Did Lone Star Funds Buy a Loan Shark?*

December 2014

A report by UNITE HERE Contact: Elliott Mallen [email protected] 312-656-5807

Did Lone Star Funds buy a Loan Shark?*

As institutional capital ﬂows into private debt at a record pace, is Lone Star Funds’ acquisition of payday lender DFC Global outside of investors’ comfort zones?

As banks and other traditional fnancial institutions globally have been required to strengthen their balance sheets following the fnancial crisis and subsequent regulatory changes, a growing number of fund managers and a wave of institutional capital have sought to fll the gap. Data provider Preqin Ltd. reported that private debt funds had raised a total of $77 billion in 2013.1

At the same time, an improving economy and a decline in corporate defaults has meant that distressed debt managers have had to search harder for deals.2

Lone Star Funds, a Texas-based institutional investment manager, has pursued a strategy of buying up distressed residential and corporate debt.3 As of September 2014, Lone Star topped the PDI 30 ranking of private debt investors.4 In July 2014, Lone Star closed its Lone Star Fund IX at $7.3 billion.5

But as Lone Star looks to deploy this capital as well as its $7 billion Lone Star Real Estate Fund III (closed October 2013), the manager’s April 2014 $1.3 billion acquisition of payday lender and pawnshop operator DFC Global raises questions about whether the current scarcity of distressed deals has forced Lone Star to look for deals in places outside of some of its LPs’ comfort zones.

Key Takeaways:

Te US Consumer Financial Protection Bureau last year levied a consent order on a DFC Global portfolio company for making false statements about auto loans to active US military servicemembers.

DFC Global operates in an industry subject to shifing regulation by state/provincial and national governments. DFC DFC Global is “serving unbanked and under-banked consumers and small business owners” with companies like Money Mart, a US payday lender (above, from Money Mart website, accessed 12/8/2014)

* This report relies on the Merriam-Webster.com deﬁnition of Loan Shark: One who lends money to individuals at exorbitant rates of interest. (Accessed Dec 10, 2014) Global management said the sale “transfers all business risks and regulatory uncertainties” from the company to Lone Star.

DFC Global’s business model benefts from economic downturns that broaden its customer base of fnancially insecure consumers.

Questions for limited partners:

What new standards have been implemented at the MILES program since the Lone Star acquisition to protect military servicemembers and mitigate additional headline risk? Should Lone Star own a platform whose business practices beneft from lax oversight of predatory lending practices? How does Lone Star balance its interest in seeing DFC’s consumer base grow through economic recessions in the US and Europe with its interest in seeing an economic recovery raise the value of its other investments in those markets? Under Lone Star’s ownership, will DFC Glob- al continue ofering payday loans with APRs as high as 32,000%?

DFC Global snapshot

An afliate of Lone Star Fund VIII purchased Pennsylvania-based DFC Global Corp (formerly known as Dollar Financial Group) in June 2014 for $1.3 billion, taking the company private.6 Te company, which Lone Star described as “a leading international non-bank provider of alternative fnancial services,“7 is a major payday lender, pawnshop operator and check-cashing provider. Lone Star’s new “direct lending” platform includes companies like Money Mart and the Check Cashing Store. (Google Street View, DFC afliates owned and operated 1,525 retail accessed 12/8/2014) payday lending/pawn locations in nine countries8 and

2 provided internet-based payday loans in six countries as March 31, 2014.9 Te bulk of the DFC’s revenue at the time came from the United Kingdom (46%) and Canada (30%), with the remainder coming from the United States (13%) and the rest of Europe (10%).10 See Appendix for detailed fnancial information and a list of subsidiaries and brands.

DFC operated 292 retail payday lending and pawn locations in the United States, most of which were in California and Florida, as of June 30, 2013.11 Federal action to stop fraudulent lending to active US military servicemembers

DFC has faced regulatory action in the United States over its lending practices. Dealers’ Financial Services, a DFC-owned auto loan originator, was required by the US Consumer Financial Protection Promotional material from DFC’s MILES program, which was Bureau to return $3.3 million required by federal regulators to return $3.3 million to military to more than 50,000 military servicemembers. (accessed 12/8/2014) servicemembers who participated in the company’s Military Installment Loans and Educational Services (MILES) auto lending program. Working with the US Department of Defense and Judge Advocate General (JAG), the CFPB found that DFS failed to properly disclose all fees charged to participants, and misrepresented the true cost and coverage of add-on products fnanced along with the auto loans.12

According to the CFPB, the Company’s deceptive practices included:

Understating the costs of the vehicle service contract: DFS claimed in marketing materials that the vehicle service contract would add just “a few dollars” to the customer’s monthly payment “The MILES program failed to when it actually added an average of $43 per properly disclose costs associated 13 month. with repaying auto loans through Understating the costs of the insurance: DFS told the military allotments system and some customers that the insurance policy would cost only a few cents a day, when the true cost aver- the expensive auto add-on products aged 42 cents a day, or more than $100 a year.14 sold to active-duty military. We will Misleading consumers about product benefts: the continue our work to ensure that MILES marketing materials deceptively suggested servicemembers are treated fairly.” that the vehicle service contract would protect ser- -US Consumer Financial Protection Bureau vicemembers from all expensive car repairs, when Director Richard Corday, 6/27/2013 many basic parts were not covered.15

3 DFS and U.S. Bank developed the MILES program in 2001 to provide subprime auto loans to active duty servicemembers. DFS acted as the consumer-facing marketer and promoter of the program, and U.S. Bank fnanced the loans. Since 2001, the MILES program provided fnancing for more than 110,000 auto purchases by servicemembers.16 Te program required borrowers to pay their loans through military allotments, and required them to use a company that charged a $3 monthly processing fee, a portion of which was shared with DFS.17 Te CFPB found that DFS employees made of-script comments that costly add-on services would “add just a few cents to your car payment” or would cost “only a few pennies a day,”18 when the average monthly cost on a fve-year loan totaled $12.55.19

CFPB director Richard Cordroy said that the program “failed to properly disclose costs associated with repaying auto loans through the military allotments system and the expensive auto add-on products sold to active-duty military” and that the CFPB “will continue our work to ensure that servicemembers are treated fairly.”20

U.S. Bank ended its involvement with the program afer the issuance of the Consent Order.21 DFS has continued the program with diferent lender partners.22

Questions for limited partners What steps has Lone Star taken to ensure the practices DFC was cited for by the CFPB and the Department of Defense are not repeated? What new standards has DFC implemented since the Lone Star acquisition to prevent future regulatory intervention?

Lending practices under scrutiny

DFC’s lending and other business practices are illegal or under scrutiny in many US states. As the regulatory environment evolves in the UK and the rest of Europe, DFC may see its revenue streams restricted. Te impact of the Great Recession has led to increased scrutiny of the type of payday lending practices from which DFC benefts.

Retail payday lending

DFC collected $103 million in revenue (or nearly a quarter of all revenue) from consumer loans made at its storefront retail locations, $16 million of which came from stores in the US. Fifeen US states with strong predatory lending regulations, including New York, Pennsylvania, and North Carolina, had no storefront payday lenders as of early 2014.23

Online payday lending

Online payday lending, a relative new payday lending product, represented 22.5% of DFC’s revenue in its last public quarterly fling (this number was higher in the UK and continental Europe). DFC does not provide online payday loans in the United States.24 4 Regulatory intervention in the US is likelier given the release of an October 2014 survey by the Pew Charitable Trust that found that 30 percent of online borrowers reported that online lenders threatened borrowers with arrest or that their family, friends or employers will be contacted. 39 percent reported that their personal or fnancial information was sold to a third party without their knowledge.25 One in three borrowers reported that they had money withdrawn from their bank accounts without their permission.26 And 22 percent reported that they had lost their bank account because of online payday loans.27

Te Pew report also found that nine out of ten payday loan complaints to the Better Business Bureau were regarding online payday lenders.28

It is unknown whether the Is this how Lone Star Fund VIII Plans to hit issues identifed by the Pew its 25% target return? report apply to DFC’s non- US internet payday lending. Loan Loan Fees (% of Product Market 29 term amount APR Online payday loans ofered Money Mart 30 days $60 – 255 17.6% 214% by DFC afliates outside Poland 140 days 300 46% of the US have APRs from home loan 333% 2,333% in Spain up to The Check 33,465% in Poland (see 14 days $100 15% 390% chart). Store 9 to 45 Money Mart $100 15% 391% In-home loan servicing days $60 to Money Mart 14 days 17.6% 460% DFC’s Polish subsidiary $255 7 to 42 Optima provides “in-home Money Mart $500 21% days 547% servicing” of longer-term 31 €50 to unsecured loans. All “loan OKMoney.es 30 days 30% €600 2,333% disbursement and collection activities” take place in OKMoney Poland 30 days 500 32% 2,831% borrowers’ homes with PayDayUK 28 days £275 30% 6,310% commission-based Optima representatives.32 DFC has OKMoney Poland 14 days 500 27% 33,465% said that “the in-home loan servicing concept is well All “loan disbursement and collection activities” take accepted within Poland” and was place in borrowers’ homes with commission-based “initially established in the UK 33 Optima representatives. nearly 100 years ago.” DFC press release, July 14, 2009

5 Proﬁting from economic downturns

As DFC’s customer base is made up of fnancially insecure consumers living paycheck to paycheck, the company benefts when harsh economic conditions grow that customer base.

DFC has described its customers as ALICE ( “Asset Limited, Income Constrained, Employed”) and ARTI (“Asset Rich, Temporarily Illiquid”). An ALICE customer can be “a service sector worker” who “generally holds more than one job to meet monthly bills and living expenses.” ARTI customers are “temporarily unemployed individuals with highly liquid asset collateral (gold jewelry, quality watches, etc.) who are in need of short-term credit.”34

DFC naturally benefts from economic conditions that expand the pool of ALICE and ALIC consumers. Te company’s then-CEO and Chairman Jefrey Weiss said in a 2012 investor conference call that:

“We are fortunate to operate in a naturally expanding market […] Many higher paying jobs in manufacturing and other sectors of the economy are being of-shored from the more established economies of the world to lesser developed countries.

Tis narrowing discretionary income in the more mature economies is resulting in a growing base of customers who are living pay check to pay check, naturally increasing the demand for short-term credit. We are uniquely positioned through our diversifed product set and sales channel strategies to meet the needs of this growing population with our quick and simple short-term loans, secured pawn lending and check cashing among many other services.”

Former DFC Global Chairman & CEO Jefrey Weiss, 4Q2012 investor conference call.

Questions for limited partners: Does DFC Global beneft from practices that are illegal in the United States? How does Lone Star balance its interest in seeing DFC’s consumer base grow through economic recessions in the US and Europe with its interest in economic recovery raising the value of its other investments in those markets? Will DFC, under Lone Star’s leadership, continue to ofer payday loans with fve-digit APRs? UK regulatory overhaul restricted lending

In April 2014, amidst widespread criticism of industry practices, oversight of payday lenders and pawnbrokers in the United Kingdom shifed from the Ofce of Fair Trading (OFT) to the

6 Financial Conduct Authority (FCA).35 DFC’s revenues in its most important market sufered as a result of the tightening regulatory environment.

In 2012, the OFT began a review of the short-term lending “We received a follow-up letter sector and investigated ffy companies, including three DFC from the OFT on February 28, afliates (MEM Consumer Finance Ltd., Instant Cash Loans 2014, indicating that the OFT Ltd., and Express Finance (Bromley) Ltd). All three were sent had serious concerns about the letters from the OFT in early 2013 that, according to DFC, detailed “required actions in a number of compliance areas, ability of our U.K. operations to including advertising and marketing; pre-contract information meet the enhanced regulatory and explanations; afordability assessments; rollovers (including requirements of the FCA.” deferred refnance and extended loans); and forbearance and DFC Global SEC form 10-Q, Mar 31, 2014. debt collection.”36

Afer a meeting with the company, OFT sent them a letter “indicating that the OFT had serious concerns about the ability of our UK operations to meet the enhanced regulatory requirements of the FCA,” according to DFC.37 Te company and regulators met again in March 2014,38 soon before it was taken private by Lone Star.

Te company described the impact of the regulatory enhancements in its fnal 10-Q:

“Tese regulatory developments have resulted in modifcations to our U.K. lending operations, including imposing additional limitations on our use of continuous payment authority and restricting the number of times a loan can be rolled over, considering broader afordability assessments and exercising greater forbearance for customers in fnancial difculty. Tese changes, and any other changes we may consider or be required to make to our lending and collection practices in the United Kingdom, will likely negatively impact our business for the foreseeable future.”39

Te company also reported unsecured consumer lending revenue dropped 13.1% in 3Q 2014 “due primarily to the impact of the continued regulatory transition in the United Kingdom,”40 and that the company’s loan loss provision “was signifcantly impacted by higher loan defaults in the United Kingdom resulting from the implementation of the loan rollover limitation, as well as from a modifcation of our collection practices, which now place additional limitations on the number and duration of electronic debit attempts.”41

DFC management may have sought an exit as regulations in its most important market tightened, and found an opportunity with Lone Star. DFC management touted the Lone Star acquisition as an opportunity for shareholders to avoid “regulatory uncertainty” in an investor presentation encouraging shareholders to accept the buout:

7 DFC Global Investor Presentation, May 29, 2014

DFC afliates have continued to operate in the UK since the Lone Star purchase.42

Questions for limited Partners: How does Lone Star plan to address the regulatory uncertainties that were “transferred” to it according to DFC? Should Lone Star own a platform whose business practices beneft from lax oversight of predatory lending practices? How will a regulatory scrutiny in the UK and elsewhere afect DFC’s growth in that market? With regulation tightening in the UK, what expansions does DFC have planned in countries with less regulation on payday lenders?

Is DFC Global the future of distressed private debt?

With private equity pouring capital into distressed debt, sellers in the sector may be asking for higher premiums. As obvious deals grow scarce, will Lone Star forgo debt itself and purchase more payday lending platforms like DFC Global? If so, will Lone Star limited partners have strong enough stomachs for the messy realities of what some might call “loan sharking”?

8 Appendix 1 – CFPB Press Release

9 10 11 Appendix 2

DFC Global Quarterly Revenue as of 3/31/2014 by Region and Product Internet Total Share of Revenue Revenue Revenue Revenue $69.7 $45.6 $115.3 46.4% Canada $71.5 $3.4 $74.9 30.2% $33.4 $0.0 $33.4 13.5% $17.7 $7.0 $24.7 9.9% Total Revenue $192.3 $56.0 $248.3 Source: DFC Global press release 5/12/201443

Appendix 3

Brand Product Money Shop PaydayUK Money Mart Canada, USA Insta Cheques Canada The Check USA Auto loans to US USA loans Poland Poland OK Money Source: Company website accessed 11/20/2014

12 Endnotes

1 “Preqin Special Report: Private Debt,” Preqin Ltd. Nov, 2014. 2 “Oaktree said to cut fund as distressed deals diminish,” Bloomberg, Jun 11, 2014. 3 http://www.lonestarfunds.com/funds-raised/capital-growth/lone-star-fund-viii/, accessed Dec 10, 2014. 4 “Special report: Te PDI 30,” Private Debt Investor, September 2014. 5 “Special report: Te PDI 30,” Private Debt Investor, September 2014. 6 DFC Global press release, Apr 2, 2014. 7 DFC Global press release, Jun 13, 2014. 8 DFC Global SEC Form 10Q, Mar 31, 2014. 9 DFC Global SEC Form 10Q, Mar 31, 2014. 10 DFC Global press release, May 12, 2014. 11 DFC Global SEC Form 10K, Aug, 29, 2013, p.7. 12 “CFPB Orders Auto Lenders to Refund Approximately $6.5 Million to Servicemembers,” Consumer Financial Protection Bureau, Jun 27, 2013. 13 “CFPB Orders Auto Lenders to Refund Approximately $6.5 Million to Servicemembers,” Consumer Financial Protection Bureau, Jun 27, 2013. 14 “CFPB Orders Auto Lenders to Refund Approximately $6.5 Million to Servicemembers,” Consumer Financial Protection Bureau, Jun 27, 2013. 15 “CFPB Orders Auto Lenders to Refund Approximately $6.5 Million to Servicemembers,” Consumer Financial Protection Bureau, Jun 27, 2013. 16 Consent Order, In the matter of Dealers Financial Services LLC, Consumer Financial Protection Bureau, Jun 25, 2013, p2. 17 Consent Order, In the matter of Dealers Financial Services LLC, Consumer Financial Protection Bureau, Jun 25, 2013, p3. 18 Consent Order, In the matter of Dealers Financial Services LLC, Consumer Financial Protection Bureau, Jun 25, 2013, p5. 19 Consent Order, In the matter of Dealers Financial Services LLC, Consumer Financial Protection Bureau, Jun 25, 2013, p5. 20 “CFPB Orders Auto Lenders to Refund Approximately $6.5 Million to Servicemembers,” Consumer Financial Protection Bureau, Jun 27, 2013. 21 “U.S. Bank to Reimburse Military Members in CFPB Crackdown,” Bloomberg, Jun 27, 2013. 22 https://www.usmiles.com/index.php, accessed Dec 10, 2014. 23 “State payday loan regulation and usage rates,” Pew Charitable Trusts, Jan 14, 2014. 24 DFC Global SEC Form 10Q, Mar 31, 2014, 25 “Fraud and abuse online: Harmful practices in internet payday lending,” Pew Charitable Trust, Oct 2014.p. 12. 26 “Fraud and abuse online: Harmful practices in internet payday lending,” Pew Charitable Trust, Oct 2014.p. 15. 27 “Fraud and abuse online: Harmful practices in internet payday lending,” Pew Charitable Trust, Oct 2014.p. 16. 28 “Fraud and abuse online: Harmful practices in internet payday lending,” Pew Charitable Trust, Oct 2014. 29 moneymart.com, moneymart.ca, paydayuk.co.uk, okmoney.es, okmoney.pl, optimasa.pl, and thecheckcashingstore. com, accessed Dec 10, 2014.

31 DFC Global SEC Form 10Q, Mar 31, 2014, http://www.optimasa.pl/oferty-pozyczkowe/optima-comfort/, accessed Dec 10, 2014. 32 “Dollar Financial Corp Announces Purchase of Established Consumer Lending Business in Poland,” Businesswire, Jul 14, 2009. 33 “Dollar Financial Corp Announces Purchase of Established Consumer Lending Business in Poland,” Businesswire, Jul 14, 2009. 34 http://www.dfcglobalcorp.com/about-us/our-vision, accessed Dec 10, 2014. 35 DFC Global SEC Form 10Q, Mar 31, 2014, p. 56 36 DFC Global SEC Form 10Q, Mar 31, 2014, p. 56 37 DFC Global SEC Form 10Q, Mar 31, 2014, p. 57 38 DFC Global SEC Form 10Q, Mar 31, 2014, p. 57 39 DFC Global SEC Form 10Q, Mar 31, 2014, p. 57 40 DFC Global press release, May 12, 2014. 41 DFC Global SEC Form 10Q, Mar 31, 2014, p. 76-77 42 https://www.paydayuk.co.uk/, http://www.moneyshop.tv/, http://robertbiggar.co.uk/, http://www.paydayexpress. co.uk/, and http://www.suttonsandrobertsons.com/, accessed Dec 10, 2014. 43 DFC Global press release, May 12, 2014.