May 2012

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Renovating the value within.

About Renova Partners Renova Partners was founded in 2009 to identify and unlock value drivers for community banks and emerging middle market companies. For our bank clients, Renova provides loan/asset sales services, special asset management advisory services, risk management solutions and restructuring assignments. Our investment banking team works with emerging middle market companies and community banks to provide advice on capital raises, M&A transactions and other strategic assignments.

THE RENOVA ROUND-UP

A Report Covering Trends in the Specialty Finance Industry This article provides an initial narrative for our clients and colleagues in the financial community regarding trends in the area of specialty finance, with a focus on the future of consumer finance. In this article, we will define our coverage universe and provide some general observations regarding broader market conditions and the current state of the U.S. consumer. Future articles will cover our thoughts regarding sub-segments of the broader specialty finance universe. In the process, we plan to provide periodic updates on financing conditions and valuation metrics for specialty finance companies.
Jerry L. Robinson Managing Director Phone: (404) 891-1134 Email: jerry.robinson@renovacapital.net John D. Wheeler Director Phone: (404) 891-1136 Email: john.wheeler@renovacapital.net

What is Specialty Finance?

Renovas investment banking professionals provide a diverse range of financial advisory services to middle market companies: Mergers & Acquisitions Debt and Equity Private Placements Corporate Restructuring & Bankruptcy Advisory

We define specialty finance companies as any non-bank corporate entity which provides lending or alternative financial services to consumers or small businesses/merchants. The key distinction is that specialty finance companies are not banks: they do not take deposits from customers, and while often subject to significant regulatory scrutiny, they are not regulated by federal or state bank regulators. Some specialty finance companies are engaged purely in providing alternative financial services through retail storefronts. Others serve customers via the Internet. Some target both retail and Internet channels. Among the many products that specialty finance companies provide, our focus is on providers of small loans (either single payment payday loans, installment loans or revolving credit products), pawn loans, auto title loans, check cashing, rent-to-own, tax preparation services, card-related services, buy-here / pay-here (BHPH) auto financing, indirect auto financing, life settlements, asset-based factoring and merchant finance services. Market Observations In todays market, specialty finance companies face an entirely different landscape from the previous decade, as the securitization markets have been generally closed to non-prime assets since the financial crisis of 2008. Although several of the larger specialty finance operators have been able to access the high yield 144A market, this option is not available to smaller family-run lenders. This disparity provides an impetus for consolidation. Is now the time to acquire or contract? Contrarian financial sponsors may see value in current asset prices, but given the squeeze in credit markets, an extra financing premium is inflating risk-adjusted

Investment Due Diligence & Valuation Analysis

Renova Partners, LLC 3300 Cumberland Blvd., Suite 225 Atlanta, Georgia 30339 Securities offered through Bridge Capital Associates, Inc. - Member FINRA, SPIC Bridge Capital Associates, Inc. 127 Main Street NW, Lilburn, GA 30047 Phone: (770) 923-9632 Jerry Robinson is a registered principal of Bridge Capital Associates, Inc.

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Renovating the value within.

Scale is a critical variable for determining the potential financing alternatives available to specialty finance lenders.

return hurdles. With the added benefit of cost synergies, strategic mergers between operators may pick up in the current environment. Amid the massive de-leveraging of the U.S. economy which began in 2008, debt levels for specialty finance companies were reduced to more conservative levels. Although leverage ratios have recovered from their lows, banks and opportunity lending funds still focus on liquidity and prefer to lend against assets (being inside the assets) as opposed to lending based on a multiple of cash flow. Execution, attention to detail and minimizing mistakes is more important than ever in a tight financing market. Capital remains tight and optimizing the use of this capital will quickly determine a specialty lenders success or failure. U.S. Consumer Trends We believe consumer credit is suffering from a period of prolonged contraction. The following chart shows median household incomes on an inflation-adjusted basis.
4.0%

U.S. Median Real Household Income

U.S. Median Real Household Income (2010 $) Year-over-Year Growth

$55,000

3.0% $52,500

2.0%

$49,445

$50,000

Since 2007, median household incomes (on an inflationadjusted basis) have declined sharply.

Year-over-Year Growth (%)

1.0%

$47,500

(1.0%) $45,000

(2.0%)

$42,500 (3.0%)

(4.0%) 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

$40,000

Source: U.S. Census Bureau

By way of historical background, households in the 1980s went from one to two earner homes as spouses entered the workforce. In the 1990s, as both spouses were working full time, hourly work weeks expanded from 40 to 46 hours. When work weeks for both spouses moved longer, consumers began to borrow money on their homes as prices rose, financed their cars through longer-term financing contracts and leases, and took on nearly unlimited unsecured credit card debts. By 2007, real household incomes had finally returned to their 1999-2000 levels. However, amid the ongoing economic slowdown, real economic growth stalled and real household incomes have suffered a major set-back in the absence of further productivity gains. In the resulting environment, consumers (and, by extension, the U.S. economy) found themselves overleveraged and lacked capacity to earn their way out of the situation. In contrast to other historical periods of stalled economic growth, the consumer was confronted with a credit crunch which limited traditional sources of credit. As a result, U.S. households were forced to deleverage or, alternatively, turn to specialty finance companies to meet their financial needs.
Renova Partners, LLC 3300 Cumberland Blvd., Suite 225 Atlanta, Georgia 30339 Securities offered through Bridge Capital Associates, Inc. - Member FINRA, SPIC Bridge Capital Associates, Inc. 127 Main Street NW, Lilburn, GA 30047 Phone: (770) 923-9632 Jerry Robinson is a registered principal of Bridge Capital Associates, Inc.

U.S. Median Household Income (2010 $)

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Renovating the value within.

Leverage for the U.S. consumer peaked in Q3 2007 before plummeting over the next four years. The consumer debt servicing ratio has returned to 1994 levels.

As a proxy for the ratio of U.S. household debt payments to disposable personal income, the Federal Reserve Boards household Debt Service Ratio (DSR) peaked in Q3 2007 after a decade of steady increases. Following this peak, U.S. households were forced to undergo a period of rapid deleveraging. Over the past four years, the DSR ratio has declined rapidly, all the way back to 1994 levels.
Federal Reserve Boards Household Debt Service Ratio (DSR)
14.0% 13.5% 13.0% 12.5% 12.0% 11.5% 11.0% 10.9% 10.5% 10.0% 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: U.S. Federal Reserve Board

Since 2007, the U.S. consumer has undergone significant deleveraging, steadily decreasing his/her debt obligations in the form of mortgages, car loans and credit card debt.

As further evidence of this de-leveraging, U.S. consumers have significantly reduced their exposure to revolving credit card debt. Part of this trend can be explained by reduced supply. After a period rapid ascent beginning in the 1990s when companies drove deep into the credit spectrum and expanded their business by increasing credit for consumers, heightened regulatory scrutiny and significant consolidation among credit card companies resulted in diminished supply of revolving credit, particularly at the sub-prime end of the credit spectrum. With the vast majority of sub-prime credit card originations coming from captive finance companies within large banks, the 2008 financial crisis hit the supply of revolving credit very hard. Outstanding credit card debt has dropped precipitously since its peak in December 2008. In conclusion, several variables are working in concert to prevent the U.S. consumer from borrowing funds to offset the current decline in real income: Capital scarcity resulting from exit of previous providers of capital Higher late cycle losses yield lower advance rates Lender uncertainty about historical credit models Stubbornly low asset values for homes, auto and other collateral

Given these dynamics, we expect the U.S. consumer to stay de-leveraged and will not have as much disposable income as they have had for the past ten to twenty years. In our next article, we will highlight some of the important borrowing benchmarks and valuation metrics of the specialty finance industry.
Renova Partners, LLC 3300 Cumberland Blvd., Suite 225 Atlanta, Georgia 30339 Securities offered through Bridge Capital Associates, Inc. - Member FINRA, SPIC Bridge Capital Associates, Inc. 127 Main Street NW, Lilburn, GA 30047 Phone: (770) 923-9632 Jerry Robinson is a registered principal of Bridge Capital Associates, Inc.