Medallion Financial Corp. (TAXI) - Description of business

Company Description
OF THE COMPANY GENERAL Medallion Financial Corp. (the Company) is a specialty finance company that has a leading position in originating, acquiring, and servicing loans that finance taxicab medallions and various types of commercial businesses, and in originating consumer loans for the purchase of recreational vehicles, boats, and horse trailers. Our core philosophy has been “In niches there are riches.” We try to identify markets that are profitable and where we can be an industry leader. Since 1996, the year in which the Company became a public company, we have increased our taxicab medallion loan portfolio at a compound annual growth rate of 14%, and our commercial loan portfolio at a compound annual growth rate of 15%. Total assets under our management, which includes assets serviced for third party investors, were approximately $802,000,000 as of December 31, 2005, and have grown at a compound annual growth rate of 16% from $215,000,000 at the end of 1996. The Company conducts its business through various wholly-owned subsidiaries including its primary taxicab medallion lending company, Medallion Funding Corp. (MFC). The Company also currently conducts business through Medallion Business Credit, LLC (MBC), an originator of loans to ses for the purpose of financing inventory and receivables; Medallion Capital, Inc. (MCI), which conducts a mezzanine financing business; Freshstart Venture Capital Corp. (FSVC), a S Investment Company (SBIC) which originates and services taxicab medallion and commercial loans; and Medallion Bank (MB), a bank regulated by the Federal Deposit Insurance Corporation (FDIC) and the Utah Department of Financial Institutions to originate taxicab medallion, commercial, and consumer loans; to raise deposits; and to conduct other banking activities. MFC, MCI, and FSVC operate as SBICs and are regulated and financed in part by the SBA. Until October 2005, the Company also conducted business through Business Lenders, LLC (BLL), licensed under the US S Administration (SBA) Section 7(a) program. On October 17, 2005, the Company completed the sale of the loan portfolio and related assets of BLL. In connection with this transaction, the Company sold assets in the amount of $22,799,000, less liabilities assumed by the buyer in the amount of $2,327,000. The assets were sold at book value, and therefore no gain or loss, excluding transaction costs, was recognized as a result of this transaction. For 2005, BLL generated net decrease in net assets resulting from operations of $1,003,000, compared to a net decrease of $419,000 for 2004, and BLL’s net investment loss after taxes was $696,000, compared to a loss of $201,000 in 2004. As an adjunct to the Company’s taxicab medallion finance business, the Company previously operated a taxicab rooftop advertising business through two subsidiaries, the primary operator Medallion Taxi Media, Inc. (Media), and a small operating subsidiary in Japan (MMJ) (together MTM). During the 2004 third quarter, Media was merged with and into a subsidiary of Clear Channel Communications, Inc. (CCU), and MMJ was sold in a stock sale to its management. The Company no longer conducts a taxicab rooftop advertising business. Alvin Murstein, the Company’s Chairman and Chief Executive Officer, has over 45 years of experience in the ownership, management, and financing of taxicab medallions and other commercial businesses. Andrew Murstein, the Company’s President, is the third generation in his family to participate in the business. We are a closed-end, non-diversified management investment company under the Investment Company Act of 1940, as amended (1940 Act). Our investment objectives are to provide a high level of distributable income, consistent with the preservation of capital, as well as long-term growth of net asset value. Since our initial public offering (IPO) in 1996, we have paid dividends in excess of $90,000,000 or $6.31 per share. We have elected to be treated as a Business Development Company registered under the 1940 Act. Traditionally, the Company and each of its corporate subsidiaries other than Media and MB (the RIC subsidiaries) have elected to be treated for federal income tax purposes as a regulated investment company (RIC) under the Internal Revenue Code of 1986, as amended (the Code). As RICs, the Company and each of the RIC subsidiaries are not subject to US federal income tax on any gains or investment company taxable income (which includes, among other things, dividends and interest income reduced by deductible expenses) that it distributes to its shareholders, if at least 90% of its investment company taxable income for that taxable year is distributed. It is the Company’s and the RIC subsidiaries’ policy to comply with the provisions of the Code. The Company did not qualify to be treated as a RIC for 2003. As a result, the Company was treated as a taxable entity in 2003, which had an immaterial effect on the Company’s financial position and results of operations for 2003. The Company qualified and filed its federal tax returns as a RIC for 2004 and anticipates doing so again in 2005. As a result of the above, for 2003 income taxes were provided under the provisions of SFAS No. 109, “Accounting for Income Taxes,” as the Company was treated as a taxable entity for tax purposes. Accordingly, the Company recognized current and deferred tax consequences for all transactions recognized in the consolidated financial statements, calculated based upon the enacted tax laws, including tax rates in effect for current and future years. Valuation allowances were established for deferred tax assets when it was more likely than not that they would not be realized. Media and MB are not RICs and are taxed as regular corporations. For 2003, Media’s losses were included in the tax calculation of the Company along with MFC. For 2004, Media filed a partial year tax return covering the period prior to the merger with CCU. During the 2004 second quarter, BLL changed its tax status from that of a disregarded “pass-through” entity of the Company to that of a company taxable as a corporation. For the 2005 and 2004 periods, BLL had no tax liability as a result of this election. MEDALLION LOAN PORTFOLIO Taxicab medallion loans of approximately $449,673,000 comprised 62% of our $723,253,000 net investment portfolio as of December 31, 2005. Since 1979, we have originated, on a combined basis, approximately $532,407,000 in medallion loans in New York City, Chicago, Boston, Newark, Cambridge, and other cities within the United States. Our medallion loan portfolio consists of mostly fixed-rate loans, collateralized by first security interests in taxicab medallions and related assets. As of December 31, 2005, approximately 78% of the principal amount of our medallion loans were in New York City. We estimate that the average loan-to-value ratio of all of the medallion loans was approximately 60% at December 31, 2005. The New York City Taxi and Limousine Commission (TLC) estimates that the total value of all of New York City taxicab medallions and related assets exceeds $5 billion. We estimate that the total value of all taxicab medallions and related assets in the US exceeds $6.4 billion. We believe that we will continue to develop growth opportunities by further penetrating the highly fragmented medallion financing marketplace. Additionally, in the future, the Company may enhance its portfolio growth rate through selective acquisitions of medallion financing businesses and their related portfolios. Since our initial public offering, we have acquired several additional medallion loan portfolios. Portfolio Characteristics Medallion loans generally require equal monthly payments covering accrued interest and amortization of principal over a ten to fifteen year schedule, subject to a balloon payment of all outstanding principal after four or five years. More recently, we have begun to originate loans with one-to-three year maturities where interest rates are adjusted and a new maturity period set. Borrowers may prepay medallion loans upon payment of a fee of approximately 90 days’ interest. We believe that the likelihood of prepayment is a function of changes in interest rates and medallion values. Borrowers are more likely to exercise prepayment rights in a decreasing interest rate environment when the interest rates payable on their loans are high relative to prevailing interest rates, and we believe that they are less likely to prepay in a rising interest rate environment. We generally retain the medallion loans we originate; however, from time to time, we participate or sell shares of some loans or portfolios to interested third party financial institutions. In these cases, we retain the borrower relationships and service the sold loans. The total amount of medallion loans under management was $458,457,000 at December 31, 2005, compared to $409,001,000 at December 31, 2004. At December 31, 2005, substantially all medallion loans were collateralized by first security interests in taxicab medallions and related assets (vehicles, meters, and the like), and were originated at an approximate loan-to-value ratio range of 80-90%. In addition, we have recourse against the vast majority of direct and indirect owners of the medallions who personally guarantee the loans. Although personal guarantees increase the commitment of borrowers to repay their loans, there can be no assurance that the assets available under personal guarantees would, if required, be sufficient to satisfy the obligations subject to such guarantees. We believe that our medallion loan portfolio is of high credit quality because medallions have generally increased in value and are relatively simple to repossess and resell in an active market. In the past, when a borrower has defaulted on a loan, we have repossessed the medallion collateralizing that loan. If the loan was not brought current, the medallion was sold in the active market at prices at or in excess of the amounts due. Although some of the medallion loans have from time to time been in arrears or in default, our loss experience on medallion loans has been negligible. Market Position We have originated and serviced medallion loans since 1979, and have established a leading position in the industry. Management has a long history of owning, managing, and financing taxicab fleets, taxicab medallions, and corporate car services, dating back to 1956. Medallion loans collateralized by New York City taxicab medallions and related assets comprised 78% of the value of the medallion loan portfolio at December 31, 2005. The balance of medallion loans is collateralized by taxicab medallions in Chicago, Boston, Newark, Cambridge, and other cities within the United States. We believe that there are significant growth opportunities in these and other metropolitan markets nationwide. The following table displays information on medallion loans outstanding in each of our major markets at December 31, 2005.      # of Loans   

% of



Portfolio (1)




Rate (2)





Medallion loans


New York

   1,303    78 %   6.23 %   $ 351,013,972  


   342    12     6.99       52,241,611  


   171    6     7.47       27,879,446  


   68    2     8.49       6,541,369  


   32    1     7.21       5,663,785  


   45    1     7.53       6,464,175                        

Total medallion loans

   1,961    100 %   6.46       449,804,358                      

Deferred loan acquisition costs


Unrealized depreciation on loans

            (1,348,535 )                

Net medallion loans

          $ 449,672,510                   (1) Based on principal balance outstanding. (2) Based on the contractual adjustable or fixed rates of the portfolios at December 31, 2005. The New York City Market . A New York City taxicab medallion is the only permitted license to operate a taxicab and accept street hails in New York City. As reported by the TLC, individual (owner-driver) medallions sold for approximately $350,000 and corporate medallions sold for approximately $391,000 at December 31, 2005. The number of taxicab medallions is limited by law, and as a result of the limited supply of medallions, an active market for medallions has developed. The law limiting the number of medallions also stipulates that the ownership for the 12,779 medallions outstanding at December 31, 2005 shall remain divided into 5,112 individual medallions and 7,667 fleet or corporate medallions. Corporate medallions are more valuable because they can be aggregated by businesses, leased to drivers, and operated for more than one shift. In 2003 the state legislature and city council authorized the TLC to sell up to 900 additional medallion licenses, 592 of these were sold via auctions in 2004. It is anticipated that the remaining 308 will be auctioned off in 2006. The City announced a 25% fare hike to support the increased level of medallions, which took effect in the 2004 second quarter. The results of the auctions held were highly successful with a large number of bids received, and record-setting medallion values established. The floor on the remaining auction bids is expected to be the current market values at the date of the auction, which as of January 2006 are in excess of $390,000 for a corporate medallion. Although there can be no assurances, in past auctions, the establishment of a bid floor has tended to support the existing valuation level of the medallions. A prospective medallion owner must qualify under the medallion ownership standards set and enforced by the TLC. These standards prohibit individuals with criminal records from owning medallions, require that the funds used to purchase medallions be derived from legitimate sources, and mandate that taxicab vehicles and meters meet TLC specifications. In addition, before the TLC will approve a medallion transfer, the TLC requires a letter from the seller’s insurer stating that there are no outstanding claims for personal injuries in excess of insurance coverage. After the transfer is approved, the owner’s taxicab is subject to quarterly TLC inspections. Most New York City medallion transfers are handled through approximately 30 medallion brokers licensed by the TLC. In addition to brokering medallions, these brokers also arrange for TLC documentation insurance, vehicles, meters, and financing. The Company has excellent relations with many of the most active brokers and regularly receives referrals from them. However, the Company receives most of its referrals from a small number of brokers. Brokers generated 23% of the loans originated for the year-ended December 31, 2005. The Chicago Market . We estimate that Chicago medallions currently sell for approximately $50,000. Pursuant to a municipal ordinance, the number of outstanding medallions is currently capped at 6,800, which includes an additional 150 and 200 medallions that were auctioned and placed into service in July 1999 and December 2000, respectively. We estimate that the total value of all Chicago medallions and related assets is over $475,000,000. The Boston Market. We estimate that Boston medallions currently sell for approximately $325,000. The number of Boston medallions had been limited by law since 1934 to 1,525 medallions. In March 1990 an immediate increase to 1,825 was ordered with additional increases over a two and one-half year period to a total of 2,025. We estimate that the total value of all Boston medallions and related assets is over $699,000,000. The Newark Market. We estimate that Newark medallions currently sell for approximately $210,000. The number of Newark medallions currently has been limited to 600 since 1950 by local law. We estimate that the total value of all Newark medallions and related assets is over $138,000,000. The Cambridge Market. We estimate that Cambridge medallions currently sell for approximately $312,000. The number of Cambridge medallions has been limited to 248 since 1945 by a Cambridge city ordinance. We estimate that the total value of all Cambridge medallions and related assets is over $82,000,000. COMMERCIAL LOAN PORTFOLIO Commercial loans of $145,797,000 comprised 20% of the $723,253,000 net investment portfolio as of December 31, 2005. From the inception of the commercial loan business in 1987 through December 31, 2005, we have originated more than 10,000 commercial loans for an aggregate principal amount of approximately $718,440,000. The commercial loan portfolio consists of floating-rate, adjustable, and fixed-rate loans. We had increased our commercial loan activity in recent years to 20% of net investments, primarily because of the attractive higher yielding, floating rate nature of most of this business. The outstanding balances of commercial loans grew at a compound annual rate of 15% since 1996, although balances declined during 2002 and 2003, as the Company sought to increase liquidity by selling and not renewing certain loans, grew 55% during 2004, reflecting a return to the Company’s historical growth patterns, and grew 7% in 2005 which was dampened by the sale of $19,414,000 of BLL loans. The increase since 1996 has been primarily driven by internal growth through the origination of additional commercial loans. We plan to continue expanding our commercial loan activities by developing a more diverse borrower base, a wider geographic area of coverage, and by expanding targeted industries. Commercial loans are generally secured by equipment, accounts receivable, real estate, and other assets, and have interest rates averaging 325 basis points over the prevailing prime rate. As with medallion loans, the vast majority of the principals of borrowers personally guarantee commercial loans. The aggregate realized loss of principal on commercial loans has averaged less than 2% per annum for the last five years. Asset Based Loans The Company originates, manages, and services asset-based loans to ses who require working capital credit facilities ranging from $500,000 to $3,600,000 through its MBC subsidiary. These loans represent approximately 47% of the commercial loan portfolio. The credit facilities are secured principally by the borrower’s accounts receivable, but may also be secured by inventory, machinery, equipment and/or real estate, and are personally guaranteed by the principals. Currently, our clients are mostly located in the New York metropolitan area and include manufacturers, distributors, and service organizations. We had successfully established 46 credit lines at December 31, 2005. Secured Mezzanine Loans Through our MCI subsidiary we originate both senior and subordinated loans to businesses in a variety of industries, including radio and television stations, airport food service operations, and various manufacturing concerns. These loans are primarily secured by a second position on all assets of the businesses, range from $1,000,000 to $5,000,000, and represent approximately 35% of the commercial loan portfolio. Frequently, we receive warrants to purchase an equity interest in the borrowers of secured mezzanine loans. SBA Section 7(a) loans The Company originated loans under the Section 7(a) program of the SBA through its BLL subsidiary. The Company sold all of the Section 7(a) loans in its portfolio in connection with the sale of the assets of BLL to a subsidiary of Merrill Lynch in October 2005. Other Secured Commercial Loans The Company originates other commercial loans that are not concentrated in any particular industry. These loans represent approximately 18% of our commercial loan portfolio. Historically this portfolio had been made up of fixed-rate loans, but substantially all business originated over the last four years has been at adjustable interest rates, generally repricing on their anniversary date. Borrowers include food service, real estate, dry cleaner, and laundromat businesses. The following table displays information on the types of loans outstanding in our commercial loan portfolio at December 31, 2005.      # of Loans   

% of



Portfolio (1)




Rate (2)





Commercial Loans



   78    47 %   9.64 %   $ 72,084,697  

Secured mezzanine

   35    35     14.06       53,207,394  

Other secured commercial

   154    18     7.06       28,058,435                        

Total commercial loans

   267    100 %   10.70       153,350,526                      

Deferred loan acquisition costs


Unrealized depreciation on loans

            (7,621,157 )                

Net commercial loans

          $ 145,796,652                   (1) Based on principal balance outstanding (2) Based on the contractual rates of the portfolios at December 31, 2005. Portfolio Characteristics Commercial loans finance either the purchase of the equipment and related assets necessary to open a new business or the purchase or improvement of an existing business. We have originated commercial loans in principal amounts ranging from $50,000 to approximately $5,000,000. These loans are generally retained and typically have maturities ranging from one to ten years and require equal monthly payments covering accrued interest and amortization of principal over a four to five year term. Substantially all loans generally may be prepaid with a fee ranging from 30 to 120 days’ interest. The term of, and interest rate charged on, certain of our outstanding loans are subject to SBA regulations. Under SBA regulations, the maximum rate of interest permitted on loans originated by the Company is 19%. Unlike medallion loans, for which competition precludes us from charging the maximum rate of interest permitted under SBA regulations, we are able to charge the maximum rate on certain commercial loans. We believe that the increased yield on commercial loans compensates for their higher risk relative to medallion loans and further illustrates the benefits of diversification. Commercial loans are generally originated at an average loan-to-value ratio of 70 to 75%. Substantially all of the commercial loans are collateralized by security interests in the assets being financed by the borrower. In addition, we have recourse against the vast majority of the principals of borrowers who personally guarantee the loans. Although personal guarantees increase the commitment of borrowers to repay their loans, there can be no assurance that the assets available under personal guarantees would, if required, be sufficient to satisfy the obligations secured by such guarantees. In certain cases, equipment vendors may provide full and partial recourse guarantees on loans. CONSUMER LOAN PORTFOLIO Consumer loans of $85,678,000 comprised 12% of our $723,253,000 net investment portfolio as of December 31, 2005. About half of the existing portfolio was purchased on April 1, 2004 from an unrelated financial institution and the transaction closed May 6, 2004. The Company started originating new adjustable rate consumer loans during the 2004 third quarter. Recreational vehicles, boats, and horse trailers located in all 50 states collateralize the loans. The portfolio is serviced by a third party subsidiary of a major commercial bank. Portfolio Characteristics Consumer loans generally require equal monthly payments covering accrued interest and amortization of principal over a negotiated term, generally around ten years. Interest rates offered are both floating and fixed, and certain of the floating rate notes have built in caps or floors. Borrowers may prepay consumer loans without any prepayment penalty. In general, MB has established relationships with dealers in the industry, who source most of the customers to MB. At December 31, 2005, substantially all consumer loans were collateralized by first security interests in the recreational vehicles, boats, and trailers, and were originated at an approximate loan-to-value ratio of 95%. We believe that our consumer loan portfolio is of acceptable credit quality given the high interest rates earned on the loans, which compensate for the higher degree of credit risk in the portfolio. INVESTMENT ACTIVITY The following table sets forth the components of investment activity in the investment portfolio for the periods indicated.      Year ended December 31,        2005     2004     2003  

Net investments at beginning of period

   $ 643,541,008     $ 379,158,525     $ 356,246,444  

Investments originated

     337,885,639       303,369,002       248,225,892  

Repayments of investments

     (225,381,052 )     (144,835,651 )     (232,171,193 )

Cash received for sold BLL SBA Section 7(a) loans

     (19,414,095 )     —         —    

Transfers from (to) other assets/liabilities

     (7,011,897 )     (439,841 )     2,362,534  

Net increase in unrealized appreciation (depreciation) (1) (2)

     (6,558,733 )     (4,539,807 )     (6,672,904 )

Amortization of origination costs

     (1,935,600 )     (1,704,194 )     (1,376,641 )

Net realized gains (losses) on investments (3)

     1,243,041       (256,347 )     11,688,310  

Realized gains on sales of loans

     884,608       474,074       856,083  

Purchase of consumer loan portfolio

     —         80,631,534       —    

CCU stock received in exchange for investment in Media

     —         31,683,703       —                             

Net increase (decrease) in investments

     79,711,911       264,382,483       22,912,081                           

Net investments at end of period

   $ 723,252,919     $ 643,541,008     $ 379,158,525                            (1) Net of unrealized depreciation related to MTM of $0, $2,826,600, and $3,932,828 for the years ended December 31, 2005, 2004, and 2003. (2) Excludes net unrealized depreciation of $1,123,136, $512,281, and $317,361 for the years ended December 31, 2005, 2004, and 2003, respectively, related to foreclosed properties, which are carried in other assets on the consolidated balance sheet. (3) Excludes net realized losses of $162,037, $38,639, and $161,682 for the years ended December 31, 2005, 2004, and 2003, related to foreclosed properties, which are carried in other assets on the consolidated balance sheet. Investment Strategy Our core philosophy has been “In niches there are riches.” We try to identify markets that are profitable and where we can be an industry leader. Core lending areas include taxicab medallion lending, automobile lending (taxicabs and limousines only), asset-based financing, and Consumer RV and marine lending. Additionally, we lend to ses that meet our overall credit criteria of strong collateral values and personal ability to repay the debt. Until October 2005, the Company also conducted business through Business Lenders, LLC (BLL), licensed under the US S Administration (SBA) Section 7(a) program. The Company sold all of the assets of BLL to a subsidiary of Merrill Lynch & Co. in October 2005 for book value for the assets, and received payment for all intercompany funding provided, in total, $20,472,000. In all lending divisions, we focus on making secured loans to achieve favorable yield to risk profiles and below average losses. In addition to increasing market share in existing lending markets and identifying new niches, we seek to acquire specialty finance companies that make secured loans to ses which have experienced historically low loan losses similar to our own. Since the Company’s initial public offering in May 1996, eight specialty finance companies, four loan portfolios, and three taxicab rooftop advertising companies have been acquired. Our most recent acquisition was the purchase of a consumer loan portfolio by MB in April 2004 for $86,309,000. Marketing, Origination, and Loan Approval Process We employ 16 loan originators to originate medallion and commercial loans. Each loan application is individually reviewed through analysis of a number of factors, including loan-to-value ratios, a review of the borrower’s credit history, public records, personal interviews, trade references, personal inspection of the premises, and approval from the TLC, SBA, or other regulatory body, if applicable. Each applicant is required to provide personal or corporate tax returns, premises leases, and/or property deeds. Senior management establishes loan origination criteria. Loans that conform to such criteria may be processed by a loan officer with the proper credit authority, and non-conforming loans must be approved by the Chief Executive Officer and/or the Chief Credit Officer. Both medallion and commercial loans are sourced from brokers with extensive networks of applicants, and commercial loans are also referred by contacts with banks, attorneys, and accounting firms. Consumer loans are primarily sourced through relationships which have been established with RV and boat dealers throughout our market area. TAXICAB ROOFTOP ADVERTISING In addition to its finance business, the Company also conducted a taxicab rooftop advertising business primarily through Media, which began operations in November 1994, and ceased operations during the 2004 third quarter upon the merger of Media with and into a subsidiary of CCU, and the sale of MMJ to its management. See Note 3 to the financial statements for additional information. Media’s revenue was affected by the number of taxicab rooftop advertising displays showing advertisements, and the rate charged customers for those displays, which totaled 6,800 in the US at the date of sale. Although Media was a wholly-owned subsidiary of the Company, its results of operations were not consolidated with the Company’s operations because SEC regulations prohibit the consolidation of non-investment companies with investment companies. SOURCES OF FUNDS Overview We have historically funded our lending operations primarily through credit facilities with bank syndicates and, to a lesser degree, through fixed-rate, senior secured notes and long-term subordinated debentures issued to or guaranteed by the SBA. Since the inception of MB, substantially all of MB’s funding has been provided by FDIC insured brokered certificates of deposit. The determination of funding sources is established by our management, based upon an analysis of the respective financial and other costs and burdens associated with funding sources. Our funding strategy and interest rate risk management strategy is to have the proper structuring of debt to minimize both rate and maturity risk, while maximizing returns with the lowest cost of funding over an intermediate period of time. The table below summarizes our cash levels and borrowings as of December 31, 2005, and amounts outstanding under credit facilities and their respective end of period weighted average interest rates at December 31, 2005. See notes 4 and 5 to the consolidated financial statements for additional information about each credit facility.      Total  


   $ 43,036,000  

Bank loans (1)


Amounts available


Amounts outstanding


Average interest rate

     6.76 %



Lines of credit (2)

   $ 325,000,000  

Amounts undisbursed


Amounts outstanding


Average interest rate

     4.53 %



Margin loan

   $ 10,663,000  

Average interest rate

     5.00 %



SBA debentures (3)

   $ 77,250,000  

Amounts undisbursed


Amounts outstanding


Average interest rate

     6.02 %



Brokered CD’s

   $ 219,107,000  

Average Interest Rate

     3.47 %



Total cash and remaining amounts undisbursed under credit facilities

   $ 77,083,000           

Total debt outstanding

   $ 620,022,000            (1) In January 2005, MFC entered into a $4,000,000 revolving note agreement with Atlantic Bank that matures in August 2006, and is secured by medallion loans in process of being sold to the Trust. (2) In January 2006, this line of credit was extended for an additional two years to September 2008, with the committed amount adjusting to $475,000,000. (3) In March 2006, the SBA approved a $13,500,000 commitment for MCI to issue additional debentures to the SBA during a ten year period upon payment of a 1% fee and the infusion of $4,500,000 of additional capital. We fund our fixed-rate loans with variable-rate credit lines and bank debt, and with fixed-rate senior secured notes and SBA debentures. The mismatch between maturities and interest-rate sensitivities of these balance sheet items results in interest rate risk. We seek to manage our exposure to increases in market rates of interest to an acceptable level by:   •   Originating adjustable rate loans;   •   Incurring fixed-rate debt; and   •   Purchasing interest rate caps to hedge a portion of variable-rate debt against increases in interest rates. Nevertheless, we accept varying degrees of interest rate risk depending on market conditions. For additional discussion of our funding sources and asset liability management strategy, see Asset/Liability Management on page 39. OUR OPERATION AS A RIC We previously elected to be taxed as a RIC under Sections 851 through 855 of the Internal Revenue Code for each taxable year, assuming we satisfied the qualification requirements for RIC treatment in each year. As further described herein, and in the notes to the consolidated financial statements, during taxable year 2002 we did not qualify as a RIC and were therefore subject to tax as an ordinary corporation under Subchapter C of the Code. Importantly, because we had a net operating loss for 2002, our non-qualification of RIC status did not materially affect dividend distributions to our stockholders, and produced a potentially beneficial taxable loss to carry forward. The Company qualified as a RIC in 2003, but chose to be taxed as a C Corporation in 2003 in order to better utilize the net operating loss carryforwards generated in 2002 and prior years. The sections of the Code relating to qualification and operation as a RIC are highly technical and complex. The following discussion summarizes material aspects of the sections of the Code that govern the federal income tax treatment of a RIC and the treatment of stockholders. This summary is qualified in its entirety by the applicable Code provisions, rules and regulations developed under the Code and the rules, and administrative and judicial interpretations of these provisions, rules and regulations. In general, if certain detailed conditions of the Code are met (including the election of RIC taxation in each such year), Business Development Companies, like us in previous taxable years, are generally not taxed at the corporate level on the “investment company taxable income” and net capital gains that are distributed to stockholders, where they are taxed at ordinary income and capital gains rates, respectively. The income of a non-RIC corporation is generally subject to corporate tax. In addition, stockholders who receive income from non-RIC corporations are also taxed on the income they receive at the lower capital gains rate. Thus, the income of a non-RIC corporation is subject to “double taxation” (i.e., taxation at both the corporate and stockholder levels). RIC treatment reduces this “double taxation.” A RIC is, however, generally subject to federal income tax, at regular corporate rates, on undistributed investment company taxable income and net capital gains. To avoid a 4% nondeductible federal excise tax on undistributed income and capital gains, we must distribute (or be deemed to have distributed) by December 31st of each year at least 98% of the sum of (1) our ordinary income for such year; (2) our capital gain net income (which is the excess of our capital gain over our capital loss and is generally computed on the basis of the one-year period ending on October 31st of such year); and (3) any amounts that were not distributed in the previous calendar year and on which no income tax has been paid. As in 2002, if we do not qualify as a RIC in any year, we will be subject to income taxes as if we were a domestic corporation, and our stockholders will be taxed on any amounts distributed to them in the same manner as stockholders of an ordinary corporation. Depending on the relevant circumstances, if this were to occur, we could be subject to potentially significant tax liabilities and the amount of cash available for distribution to our stockholders could be reduced. In 2002, however, because we had a net operating loss we did not suffer any significant tax liabilities as a result of our loss of RIC status. Likewise, in 2003, we were not taxed as a RIC on our federal tax return, and were able to offset substantially all of our federal and state tax liabilities by the use of net operating loss carryforwards generated in prior years. The Code’s definition of the term “RIC” includes a domestic corporation that has elected to be treated as a Business Development Company under the 1940 Act and meets certain requirements. These requirements are:   (a) The Company derives at least 90% of its gross income for each taxable year from dividends, interest, interest payments with respect to securities loans, and gains from the sale or other disposition of stocks or securities or foreign currencies; and   (b) The Company diversifies its holdings so that, at the close of each quarter of its taxable year,   (i) At least 50% of the value of its total assets is represented by (A) cash, and cash items (including receivables), US Government securities and securities of other RICs, and (B) other securities limited in respect of any one issuer to an amount not greater in value than 5% of the value of the total assets of the Company and to not more than 10% of the outstanding voting securities of such issuer; and   (ii) Not more than 25% of the value of total assets is invested in the securities (other than US Government securities or securities of other RICs) of any one issuer or two or more issuers controlled by the company and engaged in the same, similar or related trades or businesses. These income and asset diversification requirements could restrict the expansion of our banking business conducted by MB. In addition, to qualify as a RIC under the Code, in each taxable year a company also must distribute to its stockholders at least 90% of (a) its investment company taxable income and (b) the excess of its tax-exempt interest income over certain disallowed deductions. If we satisfy these requirements, we would not be subject to federal income tax on the investment company taxable income and net capital gain distributed to our stockholders. However, any investment company taxable income and/or net capital gains retained by us would be subject to federal income tax at regular corporate income tax rates. However, we may designate retained net capital gains as a “deemed distribution” and pay a tax on this for the benefit of our stockholders. As a RIC, if we acquire debt obligations that were originally issued at a discount, or bear interest rates that do not call for payments at fixed rates (or certain “qualified variable rates”) at regular intervals over the life of the obligation, we will be required to include, as interest income, in each year, a portion of the “original issue discount” that accrues over the life of the obligation regardless of whether we receive the income, and we will be obligated to make distributions accordingly. If this were to occur, we may borrow funds or sell assets to meet the distribution requirements. However, the 1940 Act prohibits us from making distributions to stockholders while senior securities are outstanding unless we meet certain asset coverage requirements. If we are unable to make the required distributions, we may be subject to the nondeductible 4% excise tax or we may fail to qualify as a RIC. In addition, the SBA restricts the amount of distributions to the amount of undistributed net realized earnings less the allowance for unrealized loan losses (which in our case includes unrealized depreciation). If we qualify as a RIC, distributions made to our taxable domestic stockholders out of current or accumulated earnings and profits (and not designated as capital gain dividends) will be considered ordinary income to them. Distributions that are designated as capital gain dividends will be taxed as long-term capital gains, (to the extent they do not exceed our actual net capital gain for the taxable year) without regard to the period for which the stockholder has held the stock. Corporate stockholders, however, are subject to tax on capital gain dividends at the same rate as ordinary income. To the extent that we made (or continue to make in 2005 and beyond) distributions in excess of current and accumulated earnings and profits, these distributions were (and would be) treated first as a tax-free return of capital to the stockholder, reducing the tax basis of a stockholder’s common stock by the amount of such distribution (but not below zero). Distributions in excess of the stockholder’s tax basis are taxable as capital gains (if the common stock is held as a capital asset). In addition, any dividends declared by us in October, November, or December of any year and payable to a stockholder of record on a specific date in any such month shall be treated as both paid by us and received by the stockholder on December 31st of such year, provided that the dividend is actually paid by us during January of the following calendar year. Stockholders may not include in their individual income tax returns any net operating losses or capital losses by us. If we choose to retain and pay tax on any net capital gain rather than distribute such gain to our stockholders, we will designate such deemed distribution in a written notice to stockholders within 60 days after the close of the taxable year. Each stockholder would then be treated, for federal income tax income tax purposes, as if we had distributed to such stockholder, on the last day of its taxable year, the stockholder’s pro rata share of the net long-term capital gain retained by us and the stockholder had paid its pro rata share of the taxes paid by and reinvested the remainder in us. In general, any losses upon a sale or exchange of common stock by a stockholder who has held the stock for six months or less (after applying certain holding period rules) will be treated as long-term capital loss to the extent that distributions from us are required to be treated by the stockholder as long-term capital gains. As noted above, we were not taxed as a RIC in 2002 or 2003, and were taxed as a RIC in 2004. If we fail to meet the RIC requirements for more than two consecutive years and then seek to requalify as a RIC, we would be required to recognize gain to the extent of any unrealized appreciation on our assets unless we make a special election to pay corporate-level tax on any such unrealized appreciation recognized during the succeeding 10-year period. Absent such special election, any gain we recognized would be deemed distributed to our stockholders as a taxable distribution. OUR OPERATION AS A BDC As a Business Development Company, or BDC, we are subject to regulation under the 1940 Act, and we are periodically examined by the SEC for compliance with the 1940 Act. The 1940 Act contains prohibitions and restrictions relating to transactions between investment companies and their affiliates, principal underwriters and affiliates of those affiliates or underwriters. In addition, the 1940 Act provides that we may not change the nature of our business in a way which would cause us to lose our status as a BDC or withdraw our election as a BDC, unless we are authorized by a vote of a “majority of the Company’s outstanding voting securities,” as defined under the 1940 Act. We are permitted, under specified conditions, to issue multiple classes of indebtedness and one class of stock (collectively, “senior securities,” as defined under the 1940 Act) senior to the shares of common stock if the asset coverage of the indebtedness and all senior securities is at least 200% immediately after the issuance. Subordinated SBA debentures guaranteed by or issued to the SBA by our RIC subsidiaries are not subject to this asset coverage test. In addition, while senior securities are outstanding, provisions must be made to prohibit the declaration of any dividend or other distribution to stockholders (except stock dividends) or the repurchase of securities or shares unless we meet the applicable asset coverage ratios at the time of the declaration of the dividend or distribution or repurchase after deducting such dividend, distribution or repurchase price. Under the 1940 Act, a BDC may not acquire any asset other than assets of the type listed in Section 55(a) of the 1940 Act (Qualifying Assets) unless, at the time the acquisition is made, certain Qualifying Assets represent at least 70% of the value of the Company’s total assets. The principal categories of Qualifying Assets relevant to our business are the following:   (1) Securities purchased in transactions not involving a public offering from the issuer of such securities, which issuer is an eligible portfolio company. An “eligible portfolio company” is defined in the 1940 Act as any issuer which:   (a) Is organized under the laws of, and has its principal place of business in, the United States;   (b) Is not an investment company other than a SBIC wholly-owned by the BDC; and   (c) Satisfies one or more of the following requirements:   (i) The issuer does not have a class of securities with respect to which a member of a national securities exchange, broker or dealer may extend margin credit, or   (ii) The issuer is controlled by a BDC, such BDC exercises a controlling influence over the issuer’s management or policies as a result of such control, and the BDC has an affiliated person serving as a director of issuer;   (iii) The issuer has total assets of not more than $4 million and capital and surplus (shareholder’s equity less retained earnings) of not less than $2 million, or such other amounts as the Securities and Exchange Commission (SEC) may establish by rule, regulation, or order; or   (iv) Issuer meets such other criteria as the SEC may establish from time to time by rule;   (2) Securities for which there is no public market and which are purchased in transactions not involving a public offering from the issuer of such securiti