recovery. Total loans more than 90 days past due were $14,061,000 at September 30, 2018, or 1.29% of the total loan portfolio, compared to $60,450,000, or 18.9% at December 31, 2017.

Loan collateral in process of foreclosure primarily includes taxicab medallion loans that have reached 120 days past due and have been charged down to their net realizable value, in addition to consumer repossessed collateral in the process of being sold. The taxicab medallion loan component reflects that the collection activities on the loans have transitioned from working with the borrower, to the liquidation of the collateral securing the loans.

The Company had $123,173,000 and $183,529,000 of net loans pledged as collateral under borrowing arrangements at September 30, 2018 and December 31, 2017.

The Company accounted for its sales of loans in accordance with FASB Accounting Standards Codification Topic 860, Transfers and Servicing (FASB ASC 860) which provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. In accordance with FASB ASC 860, the Company had elected the fair value measurement method for its servicing assets and liabilities. The principal portion of loans serviced for others by the Company and its affiliates was $26,558,000 at September 30, 2018 and $338,867,000 at December 31, 2017, which included $311,988,000 of loans serviced for Medallion Bank. The Company has evaluated the servicing aspect of its business in accordance with FASB ASC 860, most of which relates to servicing assets held by Medallion Bank, and determined that no material servicing asset or liability existed as of September 30, 2018 and December 31, 2017. The Company assigned its servicing rights to the Medallion Bank portfolio to MSC. The costs of servicing were allocated to MSC by the Company, and the servicing fee income was billed to and collected from Medallion Bank by MSC.

Allowance for Loan Losses (Bank Holding Company Accounting)

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions, and excess concentration risks. In analyzing the adequacy of the allowance for loan losses, the Company uses historical delinquency and actual loss rates with a one year lookback period for consumer loans. For commercial loans deemed nonperforming, the historical loss experience and other projections are looked at, and for medallion loans, non performing loans are valued at the median sales price over the most recent quarter, and performing medallion loans are reserved utilizing historical loss ratios over a three year lookback period. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. As a result, reserves of $15,587,000 (includes Bank’s reserves since April 2^nd); are recorded as a general reserve on medallion loans as an additional buffer against future losses. Credit losses are deducted from the allowance and subsequent recoveries are added back to the allowance.

Unrealized Appreciation (Depreciation) and Realized Gains (Losses) on Investments (Investment Company Accounting)

Prior to April 2, 2018, under Investment Company Accounting, the Company’s loans, net of participations and any unearned discount, were considered investment securities under the 1940 Act and recorded at fair value. As part of the fair value methodology, loans were valued at cost adjusted for any unrealized appreciation (depreciation). Since no ready market existed for these loans, the fair value was determined in good faith by the Board of Directors. In determining the fair value, the Board of Directors considered factors such as the financial condition of the borrower, the adequacy of the collateral, individual credit risks, cash flows of the borrower, market conditions for loans (e.g. values used by other lenders and any active bid/ask market), historical loss experience, and the relationships between current and projected market rates and portfolio rates of interest and maturities. Investments other than securities, which represent collateral received from defaulted borrowers, were valued similarly.

 

Page 17 of 108

Under Investment Company Accounting, the Company recognized unrealized appreciation (depreciation) on investments as 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 on investments was $139,700,000, and $100,732,000 as of December 31, 2017 and September 30, 2017. Refer to Note 5 for additional details.

Goodwill and Intangible Assets

The Company’s goodwill and intangible assets arose as a result of the excess of fair value over book value for several of the Company’s previously unconsolidated portfolio investment companies as of April 2, 2018. This fair value was brought forward under the Company’s new Bank Holding Company reporting, and was subject to a purchase price accounting allocation process conducted by an independent third party expert to arrive at the current categories and amounts. Goodwill is not amortized, but is subject to impairment testing on an annual basis. Intangible assets are amortized over their useful life of approximately 20 years. See below for detailed information on the fair value allocation as of April 2, 2018. As of September 30, 2018, the Company had goodwill and intangible assets of $210,761 and recognized $361 and $722 of amortization expense for the three and nine months periods then ended.

 

(in thousands)		Fair Value as of March 31, 2018				Allocation as of April 2, 2018
Medallion Bank
Assets
Net loans(1)						$	890,000
Other assets							130,393
Liabilities
Funds borrowed and other liabilities							(853,650	)
Total fair value excluding goodwill and intangibles							166,743
Goodwill							150,803
Intangibles							28,900
Total fair value(2)		$	346,446			$	346,446

 

(1)	Includes $12,387 of premiums associated with the loan portfolio.

(2)	Includes $26,303 of preferred stock held by the US Treasury. See Note 17 for details.

 

(in thousands)		Fair Value as of March 31, 2018				Allocation as of April 2, 2018
RPAC Racing LLC
Assets
Cash						$	1,647
Net fixed assets							774
Race cars and parts, net							203
Race cars held for sale							916
Other assets							1,902
Liabilities
Deferred revenue							(6,531	)
Notes payable(1)							(27,220	)
Other liabilities							(2,275	)
Total fair value excluding goodwill and intangibles							(30,584	)
Intangibles							31,779
Total fair value(2)		$	1,195			$	1,195

 

(1)	Includes $20,177 due to the Company and its affiliates as of March 31, 2018.

(2)	Fair value as of March 31, 2018 represents the Company’s investment in RPAC Racing LLC series D units.

 

Page 18 of 108

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 $131,000 and $23,000 ($64,000 had Medallion Bank been consolidated) for the quarters ended September 30, 2018 and 2017, and was $289,000 and $71,000 ($166,000 had Medallion Bank been consolidated) for the comparable nine months.

Deferred Costs

Deferred financing costs, included in other assets, represents costs associated with obtaining the Company’s borrowing facilities, and are amortized on a straight line basis over the lives of the related financing agreements and life of the respective pool. Amortization expense was $558,000 and $229,000 ($567,000 had Medallion Bank been consolidated) for the quarters ended September 30, 2018 and 2017, and was $1,322,000 and $697,000 ($1,680,000 had Medallion Bank been consolidated) for the comparable nine months, recorded as interest expense. In addition, the Company capitalizes certain costs for transactions in the process of completion (other than business combinations), including those for potential investments, and the sourcing of other financing alternatives. Upon completion or termination of the transaction, any accumulated amounts are amortized against income over an appropriate period, or written off. The amount on the Company’s balance sheet for these purposes was $4,859,000, $3,070,000 ($5,011,000 had Medallion Bank been consolidated), and $3,295,000 ($5,437,000 had Medallion Bank been consolidated) as of September 30, 2018, December 31, 2017, and September 30, 2017.

Income Taxes

Income taxes are accounted for using the asset and liability approach in accordance with FASB ASC Topic 740, Income Taxes (“ASC 740”). Deferred tax assets and liabilities reflect the impact of temporary differences between the carrying amount of assets and liabilities and their tax basis and are stated at tax rates expected to be in effect when taxes are actually paid or recovered. Deferred tax assets are also recorded for net operating losses, capital losses, and any tax credit carryforwards. A valuation allowance is provided against a deferred tax asset when it is more likely than not that some or all of the deferred tax assets will not be realized. All available evidence, both positive and negative, is considered to determine whether a valuation allowance for deferred tax assets is needed. Items considered in determining our valuation allowance include expectations of future earnings of the appropriate tax character, recent historical financial results, tax planning strategies, the length of statutory carryforward periods, and the expected timing of the reversal of temporary differences. Under ASC 740, forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence, such as cumulative losses in recent years. The Company recognizes tax benefits of uncertain tax positions only when the position is more likely than not to be sustained assuming examination by tax authorities. The Company records income tax related interest and penalties, if applicable, within current income tax expense.

 

Page 19 of 108

Earnings (Loss) Per Share (EPS)

Basic earnings (loss) per share are computed by dividing net income (loss)/net increase (decrease) 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, or if restricted stock vests, and has been computed after giving consideration to the weighted average dilutive effect of the Company’s stock options and restricted stock. 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, including unvested compensation expense related to the shares, 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.

 

		Three Months Ended September 30,								Nine Months Ended September 30,
(Dollars in thousands, except per share data)		2018				2017				2018				2017
Net loss/ net decrease in net assets resulting from operations available to common shareholders		($	4,697	)		$	619			($	34,218	)		($	3,067	)
Weighted average common shares outstanding applicable to basic EPS			24,235,242				23,930,086				24,207,273				23,916,334
Effect of dilutive stock options			—				—				—				—
Effect of restricted stock grants			—				153,833				—				—
Adjusted weighted average common shares outstanding applicable to diluted EPS			24,235,242				24,083,919				24,207,273				23,916,334
Basic loss per share		($	0.19	)		$	0.03			($	1.41	)		($	0.13	)
Diluted loss per share			(0.19	)			0.03				(1.41	)			(0.13	)

Potentially dilutive common shares excluded from the above calculations aggregated 115,000 and 359,000 shares as of September 30, 2018 and 2017.

Stock Compensation

The Company follows FASB ASC Topic 718 (ASC 718), “Compensation – Stock Compensation”, for its equity incentive, stock option and restricted stock plans, 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 income (loss)/net increase (decrease) in net assets resulting from operations for any new grants using the fair values established by usage of the Black-Scholes option pricing model, expensed over the vesting period of the underlying option. Stock-based employee compensation costs pertaining to restricted stock are reflected in net income (loss)/net increase in net assets resulting from operations for any new grants using the grant date fair value of the shares granted, expensed over the vesting period of the underlying stock.

During the nine months ended September 30, 2018 and 2017, the Company issued 101,010 and 258,232 of restricted shares of stock-based compensation awards, and 39,000 and 23,333 shares of other stock-based compensation awards, and recognized $151,000 and $446,000, or $0.01 and $0.02 per share for the 2018 third quarter and nine months, and $222,000 and $551,000, or $0.01 and $0.02 per share in the comparable 2017 periods, of non-cash stock-based compensation expense related to the grants. As of September 30, 2018, the total remaining unrecognized compensation cost related to unvested stock options and restricted stock was $408,000, which is expected to be recognized over the next 11 quarters (see Note 9).

Derivatives

The Company manages its exposure to increases in market rates of interest by periodically purchasing interest rate caps to lock in the cost of funds of its variable-rate debt in the event of a rapid run up in interest rates. The Company entered into contracts to purchase interest rate caps on $20,000,000 of notional value of principal from various multinational banks, with termination dates ranging to December 2018. The caps provide for payments to the Company if various LIBOR thresholds are exceeded during the cap terms. Total cap purchases were generally fully expensed when paid, including $0 for the three and nine months ended September 30, 2018 and $0 and $19,000 for the comparable 2017 periods, and all are carried at $0 on the balance sheet at September 30, 2018.

 

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