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Going from mkv to lossless AVI is very backwards. You're converting a lossy format to another lossy format to a lossless format - basically, adding a whole unnecessary step in between that will decrease the quality, however small that decrease may be.
Plus, those subs look really awkward (to me), being half in the letterboxing and half in the frame. And aren't the subtitles in that scene supposed to be yellow? I thought they were yellow most of the time, and green every once in a while, but never white.
I still think you should render the m2v to lossless AVI, then do the subtitles yourself in Vegas or Premiere or whatever you decide to use.