Over the weekend, Barron's published an article in defense of Medallion Financial (TAXI +1.27%), a company which specializes in financing taxi medallions.
Taken at face value, its arguments were compelling. At six times expected earnings, and with a dividend yield of 15%, Medallion Financial is an alluring stock. Shares jumped 20% in response.
But deeper dive into the bull thesis leaves a lot to be desired. I'd like to address a couple comments in the Barron's piece, and bring some additional perspective.
1. "No losses on any of its medallion loans"
Medallion Financial CEO Andrew Murstein told Barron's that his company hasn't had any losses on any of its medallion loans. While true, this misses the forest for the trees.
In the first six months of 2015, Medallion Financial restructured $10.6 million of medallion loans held at the parent company. The percentage of loans past due is increasing. This is a recipe for future loan losses.
On Friday, a competing medallion financier, Montauk Credit Union, was seized by regulators due to the poor performance of its medallion-heavy loan book. Previously, the bank reported its highest-ever amount of net charge-offs of 0.42% on an annualized basis, well below the NCUA credit union average.
I brought this up to make a point: Prior to its seizure, Montauk could make a similar claim that it had little to no losses from its medallion loan portfolio. And yet it was seized for being "unsafe and unsound," due to its growing pile of past due medallion loans.
No one disputes Medallion Financial's past performance; the questions surround its future. With late loans ballooning with each passing quarterly report, it seems impossible for loan losses to remain at zero.
2. LTVs are safe at 75%
Loan-to-value ratios are fickle things. A small change in the value of an asset can have an outsize impact on the LTV ratio, particularly as the ratio rises toward 100%. And given there have been only a handful of medallion transfers in 2015, nailing the right value for a medallion in New York, Chicago, Boston, or any city with a medallion system, is difficult, to say the least.
I wish Barron's had provided additional context on Medallion Financial's LTV ratios. Its LTV ratios were last reported at 75% in June. At the end of 2014, LTVs were 60%. Last September, it said its LTVs were 40%.
The trend is quite clear, and it all happened during a period with relatively few foreclosures. Should the pace of foreclosures and stressed sales tick up, you can bet medallion prices will resume their slide, and LTVs will trend even higher.
3. Conservative and "aggressive" lenders
Barron's called out Capital One Financial and Signature Bank as being "aggressive" lenders. The article notes that when these two publicly traded banks were actively originating new medallion loans, Medallion Financial upped its credit standards, seeking out loans at lower LTV ratios.
Medallion prices peaked in 2013 and 2014 in New York City. If you compile the data on its NYC medallion loans, you'll see that the majority of its loans by cost were originated in 2013 and 2014.
A loan is a commodity. Lenders compete on terms and pricing. Medallion Financial was clearly originating loans when medallion prices were frothy, and competition for loans was robust. It requires a big logical leap to assume that one lender would be able to siphon off the very best borrowers, on favorable terms, while reporting loan yields in line with its peers.
4. On diversification
It's true that Medallion Financial has diversified by lending to individuals. The company's Medallion Bank subsidiary is actively writing high-yielding home improvement and recreational vehicle loans. But the same banking unit that holds its consumer loans is also betting heavily on medallions.
Medallion Bank's medallion loans are equal to 2.8 times its equity. A 10% loss rate on its medallion loans would consume 28% of the bank's equity. A 35% loss rate would result in a complete and total wipeout of the bank's equity cushion. No matter how well its consumer loans perform, the bank's medallion loans will be an anchor to its performance.
Medallion Bank is no small matter, as it makes up 49% of Medallion Financial's book value. FDIC insured, the stakes are higher in the banking subsidiary, which, unlike Medallion Financial, is regulated and monitored for credit performance.
Buyer beware
The simple fact is that Medallion Financial's historical credit metrics are impeccable. That's what you would expect from a lender that had the advantage of writing loans against collateral that only went up in value. But now medallion values are trending in the opposite direction, and a loan, no matter how well it is underwritten, won't perform if the borrower would be better off walking away.
Shareholders should follow the lead of the industry's borrowers and simply walk away.
