Medallion Financial's (NASDAQ:MFIN) filings tell an interesting tale.
It's December 2011. Chicago taxi medallions are rising quickly in value, now trading hands for about $300,000. A medallion lessor named Jim is making a fortune. Jim owns 159 medallions and wants to capitalize on the rising price. He reaches out to a lender, who will lend at favorable rates with the medallions standing as collateral.
The paperwork is drawn up. The lender offers to lend Jim $26.1 million, or about 55% of the medallions' collective value. Jim will make monthly payments for the next 25 years, at which point the loan will be paid in full. The interest rate is a paltry 4.04%. It's a great deal.
Both the lender and borrower are happy. The lender is protected by substantial collateral. The borrower likes the low interest rate and long, 25-year amortization period. Both parties win.
Let's advance about four years into the future. It's June of 2015. Jim has paid on time every single month, paying down the balance to about $24 million. Thanks to falling interest rates, his variable interest rate fell to 3.12%, down from 4%.
It's all going well, except for one growing problem: Uber is stealing the taxi industry's riders and drivers.
Jim's medallions, which were once worth $300,000 each, are worth less than half that. Brokers around town are listing medallions for $150,000, but they aren't getting any takers.
Jim's loan, which was underwritten at a 55% loan-to-value ratio, is now sitting at 100%, thanks to the rapid decline in medallion prices and minimal decline in his loan balance.
And Jim's monthly loan payment is no longer covered by the fees he earns leasing out his medallions. In the first six months of 2015, Jim has lost an average of $3,000 a month due to the difference between his lease income and debt service.
Not just a fairy tale
Jim isn't fictional. He's real. He just goes by a different name. His name just so happens to be Medallion Financial.
The story I just told you is the story you can read in Medallion Financial's SEC filings. In 2011, it took out a loan at a 55% LTV ratio against medallions it owned, based on an estimated market price of $300,000 each. By 2015, that LTV ratio had jumped to 100%, using an estimated market price of $150,000 per medallion.
The lease income Medallion Financial earns on its Chicago medallions does not cover its debt service, and hasn't for the entirety of 2015.
Luckily, Medallion Financial is paying a very low interest rate of 3.12% to finance the medallions it owns. By comparison, Medallion Financial's customers -- people who borrowed from the company to buy their own medallions -- are paying a weighted-average rate of 5.08%.
If the economics are bad at an interest rate of 3.12%, you can only imagine how much worse it is for the company's borrowers, who are paying significantly higher interest rates. Unfortunately, Chicago is no small matter for Medallion Financial. In all, about 29% of its book value is tied up in loans on Chicago medallions, and in the medallions it owns outright.
Medallion Financial's filings provide a perfect case study for how a "safe," low-LTV loan can turn into a risky, high-LTV loan in just a matter of a few years. Investors would be wise to study them.
Jordan Wathen is short Medallion Financial. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.