M&A SPOTLIGHT SEPTEMBER 2013

Investing in Financial Providers to the Underserved

as “underbanked”). According Services Innovation. An increasing to the latest data from the FDIC, number of large banks, including Wells 28.3 percent of U.S. households are Fargo, have been aggressively seeking unbanked or underbanked—a figure out the underbanked by offering AFS that translates into 68 million adults products such as low dollar amount, and is expected to grow.1 short term loans with relatively higher fees.3 However, many of the AFS Unbanked and underbanked products offered by traditional banks consumers have bypassed traditional carry requirements such as existing banking products, and big banks banking relationships, minimum have historically avoided these balances, or significant fees.4 consumers due to concerns around high loss rates, regulatory issues, Recently, start ups have entered the and perceived reputational concerns. market to capitalize on this niche However, the high fee structures often group. -based LendUp accompanying the products offered offers residents the ability by AFS providers may justify an to borrow $250 for 30 days at a rate of entrance into or expansion within the 15 percent, and the ability to borrow underserved banking sector. About more funds at better rates. LendUp 25 percent of U.S. households used received seed financing from backers at least one AFS product in the year that included Andreessen Horowitz of the FDIC survey, and they did so and Kleiner Perkins Caufield & Byers.5 because they perceive AFS providers Even non financial entities have begun to be more convenient or accessible to enter the space. Last year, Walmart, than traditional banking institutions.2 in partnership with American Express, began a new service called “Bluebird,” Given the growing number of which includes a prepaid debit card underserved consumers in the and was recently expanded to add U.S. and the evolving regulatory services promoted as alternatives A surprisingly large percentage of environment, a clear opportunity to checking accounts with features American consumers do not have to serve these consumers such as mobile bill pay.6 a savings or checking account with exists. Including credit, payment, in these types of services and an insured depository institution deposit, and other products, the acquisitions of AFS providers are likely (defined as “unbanked”), or primarily fees and interest generated by to increase. rely on check-cashing services, the underbanked sector totaled payday lenders, or other Alternative approximately $78 billion in 2011, Financial Services (AFS) providers according to The Center for Financial for their financial solutions (defined

1 2011 FDIC National Survey of Unbanked and Underbanked Households, 4 2011 FDIC Survey of Banks’ Efforts to Serve the Unbanked and Underbanked, September 20, 2011, page 3 (FDIC study). December 2012, page 5. 2 FDIC study, page 5. 5 CNNMoney.com , “A startup tries to fix payday lending,” October 11, 2012. 3 , “Chasing Fees, Banks Court Low-Income Customers,” 6 Walmart press release, “American Express and Walmart Announce the Addition of April 25, 2012. FDIC and Worry-Free Check Writing to Bluebird®,” March 26, 2013.

© 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG M&A Spotlight / September 2013 International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Printed in the U.S.A. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. NDPPS 204526 The challenges and benefits of yields offered by AFS offerings, they Target identification and due diligence entering the market remain cautious in light of potential to manage risk and rationalize New market entrants and seasoned reputational risk and regulatory and the finance companies both face political uncertainty. Additionally, PE Buyers with industry acumen and substantial regulatory requirements, firms may have difficulty securing the patience to find the right mode political uncertainty, reputational competitive financing, a process of entry are best-suited to overcome concerns, and funding complexities. requiring robust forecast assumptions the challenges of entering the The underserved segment’s and an experienced management underserved market. Target selection characteristically high credit losses team with a successful track record. criteria need to be defined in the early and low liquidity command high- Despite these issues, private stages of the process, and preliminary priced financial services products. investors have expressed continued vetting efforts should concentrate on The annual percentage rate on interest in the space and are actively aligning the acquirer’s risk appetite a payday loan averages 225 to seeking attractive targets. Nadim El with return requirements. Company 300 percent, according to the Gabbani, a principal with Blackstone, culture can be of preemptive Center for Responsible Lending. Not believes there is an opportunity importance in determining whether surprisingly, these rates attract the to back innovative management the target’s operations are conducive attention of regulators and consumer teams in providing real benefits to to stringent risk management and advocacy groups and have been customers alongside predictable customer care while generating limited or prohibited in certain states. returns for investors. He says, “Key favorable returns. These challenges are complicated elements that we look for include by the relatively new Consumer advanced credit analytics, a multi- Deep-dive due diligence is also of Financial Protection Bureau, channel distribution network, and a fundamental importance to avoid which has been actively collecting robust compliance function suited risks and maximize the benefits of consumer complaints and expanding to the unique needs of serving an acquisition, particularly in the its oversight. Furthermore, certain underbanked consumers. Over underserved segment. KPMG’s evolving aspects of the Dodd-Frank time, we anticipate that increasing Tim Johnson advises potential Act, particularly around improving regulation should lead to consolidation investors to focus on the following consumer borrower protection, of the industry, benefiting companies issues during due diligence: remain in question. Despite these that are able to deliver high-quality • Pin down a reasonable estimate products in a responsible manner.” challenges, the high financial returns of normalized earnings. Consider Recent PE investments in the associated with AFS products significant changes to reserves, underserved segment reflect the remain attractive to both financial impairments, loan sales, yield and diversity of the product spectrum, services companies and private cost of funds elasticity, shared including sub-prime auto (for equity (PE) firms. The most desirable services, and other one-time example Aquiline Capital Partners’ acquisition targets are supported costs to assess the true run rate of acquisition of First Investors Financial by experienced and competent the business. management teams, strategic Services), consumer installment footprints, competitive and reliable lenders (such as the sale of Mariner • Re-grade a sample of the target’s funding structures, and conservative Finance to an undisclosed investor lending products, and independently risk management functions. group), and payments (The Carlyle assess reserve levels to avoid Group, TPG Capital, Bain Capital, paying for an over-stated balance PE firms entering the market face GTCR, and unnamed strategics are sheet; similar challenges to financial reportedly bidding for MoneyGram services companies. Although International7, 8 ), among others. PE firms are attracted to the high

7 SNL Financial, “Report: companies bidding for MoneyGram,” June 28, 2013. 8 Mergermarket, “Moneygram reaches out to strategics – industry sources,” June 28, 2013.

© 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG M&A Spotlight / September 2013 International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Printed in the U.S.A. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. NDPPS 204526 • Analyze the target’s funding • Evaluate potential contingencies Conclusion sources to determine stability and such as unfair lending practices, Opportunities abound to serve the availability of existing debt, and regulatory or tax exposures, underserved, however mitigation of identify potential synergies related outstanding legal issues or others, the associated risks is paramount to to cheaper costs of funds and higher and build these considerations success. Traditional and non-traditional advance rates; into the purchase price or obtain financial services firms stand to protection through contracting. generate incremental returns by • Scrutinize the assumptions leveraging existing risk management supporting growth strategies Advisers with experience in this competencies while launching new and aspirations to assist in sector can assist in identifying products or markets. Private equity understanding the target’s true the regulatory hurdles, funding investors can maximize their chances potential; requirements, and market appetite of success by targeting companies associated with various expansionary with well-established product • Perform an in-depth evaluation strategies. Also consider whether of the target’s risk management offerings, flexible operating platforms, the incumbent management team is and robust risk management function to provide insight into adequate to execute your investment needed investments, potential functions. The expanding population strategy or whether supplemental of underserved consumers needs exposures, and risky products, support is required. services, and practices; and financial solutions; diligent providers can benefit by serving them.

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