JANUARY 2021

Specialty Finance Sector Review

and Outlook
Defining Strategy and Executing in a Post-Pandemic World

Financial Services Investment Banking

This Report Has Been Prepared By:

Bryce Endline JJ Schmidt Christine Foster

Managing Director Vice President Vice President
Tel: (704) 602-3907 Tel: (704) 602- 3986 Tel: (704) 602- 4872
Email: bryce.endline@psc.com Email: jj.schmidt@psc.com Email: christine.foster@psc.com
Table of Contents
2020 Year in Review ............................................................................................................................... 10
Introduction ......................................................................................................................................... 11
Specialty Finance Review ................................................................................................................... 12
Strategic Trends Impacting Financial Services Broadly ..................................................................... 19
Consumer Finance Review ..................................................................................................................... 30
Introduction ......................................................................................................................................... 31
Subsector: Credit Cards ..................................................................................................................... 34
Subsector: Student Lending ............................................................................................................... 39
Subsector: Auto Finance..................................................................................................................... 43
Subsector: Installment Lending .......................................................................................................... 53
Subsector: Pawn Lending ................................................................................................................... 58
Subsector: Debt Collection ................................................................................................................. 62
Mortgage Finance Review ...................................................................................................................... 66
Introduction ......................................................................................................................................... 67
Subsector: Nonbank Mortgage Companies ....................................................................................... 68
Subsector: Residential Mortgage REITs ............................................................................................. 75
Subsector: Investor Loan Providers .................................................................................................... 80
Commercial Finance Review .................................................................................................................. 84
Introduction ......................................................................................................................................... 85
Equipment Leasing and Finance ......................................................................................................... 86
Asset-Based Lending .......................................................................................................................... 88
Year-End Review................................................................................................................................. 89

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List of Figures
Figure 1: 2020 Stock Market Performance ............................................................................................. 11
Figure 2: Considering Relative Risk and Opportunity Across Specialty Finance ................................... 13
Figure 3: Capital Requirements and Declining Rates Pressure Bank ROEs Post-Crisis ........................ 21
Figure 4: Notable Partnerships Between Asset Management and Insurance Companies ..................... 25
Figure 5: Athene Portfolio Composition and Characteristics ................................................................. 26
Figure 6: 2020 Total Return Performance Across Financial Services Sectors ....................................... 29
Figure 7: U.S. Credit Card Landscape ................................................................................................... 34
Figure 8: Credit Card Risk-Reward Profile ............................................................................................. 35
Figure 9: Historical Credit Card Charge-Off Trends and Near-Term Projections ................................... 37
Figure 10: U.S. Student Lending / Servicing Landscape........................................................................ 39
Figure 11: Total U.S. Student Loan Debt ($B) ........................................................................................ 40
Figure 12: Federal Direct Loan Servicing ($B) ........................................................................................ 40
Figure 13: Total U.S. Auto Loans Outstanding ($B)................................................................................ 43
Figure 14: U.S. Auto Finance Landscape ............................................................................................... 44
Figure 15: Net Percentage of U.S. Banks Tightening Standards for Auto Loans ................................... 45
Figure 16: Overall U.S. Auto Finance Market Share by Lender Type (New and Used) .......................... 45
Figure 17: U.S. Light Vehicle SAAR (Monthly) ........................................................................................ 46
Figure 18: U.S. Light Vehicle SAAR (Annual) .......................................................................................... 46
Figure 19: Light Vehicle Production (#000) ............................................................................................. 47
Figure 20: Automobile Inventory Levels (#000)....................................................................................... 47
Figure 21: Manheim Used Vehicle Index ................................................................................................ 47
Figure 22: Car Gurus Used Car Price Index ........................................................................................... 47
Figure 23: Second Quarter 2020 Y/Y Change in Auto Loan Volume by Borrower Credit Score............ 48
Figure 24: Third Quarter 2020 Y/Y Change in Auto Loan Volume by Borrower Credit Score ................ 48
Figure 25: Risk Distribution of Total (Loan and Lease) Auto Originations .............................................. 48
Figure 26: Average Credit Scores on Total Used Vehicle Originations .................................................. 49
Figure 27: Average Credit Scores on Total (Loan and Lease) New Vehicle Originations ....................... 49
Figure 28: Average Credit Scores on Total (Loan and Lease) Used Vehicle Originations ...................... 49
Figure 29: Y/Y Change in Rates on Used Vehicle Loans Across Credit Scores .................................... 50
Figure 30: Delinquencies (30+ DPD) on Prime Auto Loan Securitizations ............................................. 51
Figure 31: Annualized Net Losses on Prime Auto Loan Securitizations ................................................. 51
Figure 32: Delinquencies (30+ DPD) on Nonprime Auto Loan Securitizations ....................................... 51

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Figure 33: Annualized Net Losses on Nonprime Auto Loan Securitizations .......................................... 51
Figure 34: Extensions on Prime Loans ................................................................................................... 52
Figure 35: Extensions on Subprime Loans ............................................................................................. 52
Figure 36: U.S. Installment Lending Landscape ..................................................................................... 53
Figure 37: Marketplace vs. Balance Sheet ............................................................................................. 56
Figure 38: U.S. Pawn Landscape ........................................................................................................... 59
Figure 39: Y/Y Decline in Pawn Loan Balances ..................................................................................... 60
Figure 40: Y/Y Decline in Pawn Inventories ............................................................................................ 60
Figure 41: Debt Collection Landscape ................................................................................................... 62
Figure 42: ERC Compositions by Geography......................................................................................... 63
Figure 43: LTM Purchase Volumes ......................................................................................................... 63
Figure 43: U.S. Unemployment Level and Nonbusiness Bankruptcy Filings ......................................... 63
Figure 44: 2020 Global Corporate Debt Issuances Across Debt Collection Industry ............................ 64
Figure 45: U.S. Residential Mortgage Landscape .................................................................................. 67
Figure 46: Top 20 U.S. Mortgage Originators ........................................................................................ 69
Figure 47: Record Mortgage Volumes in 2020 ....................................................................................... 70
Figure 48: Market Backdrop Continues to Support Strong Performance in Near Term ........................ 71
Figure 49: Timeline of Mortgage Sector in Public Markets .................................................................... 72
Figure 50: Residential Mortgage REIT Landscape ................................................................................. 75
Figure 51: Top 10 mREIT BVPS Reductions from YE 2019 Through Q1 2020 and Q3 2020 ................ 76
Figure 52: Investor Real Estate Loan Landscape ................................................................................... 81
Figure 53: Historical U.S. Fix-and-Flip Volume ...................................................................................... 82
Figure 54: Historical U.S. Rentership Rate ............................................................................................. 83
Figure 55: Commercial Finance Market Sizing by Estimated Annual Volume ($B) ................................ 85
Figure 56: Equipment Finance Annual Market Size ($B) ........................................................................ 86
Figure 57: Equipment Finance Market: Net Business Volume By Lessor Type ..................................... 87
Figure 58: Equipment Finance Market: Net Business Volume By Market Segment .............................. 87
Figure 59: Asset-Based Lending Market Size: Total Asset-Based Lending Commitments ($B) ............ 88
Figure 60: Asset-Based Lending Market Composition: Commitments by Lender Type ........................ 88
Figure 61: Equipment Finance Drivers: GDP Growth and E&S Investment............................................ 90
Figure 62: Commercial Finance Landscape ........................................................................................... 92

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List of Tables
Table 1: 2020 Specialty Finance Initial Public Offerings......................................................................... 16
Table 2: 2020 Specialty Finance SPAC Mergers .................................................................................... 17
Table 3: 2020 Specialty Finance Mergers & Acquisitions....................................................................... 18
Table 4: Largest Announced Financial Services Transactions of 2020 .................................................. 20
Table 5: 2020 BNPL Strategic Financings .............................................................................................. 55
Table 6: 2020 BNPL Mergers & Acquisitions.......................................................................................... 55
Table 7: Universe of Investable Alternative Mortgage Assets ................................................................ 78

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Introduction
Specialty finance plays a vital role within financial services, in some cases competing on the fringe of
the regulated financial system and in others simply replacing it. The competitive landscape continues to
rapidly evolve and 2020 did more than its part to accelerate many longstanding trends that threaten to
upend the traditional way business has been conducted for decades. In this report, we examine these
fundamental dynamics and their implications on the sector, as well as specific themes affecting
individual subsectors within specialty finance. To survive and prosper in the decade ahead, senior
executives, in partnership with their boards, will need to adapt their strategies to seismic shifts that were
vastly accelerated in 2020.

Interest Rates Interest rates are lower and despite credible speculation of the impact stimulus
will have on them, inflation has failed to materialize for over a decade. For most
sectors in specialty finance, this will pressure revenue growth and force
discipline that will necessitate scale to improve operating margins and funding
efficiencies.

Credit Quality Credit quality, while surprisingly resilient, is far more uncertain. This will restrain
confidence in near-term deal making despite what is arguably the most critical
time in more than a decade to be strategically bold.

Regulation The regulatory paradigm is shifting and it is difficult to discern how the new
administration will manage its diverse coalition, let alone what the ramifications
will be. Even less obvious, but critical for consideration, is how this will impact
the balance of lending between the less regulated specialty finance players and
their regulated cohorts.

Digitalization Digital strategies and technology-forward operating infrastructures are now

essential for survival. This requires both scale and material ongoing investment
to thrive in the decade to come. Reliance on a patchwork of service providers
in place of proprietary technology will not be acceptable for those with
aspirations to build scale and be a leader in their sector.

ESG Standards Environmental, social and governance standards need to be acknowledged

and adopted to achieve efficiencies in the capital markets. Scale is predicated
on efficient access to capital, which will require careful consideration of these
ESG standards.

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2021 Board Room Topics and Questions
Despite the uncertainty remaining in the market, forward and creative strategic thinking will be critical in
2021. For many, that means fundamental changes requiring outside-the-box thinking and a relentless
pursuit to execute. We summarize key questions we have been asked to address in board discussions
and the areas we urge decision makers to focus on as we enter 2021.

Mergers & Acquisitions

Strategic Is now the time to do something bold and off script? Should we enter a new
business, acquire digital capabilities, or buy a bank charter or insurance entity
for strategic funding and other benefits?

Scale Do we have the financial resources and acumen to be a consolidator and/or

leader in our sector? If so, how do we execute on an M&A strategy now to be
the scale winner in the marketplace (or at least protect our position)?

Timing Are there unique buyers with excess liquidity and optimal funding access
willing to stretch to achieve strategic objectives? Does that make selling now
the optimal outcome for shareholders?

Preparation How do we protect ourselves from activists or a suboptimal sale/merger as we

define and execute on our long-term strategy in a post-pandemic world?

Capital Structure
Was capital structure a purposeful, strategic agenda item prior to 2020? It should be now.

Diversity Are we overly exposed to individual markets or small groups of investors and/or
lenders?

Durability Have we appropriately embedded duration and flexibility into our liability
structure? Have we limited, or appropriately hedged, the use of short-term,
mark-to-market financing facilities?

Unsecured What is the most efficient source of unsecured debt? Is it worth paying more
for unsecured capital versus secured alternatives? How do we communicate
more flexible but cost-dilutive funding strategies to investors?

Credit Ratings Which rating agencies should we approach? How will the agencies view our
business under their ratings methodology? How can we advocate for ourselves
to optimize the outcome?

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Thematic Considerations

Marketplace Model Investors are ascribing value to capital-light origination models. Will
augmenting our fundamental strategy or replacing it altogether maximize
shareholder value relative to the status quo?

Growth vs. Value Which do the markets value more: revenue growth or profitability? How do
investors think about growth at the expense of profitability? Does pursuing
mergers or acquisitions that create near-term dilution actually improve our
long-term valuation?
COVID-19 has changed many consumer habits entirely and accelerated other trends already in place
prior to the onset of the pandemic. Recognize it, plan for it and execute.

Digital Initiatives Meet the customer in a user-friendly format where they are and when they are
ready to transact. Form strategic partnerships to reduce customer acquisition
costs and augment or replace inefficient lead acquisition strategies.

Behavioral We have witnessed a rise of new trends in 2020 such as suburban sprawl, work
from home, digital/online preference, evolving spending patterns, increased
savings rates, and changing debt payment priorities. Consider the impact of
these and other trends on your customer and design your business to adapt
accordingly.

Cost Discipline Can cost discipline driven in response to COVID-19 in early 2020 be sustained
so operational efficiencies and improvements can be baked into the go-
forward profit model? How can we leverage technology, created either in-
house or in partnership with specialized service providers, to build a more cost-
competitive operating infrastructure?

Capacity Utilization Can we expand the way we make money with our clients without taking undue
risk or providing products/services that lack utility? Do we have excess
origination capacity that is idle simply because we cannot fund certain assets
on our own balance sheet?
This report is designed to help senior executives and board members recognize and focus on these
issues, provide insights into what others are doing across the sector, and offer our views on where to
prioritize resources going into 2021.

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We segment this report into four parts:

I. 2020 Year in Review Review of trends across all financial services with specific observations
regarding their implications on specialty finance companies.

II. Consumer Finance Review of the broader consumer finance market, followed by specific
subsector reviews on credit cards, student lending, auto finance,
installment lending, pawn lending, and debt collection.

III. Mortgage Finance Review of the residential mortgage landscape, including specific
subsector reviews on nonbank mortgage companies, mortgage REITs,
and investor real estate loan providers.

IV. Commercial Finance Review of the commercial finance sector, with specific commentary on
the equipment leasing and finance and asset-based lending markets.

Given the diverse backgrounds of the intended audience for this report, we provide brief overviews of
each subsector for the benefit of those with less familiarity with any individual market to help
contextualize the observations and insights offered. We hope you find it useful as you chart your path
forward in uncertain times. We fundamentally believe those who make bold, strategic decisions today
will benefit in the years to come. Those that do not adapt will find themselves trailing the pack and may
be left behind altogether.

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Part I

2020 Year in Review

Introduction
No one predicted what 2020 had in store for the economy when we kicked the year off. Markets were
setting fresh records and brushing off concerning geopolitical tensions in the Middle East; recall that on
January 8, Iran actually launched ballistic missiles into a United States military base in Iraq and
incidentally shot down a commercial Ukrainian airliner as retribution for the killing of Qasem Soleimani
several days earlier. Six weeks later, on February 19, the S&P 500 hit another all-time record. It was not
an unsettled geopolitical environment unfolding in a U.S. election year, but a curiously developing viral
outbreak in the capital city of the Hubei Province in China that would ultimately shape 2020 into the
most volatile year the global economy has experienced since the financial crisis.
The entire financial services sector was acutely impacted by the global pandemic brought on by COVID-
19. The abrupt shutdown of the global economy highlighted vulnerabilities in the plumbing of the
financial system, particularly in the United States where businesses rely more on the capital markets for
funding than their global counterparts. The comeback from the depths of despair in March was equally
astonishing. Central banking authorities flooded the markets with unprecedented liquidity and federal
governments supplied $10 trillion of additional fiscal stimulus over the course of just two months, an
amount that is roughly equivalent to ten times the total stimulus supplied during the entire financial crisis
when measured as a percentage of gross domestic product (GDP).
Despite an impressive comeback that put the financial services sector generally in line with where it
started the year, the landscape could not be more different, and 2021 promises to pose unique
opportunities and threats that all companies will need to consider as they build, re-tool and execute
upon their strategic plans in a post-pandemic world.

Figure 1: 2020 Stock Market Performance

30% New Stimulus,

S&P 500 Vaccine and General
Pre-Labor Day
S&P 500 Financials Sell-Off Led by Optimism for 2021
20%
Tech Stocks 18%
States Reopen
10% and COVID-19
Cases Spike
–
(3%)
(10%) CARES
Act
(20%)

(30%) COVID-19
Spreads
(40%) Across the
Globe
(50%)
Dec-19 Feb-20 Apr-20 Jun-20 Aug-20 Oct-20 Dec-20
Source: S&P Global Market Intelligence. Market data for December 31, 2019, through December 31, 2020.

PIPER SANDLER | 11
Specialty Finance Review

2020 Specialty Finance Summary

As a higher beta industry than its regulated cohorts, the specialty finance sector experienced extreme
volatility during 2020. While the entire sector plunged in unity in March as nationwide lockdowns took
effect, each subsector experienced divergent fates. As a whole, the sector is in better shape than many
of those in the regulated segments of financial services, since asset yields tend to be stickier to the
upside, funding costs have gone down more or less in lockstep with broader interest rates, and credit
conditions remain benign as yet another round of stimulus is on its way in the United States.
Nevertheless, not all things are relative and yield compression did have a negative impact on revenue
growth for most during the second half of the year, which will continue into 2021.
Residential mortgage originators were the clear winners across specialty finance in 2020, as a rapid
decrease in interest rates effectively left every mortgage across the country in the money for a refinance
and wider pricing was the only way lenders could control volumes that overwhelmed operating capacity.
Balance sheet lenders across both commercial and consumer asset classes ultimately fared well in a
year marked by the formal implementation of the Current Expected Credit Losses (CECL) standard due
to unprecedented fiscal and monetary stimulus, although there continues to be real stress in certain
shutdown-affected segments of the commercial finance sector such as storefront retail and hospitality.
Similarly, decreased loan demand and higher payoff rates constrained balance sheet growth, and in
many cases drove portfolio shrinkage, across most consumer finance asset classes. Credit quality
across the board will face continued uncertainty going into 2021, but for now appears resilient and
appropriately, if not overly, reserved.
Mortgage REITs (mREITs) suffered the worst fate across the sector, as short-term mark-to-market
repurchase financing on retained subordinated bonds disappeared and credit-sensitive securities faced
sharper price deterioration than that seen even during the financial crisis (at least in pace of decline).
Funding strategies were not resilient and many were forced to accept costly and dilutive financings to
survive the storm and/or sell assets at distressed prices. As a result, mREIT senior management teams
and their boards enter 2021 with more imminent need for bold, value-enhancing strategies than any
other segment in specialty finance.

Risk and Opportunity Across Specialty Finance

We provide some context across the spectrum of specialty finance asset classes for consideration as
companies within the entire financial services ecosystem consider product extension and/or entering
new markets. For decades, financial services companies have had to contend with a continually evolving
regulatory landscape, and 2021 will offer outsized uncertainty as the sector faces a starkly different
administration. Generally speaking, sectors that endured more stringent regulation in response to the
financial crisis, notably credit cards, residential mortgage and debt collection, will face less uncertainty
than those such as auto finance and student lending which have proliferated post-crisis. Separately, the
accelerated shift to e-commerce and ensuing need for digital capabilities has facilitated recent success
for a number of new, well-funded technology-enabled competitors that will continue to encroach on the
turf of traditional financial services providers, both within and outside of the regulated financial system.
We illustrate a continuum that force ranks the specialty finance asset classes according to the relative

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risks posed by the evolving online/digital landscape and the uncertain regulatory backdrop heading into
2021 (see Figure 2).

Figure 2: Considering Relative Risk and Opportunity Across Specialty Finance

Ranking Specialty Finance Subsectors By Relative Competitive Risk from

Digitalization (Vertical) and Regulatory Risk from New Administration (Horizontal)

Higher Competitive Risk

Credit Cards

Installment

Mortgage Student

Auto
Lower Higher
Regulatory Regulatory
Risk Pawn Risk

Debt Collection
Commercial Finance

Lower Competitive Risk

We characterize strategic changes in the online/digital landscape as posing the highest risk for the
residential mortgage, credit card, installment lending and student lending subsectors, where emerging
digital payments alternatives that seamlessly meet customers when and where they transact and an
acceleration towards online/digital origination will require strategic reorientation to remain relevant over
the next decade. With well-funded platforms, newcomer point of sale lenders will likely find their way
into other segments of consumer finance in the same way Ant Group has grown to dominate financial
services in Asia (although that dominance is now being challenged by regulators). We view these
particular subsectors as requiring the highest relative level of technology investment to prosper, which
will necessitate scale and drive further consolidation, either through strategic mergers and acquisitions
or smaller players simply ceding ground. Profitable lenders with branch footprints in place today do

PIPER SANDLER | 13
have a unique competitive advantage, as credit performance tends to be better when borrowers visit a
branch and have a relationship versus loans sourced online, but these lenders must recognize the
shifting landscape and invest today to remain competitive as origination channels continue to evolve in
the decade to come, as branch visits will inevitably decline over the long-term. Student lenders face a
more pronounced dual threat than any other segment in specialty finance, as these competitive
dynamics pair with heightened regulatory uncertainty from an incoming administration that has long
made elevated student debt loads an important pillar of its platform.
The auto finance and pawn lending subsectors sit somewhere in the middle. Saturated from a wave of
post-crisis capital formation, the auto finance industry continues to require lenders to find creative ways
to differentiate their strategies. In pawn, while the market remains highly fragmented, consolidation over
the last five years has left some considerable scale benefits to the two largest lenders which does
provide some safe harbor in competition versus other consumer asset classes. Origination strategies
and digital disruption, while certainly not irrelevant, have also been relatively more stable for auto and
pawn lenders compared to other segments of consumer finance, although auto lenders’ required
response to the shift away from dealerships during the pandemic does have longer-term implications
that will need to be considered. Potentially more concerning for auto lenders is uncertainty around long-
term vehicle ownership trends posed by the gig economy and less miles being traveled for in-store
shopping and work commutes, which, according to KPMG’s Automotive’s New Reality report,
accounted for 40% of the 3 trillion annual miles that Americans logged in 2019. KPMG estimates that
changes in driving habits from COVID-19 alone could lead to a drop of up to 10% of annual vehicle
miles driven. It seems unlikely that vehicle ownership levels will drop materially over the next decade,
particularly as people have dispersed from urban centers to suburban and rural areas, but small
reductions in growth rates can have profound implications on long-term returns. Compared to other
segments of consumer finance, auto lenders also face relatively higher regulatory risk from the new
administration, which includes potential subjection of auto loans to maximum terms and ability to repay
underwriting standards. We do not believe pawn lenders will be immediate targets for the new
administration, but changes to policy designed to bring underbanked and unbanked consumers back
into the lower-cost, regulated financial system poses some risk (as it does for all nonbank lenders).
Following a decade of consolidation that has left a smaller number of platforms controlling the
mainstream market, the debt collection industry is less exposed to secular risks posed by the
digital/online evolution. On the other hand, an emboldened Consumer Financial Protection Bureau
(CFPB) under the new administration, which plans to nominate Rohit Chopra as its director, will
undoubtedly reintroduce regulatory risks across the consumer finance landscape that had become less
relevant during the previous administration.
Commercial finance sits in the most enviable position, as the regulatory environment will likely remain
supportive and competition, for the most part, has been more focused on cost of capital than on
redesigning origination channels or business models (the exception perhaps being in the tech-enabled,
small business-focused segment of the market). Nevertheless, unprecedented capital formation in the
private markets and an overcapitalized bank sector searching for yield in an even lower interest rate
environment will continue to pressure the space to build scale and drive funding efficiencies, or
concentrate on niche segments of the market that require unique underwriting expertise and/or well-
established relationships.

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2020 Specialty Finance Strategic Activity
There was a significant amount of strategic activity across specialty finance during 2020, led by a robust
start and then a remarkable comeback in the second half of the year. Nonbank mortgage companies
drove an outsized share of the transactions in light of the origination environment, but we also saw some
much needed cleanup of subscale public companies in the mix. We expect “cleanup” consolidation to
be a meaningful contributor to M&A in the years to come, as the number of sub-$500 million market cap
public companies in specialty finance has proliferated post-crisis. These businesses are not large
enough to enjoy the benefits of being public, but still bear the cost of maintaining a public company
infrastructure. We do not suggest that all sub-$500 million market cap companies need to imminently
sell, but they all need a credible near-term plan to get above that threshold that is scrutinized and agreed
at the board level, which must consider transformative M&A. Assuming markets remain resilient, we
expect most sectors within specialty finance will be active during 2021 in response to the pressures set
forth at the beginning of this report, a robust equity market supporting new issue activity, and a special
purpose acquisition company (SPAC) universe with limited time horizons to deploy an unprecedented
amount of dry powder.
On the following pages, we summarize notable strategic activity during 2020, split amongst initial public
offerings (Table 1), SPAC mergers (Table 2), and (controlling stake) mergers and acquisitions (Table 3).
Shortly before publishing this report, we saw a number of marquee transactions at the beginning of
2021. On January 6, Affirm Holdings, Inc. (NASDAQ:AFRM) launched its long anticipated IPO, ultimately
pricing above its target range in a deal that valued the lender at $11.9 billion, or nearly 20x trailing
revenue for the twelve months ended September 30, 2020; Affirm has yet to turn a profit and lost $97
million on $596 million of revenue during that same twelve month period. In demonstration of investor
enthusiasm for the model, Affirm’s shares doubled on their first day of trading. The day after Affirm
launched its IPO, on January 7, Social Finance, Inc. (SoFi) announced its plans to merge with Chamath
Palihapitiya-backed Social Capital Hedosophia Holdings Corp. V, a SPAC whose founder also struck
deals with Virgin Galactic Holdings Inc. (NYSE:SPCE) in 2019 and Opendoor Technologies Inc.
(NASDAQ:OPEN) in October 2020. The transaction values SoFi, who has not turned a profit and expects
to lose $238 million on $980 million of revenue in 2021, at $8.7 billion, representing a 21x multiple of
2024 projected net income of $406 million and a 14x multiple of 2025 projected net income of $635
million (or approximately 14x 2020 expected revenue, for comparison with the Affirm transaction). These
transactions demonstrate investor willingness to supply capital to technology forward financial services
competitors with the implicit bet that these investments will help build future industry titans.

PIPER SANDLER | 15
Table 1: 2020 Specialty Finance Initial Public Offerings

Source: Company Filings, S&P Global Market Intelligence. Forward estimates based on equity research consensus estimates at time of offering.
(1) Based on midpoint of estimated book value range at December 31, 2019 provided in S-1 pro forma for initial public offering including overallotment.
(2) Based on midpoint of estimated book value range at September 30, 2020 provided in S-1 pro forma for initial public offering (overallotment not exercised).

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Table 2: 2020 Specialty Finance SPAC Mergers

Source: Company Filings, S&P Global Market Intelligence.

(1) Assumes no SPAC shareholder has exercised its redemption rights to receive cash from the trust account.
The cash amount to selling shareholders will be reduced by the amount of cash used to satisfy any redemptions.
(2) Assumes nominal share price of $10.00 per share. Excludes impact of earn-out to selling shareholders.

PIPER SANDLER | 17
Table 3: 2020 Specialty Finance Mergers & Acquisitions

Buyer / Spec. Fin. Date Deal Value Buyer Stock

Target Subsector Announced ($ Millions) P / TBV P/E Performance

Rent-A-Center /
Consumer 12/20/20 $1,653 ‒ ‒ 8.7%
Acima Credit

Apollo/Blackstone/Nelnet /
Consumer 12/18/20 ‒ ‒ ‒ ‒
WF Student Loan Portfolio

Ready Capital Corp. /

Mortgage 12/07/20 292 1.0x ‒ (9.8%)
Anworth Mortgage

Solar Capital /
Commercial 11/03/20 216 ‒ 10.8x 9.8%
Kingsbridge Holdings

Alliance Data Systems /

Consumer 10/28/20 450 ‒ ‒ 64.5%
Bread (Lon Operations)

Pretium Partners/Ares /
Mortgage 10/19/20 960 3.2x ‒ ‒
Front Yard Resi. Corp.

Gallatin Point Capital /

Consumer 10/12/20 ‒ ‒ ‒ ‒
First Investors Financial

Western Alliance Bancorp. /

Mortgage 10/09/20 ‒ ‒ ‒ 60.9%
Galton Funding

American Express /
Commercial 08/17/20 ‒ ‒ ‒ 20.4%
Kabbage

Enova International /
Commercial 07/28/20 90 0.4x 26.5x 80.8%
On Deck

Triumph Bancorp /
Commercial 07/08/20 132 ‒ ‒ 119.5%
Transp. Factoring Assets

Zip Co /
Consumer 06/02/20 343 ‒ ‒ 41.1%
QuadPay

Jefferson Capital Systems /

Consumer 03/10/20 ‒ ‒ ‒ ‒
Canaccede Financial

Regions Financial Corp. /

Commercial 02/27/20 ‒ ‒ ‒ 10.6%
Ascentium Capital

LendingClub Corp. /
Consumer 02/18/20 188 1.7x 28.6x (19.8%)
Radius Bancorp

Average $480 1.6x 22.0x 35.2%

Median $292 1.3x 26.5x 20.4%

Source: Company Filings, Press Releases, S&P Global Market Intelligence. Includes reported specialty finance controlling stake acquisitions. Transactions sorted
by date of announcement. Valuation metrics reflect announced metrics as reported by buyer or as estimated by S&P Global Market Intelligence. Buyer stock
performance reflects change in buyer’s stock price from the date one day prior to announcement through December 31, 2020.

PIPER SANDLER | 18
Strategic Trends Impacting Financial Services Broadly
The broader financial services sector faces many of the same threats posed to specialty finance
companies, as interest rates continue to fall and the market further adapts to a growing digital economy.
In response, we have observed increasing strategic alignment across financial services verticals.
Despite the uncertainty introduced by COVID-19, we saw banks expanding into asset management in
search of enhanced customer relationships and fee streams to improve return on equity (ROE), and
asset managers partnering with life insurance companies to mutually address needs for assets under
management (AUM) growth and unique capital deployment opportunities. Moreover, the entire sector
continues to strategically invest in financial technology to enhance operating leverage, compete in
evolving distribution ecosystems and improve the customer experience. One trend we concede has
moved in the opposite direction is the relationship between banks and insurance companies, as banks
have been shedding legacy insurance operations, while insurance companies have likewise withdrawn
from pre-crisis banking ambitions. While specialty finance has generally carved its niche outside the
regulated financial system, we believe we will see more convergence there as banks, asset managers
and insurance companies alike search for asset manufacturers to expand their customer base and/or
contend with a lower for longer interest rate environment that, despite credible speculation of future
inflation, has yet to materialize in over a decade.
Despite a collapse in global mergers and acquisitions during the first half of the year, 2020 produced a
surprising number of large, strategic transactions across the financial services landscape. While the year
brought several intra-vertical scale trades, the variety of cross sector transactions was also striking. This
provides further evidence of the struggle the financial services sector continues to endure as investors
demand sustainable ROEs in excess of levered returns achievable from the traditional financial products.
Meanwhile, customers are doing business differently and technology continues to upend the supply
chain of finance. These trends have forced a strategic rethinking of business models across the entire
financial services ecosystem and the specialty finance sector would do well to observe how others are
competing and which ones are outperforming.

Table 4 outlines the largest announced transactions that occurred across the financial services sector
during 2020. Following the table, we examine some high level trends and drivers within each sector to
contextualize the implications that bank, asset management and insurance M&A strategies have on
specialty finance companies.

PIPER SANDLER | 19
Table 4: Largest Announced Financial Services Transactions of 2020
Buyer / Date Deal Value Buyer Stock
Target Subsector Announced ($ Millions) P / TBV P/E Performance

Morgan Stanley /
Asset Mgmt. 02/20/20 $13,127 ‒ 14.9x 21.7%
E*TRADE

PNC Financial /
Banks 11/16/20 11,567 1.3x ‒ 21.4%
BBVA USA

Morgan Stanley /
Asset Mgmt. 10/08/20 6,932 ‒ 16.2x 40.7%
Eaton Vance

Huntington Bancshares /
Banks 12/13/20 5,925 1.5x 11.8x (2.3%)
TCF Financial

Franklin Resources /
Asset Mgmt. 02/18/20 4,481 ‒ 12.0x 2.6%
Legg Mason

KKR & Co. /

Insurance 07/08/20 4,039 1.0x 6.7x 31.5%
Global Atlantic

Zurich Insurance Group /

Insurance 12/11/20 3,940 1.9x 11.3x 2.1%
Metropolitan P&C

Allstate /
Insurance 07/07/20 3,727 2.1x 10.3x 14.9%
National General

South State Corporation /

Banks 01/27/20 3,212 2.0x 13.7x (15.5%)
CenterState Bank Corp.

Great-West Lifeco /
Insurance 09/08/20 2,350 ‒ ‒ 17.8%
Mass Mutual Retirement

First Citizens BancShares /

Banks 10/16/20 2,159 0.4x 9.5x 62.5%
CIT Group

MetLife /
Insurance 09/17/20 1,675 ‒ ‒ 24.8%
Versant Health

Rent-A-Center /
Spec. Finance 12/20/20 1,653 ‒ ‒ 8.7%
Acima Credit

Macquarie Group /
Asset Mgmt. 12/02/20 1,563 2.6x 16.8x (1.2%)
Waddell & Reed

BlackRock /
Asset Mgmt. 11/23/20 1,050 ‒ ‒ 7.3%
Aperio Group

Pacific Premier Bancorp /

Banks 02/03/20 1,031 1.4x 14.7x 5.1%
Opus Bank

Great-West Lifeco /
Asset Mgmt. 06/29/20 1,000 ‒ ‒ 30.4%
Personal Capital Corp.

Third Point Reinsurance /

Insurance 08/06/20 788 0.8x ‒ 16.8%
Sirius International Group

ProAssurance Corp. /
Insurance 02/20/20 600 1.1x ‒ (45.7%)
NORCAL Mutual Insurance

FB Financial Corp. /
Banks 01/21/20 588 1.5x 13.8x (10.5%)
Franklin Financial Network

Average $3,570 1.5x 12.6x 11.7%

Median $2,254 1.4x 12.9x 11.8%

Source: Company Filings, S&P Global Market Intelligence. Includes 20 largest bank, insurance asset management, and specialty finance transactions announced
in 2020. Transactions sorted by deal value. Valuation metrics reflect announced metrics as reported by buyer or as estimated by S&P Global Market Intelligence.
Buyer stock performance reflects change in buyer’s stock price from the date one day prior to announcement through December 31, 2020.

PIPER SANDLER | 20
Banks
Prior to the financial crisis, higher interest rates, lower capital requirements, and an accommodative
regulatory environment allowed banks to dominate lending and generate lucrative returns doing so.
Figure 3 highlights the gravity of the impact that lower interest rates, higher capital requirements and
regulatory imposed limits on certain lending and proprietary investing activities has had on bank ROEs.
Punitive regulatory backlash and fear of headline risk has also moved some historically lucrative
businesses, like residential mortgage and subprime lending, further out of the banking system. With an
interest rate and leverage environment that make it difficult to generate adequate returns, many banks
are recalibrating their models towards wealth management and specialty lending, although most remain
wary of material goodwill creation in executing M&A strategies. Separately, scale has become ever more
important and we expect continued bank-to-bank mergers to address the massive technology
investments required across the sector in the decade to come. Low rates are a big part of the challenge,
but as more commerce shifts online and customers move away from branch footprints in preference for
digital ecosystems, banks will be forced to deploy shrinking resources towards technology development
and maintenance. Other changes, including the recent pronouncement from the Office of the
Comptroller of the Currency (OCC) that federally regulated banks can use “stablecoins” to conduct
payments and other activities, set the groundwork for continued innovation in the use of digital
currencies. Despite general reluctance amongst the banking community, digital currencies will force
them to invest the time and resources necessary to understand the operational, compliance and fraud
risks associated with these activities while developing ways to evolve with the technology. While not
doing so poses limited competitive challenges in the immediate term, the inevitable existential threat to
the business over the coming decade makes it a critical but challenging priority to address.

Figure 3: Capital Requirements and Declining Rates Pressure Bank ROEs Post-Crisis

20.0% 10.0%

15.0% 7.5%

10.0% 5.0%

5.0% 2.5%

– –

ROATCE (Left) TCE / TA (Right) Avg. 10Y UST (Right)

Source: S&P Global Market Intelligence. Data presented on an annual basis except for 2020 which is presented for the nine months ended September 30, 2020.
Reflects all U.S. commercial banks based on aggregate call report data. ROATCE (left hand axis) is return on tangible common equity. TCE / TA (right hand axis)
is the ratio of tangible common equity to tangible assets.

PIPER SANDLER | 21
Bank appetite in specialty finance has varied across the landscape. Post-crisis engagement around
consumer finance has been mostly concentrated in the residential mortgage sector with strategies
geared towards prime borrowers. As it relates to bank M&A appetite with respect to subprime
borrowers, the market’s reaction to Ally Financial Inc.’s (NYSE:ALLY) announced acquisition of subprime
credit card lender CardWorks, Inc., a transaction that was ultimately terminated, summed it up as Ally’s
shares fell nearly 12% the day of announcement and wiped off $1.4 billion from Ally’s market
capitalization (versus the $2.65 billion reported deal value). The negative reaction to the subprime
orientation of the deal was a bit surprising, although the meaningful book value dilution resulting from
the transaction, approximately half of which was to be paid in new stock issued below book value, made
the deal difficult to swallow. While loss rates at the subprime end of the credit spectrum are certainly
large and volatile, the excess spread generated provides strong margin for error, as Capital One
Financial Corporation (NYSE:COF) figured out decades ago. For context, Merrick Bank, CardWorks’
bank subsidiary that funds the vast majority of its subprime credit card assets, generated positive
aggregate net income across 2008 and 2009. We believe bank appetite in consumer finance could
evolve in the future, as politicians grapple with how to get under and unbanked consumers back into
the regulated financial system. We have already seen some evidence of that in recent history, including
Green Dot Corporation’s (NYSE:GDOT) launch of GO2bank, a mobile bank designed to help Americans
living paycheck to paycheck, and the Venmo credit card launched through Synchrony Bank, which we
discuss further in this report. However, we would be surprised to see any large strategic activity from
banks at the subprime end of the spectrum in 2021, with most bank strategies geared towards prime
and near-prime borrowers. We do believe many banks with smaller footprints in residential mortgage
will seriously evaluate that strategy as a way to grow fee income and take advantage of pent up home
buying demand, particularly given much of it is from first time homebuyers that represent potentially
attractive long-term customers when captured early in their financial lives.
Bank sentiment in commercial finance has been significantly different than the consumer end of the
spectrum, as they push to regain ground ceded post-crisis to nonbank lenders. While much of this
competition has been pursued organically, equipment finance companies have enjoyed particularly
strong bank M&A appetite post-crisis. 2020 saw yet another large transaction in the space with Regions
Financial Corporation’s (NYSE:RF) acquisition of Ascentium Capital, which had an approximately $2
billion portfolio. Despite the funding logic of these combinations, a vibrant securitization market has
offered a reasonable debt alternative to deposits and the lack of regulatory restrictions make operating
outside the banking system an acceptable, and oftentimes better, option. Nevertheless, we expect
banks to continue to be active acquirers in the commercial segment of the market, particularly for niche
lenders where there are opportunities to provide other complimentary products, as even lower interest
rates than we started 2020 off with and increased capital levels from suspended buybacks compel
further activity.

Insurance
While the P&C segment of the insurance sector has fared better post-crisis than its life insurance
brethren, whose profits are more dependent on interest rate sensitive investment portfolio returns than
pricing and underwriting performance, the segment has not been immune to the challenges of the post-
crisis environment. Mounting pressure to increase capital and operational efficiency in a soft pricing (i.e.,
insurance premiums are relatively low) and low interest rate environment has encouraged consolidation
among larger P&C insurers. The need to increase capabilities, scale and footprint spurred a number of
transactions across the sector, including several megadeals (i.e., transactions over $1.0 billion), as
insurers turned to inorganic growth strategies to compete. The sector has made notable plays in the

PIPER SANDLER | 22
“InsurTech” space in search of digital platforms and new underwriting capabilities, but has otherwise
stayed largely within its insurance lane rather than exploring other parts of the financial services
ecosystem for strategic growth.
P&C insurance mergers slowed materially in 2020 as uncertainties created by the COVID-19 pandemic
forced many companies to focus on capital preservation and organic growth. Deal activity was virtually
nonexistent during the second quarter, but began to rebound in the second half of the year beginning,
most notably, with the announcement of The Allstate Corporation’s (NYSE:ALL) $3.7 billion acquisition
of National General Holdings Corporation (NASDAQ:NGHC) in July. Through the first eleven months of
the year, this marked the only deal in the sector in excess of $1 billion. In December, MetLife, Inc.
(NYSE:MET) announced that it is selling its P&C business (Metropolitan Property and Casualty Insurance
Company) to Farmers Group, Inc., a subsidiary of Zurich Insurance Group (SWX:ZURN), for $3.9 billion.
The sale follows a broader industry trend of insurers separating their P&C and life insurance businesses.
In October, AIG announced that they also intend to split their P&C operations from their life and
retirement operations. We expect M&A activity to continue into 2021 as the pandemic and related fallout
create new urgency for inorganic strategies to help restore profitability.
The life insurance industry experienced a similar pullback in deal activity through the first half of the
year, but acquisitions and divestitures are coming back strongly as insurers become resigned to a lower
for longer interest rate environment. Driven by the economic repercussions of the pandemic, we expect
sustained pressure on the sector to continue to fuel deal activity in 2021 as insurance companies shift
their focus to de-risked core strategies. As the recovery unfolds, life insurers are now assessing the
implications of an economic environment with even lower interest rates and increased asset volatility,
and are evaluating how to position their portfolios and their businesses to deliver the greatest returns.
Prior to the onset of the pandemic, insurers were already grappling with compressed yields and
diminished returns driven by the interest rate and regulatory landscape. While strong demographic-
driven demand for fixed annuities has provided stability to the right side of the balance sheet, a lack of
places to lucratively deploy the capital has constrained profitability. This dynamic has laid the foundation
for unique marriages between life insurance companies and alternative asset managers, and 2020
ushered in another wave of acquisitions and strategic investments between the two sectors. These
partnerships are largely driven by a mutual desire for AUM growth and access to accretive capital
deployment opportunities. The timing of new capital entering the space has been fortuitous allowing
many existing life insurance companies to shed legacy blocks of business in an attempt to refocus
operations. While the valuation arbitrage between asset managers (high teens to low twenties earnings
multiples) and life insurance companies (mid to high single digit earnings multiples) has typically led the
former to be the acquiror, there are instances of the opposite, such as Sun Life Financial Inc.’s (TSX:SLF)
acquisition of a 51% interest in Crescent Capital Group in October. We discuss the evolving partnerships
between asset managers and life insurers beginning on page 24.
As it pertains to specialty finance, the life insurance segment tends to have a more stated impact on the
sector than the P&C insurance segment. As the perfect owner for many of the financial assets specialty
finance companies create, life insurers have been surprisingly quiet as M&A players. Rather, the sector
has played an indirect, albeit critical, financier role as a foundational owner of a large portion of the
asset-backed securities issued across asset classes. That said, there are a number of instances of
specialty finance companies having controlling ownership by life insurance companies, such as Athene
Holding Ltd.’s (NYSE:ATH) ownership of correspondent mortgage lender AmeriHome Mortgage
Company and commercial lender MidCap Financial, or Security Benefit Corporation’s ownership of
commercial lender Stonebriar Commercial Finance. As an alternative to direct platform ownership, many

PIPER SANDLER | 23
have opted for exposure through partnerships with alternative asset managers. While we expect this
indirect involvement to continue, the opportunity for scaled life insurance companies to eliminate the
margin of a middleman or loan acquisition premiums paid to originators by directly owning a platform is
worthy of consideration. This strategy has been more evident in the private credit sector, with the
aforementioned Sun Life acquisition of Crescent Capital this year, and then New York Life Insurance
Company and Massachusetts Mutual Life Insurance Company’s ownership of Madison Capital Funding
and Barings, respectively, both leading heavyweights in the middle-market credit space.

Asset Management
Despite share prices sitting at all-time highs, a stock market that has mostly gone up over the last
decade, and an abundant supply of capital to manage, asset management firms face a variety of
existential threats to their businesses as fees compress across the board, baby boomers retire and
become spenders rather than savers, and distribution channels evolve. As a result, 2020 saw a number
of large, scale-driven strategic combinations in the space. Perhaps more notably, the sector also saw
more convergence transactions than any other, including Morgan Stanley’s (NYSE:MS) back-to-back
acquisitions of E*TRADE Financial Corporation (NYSE:ETFC) and Eaton Vance Corp. (NYSE:EV), KKR &
Co. Inc.’s (NYSE:KKR) acquisition of Global Atlantic Financial Group, and American Equity Investment
Life Insurance Company’s partnerships with Brookfield Asset Management Inc. (TSX:BAM.A) and
Pretium Partners.
Specialty finance has long played an integral role within the asset management sector. Many specialty
finance companies such as business development companies (BDCs) and mREITs are in fact fee-paying
managed investment vehicles. Several managers, such as Pretium Partners in their acquisitions of
Deephaven Mortgage and Selene Holdings, or Angel Oak Capital Advisors in its ownership of the largest
non-qualified mortgage originator in the United States, have gone a step further and built and/or
acquired operating platforms to provide differentiated investment offerings to limited partners (LPs),
promising better or more stable returns through a more vertically integrated strategy. We expect this
trend to continue, particularly for newer managers that are vying for shelf space with larger, well known
institutions that have longer track records. Similarly, we expect more asset management M&A in the
mREIT and BDC spaces since public company management contracts remain in high demand as new
IPOs become more difficult to complete amidst an abundance of supply at the same time that managers
are continuing their quest for permanent capital, which is more highly rewarded by investors.

Evolving Partnerships Between Life Insurers and Asset Managers

Life insurance has caught a new flare post-crisis, despite a historically staid reputation. On the funding
side, demographic-driven demand for retirement products such as fixed income annuities continues to
attract more capital to a global insurance industry that already has over $30 trillion in total assets.
However, on the investment side, plain vanilla strategies don’t work in the current interest rate
environment so a prudent plan to produce returns has to contemplate increasing allocations to
alternatives and strategies across the portfolio that generate alpha. The resulting impact has been a
reimagined relationship between asset managers and life insurers, with the former managing the left
side of the balance sheet and the latter managing the right. No one was earlier to see this opportunity
than Apollo Global Management, Inc. (NYSE:APO), which founded Athene in partnership with current
chief executive officer Jim Belardi in 2009 and now directly owns approximately 35% of the insurer,
including related parties and employees (Athene in turn owns an approximately 7% stake in Apollo). In
addition, Athene represents just over 40% of Apollo’s total AUM, further demonstrating the strategic

PIPER SANDLER | 24
value embedded within the relationship. Figure 4 provides a summary of specific partnerships between
asset managers and life insurers.

Figure 4: Notable Partnerships Between Asset Management and Insurance Companies

Increased general account allocations to alternatives isn’t the only envy of the alternative asset
management world, and certainly weren’t the driving force for strategic transactions such as KKR’s
recently announced acquisition of Global Atlantic. Asset managers are competing fiercely for capital
from LPs at the same time they are trying to expand into new strategies for growth. An insurance
company balance sheet is effectively a one-stop shop, with pockets for every part of the capital structure
and an ability for managers to be more relevant in a wider variety of markets. This has a multiplier effect,
as it increases AUM at the same time it increases the overall investable universe. In addition to these
strategic underpinnings, the wide valuation disparity between alternative asset managers and life
insurers that we previously noted has helped facilitate deal making. Figure 5 outlines high level
characteristics of the asset and liability structure of Athene, which illustrates the diverse types of capital
that life insurers are able to leverage in fulfilling their investment ambitions.

PIPER SANDLER | 25
Figure 5: Athene Portfolio Composition and Characteristics

3%
Corporate & Gov't
2%
Comm Mortgages 5%

Resi MBS/Mortgages 5%
Net Invested Assets $143B
CLO 7%
49%
Portfolio Yield (1) 4.22%
ABS
9%
Liability Funding $137B
Alternatives
CMBS 9% Cost of Funds (2) 2.81%
Cash & Equivalents 11%
Other

Source: Company Filings. Financial data as of September 30, 2020.

(1) Reflects reported total net investment earned rate, including alternative investments, for the three months ended September 30, 2020.
(2) Reflects reported cost of funds for the three months ended September 30, 2020.

What relevance does this have to specialty finance company executives and boards, the intended target
of this report? The creativity. Alternative asset managers expanded into life insurance not because of a
fundamental view that the space was undervalued, but rather, because they reimagined it as a way to
raise money and increase the overall investable universe that they supply capital to. While we
commented earlier in this report on the surprising lack of M&A activity amongst insurance companies in
the specialty finance sector, we are similarly surprised at the lack of effort on behalf of specialty finance
companies to acquire non-captive insurance subsidiaries which could serve as strategic funding
vehicles and offer other potential benefits such as Federal Home Loan Bank funding access. Given the
continually shifting landscape and yet another interest rate reset down during 2020, we expect
seemingly far out ideas like this to gain attention in a year where capital structure becomes a more
strategically managed aspect of the business. As evidenced in the next section of this report, specialty
finance has already availed itself in another key market as specialty lenders seek to regain access to the
regulated banking sector.

Nonbanks Pursuing Bank Charters

After almost a decade of inactivity following the financial crisis, the arrival of the Trump Administration
brought a renewed enthusiasm, focus and wave of activity around FDIC-insured industrial loan
companies (ILCs) and other special purpose banking charters, including a new “FinTech” charter for
financial technology companies from the OCC. While the Dodd Frank-imposed moratorium on ILC
activity for “commercial firms” (i.e., nonbanks) technically expired in 2013, there was little to no optimism
for a successful application or acquisition in the world of heightened post-crisis regulation that persisted
prior to Trump’s election victory in late 2016.
However, when Trump came into office the OCC was not yet ready to accept FinTech charter
applications, so the immediate response between 2017 and 2019 was a roller coaster of ILC applications
and withdrawals and refiling. SoFi and Square Inc. (NYSE:SQ) were the first to apply in 2017 but
withdrew within six months. The OCC finally opened the door for FinTech charter applications in mid-

PIPER SANDLER | 26
2018, and while the charter does provide a parent company exemption from the Bank Holding Company
Act, it does not offer the highly sought after deposit gathering capabilities afforded by an ILC charter,
nor does it provide a reprieve from the more stringent oversight synonymous with the OCC itself. Not
surprisingly, both charters continue to receive stiff opposition from the traditional bank lobby which has
been fighting against ILCs for decades and helped instigate the initial 2006-2008 ILC moratorium that
was parlayed into part of the Dodd-Frank Act.
Early in 2020, the FDIC announced its intentions to formalize the ILC approval process, a move aimed
at returning the charter to viability, which provided tailwinds to events over the balance of the year. In
March, the FDIC approved Square and Nelnet, Inc.’s (NYSE:NNI) ILC applications, marking the first such
approvals since the 2006-2008 moratorium was instituted. In December, the FDIC approved a final rule
formalizing its ILC approval process, opening the door for future applications.
Square is preparing to launch its ILC, Square Financial Services, in 2021. Deposit gathering and deposit-
funded lending capabilities should greatly increase Square’s competitiveness across both its “Seller”
merchant acquiring and “Cash App” consumer finance and payments segments. Square already
competes with banks such as Bank of America Corporation (NYSE:BAC), Citigroup Inc. (NYSE:C), and
JPMorgan Chase & Co. (NYSE:JPM) in its Seller segment and its Cash App is already a quasi-deposit
gathering platform. The charter will also open a path for Square to transform into a diversified banking
franchise over time and differentiate itself from nonbank competition. Whereas nonbank payments
competitor PayPal Holdings, Inc. (NASDAQ:PYPL) had to partner and share economics with Synchrony
Financial (NYSE:SYF) to launch its Venmo Credit Card, Square will be able to issue its own Cash App
credit card and maintain full control over economics.
In a somewhat surprising approach, in October 2020 SoFi leapfrogged the ILC and FinTech charters
and received conditional approval from the OCC to form a full service national bank. For SoFi, this not
only leveled the playing field with direct student lending competitors SLM Corporation (NASDAQ:SLM),
the owner of long-standing ILC Sallie Mae Bank, and the aforementioned Nelnet, which took a similar
step as Sallie Mae when it opened its ILC subsidiary, Nelnet Bank, in November 2020, but will also
provide the same diversified banking capabilities and allow SoFi to compete more holistically with the
likes of Ally, American Express Company (NYSE:AXP), Capital One, Discover Financial Services
(NYSE:DFS), Marcus by Goldman Sachs Group, Inc. (NYSE:GS) and other consumer-oriented banking
franchises. A similar approach was taken by Oportun Financial Corporation (NASDAQ:OPRT), an
unsecured consumer lender, which applied for a full service national charter with the OCC in November
2020.
Similarly, specialty lender LendingClub Corporation (NYSE:LC), which had been evaluating a potential
charter application, announced its pending acquisition of Radius Bancorp, Inc. in February 2020. Radius
is a Boston-based bank operating a digital, “branch-lite” online lending and deposit gathering model
that made it uniquely positioned as a target for a nonbank. LendingClub estimated a 220 basis point
reduction in its cost of funds when it announced the transaction, but its stock traded roughly flat on the
day of announcement as synergistic optimism was mixed with skepticism around its ability to secure
regulatory approval. When LendingClub announced that it had received regulatory approval in January
2021, its stock traded up almost 15% on the day. While the fit, synergies and potential valuation
tailwinds are obvious, there are few non-ILC bank targets like Radius and this marked the first-ever
nonbank FinTech acquisition of a bank. As such, future activity is expected to center around de novo
chartering, with an outright ILC acquisition unlikely given the value and economics of the charters to
their existing owners.

PIPER SANDLER | 27
In terms of other notable chartering activity, 2020 brought pending ILC applications for two more
traditional specialty finance companies: GreatAmerica Financial Services and GM Financial Co. Inc.
GreatAmerica is a leading independent small ticket equipment lessor with a successful track record
operating through the financial crisis and funding in the securitization markets, but still a firm that will
benefit from the permanence and marginal cost benefit of deposit funding. GM Financial is General
Motor’s (NYSE:GM) captive finance company that emanated from GM’s 2010 acquisition of AmeriCredit
Corp. The proposed GM Financial Bank is a natural parlay off precedent automobile manufacturer-
backed ILCs BMW Bank of North America and Toyota Financial Savings Bank.
In our view, GreatAmerica and GM Financial are arguably as well positioned as any finance company
could be in terms of successfully securing FDIC approval. In addition to its performance track record,
GreatAmerica at its core offers a leasing product that supports small business growth and that is
primarily offered by large and select regional banks versus the broad universe of community banks.
Similarly, GM Financial offers a product that allows consumers to buy or lease vehicles from one of the
few remaining U.S. manufacturers and that is less of a competitive threat to the community bank lobby,
and which also has the aforementioned ILC precedents.
Chartering activity should continue as a key theme into 2021 and beyond and center around consumer-
and FinTech-oriented businesses that now have a clearer path to the type of success already enjoyed
by SoFi, Square and Nelnet. We also expect other commercial finance companies, like GreatAmerica,
that serve customers and provide products that fit within the regulated financial services universe to
seriously evaluate the pros and cons of applying for, and conducting business with, a banking charter.

PIPER SANDLER | 28
Figure 6: 2020 Total Return Performance Across Financial Services Sectors

Asset
Banks Insurance Management Specialty Finance S&P 500

39.9%

21.6%
19.7%
18.4%
13.9%

1.8%

(1.7%)
(4.1%) (5.3%)
(8.3%)

(13.2%)

(26.2%)

SNL U.S. SNL U.S. SNL U.S. Alternative Traditional Alternative Credit Card Student Nonbank Residential S&P 500 S&P 500
Bank & Insurance Insurance Manager Manager Consumer Average Lending Mortgage mREIT Financials
Thrift Index L&H Index P&C Index Average Average Average Average Average Average

Source: S&P Global Market Intelligence. Market data for December 31, 2019, through December 31, 2020. Alternative asset managers include APO, ARES, BX, CG, and KKR. Traditional asset managers include AMG,
AMP, BLK, CNS, AB, BEN, IVZ, JHG, SEIC, and TROW. Alternative consumer lending index includes auto finance (ALLY, CACC, SC), debt collection (ECPG, PRAA), installment lenders (OMF, OPRT, RM, WRLD), pawn
lenders (FCFS, EZPW), and other digital consumer lenders (ELVT, ENVA, GSKY, LC). Credit cards include ADS, AXP, COF, DFS, and SYF. Student lending includes NAVI, NNI, and SLM. Nonbank mortgage companies
include COOP, GHLD (since initial public offering), OCN, PFSI, RKT (since initial public offering), and VEL (since initial public offering).
Part II

Consumer Finance Review

Introduction
CECL implementation, fast-moving digital transformation and the outcome of the U.S. presidential
election were top of mind for the consumer finance sector as we entered 2020. By the end of the first
quarter, however, COVID-19 had filled the entire priority list as companies across the landscape quickly
shifted to a work from home environment while striving to protect both the left and right sides of the
balance sheet.
The U.S. consumer was disparately impacted by COVID-19, with many surprisingly ending up net
beneficiaries from the fiscal and monetary reactions to the virus-induced economic slowdown while
others have borne the brunt of the quickest increase in unemployment in the United States since the
Great Depression (for perspective the economy shed a net 9.37 million jobs, nearly double the 5.05
million jobs lost in 2009). White collar employees largely maintained strong levels of job stability and
settled into new lifestyles, driving a suburban sprawl that had elsewise been on a two-decade decline.
On the other hand, the service sector economy, which directly provides approximately 27 million jobs,
representing 20% of the total workforce, was disproportionately impacted by the shutdown in bars,
restaurants and other in-person entertainment venues. The latest wave of infections has only elongated
the pain inflicted by these curtailments.
Unprecedented government stimulus helped fill the cash hole for the newly unemployed, and created a
cash buttress for many of those that retained their jobs but still received stimulus checks, allowing the
consumer broadly to keep current on its bills, and in fact pay down debt, bucking the age-old correlation
between delinquency and unemployment (for now). Despite this strong performance, the Federal
Reserve Bank of New York’s Survey of Consumer Expectations Credit Access released in December
demonstrates some stark realities facing the entire space:

 Reported application rates for any kind of credit over the past 12 months dropped 11 percentage
points (or 24%) over the course of 2020, slipping from 45.6% in February to 34.6% in October,
a new series low. The decline was broad-based across credit score and age groups, but largest
for those with credit scores below 760 and those aged 60 or older. Overall, the average 2020
application rate of 39.8% was well below the 2019 average of 45.8%.

 Reported rejection rates among applicants increased by 3.8 percentage points (or 27%) during
2020 from 14.2% in February to 18.0% in October. The increase was largest for respondents
with scores under 680, consistent with a general tightening of lending standards since February.
Overall, the average 2020 rejection rate of 15.7% was moderately below its 2019 level of 17.6%.
These findings, as reported by households, are consistent with the July and October 2020 results
of the Federal Reserve Board’s Loan Officer Opinion Survey on Bank Lending Practices,
revealing a tightening of lending standards on consumer loans.

 The share of respondents who were too discouraged to apply for credit over the past 12 months
(despite needing it) increased slightly, rising from 6.9% in February to 7.2% in October. The 2020
average of 7.0% was slightly above the 2019 average of 6.4%.
Asset owners came out ahead in 2020, as government stimulus and monetary support provided by the
Federal Reserve and other central banking authorities drove markets and asset values to all-time highs.
That helped drive consumer confidence at the higher end of the wealth spectrum, creating unexpected
pockets of spending growth across a variety of things including home improvement projects, at-home

PIPER SANDLER | 31
coffee products and even all-terrain vehicles. While the broader impact of these fiscal and monetary
stimulus programs will play out over a longer period of time, 2021 will undoubtedly provide helpful near-
term evidence of their success or failure as the global economy continues to contend with the latest
resurgence of the virus.

Top Themes of 2020

Return of Consumer-Focused, Tech-Enabled Lender IPOs

Rocket Companies, Inc. (NYSE:RKT), the parent of leading nonbank mortgage company Rocket
Mortgage, raised $1.8 billion in August, which was the first initial public offering of a consumer-focused,
tech-enabled lender since the May 2018 debut of GreenSky, Inc. (NASDAQ:GSKY). Former Google
engineer Dave Girouard-backed Upstart Holdings Inc. (NASDAQ:UPST), which provides consumer
installment loans based on alternative underwriting criteria and sells them to banks and other
counterparties, followed that up later in the year when it raised $240 million in its December debut. As
of December 31, 2020, Rocket’s shares were up 12% from their August debut and Upstart shares were
up a striking 101% in just two weeks since pricing their IPO in mid-December.
Affirm Holdings, Inc. (NASDAQ:AFRM) kicked off a continuation of the frenzy in 2021, ultimately pricing
its IPO approximately 30% above the high end of the launch range and then doubling on its first day of
trading. SoFi announced its SPAC merger a day after the launch of the Affirm IPO. Swedish company
Klarna, a “buy now, pay later” provider like Affirm, is also expected to evaluate the public markets in
2021, which is already shaping up to be the busiest year ever for transformative disrupters in financial
services.

Accelerated Technology Adoption: Digital Transformation and Alternative Underwriting

A decade of digital evolution was compressed into 2020, as borrower preference for seamless, online
applications and independent online research of alternatives prior to selecting a lender was only
accentuated. The cost competitiveness of digital strategies versus branch or store-based approaches
is undeniable, although up-front capital investments to get there does necessitate scale for adoption.
As evidenced by the Affirm and SoFi transactions, as well as general trading levels for online or tech-
enabled competitors versus traditional lenders, investors are willing to supply capital for these up front
investments if there is a credible path to long-term, sustainable revenue growth. The investment
community firmly recognizes the existential threat this digital revolution poses to traditional financial
services providers and is making its bets on who it believes the titans of the industry will be in the
decades to come, even if operating losses are required in the near-term to build the platforms necessary
to compete for those positions.
Additionally, static underwriting models continue to be replaced with more dynamic applications that
utilize machine learning and artificial intelligence to continuously enhance risk pricing and reduce
reliance on FICO. While the very factors that derive a FICO score play a significant role in alternative
underwriting decisions, it has statistically expanded the borrower base and, heretofore, credit
performance continues to support adoption (although this trend will be important to watch given the
benign credit environment we’ve been in for the last decade and the masking effect that recent
government stimulus efforts have had on consumer credit quality).

PIPER SANDLER | 32
Resilient Credit
Delinquency and charge off rates remain suppressed, with most asset classes seeing improved credit
quality during 2020 (mortgage forbearance being the exception, although home price appreciation in
2020 coupled with low loan to values going into the year make the likelihood of material losses remote).
Congress’s recent $900 billion fiscal stimulus package, which in addition to other benefits, includes a
$300 per week federal unemployment supplement and $600 direct payment for each adult and child in
households below certain income thresholds, will support consumer credit going into 2021. While credit
will remain uncertain in the near to medium term, we do not advise restraint in commitment to bold,
strategic priorities as the landscape continues to evolve, as over-caution may ultimately prove perilous.

Renewed Pursuit of Bank Charters

As previously highlighted in this report, the onset of the Trump administration emboldened FinTech and
specialty finance companies alike to rethink the viability and merits of pursuing bank charters. While the
new administration may change the amount of momentum seen in recent years, we believe there is
bipartisan interest in seeing the regulated financial system support all Americans, for which a large
portion presently fall within the confines of the under and unbanked. That could help the case for
additional chartering during the Biden administration.

Incoming Biden Administration

After a prosperous four years of regulatory pullback across the consumer finance sector, the incoming
Biden administration is expected to bring more scrutiny back amongst nonbank lenders (particularly
those with higher cost or lower dollar-denominated products). With COVID-19 likely to extend well into
2021 and consumers continuing to face an incredibly burdensome economic backdrop, a new regime
focused on consumer protection and an emboldened CFPB are grounds for some contingency planning
as lenders continue to refine their strategic plans. Equally concerning to watch for will be a potential
shift back into the regulated financial system of certain activities, effectively a reversal of a decade-long
trend that’s been in place since the financial crisis.

PIPER SANDLER | 33
Subsector: Credit Cards

Industry Overview
The U.S. credit card market is arguably one of the most consolidated and concentrated but also one of
the largest subsectors within specialty finance. According to data from the Nilson Report, the seven
largest issuers accounted for 78% of total purchase volume for U.S. credit cards in 2019, a level that
has remained consistent over the past decade. According to data from the FRBNY, U.S. consumer
credit card debt peaked at $866 billion in the fourth quarter of 2008 before falling 24% to a trough of
$659 billion in the first quarter of 2014 and then returning to pre-crisis levels in 2018 and 2019, reaching
a new peak of $927 billion in the fourth quarter of 2019.
That the absolute debt level is up only 7% over more than a decade is more of a function of the credit
excesses of the pre-crisis era and prudent household debt levels since than it is a reflection of underlying
fundamentals. Credit cards and the issuers themselves are becoming increasingly larger contributors to
the U.S. consumer payments ecosystem and digital economy, with credit card transactions totaling 44.4
billion in 2019, up almost 55% from 28.7 billion in 2014 according to data from the Nilson Report. For
comparison, FRBNY data indicates total credit card debt rose 32% from 2014 to 2019, reflecting a more
transactional and disciplined credit environment than what preceded the financial crisis.

Figure 7: U.S. Credit Card Landscape

Note: Intended to reflect representative, not comprehensive sampling of market participants.

Credit cards can generally be segmented into three product types: (i) general purpose cards, (ii) co-
brand cards, and (iii) private label cards. General purpose cards are usable anywhere in network (i.e.,
American Express, Discover, MasterCard, Visa) and, in recent times, generally offer some form of issuer-
specific cash back or rewards program (e.g., Chase Sapphire Preferred). Co-brand cards are general

PIPER SANDLER | 34
purpose cards in which an issuer partners with a third-party loyalty program to offer program-specific
rewards on a co-branded card (e.g., Chase Marriott Bonvoy Boundless Card by JPMorgan Chase).
Private label cards were traditionally only for use with a specific retailer or merchandiser that would
“white label” an issuer’s card platform as an affinity product for the retailer’s or merchandiser’s customer
base (e.g., Lowe’s Advantage Card issued by Synchrony Bank), but have evolved to also include hybrids
that are for use anywhere in the particular network (e.g., Verizon Visa issued by Synchrony Bank).
The large bank holding company issuers offer some form of one or more of these products to consumers
in the near-prime (credit scores between 620 and 659), prime (660-719) and super-prime (720 and
above) segments, with co-brand typically skewing higher on credit score, private label typically skewing
lower and general purpose spanning the spectrum. In addition, Alliance Data Systems (NYSE:ADS),
which has two ILC bank charters, and Synchrony, a savings and loan holding company for Synchrony
Bank, specialize in private label cards for these consumer segments. The subprime (credit scores
between 580 and 619) segment is served by Credit One Bank, a special purpose national credit card
bank owned by Sherman Financial Group; Merrick Bank, the ILC owned by CardWorks; and other
specialty finance companies such as Genesis Financial Solutions, Fortiva Financial LLC and Credit
Shop, Inc. that “rent a charter” from a small group of specialty issuing banks. Some lenders also serve
deep subprime (credit scores below 580) consumers on a more limited basis, including via secured card
products.

Figure 8: Credit Card Risk-Reward Profile

Source: Company Filings, S&P Global Market Intelligence. Financial data for the twelve months ended September 30, 2020.
Based on standardized regulatory data from bank-level call report filings. Data for multi-charter companies aggregated and presented at parent level.
CardWorks data reflects Merrick Bank. Figures may not sum due to rounding.

PIPER SANDLER | 35
2020 Review
2020 brought the long-anticipated implementation of CECL, but that wasn’t the only driver of increased
reserves as the COVID-19 pandemic spread to the U.S. before issuers were able to produce their initial
results. “Day one” CECL implementation on January 1, 2020 still drove the majority of reserve building
in the first quarter of 2020, but each of the pure play U.S. card issuers disclosed at least some degree
of additional reserve building as COVID-19 materialized later in the quarter.
While reserve levels effectively doubled in the first quarter, credit card delinquencies and net charge-
offs remained stable, and frankly benign, in March and into April and May. Beginning in June,
delinquencies and net charge-offs began an essentially constant decline through the rest of 2020 as
consumers benefited from a much needed elixir of issuer-provided deferrals and government-provided
stimulus, and issuers benefited from accelerated payment rates and reduced exposures. According to
data compiled by S&P Global Market Intelligence from master trust filings for the major U.S. credit card
issuers, the average 30+ day delinquency rate remained in the area of 150 basis points from March to
May, consistent with the same period the prior year, before falling to the 110-120 basis points area late
in the third quarter and into the early portion of the fourth quarter. According to the same data, average
annualized charge-offs remained in the 250 basis points area between March and May, only slightly
above the 240 basis points recorded a year prior, before falling below prior year levels in each month
from June to November.

Credit Fallout Should Be Modest

Whether unprecedented fiscal stimulus prevented or simply masked credit deterioration was a key
theme putting downward pressure on credit card stocks in 2020 and will remain at the forefront as we
move into 2021. However, there is growing optimism around consumer credit broadly, with credit card
stocks slowly recovering from their March lows to end 2020 effectively breakeven from an annual total
return perspective (with the exception of ADS which was recovering in lockstep before facing outsized
headwinds to end the year in reaction to worse than expected guidance for the fourth quarter). The most
recent stimulus package, for which even more is likely on the way, should provide a safety net to bridge
the U.S. consumer to the coming vaccine which is widely expected to reopen and restart the economy,
particularly the service economy and travel and entertainment spending. With that said, there is still
likely to be some loss content that falls out over the back half of 2021.
Like most in consumer finance, credit card charge-offs have historically exhibited a natural correlation
to unemployment, and the unprecedented initial COVID-19 shock had industry expectations for loss
rates at or near crisis levels. As such, issuers built significant reserves in early-to-mid 2020 using
significantly higher unemployment forecasts than were experienced over the balance of the year and
that are now expected for 2021. This leaves issuers well, if not overly, reserved and current analyst
estimates forecast charge-offs for public issuers (i.e., near-prime cards and higher) to peak modestly at
approximately 100-200 basis points above normalized levels in the second through fourth quarters of
2021.

PIPER SANDLER | 36
Figure 9: Historical Credit Card Charge-Off Trends and Near-Term Projections

14%

12%

10%

8%

6%

4%

2%

General Purpose/Prime Charge-Offs Private Label Charge-Off Rate Unemployment Rate

Source: Federal Reserve Bank of St. Louis, S&P Global. Historical general purpose / prime card data based on S&P Global Ratings’ Credit Card Quality Index
(CCQI) for U.S. Bankcard ABS. Estimates based on equity research consensus for AXP, COF, and DFS. Historical private label card data based on S&P Global
Ratings’ CCQI for U.S. Private Label Credit Card ABS. Estimates based equity research consensus for ADS and SYF.

However, it should be noted that there is an increasing potential for late stage white collar layoffs
emanating from both the short- and long-term effects of COVID-19, a risk that would disproportionately
impact public issuers. To date, these near-prime, prime and super-prime focused issuers have been
largely insulated from COVID-19 related layoffs which generally skewed towards the lower wage non-
prime consumer, but this second wave could drive greater loss volatility given the higher balance and
more discretionary nature of this segment versus non-prime. While non-prime issuers were the most
exposed to initial layoffs, they have and should continue to perform well given their cards tend to be
much smaller balance and higher utility products with significantly more excess spread to absorb losses,
and this segment of consumers has benefited the most from the fiscal stimulus offered in response to
COVID-19.

Return to Growth
Tightened underwriting standards and elevated, stimulus-induced payment rates drove Y/Y receivables
compression of as high as 10% to 15% for most issuers in the second through fourth quarters of 2020,
with shrinkage expected to continue into the first quarter of 2021. Moving into the second quarter,
vaccine adoption and its resurgent effect on the economy is expected to drive mid-to-high single digit
balance growth through the remainder of the year with issuers able to avoid “growth math” in the near-
to intermediate-term by growing into existing reserves and/or taking reserve releases versus having to
record punitive provisions to support new accounts and balances. This return to growth is further
validated by positive mailing trends in the second half of 2020, with mail volumes returning to more
normalized levels above 200 million per month in October and November.
While the most significant credit transaction announced in 2020 (Ally’s aforementioned $2.65 billion
acquisition of CardWorks) was subsequently terminated amidst a confluence of negative investor

PIPER SANDLER | 37
reaction and uncertainty around COVID-19, Synchrony, American Express and Alliance Data Systems
each made notable announcements that should begin to bear fruit in 2021. Synchrony announced new
private label partnerships with Verizon and PayPal’s Venmo in June and October, respectively, providing
a fresh wave of new accounts and balance growth. American Express announced and closed its
acquisition of Kabbage, Inc.’s operating and technology platform in August and October, respectively,
accelerating and expanding American Express’ presence in B2B payments and the SMB market more
broadly. Lastly, in the fourth quarter, Alliance Data Systems announced and closed its $450 million
acquisition of Lon, Inc. (d.b.a. Bread), a “buy now, pay later” FinTech company, in a highly strategic
transaction that will open a new growth channel for ADS outside of its core private label card business.

PIPER SANDLER | 38
Subsector: Student Lending

Introduction
Student loans comprise the second largest consumer debt class in the United States, behind residential
mortgage, and often represents the first material debt obligation a consumer takes on in their life. Like
the residential mortgage market, the U.S. government via the Department of Education (DOE) heavily
influences the sector, effectively backing the credit risk of over 90% of the entire $1.7 trillion market.
For almost 50 years prior to the Health Care and Education Reconciliation Act of 2010, the DOE backed
the sector using the Federal Family Education Loan Program (FFELP), which was initiated by the Higher
Education Act of 1965. Since that time, the DOE has been a direct lender, relying on third-party servicers
to manage their portfolio. While innovators continue to find creative solutions for current and former
students, the preponderance of the sector is dedicated to the government-backed system which
comprises 90% of the market. The private portion of the student lending market is mostly served by
bank lenders that have made students a strategic priority, as well as a select number of nonbanks, many
of which as we described earlier are shifting back into the traditional banking system.

Figure 10: U.S. Student Lending / Servicing Landscape

Note: Intended to reflect representative, not comprehensive sampling of market participants.

Federal Student Lending Industry Background

Prior to passage of the Health Care and Education Reconciliation Act of 2010, which established the
DOE as a direct lender, the DOE backed student loans using a program created by the Higher Education
Act of 1965, called the FFELP. This was a private/public partnership not completely dissimilar from how
the U.S. mortgage market functions that aimed to align private-sector loan originator/servicers with the

PIPER SANDLER | 39
ultimate credit risk carrier (the U.S. government). Legacy FFELP loans are, for the most part, serviced
by those that originate (or acquire) the loans, whereas direct loans are serviced by 35 pre-defined third-
party providers (31 non-profits and four private sector entities) in accordance with a defined allocation
policy that is revisited twice a year. Private student loans, which represent approximately 10% of new
annual originations, are done away from the U.S. government and are generally funded by deposits (for
bank lenders) or the asset-backed securities market (for nonbank lenders).

DOE Direct Loan Servicer Landscape

The DOE is currently undergoing a contract procurement process entitled “Next Generation Financial
Services Environment” to reassign responsibilities under these servicing contracts. While the process
has evolved over several years, there are presently two components that are up for renewal. The first of
those two components, Business Process Operations, represents the back office and call center
operational functions. In June 2020, the DOE signed Business Process Operations contracts with five
counterparties: Edfinancial Services LLC, F.H. Cann & Associates LLC, MAXIMUS Federal Services Inc.,
Missouri Higher Education Loan Authority and Texas Guaranteed Student Loan Corporation (Trellis
Company). The second of those two components, Enhanced Process Solution, remains ongoing. There
was a third component to the original solicitation, Optimal Processing Solution, but that component was
cancelled in April 2020.

Figure 11: Total U.S. Student Loan Debt ($B) Figure 12: Federal Direct Loan Servicing ($B)

Private $469
Perkins $130.0
$5.2
Legacy
$381
FFELP
$245.9
Great
Lakes
$234

Federal Direct
$1,315.2
$152

$1.7 Trillion Nelnet PHEAA Navient Non-Profit

Total U.S. Student Loan Debt Outstanding Servicers

Source: National Student Loan Data System (NSLDS). Includes outstanding Source: National Student Loan Data System (NSLDS). Reflects servicing
principal and interest balances as of September 30, 2020. Private loans reflect portfolio UPB in billions as of September 30, 2020. Includes direct loans and
Piper Sandler estimate. Pie chart data presented in billions ED-owned FFELP loans.

2020 Review
COVID-19 upended the world of higher education and exposed what has been limited adoption of high-
end technology and digital capabilities for universities and colleges across the country (not surprising
as some measures suggest less than 5% of college budgets are dedicated to IT spending). Private
capital has made note of the opportunity and come in to help fill the void, as the first half of 2020 saw

PIPER SANDLER | 40
the second largest half year of global educational technology investment on record (at $4.5 billion, 3x
the average 6-month period over the last decade).
The cash flow plumbing of the student lending market was also greatly impacted by COVID-19, as
federal student loan borrowers were automatically placed in an elective administrative forbearance
through the end of the year and private lenders similarly offered a range of payment options to borrowers
to assist during the pandemic. As of the end of the third quarter, 63% of the $1.7 trillion in DOE direct
loans and legacy FFELP loans were in forbearance (versus merely 10% at the end of 2019). Lending
volumes were down double digit percentages versus last year in the most acutely impacted in-school
segment, but the entire market shared in reduced volumes. While each lender will ultimately be impacted
differently, particularly between those providing loans to in-school borrowers versus offering refinancing
options for those presently in the workforce, it remains too early to tell the ultimate credit impact COVID-
19 will have on the sector (notwithstanding how politics will influence repayment trends).
The most impactful result of 2020 on the student lending industry, however, will be the evolving political
landscape and the incoming Biden administration. While many industry insiders agree that revolutionary
changes to the system, such as free college for all or new policy that would govern existing private
student borrower rights, seem unlikely, concern around the usage of existing authority under the Higher
Education Act to cancel up to $50,000 in Federal student loan debt by executive order is entirely
plausible in 2021, although no such relief was contemplated in the $1.9 trillion stimulus plan currently
underway. Elevated student debt levels have long been a key issue for the left part of Biden’s coalition,
and new CFPB director nominee Rohit Chopra in particular, so we expect real uncertainty to cloud this
sector in the near term, as we describe later in this report.

Wells Fargo Exits Private Student Lending

The most notable transaction in the sector during 2020 was undoubtedly Wells Fargo & Company’s
(NYSE:WFC) agreement to sell its $10 billion private student loan portfolio to Apollo and The Blackstone
Group Inc. (NYSE:BX) after discontinuing new originations of the product earlier in the year. Apollo and
Blackstone tapped Nelnet to service the portfolio, which greatly expanded its participation in the private
student lending market at a critical juncture for the firm following the DOE’s decision to not renew the
BPO portion of its direct loan servicing contract. Other diversified bank lenders in the private student
loan market include Citizens Financial Group, Inc. (NYSE:CFG), Discover, First Republic Bank
(NYSE:FRC), and M&T Bank Corporation (NYSE:MTB), none of which at this point have publicly
indicated similar desires to Wells Fargo but will nonetheless evaluate the businesses fit within the go-
forward strategy. Wells Fargo admittedly is under disproportionate stress in allocating capital as it
contends with a Federal Reserve mandated asset cap, so their conclusion should by no means be
considered a panacea for other banks.

Incoming Biden Administration

While Congress will play a significant role in education reform, the Biden administration was built with
support from both leftist and centrist Democrats and there is a significant divergence of appetite and
prioritization of issues within that coalition. These dynamics will impact what gets done via policy over
the next four years, but we highlight some near- and medium-term issues that will rise to the forefront.
Executive order may ultimately be used in lieu of policy, which presents a bit of a wild card for the
landscape as we step into 2021.

PIPER SANDLER | 41
Debt Cancellation Biden has recommended canceling federal student loan debt related to
undergraduate tuition for those that attended a public college/university and
earn less than $125,000. Biden had previously recommended that $10,000 be
offered in federal student debt cancellation as part of the next round of COVID-
19 relief (approximately one-third of federal student borrowers have less than
$10,000 in remaining student debt), however, we note that this was not
ultimately included in the most recent $1.9 trillion stimulus plan outlined as this
report goes to press.

Revised Income- For undergraduate loans only, Biden would reduce what is currently a
Driven Repayment requirement to pay 10% to 20% of your discretionary income towards debt
repayment down to 5%, with the balance forgiven after 20 years (tax free).

Pell Grants Biden would increase these grants, which provide approximately $30 billion to
approximately 7 million at-need students per year, and expand eligibility to
cover more of the middle class.

Public Service Biden would introduce a new federal student loan forgiveness program for
borrowers providing public service, up to $50,000 in total at $10,000 per year
of providing such service. Biden would also rework “public service loan
forgiveness,” which is available to government workers, teachers and other
nonprofit employees.

It is difficult to discern what the long-term ramifications of such policies will be on industry volumes, let
alone which ones will ultimately make their way through legislation, but this uncertainty will create real
anxiety for the student lending business in the near to medium term, and will necessitate strategic
thinking around diversification options.

PIPER SANDLER | 42
Subsector: Auto Finance

Industry Overview
Behind residential mortgages (70%) and student loans (11%), automobile financing (10%) represents
the third largest source of household debt in the United States. Entering 2020, the outstanding balance
on automobile loans and leases reached a record $1.3 trillion, up from $0.7 trillion (+84%) at the
beginning of the previous decade. (1)

Figure 13: Total U.S. Auto Loans Outstanding ($B)

$1,400

$1,300
U.S. Auto Loan Debt Totaled
$1,200 $722 Billion Entering 2010
and Nearly Doubled (+84%)
$1,100 Over the Decade to $1,331
Billion in Fourth Quarter 2019
$1,000

$900

$800

$700

$600
4Q04
2Q05
4Q05
2Q06
4Q06
2Q07
4Q07
2Q08
4Q08
2Q09
4Q09
2Q10
4Q10
2Q11
4Q11
2Q12
4Q12
2Q13
4Q13
2Q14
4Q14
2Q15
4Q15
2Q16
4Q16
2Q17
4Q17
2Q18
4Q18
2Q19
4Q19
2Q20
Source: Federal Reserve Bank of New York

The automotive finance industry is large and highly competitive. The market is currently served by a
variety of lenders, both publicly and privately owned, that can be broadly classified as one of the
following: banks or bank-owned/affiliated lenders, captive finance affiliates of automobile
manufacturers, credit unions, independent (nonbank) finance companies, or “buy here, pay here”
(BHPH) dealerships.
Banks and credit unions, which skew towards higher credit borrowers, comprise around 50% of the
overall financing market (combined loans and leases), but captives in particular, as well as finance
companies and BHPH dealers, are gradually gaining market share as banks tighten credit standards
(see Figure 15). Since the start of the pandemic, captives have captured additional market share from
other lenders due to aggressive financing incentives to encourage consumers to purchase vehicles (see
Figure 16).

1
Source: Federal Reserve Bank of New York

PIPER SANDLER | 43
Figure 14: U.S. Auto Finance Landscape

Note: Intended to reflect representative, not comprehensive sampling of market participants.

PIPER SANDLER | 44
Figure 15: Net Percentage of U.S. Banks Tightening Standards for Auto Loans

A Modest Net Share of Banks (9%) Began Tightening Standards During the Fourth Quarter of 2019

Tightening Continued in the First Quarter of 2020 (Net 16% of Banks Tightening Standards) and
B
Increased Significantly During the Second Quarter of 2020 (Net 55% of Banks Tightening Standards)
60%
50% A B

40%
30%
20%
10%
–
(10%)
(20%)
Oct-14
Jan-15

Oct-15
Jan-16

Oct-16
Jan-17

Oct-17
Jan-18

Oct-18
Jan-19

Oct-19
Jan-20

Oct-20
Apr-15
Jul-15

Apr-16
Jul-16

Apr-17
Jul-17

Apr-18
Jul-18

Apr-19
Jul-19

Apr-20
Jul-20
Source: Board of Governors of the Federal Reserve System’s Senior Loan Officer Opinion Survey on Bank Lending Practices

Figure 16: Overall U.S. Auto Finance Market Share by Lender Type (New and Used)

Banks Captives Credit Unions Finance BHPH/Other

40%
35.47% 35.97%
34.89% 34.68% 34.49%
35% 32.16%

30% 33.25%
31.43% 31.13% 30.85% 31.46%
29.51%
25%

20% 22.19% 23.14%

20.02% 20.49% 20.00%
18.56%
15%
9.03% 8.83% 8.71% 9.27% 9.66% 9.36%
10%

3.75% 4.70% 4.30% 4.32% 4.69%

3.70%
5%

–
2015 2016 2017 2018 2019 2020
Source: Experian’s State of the Automotive Finance Market Q3 2020. Years reflect date of purchase. Data through third quarter of 2020.

PIPER SANDLER | 45
2020 Review
Despite the profound initial impact of COVID-19 that shut down vehicle production across the world,
the U.S. automotive market and its associated financing industry are staging somewhat of a comeback
albeit in a unique environment.
In November, the SAAR (a measure of light weight new vehicle sales in the United States) reached 15.6
million units, an 8.4% decline from the prior year, but a significant improvement from just a few months
earlier when the SAAR dipped to 8.7 million units (down almost 50% Y/Y), its lowest level since the data
started being recorded in 1976 (worse even than the height of the financial crisis). Fitch is forecasting
light vehicle sales of 14.2 million for 2020, a 16% decline from 2019, but expects sales to rebound in
2021. Their current projection, which assumes macroeconomic conditions improve and widespread
lockdowns do not return, of 15.6 million sales in 2021 reflects a 10% increase over their 2020 forecast.
Although the trend will be improving in 2021, new vehicle sales are expected to be about 8% below
2019. Fitch does not expect sales to return to 2019 levels until 2022 at the earliest even if a COVID-19
vaccine becomes widely available by mid-2021.

Figure 17: U.S. Light Vehicle SAAR (Monthly) Figure 18: U.S. Light Vehicle SAAR (Annual)
20.0 10% 18.0 17.5
Y/Y Change 17.1 17.2
17.0
18.0 – 17.0 -8%
16.0 -16% 15.6
16.0 (10%)
15.0
14.0 (20%) 14.2
14.0
12.0 (30%)
13.0
10.0 (40%)
12.0
8.0 (50%) 11.0

6.0 (60%) 10.0

2016 2017 2018 2019 2020 2021E

Millions of units, seasonally adjusted annual rate. Source: U.S. Bureau of Millions of units, seasonally adjusted annual rate. 2021E based on estimate
Economic Analysis, Light Weight Vehicle Sales: Autos and Light Trucks, from Fitch Ratings as of December 2020. Source: U.S. Bureau of Economic
Federal Reserve Bank of St. Louis. Analysis, Light Weight Vehicle Sales, Federal Reserve Bank of St. Louis.

The precipitous decline in vehicle sales at the onset of the pandemic reflects a confluence of factors as
governments acted to temporarily close businesses, including car dealerships, and consumers changed
their behavior in response to government mandates and health advisories. Vehicle manufacturers and
their suppliers also took measures to slow or shut down production in response to the pandemic, which
negatively impacted inventory levels.
Sales began to rebound towards the end of the second quarter as governments loosened restrictions
and consumers adapted to a new environment which saw people avoiding mass transportation and
leaving large urban centers. Met with a reduction in manufacturing, this heightened demand drove
vehicle inventories to new lows causing used car sales to boom, particularly as consumers became
more cautious about spending on large purchases and turned to the used car market to save money.
As inventory diminished, used vehicle pricing rose sharply over the summer and, though it is starting to
show signs of waning, remains elevated above pre-pandemic levels. Used vehicle supply likewise
remains tight, but is also showing signs of loosening. Although some of these trends could be attributed

PIPER SANDLER | 46
to seasonality, we expect used vehicle pricing to continue to soften over the next few months as
production returns to pre-pandemic levels and demand from the post-pandemic surge fades.

Figure 19: Light Vehicle Production (#000) Figure 20: Automobile Inventory Levels (#000)
300 750
700
250
650
200 600
550
150
500
100 450
400
50
350
– 300

Source: U.S. Bureau of Economic Analysis, Domestic Auto Production, Source: U.S. Bureau of Economic Analysis, Domestic Auto Inventories,
Federal Reserve Bank of St. Louis. Thousands of units, seasonally adjusted. Federal Reserve Bank of St. Louis. Thousands of units, seasonally adjusted.

Figure 21: Manheim Used Vehicle Index Figure 22: Car Gurus Used Car Price Index
Manheim Used Vehicle Value Index Y/Y Change (%) $23,000
165 20%
$22,500
160
15%
155
10% $22,000
150
145 5% $21,500
140 –
$21,000
135
(5%)
130
$20,500
(10%)
125
120 (15%) $20,000

Source: Manheim Source: Car Gurus

On the financing side, the pandemic has created a unique scenario with heightened demand for vehicles
(and related financing) occurring against a backdrop of rising unemployment. The result is that lenders
must navigate a complex environment to meet their customers’ financing needs while protecting their
investments in the face of an uncertain financial future.
In the second quarter of 2020, according to data from the New York Fed Consumer Credit Panel, U.S.
auto loan originations (which includes both loans and leases) fell 12.7% Y/Y with subprime (consumer
credit scores below 660) originations falling 21.2% Y/Y. Originations picked up significantly during the
third quarter, reaching a record $168.2 billion, rising 23.8% from the prior quarter and 5.7% from the
same period of 2019, and grew for all segments of the credit spectrum (as classified by the FRBNY)
except for the deepest subprime segment (consumer credit scores below 620) where originations
continued to fall on a Y/Y basis.

PIPER SANDLER | 47
Figure 23: Second Quarter 2020 Y/Y Change in Figure 24: Third Quarter 2020 Y/Y Change in
Auto Loan Volume by Borrower Credit Score Auto Loan Volume by Borrower Credit Score

Pandemic Triggered Significant Decline in Auto Loan Record Auto Loan Originations in Third Quarter, But
Volume; Subprime Segment Most Severely Impacted
620-659 Deepest Subprime Segment Continued to Decline

660-719

720-759
10.5%
< 620

≥ 760
9.8%

Total
8.6%

5.7%
4.5%

< 620
-7.3% -8.0%
-10.8%
-12.7%

Total
620-659

660-719

720-759

≥ 760
-17.9%

-23.1% -6.0%

Source: New York Fed Consumer Credit Panel/Equifax from FRBNY Quarterly Source: New York Fed Consumer Credit Panel/Equifax from FRBNY Quarterly
Report on Household Debt and Credit. Credit score is Equifax Riskscore 3.0. Report on Household Debt and Credit. Credit score is Equifax Riskscore 3.0.

According to Experian’s State of the Automotive Finance Market report, subprime (which Experian
classifies as credit scores below 600) originations comprised only 17.5% of total (loans and leases)
automotive originations in the third quarter, which is a historic low. While COVID-19 has certainly
impacted subprime originations, it is unlikely the only factor driving this trend, as subprime originations
have been steadily falling for some time. As shown in Figure 25, subprime comprised 22.9% of total
automotive originations in the third quarter of 2015 and has gradually decreased since then.

Figure 25: Risk Distribution of Total (Loan and Lease) Auto Originations
Reflects Third Quarter of Each Year

Prime (>660)
Near Prime (601-660)
Subprime (≤600)
58.7% 59.9% 61.8% 62.3% 62.9% 65.0%

Gradual Decline in
Subprime Originations
18.4% 18.2% 17.5% Since 2015, Hitting
17.4% 17.3% 17.5%
Record Low in 2020
22.9% 22.0% 20.7% 20.3% 19.8% 17.5%

2015 2016 2017 2018 2019 2020

Source: Experian’s State of the Automotive Finance Market Quarterly Reports. Includes total (loan and lease) originations on both new and used vehicles.

PIPER SANDLER | 48
Experian notes that there are likely several factors influencing the subprime origination trend. At the
same time that subprime originations have been declining, the average credit scores for both new and
used vehicle loans have increased (see Figure 27 and Figure 28). This is also reflected in Experian’s
annual State of Credit report, which found that the average VantageScore was 688 in 2020, up from 682
in 2019, and the highest average score reported since 2011. Ultimately, this could mean that there are
fewer consumers who fall into the subprime tiers.

Figure 26: Average Credit Scores on Total Used Vehicle Originations

670
665
660
655
650
645
640
635
630
First Quarter Second Quarter Third Quarter Fourth Quarter

2015 2016 2017 2018 2019 2020

Source: Experian’s State of the Automotive Finance Market

Figure 27: Average Credit Scores on Total Figure 28: Average Credit Scores on Total
(Loan and Lease) New Vehicle Originations (Loan and Lease) Used Vehicle Originations
726 662
725 661
724 660
660
722 658 658
721
720 720 656
719 655
718 654

716 652
715 651
714 650
713
712 648
647
710 646
2015 2016 2017 2018 2019 2020 2015 2016 2017 2018 2019 2020

Source: Experian’s State of the Automotive Finance Market Reports. Each Source: Experian’s State of the Automotive Finance Market Reports. Each
year reflects four quarter average. 2020 includes only the first three quarters. year reflects four quarter average. 2020 includes only the first three quarters.

PIPER SANDLER | 49
While there is also evidence of some lenders (noticeably banks) tightening credit standards, it is worth
noting that the current economic environment is quite different from that of the financial crisis, as the
causes are drastically different. In 2007 and 2008, subprime loans comprised a much larger portion of
lenders’ portfolios, and subprime borrowers struggled to obtain financing as lenders didn’t want to take
on additional risk. Experian notes that this is not what we are seeing now; loans are still available for
subprime consumers from a variety of lenders.
On the other hand, while financing is still available, Cox Automotive has cited evidence that the loans
being offered to subprime borrowers are coming at less attractive terms, including larger down
payments and higher interest rates. In fact, Experian data for the first three quarters of 2020 shows that
interest rates on used vehicle loans increased (Y/Y) each quarter for deep subprime and during the first
two quarters for subprime loans, while the rate on prime and subprime loans fell markedly following the
broader interest rate environment. Used vehicle loans comprise the majority of subprime originations,
accounting for 95% of deep subprime (credit scores between 300 and 500) originations and 85% of
subprime (credit scores between 501 and 600) originations.

Figure 29: Y/Y Change in Rates on Used Vehicle Loans Across Credit Scores
0.58%

1Q20
0.42%

2Q20
0.24%

0.22%
0.21%

3Q20
0.03%
-0.13%

-0.15%

-0.21%

-0.38%
-0.41%
-0.49%
-0.49%

-0.52%
-0.53%

-0.66%
-0.69%
-0.74%

Deep Subprime Subprime Near Prime Prime Super Prime Total

(300-500) (501-600) (601-660) (661-780) (781-850) (All Scores)

Source: Experian’s State of the Automotive Finance Market Quarterly Reports

Strategic Activity
There was limited strategic activity in the auto finance sector during 2020, although several subprime
auto portfolios hit the market in search of buyers and some of the larger private auto finance companies
continue to evaluate the public markets. Gallatin Point Capital’s acquisition of FIFS Holdings Corp, the
parent company of subprime auto finance company First Investors Financial Services Group, in October
from Aquiline Capital Partners who took the business private in 2012 in a deal valued at $100 million
was the most notable transaction in the sector. In general, the sector has seen a relative lull in activity

PIPER SANDLER | 50
over the last few years as private equity interest has been sparse and public markets have not presented
overly compelling valuations.

Credit Resilient, But Vulnerable to Expiring Extensions

Consistent with the broader consumer finance space, credit metrics across the auto finance sector have
been resilient given the combination of unprecedented government stimulus dollars and widespread
payment relief programs offered by lenders. Credit performance in the auto finance sector has been
further bolstered by exceptionally strong used vehicle values due to high demand and low inventories,
which has supported lease residual values.
Since the start of the pandemic, delinquent and nonaccrual balances have reached record lows. Of
course, due to the significant number of loan extensions and modifications granted to borrowers, these
metrics are likely artificially low making it difficult to accurately assess the full impact of the pandemic.
Delinquencies and losses have started to rise on a month-over-month basis, but remain well below
recent historical levels.

Figure 30: Delinquencies (30+ DPD) on Prime Figure 31: Annualized Net Losses on Prime
Auto Loan Securitizations Auto Loan Securitizations
2.5% 10% 1.00% 45%
Y/Y Change (%) Y/Y Change (%)
0.90% 30%
2.0% –
0.80% 15%
1.5% (10%) 0.70% –

1.0% (20%) 0.60% (15%)

0.50% (30%)
0.5% (30%)
0.40% (45%)

– (40%) 0.30% (60%)

Source: Kroll Bond Rating Agency, KBRA Prime Auto Loan Index. Source: Kroll Bond Rating Agency, KBRA Prime Auto Loan Index.

Figure 32: Delinquencies (30+ DPD) on Figure 33: Annualized Net Losses on
Nonprime Auto Loan Securitizations Nonprime Auto Loan Securitizations
18.0% 20% 12.0% 60%
Y/Y Change (%) Y/Y Change (%)
10% 10.0% 40%
16.0%
20%
– 8.0%
14.0% –
(10%) 6.0%
12.0% (20%)
(20%) 4.0%
(40%)
10.0%
(30%) 2.0% (60%)

8.0% (40%) 0.0% (80%)

Source: Kroll Bond Rating Agency, KBRA Nonprime Auto Loan Index. Source: Kroll Bond Rating Agency, KBRA Nonprime Auto Loan Index.

PIPER SANDLER | 51
While lenders have not experienced meaningful credit deterioration to date, they remain vulnerable to
pressures from expiring payment deferrals and extensions, particularly in the subprime segment. Data
from S&P Global Rating’s U.S. Auto Loan ABS Tracker shows a divergence in extension requests
between prime and subprime borrowers. While extensions on prime loans declined for the fifth
consecutive month in October, subprime borrowers increased their use of payment relief programs,
suggesting that the subprime segment has been disproportionately affected by the slowing economic
recovery and reduced unemployment benefits. In November, subprime extensions increased for the
third straight month, reaching their highest level since June, while prime extensions rose only slightly,
which was the first increase since April. S&P expects loan extension rates to remain elevated until
another fiscal relief package is approved and the money reaches the unemployed.

Figure 34: Extensions on Prime Loans Figure 35: Extensions on Subprime Loans
7.0% 14.0%

6.0% 12.0%

5.0% 10.0%

4.0% 8.0%

3.0% 6.0%

2.0% 4.0%

1.0% 2.0%

– –

Source: Standard & Poor’s U.S. Auto Loan ABS Tracker. Prime index includes Source: Standard & Poor’s U.S. Auto Loan ABS Tracker. Includes outstanding
all outstanding prime auto loan securitizations, which S&P generally classifies subprime auto loan securitizations from both Reg AB II and 144a issuers,
as those backed by loan pools with initial expected cumulative net losses of including DriveTime Automotive Group’s data beginning in April 2020. S&P
less than 3.00%, average FICO scores of at least 700, and APRs up to 5.00%. generally categorizes subprime securitizations as those backed by loan pools
with initial expected cumulative net losses of at least 7.50%, average FICO
scores of less than 620, and APRs that exceed 14.00%.

PIPER SANDLER | 52
Subsector: Installment Lending

Industry Overview
Installment lending has a multi-decade history within specialty finance that has typically been comprised
of several nationally scaled competitors and a wide variety of regionally based lenders. The competitive
landscape shifted for a short time in the early 2000s, which ushered in a wave of acquisitions by banks
and insurance companies of the larger lenders in the space (a trend that quickly reversed post-crisis as
the regulated cohorts of financial services generally spurned all but the highest quality borrowers).
Installment lenders provide prime, near-prime and/or subprime borrowers access to amortizing loans
that are generally used for debt consolidation, household repairs/expenses, medical bills, holiday gifts,
auto repairs and/or other retail purchases. The core specialty finance segment of the market tends to
focus on the near prime and subprime segments, and the lower end of the prime population (credit
scores up to 720). Most lenders in this segment of the market offer a variety of products, including
unsecured and secured installment loans, open-end credit lines and in select instances, payday-like
products (although most have discontinued such products following the post-crisis regulatory
crackdown on short-term, high APR financing alternatives). Banks, and some online lenders that operate
a marketplace model, tend to be more active in the 720+ credit score segment of the market.
Pre-crisis, the sector was almost entirely a branch-based business. As in other segments within
consumer finance, the digital revolution has created a new wave of competitors in the sector that
administer their business online, and in certain instances, at the point of sale tied to consumer purchases
in a sector termed “buy now, pay later” (BNPL) providers, which we describe later in this report.

Figure 36: U.S. Installment Lending Landscape

Note: Intended to reflect representative, not comprehensive sampling of market participants.

PIPER SANDLER | 53
2020 Review
Lenders battened down the hatches in preparation for a wave of recession-driven credit challenges that
ultimately never materialized in 2020. However, as we discuss further in this report, the BNPL segment
of the market was very active during the year, with six M&A transactions and six strategic financings.
Katapult, a non-prime BNPL provider that announced a SPAC merger in December, also provided a
significant boost to traditional lender CURO Group Holdings Corp. (formerly known as Speedy Cash),
as the lender’s approximate 40% stake in Katapult provided $365 million in cash and stock
consideration in the new company, before any potential earn-out (CURO’s shares traded up 89% the
day of the merger announcement).
Outside of the BNPL segment of the market there was a limited amount of activity as traditional branch-
based and online lenders alike worked to contend with the quickly deteriorating U.S. economy. In June,
online non-prime lender Elevate Credit, Inc. announced it was exiting the U.K. market and put those
operations into administration, citing a lack of regulatory clarity and the COVID-19 pandemic. In July,
online lender Enova International, Inc. announced its opportunistic acquisition of merchant cash
advance and small-business lender OnDeck Capital, Inc., a $90 million transaction (at the time of
announcement) completed as OnDeck was contending with material COVID-19 induced stress.
We expect 2021 will bring more strategic activity in the space as well-funded platforms leverage their
access to capital to make strategic moves that COVID-19 did not permit in 2020 and explosive growth
in BNPL leads to more strategic combinations and IPO activity in that segment of the market, as we’ve
already seen with Affirm. We also expect continued evaluation of new product alternatives, including
shifts into prime lending and smaller dollar balance loans, as well as investments into online and digital
efforts to counterbalance the evolving preference of borrowers to transact outside of the branch
footprint (which we believe will impact all borrower segments and product types over the next decade,
not just prime and near-prime millennials).

Buy Now, Pay Later Review

Arguably a blend between the white-hot digital payments sector and traditional consumer lending, these
providers have grown in prominence over the last few years on the heels of explosive growth in the use
of their delayed payment products. Recent estimates peg global sector volume in the $500 billion to $1
trillion range by 2025, over 10x the current market. Typically, the BNPL option is presented to a
consumer online, or in a store, at the point of sale. The consumer either logs in or creates an account
digitally while the BNPL provider does a real-time credit check, resulting in a nearly instantaneous credit
decision at which point the merchant receives the up-front purchase price from the BNPL provider and
the customer concurrently enters into an installment contract which typically lasts up to 12 months. The
real-time approval process and increased purchasing power greatly benefits the consumer, and at the
same time, increases sales for the merchant.
The BNPL sector competes head to head as a payment alternative to traditional lenders and the strategy
bears sincere consideration across the consumer finance landscape, and most notably within
installment and credit card lending. Origination channels are fast evolving away from the branch-based,
storefront model, and while 2020 didn’t necessarily introduce that as a new trend, it certainly
accentuated the need for at least an omni-channel approach. Meeting the customer where they want to
spend or borrow in an easy, digital format is going to be a more logical and cost-effective strategy for
loan originations for a large portion of the borrower population going forward. Having a strategy in
recognition of that will benefit lenders over the course of the next decade. We believe currently profitable

PIPER SANDLER | 54
branch-based lenders do have a unique advantage, but must be disciplined and invest for the long-term
today as consumers reduce usage of branches in preference for an online/digital interface.
As previously mentioned, the BNPL sector saw twelve strategic transactions globally during 2020, split
evenly between strategic financings (Table 5) and mergers and acquisitions (Table 6).

Table 5: 2020 BNPL Strategic Financings

Source: Company Filings, Press Releases, Industry Reports.

(1) Reflects market capitalization at or immediately prior to announcement date.

Table 6: 2020 BNPL Mergers & Acquisitions

Source: Company Filings, Press Releases, Industry Reports.

PIPER SANDLER | 55
Driving Enterprise Value: Marketplace vs. Balance Sheet
The traditional finance company model has been under pressure for years as low interest rates pressure
ROEs, and therefore, the ability to deliver growth without raising dilutive equity. One of the post-crisis
solutions has been a marketplace oriented model, effectively a gain on sale approach to the loan
origination business, which is predicated on monetizing the loan at the point of origination, or very
shortly thereafter, rather than over the life of it. The strategic underpinning to the model is a view that
the lifecycle of a loan fits two separate investor groups: a growth oriented investor who supplies capital
to invest in technology and systems to originate and service quality loans and then a value or yield
oriented investor base to supply the capital to fund the loans. Marketplace lenders have achieved
attractive valuations relative to the scale of their businesses versus many traditional finance companies
(see Figure 37).

Figure 37: Marketplace vs. Balance Sheet

Source: FactSet, S&P Global Market Intelligence. Market data as of December 31, 2020.
(1) Implied platform premium reflects current market capitalization (as of December 31, 2020) less tangible common equity (as of September 30, 2020).

The fundamental risk to the marketplace model is the take out, which is dependent upon loan buyers
showing up throughout cycles to buy loans at a price that compensates the originator for their costs to
produce the loan, plus a margin. Scale is critical, the up-front investments required to build proprietary
origination channels and support fixed operating costs are substantial and the platforms need to drive
considerable volume to generate consistent profitability. There is also a potentially misaligned
relationship between the originator, who is paid on volume, and the capital provider, who is paid upon
the actual collection of principal and interest. This misalignment has been addressed in a variety of
ways, mostly through some form of incentive payment to the originator, but also more practically to

PIPER SANDLER | 56
address the biggest fundamental risk in the business described at the beginning of the paragraph: that
unhappy loan buyers won’t keep buying loans at a profitable price to the originator, or at all.
Lenders don’t need to necessarily take one side. Tooling a business to what the public markets are
paying for at any point in time is rarely a recipe for long-term success, but rethinking how to maximize
the productivity of the platform is worthwhile. There may be opportunities to service existing customers
or merchants using an existing platform that doesn’t make sense on balance sheet, but may with other
funding partners. If this can be done in scale, it can materially enhance profitability and valuation. The
recent interest rate reset has only increased demand for high quality loans. We suggest that
manufacturers not sit on the sidelines with spare capacity if they can find a productive use for it.

PIPER SANDLER | 57
Subsector: Pawn Lending

Introduction
Pawn lending is one of the oldest sources of consumer credit, but, despite growing public interest in
pawn shop operations (as evidenced by the popularity of television shows such as “Pawn Stars” and
“Hardcore Pawn”), the industry is sparsely researched and often overlooked within the consumer
finance ecosystem. Nevertheless, pawn loans are an important lending option for millions of unbanked,
underbanked and credit-challenged consumers throughout the United States who depend on them to
meet short-term financial needs when traditional forms of credit are inaccessible. According to the
National Pawnbrokers Association, pawn stores serve an estimated 30 million customers nationwide.
Pawn shops offer small, non-recourse loans to individuals who provide items of personal property as
collateral. The borrower leaves a possession of value, including jewelry, electronics, musical
instruments, tools, sporting goods, firearms and more, in exchange for an agreed upon loan amount
based on the estimated value of the item. Given its nature, just about anyone can borrow with a pawn
loan. The transaction does not require a bank account, income verification or credit check, and does
not impact an individual’s credit rating. Pawn loans also have a significant advantage in terms of
processing speed. Unlike traditional loans, which can take up to weeks to be processed and approved,
borrowers can walk into a pawn shop and receive immediate cash in exchange for their collateral.
Pawn shops generate revenue through two distinct channels: pawn lending activities and pawn
merchandise sales. Through their lending activities, pawn shops earn fees and service charges on
outstanding pawn loan balances. In the United States, pawn loans typically earn between 10% and 25%
per month depending on the size of the loan and the state in which the loan is made. Loan terms
generally range between 30 and 90 days with an additional grace period of 10 to 60 days depending on
local regulations. The size of the loan varies depending on the collateral with pawn shops lending a
percentage (we estimate up to 65%) of the anticipated resale value of the collateral. In the United States,
these loans are often no more than a couple hundred dollars (according to the National Pawnbrokers
Association, the national average loan amount is around $150).
At the end of the loan term, the borrower can repay the loan in full with accrued fees and service charges
or forfeit the pawned item. The National Pawnbrokers Association estimates that around 85% of
borrowers redeem their loans. In the event that the borrower does not redeem the loan, the pawn shop
becomes the owner of the collateral, in which case the recovery of the principal and realization of profit
depends on the initial assessment of the collateral value and the pawn shop’s ability to sell that collateral
in a timely manner through its retail network. Retail sales may also consist of used goods purchased
directly from the general public without the use of a pawn loan. On average, margins on pawn
merchandise sales have historically ranged between 30% and 40%. As a significant portion of inventory
and sales often involve gold and jewelry, profits can be heavily influenced by the market price of gold
and diamonds. In some cases, pawn shops also melt certain quantities of non-retailable scrap jewelry
and sell the gold, silver and diamonds in the commodities market.

PIPER SANDLER | 58
Industry Landscape
The pawn industry in the United States is well established, with the highest concentration of pawn stores
located in the Southeast, Midwest and Southwest regions of the country. The operation of pawn stores
is governed primarily by state laws and accordingly, states that maintain regulations most conducive to
profitable pawn operations have historically seen the greatest concentration of pawn stores.
FirstCash Inc. (NASDAQ:FCFS) is the largest operator of pawn stores in the United States with more
than 1,000 locations across 24 states and the District of Columbia. The company also operates more
than 1,700 pawn stores across Latin America including Mexico, Guatemala, El Salvador and Colombia.
The second largest operator is EZCorp Inc. (NYSE:EZPW) which owns more than 500 pawn stores
throughout the United States and an additional 500 stores across Latin America including Mexico,
Guatemala, El Salvador, Honduras and Peru.
Outside of the two largest players, which together account for an estimated 40% of U.S. pawn revenue,
the industry, although mature, remains highly fragmented. We estimate that there are between 10,000
and 15,000 pawn stores nationwide, of which most are a family-owned small business and/or part of a
local chain (up to five stores) of small independent operators.
The fragmented nature of the broader landscape creates compelling acquisition opportunities for
leading pawn operators, like FirstCash and EZCorp, to continue expanding their market share. By
purchasing smaller operations, large companies have gained access to new markets with relative ease.
Between 2015 and 2019, FirstCash acquired 1,651 stores (906 in the United States and 745 in Latin
America), including 815 stores through its merger with Cash America International in 2016. Over that
same time period, EZCorp acquired 241 stores (40 in the United States and 201 in Latin America).

Figure 38: U.S. Pawn Landscape

Source: Company Filings, Piper Sandler Estimates.

PIPER SANDLER | 59
2020 Review
While most pawn stores were able to remain open as an essential business during widespread
shutdowns, pawn operators were impacted by significant changes in consumer spending and borrowing
behaviors related to COVID-19. Beginning in mid-March, pawn shops experienced a significant decline
in pawn lending activities, including increased redemptions of existing loans and decreased originations
of new loans, believed to be the result of the federal economic stimulus in response to the COVID-19
pandemic. Towards the end of the second quarter, pawn loan originations began to recover, although
pawn loan balances remain significantly below pre-pandemic levels. The resulting decline in pawn loan
fees was somewhat offset by improved merchandise sales which benefited from increased demand for
stay-at-home products, such as consumer electronics, tools and sporting goods. Retail sales were
further enhanced by federal stimulus dollars, unemployment benefits and lower household discretionary
spend, which drove additional demand across most product categories, including jewelry. The strong
retail demand experienced at the onset of the pandemic continued through much of the second and
third quarter, but lower inventory balances, resulting from both increased merchandise sales and less
forfeited merchandise from lower pawn loan balances, also negatively impacted retail sales.

Figure 39: Y/Y Decline in Pawn Loan Balances Figure 40: Y/Y Decline in Pawn Inventories

Source: Company Filings. Figures presented in USD millions. Source: Company Filings. Figures presented in USD millions.

Looking ahead, we expect pawn store revenues to remain under pressure in the near term. While we
have seen a rebound in new pawn loan originations since the second quarter trough, the current
economic environment remains challenging for loan demand, and the incoming round of additional
stimulus could further impact demand. Even as pawn loan volumes begin to grow, a lack of inventory
will continue to pressure retail sales. The delay in loan forfeitures that drive the majority of pawn shop
inventories is, on average, at least 60-90 days after the time of origination. Based on that, we do not
expect inventory levels to recover until at least the second quarter of 2021, and even as pawn loan
balances and inventories begin to grow, it will likely take several quarters for pawn loan fees and
merchandise sales to return to pre-pandemic levels given the inherent lag between assets and related
revenue.
While consolidation and scale will continue to benefit platforms in the sector, we believe the space
would also benefit from a strategic review of (i) potential long-term implications of the shift towards a
more digital and online economy and (ii) how technology investment, including AI and machine learning,

PIPER SANDLER | 60
could improve autonomous workflow and decisioning procedures, further enabling scale benefits and
improving the profit model. We concede that these dynamics are harder to implement in the pawn
lending sector than in any other segment of consumer finance, but these shifting trends across the
economy create opportunities for lenders to re-tool their business models for the future of competition,
which will likely not just come from other pawn lenders.

PIPER SANDLER | 61
Subsector: Debt Collection

Industry Overview
A public victim of Jake Halpern’s Bad Paper: Chasing Debt from Wall Street to the Underworld, the debt
collection industry has a long history in consumer finance and plays an integral role in the credit
ecosystem. While the sector is fragmented at the lower end of the market, post-crisis consolidation has
resulted in a much smaller number of more sophisticated U.S. and European players. These platforms
acquire charged-off receivables from credit card issuers, auto lenders, utilities, telecom companies,
student lenders, installment lenders and others, generally at pennies on the dollar, and attempt to
generate mid- to high-teens unlevered IRRs by collecting more than the purchase price (net of operating
costs). Unlike other verticals across the U.S. specialty finance ecosystem, many scaled players in this
space compete globally (primarily in North America and Europe).

Figure 41: Debt Collection Landscape

Note: Intended to reflect representative, not comprehensive sampling of market participants.

2020 Review
A countercyclical industry by nature, the onset of COVID-19 laid the groundwork for what most expected
would be an unprecedented buying opportunity as increasing levels of consumer leverage built up over
the last few years coupled with the largest and fastest increase in unemployment since the Great
Depression would saturate the system with charged off accounts. Heretofore, that wave has not
materialized as global government stimulus efforts, for which more is underway, allowed consumers to
in fact de-leverage causing delinquency rates across most consumer asset classes to decline. However,

PIPER SANDLER | 62
the impact of systematic forbearance programs offered in 2020, and in several cases extended into
2021, will undoubtedly provide a pipeline of investment opportunity that the sector is poised to take
advantage of in the coming quarters.

Figure 42: ERC Compositions by Geography Figure 43: LTM Purchase Volumes

Source: Company Filings. Reflects breakdown of estimated remaining Source: Company Filings. Total purchase volume (in USD millions) for the
collections as of September 30, 2020. twelve months ended September 30, 2020. For comparability purposes, all
figures converted from reported currency to USD at the respective prevailing
USD exchange rate as of September 30, 2020.

Figure 44: U.S. Unemployment Level and Nonbusiness Bankruptcy Filings

25,000 150

20,000 120

15,000 90

10,000 60

5,000 30

– –
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Unemployment Level (000s, Left) Avg. Monthly Nonbusiness Bankruptcy Filings (000s, Right)

Source: U.S. Bureau of Labor Statistics, Unemployment Level, Federal Reserve Bank of St. Louis and American Bankruptcy Institute.

PIPER SANDLER | 63
Corporate Debt Markets Activity
Jefferson Capital’s acquisition of Canaccede Financial, which bought them entrance into the Canadian
market, was the only notable M&A transaction in the space during 2020. However, it was a very active
year for the sector in the U.S. and European corporate debt markets, as issuers cleared out bank lines
and simplified funding structures in anticipation of the yet to materialize COVID-19 induced buying
opportunity. As we discussed earlier in relation to credit cards, the most recent stimulus package should
bridge the U.S. consumer through the widespread adoption of the vaccine, but there is still expected to
be at least modest credit fallout, which could present meaningful opportunity for the debt collection
sector in 2021 and beyond as lingering effects of the pandemic are uncovered across the economy.

Figure 45: 2020 Global Corporate Debt Issuances Across Debt Collection Industry

Amount
Issuer Month (Millions) Security Maturity Rate

Encore Capital December € 350 Secured, Floating 2028 E+425

November £300 Secured, Fixed 2026 5.375%

September € 415 Secured, Fixed 2025 4.875%

PRA Group August $300 Unsecured, Fixed 2025 7.375%

Intrum July € 500 Secured, Fixed 2025 4.875%

Lowell Group November € 600 Secured, Floating 2026 E+625

€ 740 Secured, Fixed 2025 6.750%

£400 Secured, Fixed 2025 7.750%

Source: Company Filings, S&P Global Market Intelligence.

Corporate debt should be an important part of the capital structure for all debt collectors, particularly
given the present exuberance in the capital markets. We encourage all potential issuers in this sector to
get educated on the alternatives and pursue the most efficient path to help bring down overall cost of
capital and enable greater buying power in the years to come.

CFPB Issues Final Rule on Disclosures

In December, the CFPB issued a final rule to implement Fair Debt Collection Practices Act requirements
regarding certain disclosures for consumers. The final rule, which will be effective November 30, 2021,
requires collectors to provide detailed disclosures about the consumer’s debt and rights in debt
collection, along with information to help them respond.
According to the final rule, before reporting information about the debt to a consumer reporting agency,
collectors are required to take specific steps to disclose the existence of a debt and are prohibited from
suing or making threats to sue consumers on time-barred debt. It also mandates that collectors wait a

PIPER SANDLER | 64
reasonable period to receive notice of un-deliverability before furnishing information to a consumer
reporting agency.
Overall, the final ruling had limited impact on the scaled players in the sector. However, while the CFPB
has generally struck a more conciliatory tone under the Trump administration, we anticipate it to be
rather unlikely that the regulatory environment for the sector improves under the Biden administration,
granted it remains too early to tell what specific impacts could be on the table.

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Part III

Mortgage Finance Review

Introduction
We bifurcate the residential mortgage finance sector into three groups: nonbank mortgage companies,
mortgage REITs and investor loan providers. Nonbank mortgage companies originate and/or service
loans that are typically backed or issued by Fannie Mae, Freddie Mac or Ginnie Mae. Some niche lenders
focus on other products, such as non-qualifying mortgages, which are generally securitized on a private
label basis or sold to banks that hold them in whole loan form. mREITs are pass-through investment
vehicles that own mortgage loans and/or securities which are leveraged via a variety of financing
markets with the goal of generating a current income stream which is paid out via dividends. For the
purposes of this report, we focus on those invested in the residential market, not the commercial real
estate market. Investor loan providers lend to commercial-oriented buyers of single family residential
properties, either to rehabilitate and then resell the property or rent it out.

Figure 46: U.S. Residential Mortgage Landscape

(1) Source: Inside Mortgage Finance. Reflects top seven nonbank mortgage originators (in order) by volume over the nine months ended September 30, 2020.
(2) Source: S&P Global Market Intelligence. Reflects top seven residential mortgage REITs (in order) by market capitalization as of December 31, 2020.

While we conveniently group these sectors given their collective focus on single family residential
housing finance, 2020 delivered a much different experience for each of these groups which we further
examine in this report.

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Subsector: Nonbank Mortgage Companies

Introduction
The residential mortgage market, at $11 trillion of outstanding debt, represents the largest consumer
finance asset class in the U.S. multiple times over. For the last decade, most residential mortgage credit
risk has been borne by the government, who directly or indirectly backs over 90% of the market through
Fannie Mae, Freddie Mac and Ginnie Mae, quasi-government entities referred to as government
sponsored enterprises (GSEs); Ginnie Mae is technically a wholly-owned government corporation rather
than a GSE. The GSEs and Ginnie Mae are overseen by the Federal Housing Finance Agency, a
governing authority established in response to the subprime mortgage crisis after the entities were
bailed out by taxpayers in 2008 in an effort to keep the residential housing market functioning. As such,
the vast preponderance of the mortgage market today consists of lenders making loans and selling
them to the GSEs, or on an insured basis through Ginnie Mae, and in some instances, servicing them
during the life of the loan.
Historically, mortgage lending and servicing had been dominated by banks. Following the financial
crisis, and in response to significant reputational damage and legal fines in the banking sector, nonbank
mortgage companies began a striking rise, growing their share of volumes from approximately 20% to
30% of total volume between 2000 and 2006 approximately 50% to 65% over the past five years
according to data from Inside Mortgage Finance. These lenders have seen a similar, albeit less
pronounced, rise in mortgage servicing, now managing over 50% of total outstanding mortgages versus
less than 20% on the dawn of the financial crisis, according to data from Inside Mortgage Finance. While
nonbank mortgage companies rose to power over the last decade largely by filling a void left by banks
pulling back from the market, their ability to sustain their growth and market position has been driven in
recent years by quicker adoption of digital capabilities, loan officer preference for nonbanks, better
customer service and a variety of other competitive advantages.
Approximately 10% of annual mortgage lending over the last few years has fallen outside the purview
of the GSEs and Ginnie Mae. These loans are generally referred to as non-QM loans, which don’t meet
the standards of a “qualified mortgage” (QM) as defined under the Dodd-Frank Wall Street Reform and
Consumer Protection Act. Most of this volume is represented by prime jumbo loans, which are generally
mortgages with large down payments to high quality borrowers that are simply too large to be bought
by the GSEs or insured by Ginnie Mae. However, there is a rapidly growing non-QM market comprised
of loans to self-employed and other borrowers that have funds to make meaningful down payments but
don’t fully qualify for a GSE or Ginnie Mae loan program (need for bank statements to verify income,
elevated debt to income ratios, past credit events, etc.).
The mortgage market is highly fragmented and comprised of both bank and nonbank lenders across
different origination channels: retail, wholesale and correspondent. Many lenders participate in multiple
channels but most tend to specialize in one. Each channel has its own unique characteristics but is
generally defined by how the lender interacts with the end borrower.

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Figure 47: Top 20 U.S. Mortgage Originators
Market Market
Rank Lender Type Share Rank Lender Type Share

1 Quicken Loans Inc. Nonbank 7.5% 11 Guaranteed Rate Inc. Nonbank 1.8%
2 Wells Fargo & Company Bank 6.0% 12 Fairway Independent Mortgage Nonbank 1.6%
3 United Wholesale Mortgage Nonbank 4.6% 13 Amerihome Mortgage Nonbank 1.6%
4 PennyMac Financial Nonbank 4.5% 14 Truist Bank 1.5%
5 Chase Bank 3.5% 15 Home Point Financial Nonbank 1.4%
6 Freedom Mortgage Corp. Nonbank 3.0% 16 Mr. Cooper/Nationstar Nonbank 1.3%
7 U.S. Bank Home Mortgage Bank 2.3% 17 Flagstar Bank Bank 1.3%
8 loanDepot.com Nonbank 2.3% 18 NewRez Nonbank 1.1%
9 Caliber Home Loans Nonbank 2.0% 19 Citizens Bank Bank 1.1%
10 Bank of America Home Loans Bank 2.0% 20 Lakeview Loan Servicing Nonbank 1.0%

Source: Inside Mortgage Finance. Based on total origination volume for the nine months ended September 30, 2020.

2020 Review
Aggressive monetary stimulus by the Federal Reserve laid the groundwork for an all-time record in
origination volumes during 2020 as nearly the entire $11 trillion U.S. mortgage market became eligible
for a refinance, which overlaid upon a system with finite lending capacity drove gain on sale margins
similarly towards all-time highs. As a result, 2020 offered an unparalleled record for strategic activity in
the space. Four companies announced and/or completed public equity debuts (versus three such
transactions over the entire previous decade). Equally, seven different issuers raised $6 billion from the
high yield bond markets, posting an all-time record for the space. Topping it off was Intercontinental
Exchange, Inc.’s (NYSE:ICE) acquisition of Ellie Mae, a massive services provider to the nonbank
mortgage company universe (approximately 70% of Ellie Mae’s revenue comes from the space), in a
transaction valued at $11 billion. Thoma Bravo had closed on the take private of Ellie Mae just 18 months
prior for $3.7 billion, $2.2 billion in equity and the balance in financing, making it one of the most lucrative
private equity buyouts ever. ICE had good reason to pay up, as the transaction cemented their
leadership in end-to-end electronic workflow solutions for the entire residential mortgage market (which
they believe represents a $10 billion revenue opportunity).
All this despite a regulatory landscape that proved almost as volatile as the markets, beginning with no-
questions-asked forbearance options for anyone with a GSE or Ginnie Mae loan, an uncertain
government commitment to helping nonbanks bridge massive advancing obligations tied to this
previously unthinkable forbearance offering and a foreclosure moratorium that will likely be extended to
September 2021. While the market, MBS investors and regulators alike worked to sort out whether
servicers could bear the liquidity demands from these advancing obligations, scores of borrowers opted
into forbearance which according to data from Black Knight peaked at 9% of all mortgages in May
(although about half of those in forbearance did continue to pay their mortgages). Then in August, the
GSEs announced a new loan level pricing adjustment called the “market condition credit fee in price,”
which caught most of the market off guard and created a scramble to incorporate the guidance into
pricing and evaluate the impact it would have on volumes and profitability. Finally, the Biden victory in
November cemented the fate of the long debated GSE privatization efforts, as the new administration

PIPER SANDLER | 69
generally favors using the GSEs as a way to promote homeownership and affordability. While the
Supreme Court is still reviewing whether President Biden has the right for any reason to replace FHFA
director Mark Calabria, a known advocate of GSE-privatization, prior to the end of his term in 2024,
GSE-privatization appears all but a pipe dream in the near to medium term. Nevertheless, we believe
the shifting political landscape will prove positive for nonbank mortgage companies, and while the
foreclosure moratorium will likely be extended from January 2021 to September 2021 as part of the next
round of stimulus, its eventual removal will alleviate supply issues in the housing market, further
supporting mortgage demand in the next two to three years.

Strong Momentum Going into 2021

Mortgage lenders sit in an enviable position with secular growth drivers in place to support elevated
home purchase activity and augment an already robust refinance market going into 2021. Pent up home
buying demand, limited supply of homes, high consumer savings rates and record low consumer debt
loads all provide ample ammunition for 2021 to be another banner year for originations. The mortgage
industry has been a boom and bust sector for decades, generally tied to the direction of interest rates,
but these secular growth dynamics will help drive stable growth and outsized industry profitability for at
least another 12 to 24 months, in our opinion. Those with leading digital capabilities and technology
infrastructures capable of supporting autonomous workflow will have outsized success during this
period and will be left in the best position when volumes inevitably decline back to long-term averages.

Figure 48: Record Mortgage Volumes in 2020

($ Trillions)
MBA Outlook
Purchase +95%
Refinance $3.5

2010-19 Average: $1.8 Trillion

1.4 $2.5
$2.1 $2.1 $2.2

$1.7 $1.8 $1.7 $1.7 $1.7

0.6 1.5
$1.4 $1.3 1.1 1.3
0.5 0.7
0.5 0.9 1.1 1.2 2.0
0.8
1.5
1.2 1.1 1.0
0.9 0.8 0.9 0.9
0.5 0.6 0.5

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020E 2021E

Source: Inside Mortgage Finance, Mortgage Bankers Association.

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Figure 49: Market Backdrop Continues to Support Strong Performance in Near Term

Refinance Market Purchase Market

Homeowner Non-Homeowner

27%

60% 73%
54%

46%
67%

Mortgages “In The Money” 33%

Age 40+ Millenials Millenials

(39 & Under) (29 & Under)

Approximately 60% of conforming, Nearly 3 out of 4 first time home

fixed-rate borrowers could save at buyers are millennials. Suburban
least 0.75% on their mortgage if we rebalancing and remote work will
were to see sustained mortgage only accentuate an ongoing multi-
rates in the 2.8% to 3.0% area. year trend towards increasing
homeownership rates in the U.S.

Source: Company Filings, Fannie Mae, Freddie Mac.

We also believe the current political backdrop, while admittedly uncertain for every area of consumer
finance, could prove supplementary to the fundamental market growth drivers outlined above.
Homeownership has long been a bipartisan goal and President Joe Biden’s proposed tax credit of
$15,000 for first-time home buyers, who tend to utilize nonbank mortgage companies more often than
banks in getting a mortgage, would add firepower to consumer checkbooks that could support a
virtuous feedback loop, as new homeowners enter the market and facilitate up-market moves by
existing ones.
Needless to say, we are bullish on the prospects for the broader mortgage lending industry going into
2021 and believe this market backdrop will be looked back on for decades as the golden era. However,
the industry is building massive capacity to cope with these known trends and with margins at present
levels, everyone is profitable. Two things will be critical for executive management teams and their
boards to plan for in light of the unprecedented near-term opportunity: (i) technology investment behind
digital capabilities and scalable, low-cost operating infrastructures now when profits are available will
prove critical and (ii) prudent capacity build-up to cope with the current refinance opportunity must not
come at the expense of long-term profitability when volumes do normalize. Hiring people at exorbitant
prices works with volumes and margins where they are today but “righting the ship” has always proven
more difficult on the other side. These two items will be important to manage in defining who the long-
term winners are out of this market.

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Lenders Tap the Capital Markets in Unprecedented Fashion
The mortgage banking sector has had mixed success with public equity investors dating back even
prior to the financial crisis, which is important to understand contextually in light of the significant public
equity markets activity presently taking place. We categorize the mortgage banking sector’s experience
in the public markets over the two decades leading into 2020 in three phases: (i) subprime mortgage
originators, (ii) subprime mortgage servicers and (iii) nonbank mortgage companies.

Figure 50: Timeline of Mortgage Sector in Public Markets

Pre-crisis nonbank mortgage companies were predominantly focused on subprime mortgage lending
and generally traded between 5x and 7x forward earnings before they all went out of business in 2007.
Mortgage-focused banks (IndyMac and Countrywide) generally traded between 9x and 10x, a premium
to their nonbank brethren but still a substantial discount to where diversified banks traded at the time.
The performance of the mortgage sector through the financial crisis left a profound resentment in
investor appetite for the space.
The post-crisis shift that saw mortgage lending flood out of the traditional banking system created new
demands for capital and related investor interest in supplying it, most notably in the subprime mortgage
servicing segment where massive advancing obligations were coupled with motivated bank sellers
shedding legacy subprime servicing operations. The public equity, high yield bond and leveraged loan
markets stepped in to supply billions of dollars of capital to Nationstar Mortgage Holdings, now Mr.
Cooper Group Inc. (NASDAQ:COOP), Ocwen Financial Corporation (NYSE:OCN) and Walter Investment
Management Corp., who collectively acquired servicing rights on over a half trillion dollars in pre-crisis

PIPER SANDLER | 72
originated mortgages. Ultimately, overleverage, regulatory headwinds and business models predicated
on growing in a market that continued to shrink drove poor performance, and despite promising returns
between 2011 and 2013, ultimately fizzled and left investors with subpar, and in many cases negative,
returns.
The brightest spot for investors in the post-crisis nonbank mortgage sector was PennyMac Financial
Services, Inc. (NYSE:PFSI), a correspondent mortgage servicer and originator that went public in 2013
and has generated ROEs in excess of 20% in nearly every year since its IPO. Mr. Cooper has also
persevered and become the success story amongst the three public, post-crisis subprime mortgage
servicers as it continues to build out its lucrative Xome unit, offering another positive data point for
investors. Offsetting these successes in part was the debut, challenging performance and eventual sale
of Stonegate Mortgage Corporation, a subscale originator and servicer whose earnings were driven by
high marks on originated MSR and ultimately was unable to generate sufficient cash to grow the
business to scale.
All of this historical context was helpful coming into 2020, where COVID-19 drove a liquidity crisis on
hedge positions that nearly sank the nonbank mortgage sector but subsequently resulted in an interest
rate rally that drove a refinance boom unparalleled in recent history. The long-anticipated public debut
of Rocket Companies, Inc. (NYSE:RKT), which broke through historical valuation constraints on the
space and traded reasonably well in the aftermarket, opened a floodgate for other lenders to follow suit.
Within two months of Rocket’s IPO, United Wholesale Mortgage and Finance of America Equity Capital
LLC announced mergers with SPACs and Guild Holdings Company (NYSE:GHLD), Caliber Home Loans
and AmeriHome, Inc. all launched traditional IPOs. Guild, which was able to launch ahead of Caliber
and AmeriHome, ultimately priced a downsized IPO after a difficult roadshow that saw PennyMac, the
primary comparable for investors, decline 12%. Caliber and AmeriHome, which launched their IPOs at
the end of the Guild roadshow, experienced an even more challenging backdrop, which ultimately
resulted in both issuers postponing their IPOs. 2021 will undoubtedly see other issuers pursue IPOs.
Home Point Financial Corporation and loanDepot Inc. have already added to the list of private issuers
publicly filing S-1s to kick off the year.
While the public equity markets did experience fatigue in new issue, the high yield bond market all too
happily supplied $6 billion of debt to seven issuers in the space, four of which were new to the markets
in 2020. We expect the high yield market to be more heavily used to capitalize the sector going forward
as it continues to mature and solidify its position in the go-forward mortgage landscape.

Non-QM Sector Update

After years of strong momentum in volumes, particularly for bank statement and high debt to income
borrowers, COVID-19 erased years of progress in the non-QM market as the capital markets shut down
and cut off funding access for the sector. The impact was particularly acute in the correspondent
channel where smaller lenders reliant on aggregators as a takeout were hung with loans on short-term
warehouse facilities at the same time they were battling margin calls on their hedge positions related to
their more core agency lending businesses, forcing fire sales at, in some cases, as low as 70 cents on
the dollar (larger trades from more reputable sellers with better credit to back representations and
warranties were generally in the low 90s). For many of these lenders, non-QM was a small part of their
broader business and became a big part of the pain they experienced in March. These smaller lenders
that were negatively impacted by their non-QM production formed a critical backbone of the momentum
in volumes over the last few years, as loan officers were encouraged to expand their customer base in
response to wavering refinance volumes. This, in addition to low interest rates and high gain on sale

PIPER SANDLER | 73
margins for agency loans, will likely dominate loan officer attention in 2021, further depressing supply
of non-QM loans.
The wholesale channel will be a bright spot for the sector in the year to come, as brokers only lost
potential income on loans that didn’t close rather than out-of-pocket investment dollars as those that
formally banked the product did. This channel will face the same headwinds resulting from low rates
that the correspondent channel will, but many brokers in this market have niche strategies around non-
QM borrowers and the capital markets have enabled lenders to offer relatively attractive coupons at a
time where demand for new homes is high, so we expect this channel to regain its footing in 2021.
We believe the non-QM asset class, and mortgage credit in general, remain an attractive place to
allocate capital. Robust funding markets and a massive investment landscape will continue to draw
investor capital to this sector over time and those that make platform investments today will benefit from
a disproportionate share of volumes in the future when the current refinance wave inevitably funnels
through the system and loan officers resort back to other products to meet production targets.

PIPER SANDLER | 74
Subsector: Residential Mortgage REITs

Introduction
Somewhat of a cottage industry prior to the financial crisis, mREITs proliferated in market presence over
the last decade. At $40 billion as of December 31, 2020, the residential mREIT sector aggregate market
capitalization is now more than three times what it was in 2007. mREITs differentiate themselves
primarily on their investment strategy and the types of assets they allocate capital to. The first post-
crisis wave of public mREITs was predominantly focused on levered agency MBS strategies as the yield
curve easily facilitated strong ROEs and capital could be deployed into bonds overnight given the depth
and liquidity of the market. Beginning in 2011, most mREITs that completed IPOs focused at least in
part on non-agency residential mortgage assets as investors eventually fatigued on the number of
mREITs solely dedicated to agency MBS (and who consequently were raising secondary capital
alongside the new IPO entrants, thus competing with them for capital). Leverage strategies across the
sector are dictated by asset allocation, but are typically a mix of short term repurchase debt, secured
warehouse financing and/or term securitization, with some REITs also supplementing this asset leverage
with corporate leverage.

Figure 51: Residential Mortgage REIT Landscape

Note: Intended to reflect representative, not comprehensive sampling of market participants.

2020 Review
mREITs did not fare well through the liquidity crunch resulting from the early market reaction to COVID-
19. Usage of mark-to-market repurchase financing against non-investment grade and unrated residual
securitization interests in an effort to boost ROEs and generate returns investors have required of the
space proved costly as margin calls overwhelmed access to cash and liquid securities and borrowers
generally asked for forbearance from repurchase providers (or pleaded for time and mercy when lenders
were trying to collect).

PIPER SANDLER | 75
Fortunately, the dislocation was relatively short-lived, but hindsight is 20/20 and most were forced or
opted into asset sales at depressed prices and/or costly new financings to repay repurchase providers.
In total, 18 issuers saw book value declines of over 20% in their results for the first quarter of 2020, with
a number of issuers taking on expensive corporate capital with costs in the mid-teens to low-20s area
all-in, considering dilutive warrants.
We expect 2021 to be an active year on the strategic front across the sector. As we outline below, the
market is saturated with issuers. Smaller platforms with similar investment strategies to others will need
to demonstrate to investors that independence is the right path and many larger players will need to
redefine strategies to generate alpha and maintain investor appetite. This was evident in Anworth Asset
Mortgage Corporation’s sale to Ready Capital Corporation, which was announced in December 2020.
We discuss this transaction and broader observations on M&A in the sector in the following pages.

Figure 52: Top 10 mREIT BVPS Reductions from YE 2019 Through Q1 2020 and Q3 2020
MITT IVR WMC RWT TWO ARR ANH MFA NRZ AAIC
–
(10%)
(20%)
(30%)
(40%)
(50%)
(60%)
(70%)
(80%)
(90%)
(100%) 1Q20 Decline in BVPS (1) YTD Decline in BVPS (3Q20) (2)

Source: S&P Global Market Intelligence. Ordered from left to right based on size of reduction in first quarter.
(1) Reflects change in book value per share from December 31, 2019 through March 31, 2020.
(2) Reflects change in book value per share from December 31, 2019 through September 30, 2020.

M&A Landscape
With the market saturated in capital and most issuers trading below book value, one would expect more
sector consolidation. While a handful of transactions have been completed over the past five years, they
represent in aggregate less than a quarter of the total issuers trading as of the end of 2020. Misaligned
and divergent incentives between management teams, external managers and shareholders have been
the root cause for the lack of consolidation. Large management contract termination fees and change
of control payments deter deal making as the friction costs involved drive book value deterioration which
is difficult for acquirers to sell to shareholders.
There are two primary benefits of M&A in this sector: (i) scale, which improves trading liquidity and
access to funding; and (ii) investment strategy, when used as a way to diversify into new asset classes
or change capital allocation altogether. Scale has a direct correlation to valuation. The top ten mREITs
by market cap have traded at a premium of approximately 12% to the next ten mREITs by market
capitalization over the past two years, with the premium consistently closer to 20% prior to the COVID-

PIPER SANDLER | 76
19 market dislocation. Investment strategy is harder to evidence, but the number of bandwagon
strategies in the market is undeniable and funneling that capital into assets with better relative value is
sensible, assuming the M&A partner has something differentiated to offer.

Ready Capital Acquisition of Anworth Mortgage Asset Corporation

On December 7, Ready Capital Corporation (NYSE:RC) announced the acquisition of Anworth Mortgage
Asset Corporation (NYSE:ANH) for $302 million, representing a 25% premium to the closing stock price
the day prior. The transaction will be funded with a mix of 20% cash and 80% stock, with Ready Capital
shareholders owning approximately 76% of the combined company. If shareholders approve the
transaction, which is expected to close in the first quarter of 2021, the combination would create a
mREIT with a pro forma equity base of over $1 billion, a key scale milestone in the space. For Anworth
shareholders, the transaction represented a shift in investment strategy away from agency MBS and
more aligned with mREITs in the commercial mortgage segment of the market (a segment of the mREIT
space that we do not explicitly cover in this report). For Ready Capital, the transaction was directly
geared at increasing scale, as the intention going forward will be to recycle Anworth’s capital into Ready
Capital’s core assets.
Despite a management fee waiver of $4 million for the first year post-closing by Waterfall, Ready
Capital’s external manager, Ready Capital’s shares fell over 10% on the day of announcement, wiping
out almost $80 million in market cap and reducing the implied premium to Anworth shareholders to
approximately 15% based on the closing price the day of announcement. The negative reaction was
driven by the issuance of almost 17 million new Ready Capital shares to Anworth investors at
approximately 95% of tangible book value, compared to an implied price to tangible book of 0.96x paid
for Anworth before consideration of transaction and other friction costs.
This transaction reflects similar sentiment long observed across M&A in the mREIT sector. For Ready
Capital shareholders, greater scale and public flotation should facilitate better valuation longer-term, as
we detailed in the previous section. However, the unusual pairing from an asset strategy point of view
drove skepticism amongst investors around deal motivations as book value dilution is difficult to
stomach. For smaller mREITs with limited differentiation in asset strategies, this transaction
demonstrates that there are good alternatives to the status quo worthy of serious consideration. Larger
players that already have achieved some scale are willing to transfer some wealth to sellers in an effort
to continue on an upward trajectory, an outcome that ultimately benefits both sets of shareholders (albeit
the more immediate gratification falls in the camp of the acquired).

Recalibration of Investor Expectations

Funding has always been a vulnerability for the mREIT sector. Despite compression in interest rates
over the last decade and a much flatter yield curve than persisted in the immediate years following the
financial crisis, investors have continued to demand outsized returns. At 1%, the 10-year UST is
presently one-half to one-third of what it has been over the last decade. At the same time, the spread
between the 2-year and 10-year UST has declined from over 2% in the years immediately following the
financial crisis to almost zero over the last few years. Despite that punitive interest rate backdrop for
mREITs, the sectors current dividend yield of 10% to 12% is roughly the same as it was 5-years ago. If
investors want resilient issuers that don’t go out of business once a decade, they’ll need to accept lower
returns and allow the sector to fund longer-term and with less leverage.

PIPER SANDLER | 77
This concession won’t come without cost. mREITs will need to work harder to differentiate their business
models and prove that their strategies generate real alpha, net of fees and expenses, for investors over
the long term. We expect three primary trends: internalization, scale-building and self-asset-sourcing.
Internalization has been pursued by several, particularly larger, mREITs and has been met with strong
enthusiasm from investors (as evidenced by Annaly Capital Management, Inc. (NYSE:NLY) during 2020).
The scale strategy will be limited and is largely set today. There is a place in the market for MBS-focused
strategies but not for the number of issuers that are presently pursuing it. Asset sourcing will be a big
focal point going forward, as securities strategies fall out of favor for all but the largest players in
preference of manufacturing strategies (assuming the alpha makes its way to investors when costs and
fees are factored in). In our view, mREITs will be wise to follow one of those paths. Table 7 highlights
some of the asset classes worthy of consideration for capital deployment. We would caution mREITs to
be prudent in financing strategies tied to any such extensions of the investment strategy into non-
agency asset classes, with reliance on match-funded, term securitization and without the use of
repurchase financing on any retained residual interests being most advisable (even if the impact on
ROEs must be explained to shareholders).

Table 7: Universe of Investable Alternative Mortgage Assets

Core Non-QM

Fix-and-Flip

Mortgage Servicing Rights

Multifamily

Prime Jumbo

Single Family Rental

Residential Ground-Up Construction

Note: Intended to reflect representative, not comprehensive sampling of investable asset classes.

Specific Board Room Topics for mREITs

As we’ve previously highlighted, in our opinion this sector more than any in specialty finance has
explaining to do to shareholders. Misaligned incentives, poor performance, and too many “bandwagon”
strategies leave the space ripe for consolidation and the companies within it in need of a more clearly
defined strategic vision. We highlight some key questions every board should be explicitly asking its
executive management team in an effort to redefine strategies and make objective decisions around the
best way to maximize long-term shareholder value.

PIPER SANDLER | 78
Mortgage REIT Board Room Topics and Questions

Capital Structure, Funding and Liquidity Strategies

 Have we explored and/or utilized term funding options to augment short-term, low-cost
repurchase financing strategies?
 Can we successfully communicate a funding strategy to the market that may impair
current period ROE in the spirit of generating more sustainable long-term returns?

Target Leverage and Return on Equity

 Do we still need to generate double digit ROEs in a zero interest rate and flat yield curve
environment?

 How do we manage what is practical with the apparent cost of capital for the space?

Differentiation
 Do we offer a sufficiently differentiated value proposition to investors (namely in scale,
investment strategy and/or asset sourcing)?

Asset Sourcing
 Are we able to generate risk-adjusted alpha for investors by accessing assets on more of
a wholesale basis?
 Should mREITs own or strategically partner with originators and can it be done efficiently?

Consolidation or Internalization
 Could a sale or merger drive better value for shareholders vs. status quo strategic plan?
 Alternatively, would an internal management structure improve value for shareholders?

PIPER SANDLER | 79
Subsector: Investor Loan Providers
Investor loan providers service a massive and long-standing marketplace comprised of professional and
amateur investors and developers operating in both urban and suburban markets across the United
States. Collateral types are largely residential in nature, including single-family homes (1 unit) and other
single-family properties (2-4 units) as well as small multi-family properties (generally 5-19 units in larger
ticket geographies and up to 50 units in smaller ticket geographies). The market also includes small
mixed-use and other commercial properties such as office buildings, strip retail centers and
warehouses, among others.
Investment approaches can largely be bifurcated into two primary segments: (i) transactional fix-and-
flip and (ii) buy-and-hold rental portfolios. However, there is often overlap between the two, with many
investors evolving from flipping single-family homes to more diversified strategies that employ both
approaches. For example, many investors buy and rehab properties and then make the decision to sell
/ flip or hold / rent depending on market conditions and in the context of their own liquidity position and
broader portfolio strategy. In addition, flipping strategies can range from low-intensity cosmetic to
medium-intensity value add rehabilitation to high-intensity ground-up construction projects. Similarly,
rental strategies can range from 1-2 property “mom and pop” investors to sophisticated investors with
portfolios ranging from 10 to more than 100 properties.
Despite a wave of institutionalization post-crisis, the financing markets for these investors and properties
remain highly fragmented, with the exception of stabilized small commercial and multi-family properties,
which are largely dominated by commercial banks and GSE multi-family financing programs. Scaled
national nonbank lenders represent only a fraction of the fix-and-flip and rental finance markets, with
many investors buying and/or holding properties in cash or relying on local private hard-money lenders.
Historically, less than 50% of fix-and-flip and single-family rental properties have been financed with a
recorded mortgage at the time of purchase according to data from ATTOM Data Solutions and John
Burns Real Estate Consulting, respectively. The actual level of financing is higher due to refinancing
activity post-acquisition, but these purchase statistics are telling with respect to the fragmentation of
these markets.
Other than Goldman Sachs’ 2018 acquisition of Genesis Capital LLC and one other undisclosed
transaction that occurred in December 2020, bank participation in these asset classes has been
selective and largely localized with community and regional banks. However, a return to a near zero
interest rate environment and the resiliency and performance of these asset classes could spur
increased appetite for fix-and-flip and/or rental loans. In addition to mid-to-high single digit yield lending
opportunities, professional real estate investors and developers tend to have an attractive customer
profile for banks, presenting deposit capture and other cross-sell opportunities.

There is a diverse landscape of nonbank lenders (see Figure 53) serving the fix-and-flip and rental
finance markets, including a range of origination channels (e.g., direct/retail, correspondent/wholesale
and broker) and financing strategies (e.g., bank/warehouse lines, flow sales and securitization).

PIPER SANDLER | 80
Figure 53: Investor Real Estate Loan Landscape

Note: Intended to reflect representative, not comprehensive sampling of market participants.

2020 Review
The year started strong with the initial public offering of Velocity Financial Inc. (NYSE:VEL) in mid-
January. Velocity’s strength and growth profile in single-family rental and small commercial markets
were well received by analysts and investors alike, with the IPO pricing above book value and at
approximately 8x 2020E earnings. However, Velocity and its balance sheet-based investor loan
competitors faced the same warehouse line and securitization liquidity crunch that dislocated the
mREITs at the onset of COVID-19.
Moreover, many of the other “capital light” originators relied on the mREIT sector and other private
credit managers to purchase new loans on a flow basis in those same warehouse and securitization
financing markets, further exacerbating the void of capital in the space. As a result, and combined with
general COVID-19 related caution, origination volumes fell dramatically, and in many cases to zero, in
March and April. By May, markets had stabilized and platforms with access to capital restarted the
origination engine, but with volumes governed by a combination of tightened credit, reduced housing
supply turnover and, in many cases, more tepid borrower demand.
As the industry progressed through the third quarter, financing and housing markets continued to
improve, and credit performance remained stable, allowing many originators to begin to return to
volumes and/or run rates at or near pre-pandemic levels. It should be noted that, while the current lack
of inventory is providing a tailwind to the housing market (and thus collateral values and credit
performance for these lenders) amidst these uncertain times, it is also a potential headwind to volumes
that may constrain near-term growth above pre-pandemic levels in some markets. According to data
from the National Association of Realtors, housing inventory fell to 1.9 months of supply, totaling 1.1
million units, in December 2020; both figures marked new historic lows.

PIPER SANDLER | 81
However, there remains a general sense of optimism amongst lenders, a sentiment we share, and the
fourth quarter brought signs of meaningful strategic activity in the space. A consortium led by Pretium
Partners and Ares Management announced a $2.5 billion take-private acquisition of SFR REIT Front
Yard Residential, diversified mortgage lender Finance of America announced its intention to go public
via a $1.9 billion SPAC merger with Replay Acquisition Corp., and fix-and-flip lender LendingHome
Corporation closed a $75 million growth capital raise from Benefit Street Partners. As we explore in
further detail below, we expect strategic activity, particularly as it relates to forming and securing a viable
permanent financing strategy, to remain a key theme in fix-and-flip and SFR finance in 2021.

Fix-and-Flip and SFR Are Here to Stay

Despite uncertainty and a general economic slowdown from COVID-19, fix-and-flip and rental properties
are permanent and predictable pillars of the $25+ trillion U.S. housing market that will rebound and
persist in 2021 and beyond. Since 2000, fix-and-flip has consistently represented approximately 5-7%
of U.S. home sales, including through the financial crisis and through 2020 to date, largely driven by an
aging housing stock and growing deferred maintenance balance and end-user demand for refurbished
or new properties, which many home buyers lack the time and/or resources to pursue (see Figure 54).
Since 1965, approximately 35% of the U.S. housing stock has been consistently rented, a long-term
trend that is buoyed by continued household formation and an increasing propensity among those new
households, as well as a desire by many to exit urban areas in a post-pandemic world (see Figure 55).

Figure 54: Historical U.S. Fix-and-Flip Volume

100 Single-Family Home Flips (#000) 10%

90 F&F Share of U.S. Home Sales (%) 9%
80 8%
70 7%
60 6%
50 5%
40 4%
30 3%
20 2%
10 1%
− −
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020
Source: ATTOM Data Solutions.

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Figure 55: Historical U.S. Rentership Rate
50%
35% Long-Term Average U.S. Rentership Rate Despite Pre-
45%
Crisis Spike in Mortgage Availability and Homeownership
40%

35%

30%

25%

20%
1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020
Source: U.S. Census Bureau. Data as of September 30, 2020. Reflects inverse of published U.S. homeownership rate.

Balance Sheets Are Winning

As origination volumes are recovering, many lenders are evaluating strategic alternatives in the wake of
the COVID-19 dislocation and continued cost of capital advantages held by a handful of leading balance
sheet-based lenders, largely those with access to the growing institutional securitization market.
LendingHome is one such lender, and even it strengthened its balance sheet with Benefit Street’s
support to ensure near- and improve long-term competitiveness with its other institutionally-backed
competitors: Anchor Loans (Wafra Capital Partners), Finance of America (Blackstone/SPAC IPO),
Genesis (Goldman Sachs), and Toorak Capital Partners (KKR).
While traditional M&A activity is uncommon in this space, expect lenders, particularly those that have
historically relied on flow sales to fund volume, to reevaluate their capital footings and long-term
financing strategies, including partnering with a competitor or identifying capital partners to establish a
balance sheet. As we explored earlier, there is evidence that a flow sale or marketplace model is a viable
alternative for funding assets and creating enterprise value in larger, more homogenous markets such
as consumer finance, which also has the benefit of generally higher absolute yields. The same is also
arguably true for SFR and other longer duration and more homogenous rental assets. For fix-and-flip
and other more bespoke investor loan machinations, however, the price compression being driven by
the evolution of the securitization market and rise of the larger institutional balance sheet-based lenders
is putting significant pressure on the flow sale model, as fix-and-flip loan buyers tend to have minimum
absolute yield and dollar return thresholds given the short, generally six- to twelve-month duration of
these assets. We acknowledge the presence of more bespoke and often bilateral securitization
alternatives available to flow sellers but see little, if any, cost of capital advantage vis-à-vis traditional
whole loan sales executed on a pass-through spread basis. As a result, the flow-based lenders have
the choice to either (i) find a capital partner or (ii) move into more niche parts of the market and/or
experience meaningful compression to gain on sale margins and/or pass-through spreads, neither of
which is particularly accretive to enterprise value.

PIPER SANDLER | 83
Part IV

Commercial Finance Review

Introduction
Commercial finance is a broad, multi-trillion dollar annual marketplace within specialty finance and one
that has ties across the financial services spectrum: banks, asset management, insurance, and FinTech
(see Figure 63). As we explore below, a combination of consolidation and competition from these other
sectors has created a void of scaled, independent commercial finance companies. Banks have
historically and will continue to control the majority of the commercial finance landscape and have driven
much of the aforementioned consolidation. BDCs have also traditionally been active participants, and,
as of late, more active acquirers. Asset managers are playing an increasing role following a surge of
private credit managers with direct lending capabilities to fund BDCs and other investment vehicles
(according to data from Preqin, the number of active private debt fund managers in North American has
grown to over 1,000 as of December 31, 2020). As previously highlighted in this report, insurance
companies are strategically partnering with and providing a significant amount of capital to those credit
managers, with Athene and Security Benefit also directly owning large commercial lenders in MidCap
and Stonebriar, respectively. FinTech companies have also begun to emerge post-crisis, bringing their
underbanked consumer philosophy to underbanked small businesses.
Commercial finance can generally be segmented into secured and quasi-secured financing across
asset-based lending, equipment leasing and finance, factoring, cash flow and leveraged lending,
securitization and supply chain (purchase order, supplier and inventory) finance sub-verticals (see
Figure 56). Commercial finance also includes adjacent niche verticals such as venture and life sciences,
healthcare and specialty real estate lending, as well as the merchant cash advance and small- and
medium-sized business finance niches within the supply chain finance vertical where much of the
FinTech activity has centered.

Figure 56: Commercial Finance Market Sizing by Estimated Annual Volume ($B)

>$2,000

>$1,000

>$400

>$150 >$125 >$100

Cash Flow & Equipment Supply Chain Asset-Based Securitization Factoring

Leveraged Leasing & Finance Lending
Lending Finance

Source: 2019 Secured Finance Market Sizing and Impact Study (Secured Finance Network), Equipment Leasing & Finance Foundation, Refinitiv LPC.

Below we explore equipment leasing and finance and asset-based lending, two large and discrete
markets most closely aligned with traditional balance sheet specialty finance companies.

PIPER SANDLER | 85
Equipment Leasing and Finance
At $1 trillion in annual volume according to the Equipment Leasing and Finance Association, equipment
leasing and finance is one of the largest and most notable sub-verticals within the U.S. commercial
finance landscape. Equipment finance solutions are valuable components of business’ overall financing
strategies, allowing them to finance investments to preserve capital and/or debt capacity on ABL and
other commercial facilities. As such, equipment finance volumes are generally aligned with equipment
and software investment by businesses and thus GDP growth and the health of the broader economy,
with the propensity to finance also influenced by interest rates.

Figure 57: Equipment Finance Annual Market Size ($B)

$884
$599 $664 $904
$624
$732
$720 $720
$658

$1,006 $975 $1,003 $903 $992

$722 $770 $835
$659

2011 2012 2013 2014 2015 2016 2017 2018 2019

Equipment Finance Market Non-Financed Equipment Investment
Source: Equipment Leasing & Finance Foundation, Keybridge LLC, U.S. Bureau of Economic Analysis.

When excluding “large-ticket” leasing for aircraft, container and rail assets, equipment finance can be
viewed into two primary transaction sizing segments: (i) “small-ticket” transactions of less than
$250,000, including “micro-ticket” below $25,000, and (ii) “middle-ticket” transactions between
$250,000 and $5,000,000. Small-ticket transactions include computers, copiers, fax machines, network
hardware and other office and technology equipment. Middle-ticket transactions include “yellow iron”
construction equipment, transportation assets (e.g., buses and motor coaches, trucks, trailers, etc.) and
waste equipment, among other asset classes, serving a wide range of end-users and sectors across
the economy. Together, the small- and middle-ticket segments represent approximately 80% of
equipment finance activity according to data from the ELFA.
Market participants can similarly be segmented into three primary lessor types: (i) banks, (ii) captives
and (iii) independents. Large banks such as Bank of America and Wells Fargo have an inherent cost of
funds advantage and tighter, regulatory-driven credit standards that naturally orient them towards larger
transactions and larger and higher credit quality customers through direct and vendor channels,
whereas select community and regional banks such as Huntington Bancshares Inc. (NASDAQ:HBAN),
Regions, Sterling Bancorp (NYSE:STL) and Umpqua Holdings Corp. (NASDAQ:UMPQ) have proven
more nimble down ticket sizes and customer profiles, including acquiring independents in search of

PIPER SANDLER | 86
higher yields post-crisis. Captives such as John Deere Financial, Caterpillar Financial and IBM Global
Financing are financing affiliates of original equipment manufacturers that primarily bundle equipment
and financing at the point-of-sale and benefit from their parents’ competitive funding cost allocations
and intrinsic knowledge of the collateral when setting residual values and overall lease terms. The
remaining independents, such as Commercial Credit Group and GreatAmerica, are themselves and as
a whole smaller than banks and captives but are generally more dynamic models with an ability to serve
a wider range of customers and channels, including brokers, and compete on flexibility and service
versus pricing.

Figure 58: Equipment Finance Market: Figure 59: Equipment Finance Market:
Net Business Volume By Lessor Type Net Business Volume By Market Segment

Independents
4%

Large-
Ticket
18%
Captives Middle-
32% Ticket
Banks 47%
Small-
64%
Ticket
35%

Source: ELFA 2020 Survey of Equipment Finance Activity. Reflects Source: ELFA 2020 Survey of Equipment Finance Activity. Reflects
composition of net business volume, based on data submitted by survey composition of net business volume, based on data submitted by survey
participants, by lessor type for the year ended December 31, 2019. participants, by market segment for the year ended December 31, 2019.

PIPER SANDLER | 87
Asset-Based Lending
ABL has historically been a lesser accepted form of commercial financing and somewhat associated
with distressed, non-cash flow generating borrowers, but has matured and grown into an almost $500
billion market in the U.S. according to the Secured Finance Network. ABL revolvers are primarily secured
by receivables and/or inventory and have become increasingly utilized by businesses, particularly in the
middle market, to fund not only working capital but also organic and inorganic growth as well as a
refinancing alternative for other debt. Given its defensive structure and independence from current
period cash flow generation, ABL is a full-cycle product that represents approximately 10% of leveraged
lending across cycles and as high as almost 20% as the market rotates towards security in periods of
distress according to data from Refinitiv LPC.
The ABL market is largely controlled by Bank of America, JPMorgan Chase and Wells Fargo, as well as
super regional banks such as PNC Financial Services Group Inc. (NYSE:PNC), Truist Financial Corp.
(NYSE:TFC) and U.S. Bancorp (NYSE:USB), which dominate the largely syndicated upper end of the
market at or above $25-50 million facility sizes. Nonbanks, however, remain a vital component of the
middle market segment and overall ABL market at almost $40 billion or approximately 8% of
commitments. Nonbank participants include BDCs, many of which operate via distinct portfolio
companies such as Solar Senior Capital Ltd. (NASDAQ:SUNS) via North Mill Capital and Owl Rock
Capital Corp. (NYSE:ORCC) via Wingspire Capital, as well as other independent finance companies.
Many of these other nonbanks have similar institutional backing, including BDC affiliations, from
prominent credit managers. Examples include Ares Commercial Finance backed by Ares Management
Corp. (NYSE:ARES) and its BDC affiliate Ares Capital Corp. (NASDAQ:ARCC) and MidCap Financial
backed by Apollo Global Management, Inc. (NYSE:APO) and its BDC and insurance affiliates Apollo
Investment Corp. (NASDAQ:AINV) and Athene, respectively. Similar to equipment finance, there is also
a select group of community and regional banks, including Cadence Bancorp. (NYSE:CADE), Sterling
and UMB Financial Corp. (NASDAQ:UMBF), that have built and/or acquired more nimble nonbank-like
ABL platforms within their commercial bank infrastructure to compete more directly with nonbanks in
the ABL middle market.

Figure 60: Asset-Based Lending Market Size: Figure 61: Asset-Based Lending Market
Total Asset-Based Lending Commitments ($B) Composition: Commitments by Lender Type
Nonbanks
$495 8%
$465
$439
$391 $407

Money
Center
Community 37%
& Regional
39%
Super
Regional
16%
2015 2016 2017 2018 2019
Source: Refinitiv LPC, Secured Finance Network. Source: Refinitiv LPC, Secured Finance Network. Money center banks include
banks with total assets greater than $500 billion. Super regional banks include
banks with total assets between $250 and $500 billion. Community and regional
banks include banks with total assets less than $250 billion.

PIPER SANDLER | 88
Year-End Review
The equipment finance market was robust in the first quarter of 2020, with new business volume, as
measured by the ELFA’s Monthly Leasing and Finance Index, growing 17% from the first quarter of
2019, and Regions announcing its acquisition of leading independent lessor Ascentium Capital in late
February. By the second quarter, Regions had closed the Ascentium transaction, but the effects of
COVID-19 had significantly diminished economic growth and new equipment and software investment,
with ELFA data indicating new volumes down 14% from the second quarter of 2019. As we moved into
the back half of the year, equipment and software investment experienced an unprecedented rebound
in-line with the broader recovery and, through November, ELFA data indicates year-to-date volumes
down only 6% Y/Y. November also saw a return of meaningful strategic activity with BDC Solar Capital
Ltd. (NASDAQ:SLRC) announcing an approximately $216 million investment to acquire a majority stake
in Kingsbridge Holdings LLC, a leading independent lessor of information technology, industrial,
healthcare and commercial essential-use equipment.
Conversely, originations of new credit commitments in the ABL market, as measured by the Secured
Finance Network’s Quarterly Asset-Based Lending Indices, were and continue to be more suppressed
by COVID-19’s impact on the economy, particularly given continued weakness in the retail trade and
wholesale trade sectors that traditionally account for a significant portion of overall ABL activity. Through
the third quarter, new commitments are down almost 30% Y/Y. Total committed credit lines, however,
have grown steadily over the course of the year and are up approximately 5% Y/Y, and credit line
utilization spiked to over 50% in the first quarter according to the same dataset, highlighting the
resilience and value of ABL facilities to borrowers in time of stress. While utilization rates fell in the
second and third quarters, we attribute this to the same conservatism that has led U.S. companies to
hold historic cash levels and expect a rise in new commitments and utilization rates as most companies
grow with a recovering economy and others turn to the ABL market as a viable alternative in restructuring
and turnaround situations.

Equipment and ABL Tailwinds

The commercial finance sector has historically ebbed and flowed between cash flow-based structures
(e.g., traditional C&I and leverage lending) and collateral-based structures (e.g., equipment finance and
ABL) as preferences and/or financial conditions evolve. We believe we are seeing and will continue to
see such a rotation as companies continue to utilize and/or turn to equipment finance and ABL
structures amidst the fallout of the COVID-19 pandemic. Companies will continue to borrow given the
low interest rate environment and these structures are tailor made to balance growth and investment
with a prudent desire to maintain liquidity and avoid cash flow-based covenant packages in recovering
but still uncertain times.
Whereas the ABL market will benefit more so from companies most adversely impacted by COVID-19,
the equipment finance market should benefit from a generally reemerging economy with positive overall
GDP growth and investment trends following a sharp recovery in the third quarter of 2020. Equipment
and software investment growth outpaced overall GDP growth in 2020 as companies evolved and
invested in response to COVID-19 and is projected to remain positive in 2021, with notable momentum
around construction as demand for single-family homes surges, technology as the workforce shifts
remote and transportation assets with the substantial rise in online sales. Widespread adoption of a

PIPER SANDLER | 89
vaccine should further these tailwinds and provide much needed relief to other industries such as travel,
retail and restaurants.

Figure 62: Equipment Finance Drivers: GDP Growth and E&S Investment

50%
Equipment & Software Investment GDP Growth Projections
40%

30%

20%

10%

(10%)

(20%)

(30%)

(40%)
2016 2017 2018 2019 2020 2021E
Source: Equipment Leasing & Finance Foundation, Keybridge LLC, U.S. Bureau of Economic Analysis. Seasonally adjusted annualized rates.

Competition Driving Consolidation and Evolution

Banks generally remain in pole position across the commercial finance landscape but have been forced
to rethink and adapt their appetite and approach to the sector amidst heightened regulation and the
well-publicized proliferation of nonbank platforms backed by BDCs and credit managers over the past
decade, which have been further enabled by a robust ABS financing market. We believe these factors
had banks at a critical turning point and nonbanks poised to take more share even prior to the onset of
COVID-19 and the resulting need for more flexible capital amidst uncertain times. We could see banks
pursue a number of paths ranging from a pull back or outright exit, to partnership or joint venture models
where they serve a bank customer with a nonbank’s capital, to further acquisitions of banks and/or
nonbanks with differentiated asset generation capabilities. Regardless, we see opportunity and change
ahead for banks and nonbanks alike, with nonbanks potentially further consolidating to fill voids left by
banks and a potential return of the capital and independent platform formation cycle experienced amidst
the exodus of bank talent and leadership through and following the financial crisis.

Disappearance of the C-Corp Commercial Finance Company

The previously mentioned post-crisis cycle had temporarily helped to fill a void that has grown amidst
the consolidation and evolution of the past two plus decades: a lack of scaled independent commercial
finance companies. In the late 1990s and early 2000s, the landscape included large commercial finance
companies such as Associates First Capital Corp., CIT Group Inc., GE Capital Corporation, Heller
Financial, Inc. and Newcourt Credit Group, Inc., all of which were eventually absorbed by or into the
banking system. The crisis and post-crisis eras saw the rise and consolidation of smaller, yet still notable

PIPER SANDLER | 90
platforms such as Ascentium, Commercial Credit Group (CCG), Financial Federal Corp., Financial
Pacific Leasing LLC, GreatAmerica, LEAF Commercial Capital, Inc., Marlin Business Services Corp.
(NASDAQ:MRLN), MidCap, Navitas Credit Corp., NewStar Financial, Inc., NXT Capital, LLC, Oxford
Finance LLC and Tygris Commercial Finance Group, Inc., among others, and in Canada, Element
Financial Corporation and then its successor entities Element Fleet Management Corp. (TSX:EFN) and
ECN Capital Corp. (TSX:ECN).
At the time of this report, however, only CCG, GreatAmerica, Marlin, Oxford and the Element companies
remain independent. The others identified above, in addition to countless more, were again absorbed
by the banking system or caught in the wave of BDC and other nonbank capital entering the space in
recent years. Using ELFA equipment finance data as a means of quantifying this trend, independents’
share of annual new business volume fell from over 50% in 1999 to approximately 20% in 2009 to less
than 5% by 2019.
Moreover, Marlin now primarily operates via its ILC Marlin Business Bank and GreatAmerica has a
pending ILC application to form its own bank. A bank owner or structure brings obvious advantages,
but, as previously discussed, also a highly regulated credit box that could struggle to compete with
nonbanks. Similarly, BDCs and credit managers bring ready access to capital, but BDCs have leverage
and other 1940 Investment Act limitations and credit managers have higher return thresholds.
CCG, GreatAmerica (for now) and Oxford have created efficient capital structures and become
respected leaders in their niche markets without the freedoms and limitations of a bank, BDC or massive
fund complex. It remains to be seen whether any platforms will grow or be formed and achieve similar
success or whether the new reality is simply that regional banks and BDC portfolio companies are
today’s version of the commercial finance companies of the past. We also expect the life insurance
sector to be an interesting part of this evolution, as they represent perhaps one of the most logical long-
term owners of these businesses as evidenced by Athene-MidCap and Security Benefit-Stonebriar.

PIPER SANDLER | 91
Figure 63: Commercial Finance Landscape

Note: Intended to reflect representative, not comprehensive sampling of market participants. For nonbanks, note that many platforms participate in two or more of the sub-verticals identified above.
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