Medallion Follow-Up Part 2: If You Don't Believe Us, Then Listen To Melrose

| About: Medallion Financial (MFIN)

Summary

Melrose, largest medallion lender (2.5x TAXI), is experiencing severe financial distress due to an unprecedented pace and degree of deterioration in the medallion industry.

We highlight valuable industry color from Melrose's lawsuit against NYC TLC in Nov-15.

In our view, we are only 1-2 quarters away from severe business/capital impairment.

Similar to subprime housing, holders of Medallion Financial's (NASDAQ:TAXI) stock are simply refusing to accept the reality of the rapidly crumbling medallion industry. Bear thesis supported with real facts and sound analysis has been simply met with outright denial instead of robust opposing arguments. Unlike devoted long-time believers of TAXI, industry insiders, including lenders, owners and taxi operators, are already aware of the disastrous fundamentals of the industry. In our two previous articles, we noticed a number of comments discrediting our facts and assumptions, which were basis of our short thesis.

In Nov-15, Melrose Credit Union ("Melrose"), along with two other credit unions, the Taxi Medallion Owner Driver Association, a few large yellow cab operators ("Plantiffs"), filed a lawsuit against NYC TLC. Why should you care? Melrose is the largest medallion lender in the country. As of Jun-15, Melrose held a security interest in approximately 3,110 taxicab medallions as collateral for 3,055 medallion loans totaling approximately $1.56B (2.5x TAXI), which accounts for over 80% of Melrose's total loan portfolio! Plaintiffs argued the medallion taxicab industry is subject to regulatory burdens that rideshare companies such as Uber (Private:UBER) are not subjected to, which have unfairly penalized the taxicab medallion industry. We are not here to opine on the merits of the lawsuit. Rather, we are trying to share valuable insight about the current state of the medallion industry contained in the lawsuit that is highly relevant to our investment with TAXI. Since all the information quoted below is provided by the plaintiffs, there should be little doubt about the credibility of information.

Impact on medallion lenders

"(p10-11) The resulting harm to medallion owners and the businesses that they operate has been catastrophic. In January 2014, Plaintiff Melrose Credit Union had aggregate taxicab medallion loan delinquencies of approximately $32,000. As of May 31, 2015, delinquencies ballooned to $167,704,125. In January 2014, Melrose had no medallion loans that were classified as troubled debt restructurings. As of May 31, 2015, loans classified as troubled debt restructurings totaled approximately $148,491,250. As of June 30, 2015, Melrose's medallion loan delinquencies totaled $202,670,195-an increase of approximately 21% in just four weeks. As of June 30, 2015, Melrose had approximately $360,864,282 in delinquencies and troubled debt restructurings across its medallion loan portfolio-an increase of approximately 14% in the same four-week period.

The numbers have only continued to worsen as market share continues to erode and the value of the medallion plummets. As of July 31, 2015, Melrose's medallion loan delinquencies had increased to $206,248,126 and its delinquencies and troubled debt restructurings had increased to approximately $395,626,920 across its medallion portfolio. As of August 31, 2015, Melrose's medallion loan delinquencies totaled $226,552,719 - an increase of approximately 10% in a one-month period. Likewise, as of August 31, 2015, troubled debt restructurings totaled approximately $195,529,000. Thus, Melrose reached approximately $422,081,719 in delinquencies and troubled debt restructurings ("TDR") - an increase of approximately 7% in a single month, and a staggering 34% increase since May 31, 2015.

Worse, every indication is that the industry shows no sign of stabilization and recovery. Plaintiff Melrose Credit Union alone has hundreds of medallion loans maturing between now and February 2016, virtually assuring that foreclosures will grow even more widespread. In December alone, Melrose has 190 medallion loans maturing with almost $83,000,000 in balloon payments becoming due."

$422M in delinquencies and TDRs represent a staggering 27% of Melrose's medallion loan book! Melrose was still considered "well capitalized" as of Dec-15. However, we expect Melrose to face serious capital issues in the near term. Net worth ratio measures capital adequacy for credit unions and is similar to bank capitalization ratios such as Tier 1 Capital Ratio. A credit union with net worth ratio of 7% or greater is considered well capitalized. According to the latest financial statements published by NCUA (National Credit Union Administration), net worth ratio for Melrose fell off the cliff from 17.3% in Sep-15 to 10.7% in Dec-15. Average medallion loan size of just over $500k is similar to that of TAXI. While we don't have the exact composition of Melrose's medallion loan book, given its sheer size, it is likely overweight New York and Chicago. Thus, we strongly believe TAXI's medallion book to experience similar performance in the future. There may be some lag if a loan is restructured with principal repayment being postponed again at renewal, which appears to be a popular practice by many banks at the moment (take a look at the transcript of Signature Bank's 4Q15 earnings call).

Most investors will remember the collapse of Montauk Credit Union of New York, which was seized by NY State on Sept. 18, 2015. The Montauk headline was largely dismissed as a very small lender which eventually fell victim to aggressive lending practices. It was not totally unreasonable since Montauk was in fact a small player with $50M medallion loans out of $167M total loan book. It also was under capitalized with only $18M in capital and $6M in reserves. By Sep-15, nearly all of Montauk's medallion book was either delinquent or in troubled debt restructurings.

We are as anxious to see Mar-16 financial statements of Melrose as those of TAXI. If Melrose enters into some form of conservatorship or restructuring, it will have a profound impact on the medallion industry. What happens to over 3,000 medallions that are collateralizing Melrose's loans? Liquidation at reasonable prices is simply not an option when we have just a few transactions per month. When you already have a high percentage of loan book as TDRs, how can you restructure again? We know with a high degree of confidence how this movie will end…

Impact on medallion owners and operators

"(p11) On July 22, 2015, twenty-two taxicab companies filed for bankruptcy protection in the United States Bankruptcy Court for the Eastern District of New York as a direct result of plummeting taxicab medallion values and an inability to continue servicing medallion loans"

"(p13) White & Blue Group Corp [a TLC licensed agent that manages the single largest fleet of medallion taxicabs leased by shift in NYC] has seen its monthly leasing income drop as much as 50% in the past year, as it has been forced to idle approximately 20% of its taxicab medallion fleet on average, each day. With companies like Uber operating in the marketplace free of the disparate regulatory burdens imposed on the medallion taxicab industry, including the Accessible Conversion Rules, licensed taxicab drivers have left the taxicab industry in droves, choosing instead to drive for Uber.

As a result, companies like White & Blue Group Corp. have been forced to repeatedly slash daily lease rates to compete, thereby reducing leasing payments to medallion owners. Despite this, there are still not enough drivers willing to lease medallion taxicabs at any price, resulting in taxicab graveyards scattered throughout New York City.

Once the Accessible Conversion Rules fully take effect, the impact on White & Blue Group Corp.'s business and the countless medallion owners it serves will be apocalyptic. In fact, White & Blue Group Corp. may not be able to keep even half of its total fleet of medallion taxicabs on the road as the mini-fleet medallions are forced to convert to accessible vehicles. The inevitable result across the taxicab industry will be thousands of additional previously unrestricted medallions being rendered worthless"

"(p27) Before Defendants authorized the acceptance of on-demand E-Hails by all FHVs, Mr. Ginsberg [82 year old NYC medallion owner] was earning approximately $3,300 per month leasing his medallion. Over the past twelve months, Mr. Ginsberg's medallion leasing income has been reduced by almost a third, as leasing companies have been unable to attract enough drivers to lease all of the available medallion yellow taxicabs"

Before Defendants authorized the acceptance of on-demand E-Hails by all FHVs, Mr. Itzchaky [73 year old NYC medallion owner] was receiving more than $3,000 per month in medallion leasing income. In the past twelve months, those payments have been reduced by almost a third, as leasing companies have been unable to attract enough drivers to lease all of the available medallion yellow taxicabs. Mr. Itzchaky received his last medallion leasing payment in September 2015, which totaled approximately $2,100"

"(p45) Passenger wait times for Uber E-Hails have all but disappeared, as its network of linked FHVs has grown exponentially. The average wait time for an Uber vehicle in Manhattan is now barely two minutes; actual response time is often faster than that. See Polly Mosendz and Hanna Sender, Here's How Long It Takes to Get an Uber in U.S. Cities, NEWSWEEK (Dec. 4, 2014). With the steady stream of new FHVs being added to its network every day, there will soon be an Uber vehicle standing on every street corner in New York City, making response times to Uber's E-Hails virtually instantaneous"

"(p47) The crisis with accessible medallions is further evidenced by the current status of the vast majority of the accessible medallions auctioned to the public by the TLC in November 2013. Plaintiff Melrose financed approximately 128 of the roughly 200 accessible medallions sold at the November 2013 auction. Today, 108 of the approximately 128 (or 84%) of the medallions sold in the November 2013 auction and financed by Plaintiff Melrose are now classified as either delinquent or troubled debt"

"(p48) Further evidencing the destruction of the industry is the drastic migration of taxicab drivers to Uber and the corresponding increase in unleased medallion taxicabs. As recently as one year ago, McGuinness Management Corporation, a taxi dispatcher in New York, reportedly had only 50 of its 341 associated medallions sitting idle on its lot. As of August 2015, that number has jumped to 171, and continues to increase every week"

Disclosure: I am/we are short TAXI.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.