Bull thesis on Medallion Financials (NASDAQ:TAXI) goes something like this: Negative impact of Uber is overstated - TAXI never had losses in the past and collateral value remains more than enough to cover loans. Moreover, medallion is no longer material to TAXI since over 80% of earnings now come from consumer loan book (mainly subprime RV loans). Stock is currently trading at over 10% dividend yield and almost 20% discount to book value. Where can you get that kind of yield in this market?
True book value is substantially lower than reported book value... ALL ABOUT MEDALLION VALUATION
Due to hybrid structure, approx. 40% of TAXI's assets are held on balance sheet at the holdco with the remainder held off balance sheet at the wholly owned banking subsidiary, Medallion Bank ("MB"). As a BDC, the holdco is not required to book provisions. Instead, BDCs are supposed to carry investments/loans at fair market value. Per 10-K, "Medallion loans and the asset-based portion of the commercial loan portfolio are primarily collateral-based lending, whereby the collateral value exceeds the amount of the loan, providing sufficient excess collateral to protect against losses to the Company. As a result, the initial valuation assessment is that as long as the loan is current and performing, its fair value approximates the par value of the loan". As you can see in 10-K F-32, currently Medallion loans at holdco are held essentially at cost.
TAXI's banking subsidiary, MB, is wholly owned but not consolidated with respect to accounting. However, TAXI provides separate financial statements for holdco and MB as well as loan performance data on an annual basis. As a bank, MB is required to set provisions to cover future losses. Despite rapid rise in medallion delinquency from 0% to 11% over the past 12 months (total delinquent medallion loans at holdco and MB as of Dec-15, source: F-11 and F-54 in 10-K), allowance remains at ~1% of total medallion loan outstanding.
As discussed below, our estimated book value of TAXI is significantly lower than the reported figure because we believe the current market value of medallions in TAXI's key markets is dramatically lower than what's assumed by management. While management touts "strong credit performance", reality is that a substantial portion of the medallion loan portfolio is underwater - similar to negative equity with many subprime homeowners during the financial crisis.
As of Dec-15, management states current LTV of medallion portfolio is 76% (see our estimated breakdown below by region). This is based on collateral value of $754k in New York (avg. of independent and corporate), $239k in Chicago, $321k in Newark, $389k in Boston and $301k in Cambridge. In this article, we are going to focus on NYC and Chicago since these two markets account for almost 90% of TAXI's total medallion book.
(1) Company discloses only the number of loans not underlying medallions. We assume ~1.15 medallions per loan to solve for LTV of 76%, same as what's reported by TAXI.
New York City
NYC is biggest market representing 74% of TAXI's medallion loan book with $480m loans outstanding. TAXI uses TLC transfer data as the main valuation benchmark. "As reported by the TLC, individual (owner-driver) medallions sold for approximately $715k and corporate medallions sold for approximately $793k as of December 31, 2015". However, we believe TLC data is stale and does not represent CURRENT market value. At the moment, the secondary market is virtually non-existent. For the entire 2015, there were only 30 transactions (~100 in 2014) with many being foreclosures. Based on our conversation with local medallion brokers, most foreclosures were NOT arms-length transactions. In many cases, banks would try to resell to another buyer by offering a 100%+ LTV loan so that ownership transfer can take place at an inflated medallion price. At the same time, nonperforming loans would quickly transform into performing loans. TLC data used to be much more reliable when most transactions tend to be true secondary deals. However, that is not the case today. We believe unprecedented illiquidity in the secondary market is a sign of significant weakness in the medallion market.
Another interesting fact is the huge difference between TLC transfer prices and listing prices of medallions for sale posted in a secondary market place. There are several medallions up for sale in the range of $500-550k. When we spoke to sellers/brokers, even those listings are having difficulty of attracting bids. While TLC's Mar-16 reports showed 2 transactions - $580k and $520k, our diligence suggests further pressure in the near-future.
There is another major obstacle for the secondary market - lack of financing. In the past, there were many banks and credit unions offering a tremendous amount of liquidity at low rates because of extremely strong medallion value. However, today most lenders have either stopped medallion lending altogether or are only lending with 20%+ down payment. Very similar dynamic to housing crisis in 2008. Not surprisingly, TLC has reported only 2 secondary transactions so far this year.
There is another dynamic particularly relevant to TAXI. Almost all of medallions available for sale in the $500-550k range are independent (owner-driver) medallions. The same broker mentioned above told us that for a corporate/minifleet medallion, one would have to pay at least $650k. Why? Corporate medallions tend to be worth more because there is no ownership restriction in terms of number of medallions an individual can own. However, that's not the main reason for the higher asking price. Almost 90% of corporate medallions were financed with mortgages and owners won't sell unless they can pay off debt. Since there is no liquidity at such a high price (or even at materially below), many owners are trying to delay the sale by servicing the mortgage and hoping the market will recover soon. For now, based on the current leasing rate and interest rate, leasing income appears to cover a large portion of monthly interest payment. Moreover, banks have been willing to facilitate this for obvious reasons through extending and restructuring. This is probably why we have seen so few medallion loan defaults to date. This is not sustainable.
Based on our diligence, we think current market value is $450-500k vs. $754k used by TAXI. $450-500k would imply an LTV of 110%-120%. What is the reasonable fair market value of the loans with LTV exceeding 100%? By the way, if there is a flood of foreclosures in a short period of time, liquidation value would be even much lower given the absolute lack of demand. Simply getting back to 100% LTV would imply loss of $35-$79m or $1.5-$3.3/share.
You can make similar observations in TAXI's second biggest market, Chicago. While the total exposure is much smaller than in NYC, the severity of medallion market distress in Chicago appears materially worse. TAXI's Chicago exposure consists of a $93m loan book and 159 owned medallions (classified as "investments other than securities") with a carrying value of $38m or $238k per medallion as of 4Q'15.
Before we dive into Chicago, let's start by looking at TAXI's answer to SEC's recent request for clarifying valuation methodology for medallions. Management states that it removes outlier transactions and calculates the average value of the remaining set of closed transactions. Sounds reasonable so far…
But, here is a link to historical medallion transfer prices at the City of Chicago. You will see a dramatic decline in the number of transactions - 370 (2013), 14 (2015), 3 (YTD 2016) pointing to a complete lack of liquidity in the secondary market similar to NYC.
Per 10-K, company's valuation was based on precedent transfer prices of medallions. Now compare the figures in the following two tables: 1) F-30 of TAXI's 2015 10-K, which shows valuation methodology by TAXI, 2) actual medallion transfer prices in 2015 reported by City of Chicago.
You can see TAXI is valuing its medallions at $238k each, which is at the high end of the range reported by City of Chicago. However, there were only 2 transactions during 4Q'15 - one at $150k the other at $238k.
Only way to get to TAXI's medallion value of $238k as of Dec-15 is by removing the $150k transaction, one of only 2 closed transactions. Perhaps $150k should be considered a one-off outlier? Highly unlikely. Of the 14 transactions in 2015, 4 cleared at $150k.
Here is a follow-up question. As you can see in the table below, subsequent to Dec-15, transfer prices in Chicago have continued to decline with 2 deals closing at $50k each and one at $95k. Logically, we now expect significant write-downs in 1Q'16 based on the latest transfer data.
So what is the fair value of a Chicago medallion? Our view is $100-150k. TAXI's $93m Chicago medallion loan book would have an LTV of over 160% and 250%, respectively. Merely returning to 100%, LTV would imply a loss of $38-$56m, respectively, or $1.6-$2.3/share.
In addition, 159 owned medallions would be valued at $16-$24m, respectively or implied markdown of $14-$22m, $0.6-$0.9/share. Thus, total impact from devaluation of the Chicago medallions would equal $52-$78m, or over $2-$3/share.
Our view of current fair book value
Based on our analysis on NYC and Chicago, we made a reasonable set of price assumptions for TAXI's remaining medallion markets. In addition, we value MB at book value, which we consider rather generous given the quality of the loan book vs. 11.4% premium assumed by TAXI (as most readers are already aware). We see absolutely no justification for such premium especially when a non-binding "external interest" that management quoted never materialized subsequently. It is humorous that management would mark up the book value of MB based on hope while removing one of only 2 actual closed transactions in Chicago during 4Q'15 to support its book value.
As you can see in the table below, we believe true book value could be 46%-77% below from the reported Dec-15 book value.
Latest announcement of $25m convertible bond offering - we have lots of questions
On Mar. 30, 2016, TAXI announced commencement of offering of $25m of convertible notes due 2021. The press release says, "The Company expects to use the net proceeds from the offering to make loans and other investments in portfolio companies and for general corporate purposes, including repaying borrowings under its revolving credit facilities in the ordinary course of business and expanding its operations". Obviously, it's an opportune time to raise equity-like capital given the recent run-up in stock price. Just in Aug. last year, TAXI increased stock buyback authorization to $26m when the stock was trading at $8-$8.5, which is not far from the current share price.
Why issue convert now when you are about to release 1Q'16 in a few weeks? The press release contained no operational update for 1Q'16. We find it appalling that management is trying to raise fresh capital without providing any operational update especially when the underlying fundamentals of their medallion loan book are deteriorating rapidly.
When you had $31m and $23m in cash at holdco and MB, respectively as of Dec-15, why do you need to raise another $25m? Medallion book is obviously not growing ($651m o/s in Dec-15 vs. $677m o/s in Dec-14). MB loan has already reached near its maximum size since non-qualifying assets already represent close to the 30% cap as part of the BDC regulation. We are anxious to see how this fresh $25m capital will be used by the management and to receive updates on the performance of their loan portfolio.
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.