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 cus- tomer 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 servicemem- bers 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 recov- ery 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.