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Newtek Business Services (NEWT):

A House of Cards: Atrocious Credit, Manufactured Earnings, Fictional Net Asset


Value and Regulatory Peril

Newtek Business Services (NEWT) is a rogue company we believe is engaged in defrauding


multiple stakeholders. The Company has exploited its Business Development Company (BDC)
structure to dramatically misrepresent the health and profitability of its business. This report
irrefutably documents how this subprime commercial lender defrauds the Small Business
Administration (SBA), a taxpayer-backed government agency, misrepresents and overstates
income, pays dividends it does not earn, raises capital under false pretenses, and presents a
balance sheet divorced from economic reality and common sense. Despite the litany of red flags,
Newtek has employed a carefully crafted strategy to prey on unsophisticated retail investors
while avoiding the scrutiny of capital markets and regulators. Until now.

Fair Value: $8.00 per share, 60% downside

“I will tell you I have, as the primary face of the company, kind of maintained a
lot of the Investor Relations contacts… I'm good at it”1

CEO Barry Sloane explaining why he refuses to hire a Chief Financial Officer

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IMPORTANT Disclaimer – Please read this Disclaimer in its entirety before


continuing to read our research opinion. You should do your own research and due
diligence before making any investment decision with respect to securities covered
herein. We strive to present information accurately and cite the sources and analysis
that help form our opinion. As of the date this opinion is posted, the author of this
report has a short position in the company covered herein and stands to realize gains
in the event that the price of the stock declines. The author does not provide any
advanced warning of future reports to others. Following publication of this report,
the author may transact in the securities of the company, and may be long, short, or
neutral at any time hereafter regardless of our initial opinion. To the best of our
ability and belief, all information contained herein is accurate and reliable, and has
been obtained from public sources we believe to be accurate and reliable. However,
such information is presented “as is,” without warranty of any kind – whether
express or implied. The author of this report makes no representations, express or
implied, as to the timeliness or completeness of any such information or with regard
to the results to be obtained from its use. All expressions of opinion are subject to
change without notice and the author does not undertake to update or supplement
this report or any of the information contained herein. This is not an offer to buy any
security, nor shall any security be offered or sold to any person, in any jurisdiction
in which such offer would be unlawful under the securities laws of such jurisdiction.

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Executive Summary

We believe Newtek Business Services (“Newtek” or “NEWT”) is a Pyramid Scheme dividend structure2
predicated on (1) Paying dividends that are not earned, (2) Systematically overstating the operating
earnings management claims cover the dividend, (3) Systematically overstating the value of its assets,
and (4) Misrepresenting the health of its credit portfolio through: non-economic/unrealistic asset
valuations, and a refusal to recognize credit losses, including to many bankrupt borrowers (we found 37
loans Newtek deems “performing” to borrowers who had filed Chapter 11). These misleading
shenanigans enable Newtek to raise capital from unsuspecting individual investors to finance unearned
dividends. We believe this circuitous process is the lifeblood of Newtek’s public markets existence. With
the tailwind of a historically prolonged credit cycle, management has thus far papered over the
enormous defects of this “business model.” However, economic reality, potentially hastened by
meaningful regulatory enforcement, suggests a material cut to, or the elimination of, the dividend is
inevitable. We see at least 50% downside to the value of NEWT shares.

Newtek’s management uses a variety of accounting tricks to materially overstate its reported income.
With only a handful of sell-side analysts, and a shareholder base dominated by unsuspecting retail
investors, roundtrip transactions with control companies, capitalized servicing that runs through
operating earnings and is then reversed out “below the line” every year since 2014, charging its own
wholly owned subsidiaries rent and managerial fees that run through income but are then excluded as
expenses when valuing those same investments, and a long list of other deceptions have gone
unnoticed despite accounting for 20-30% of annual operating income. And these misstatements are
modest when compared to the credit expenses management has concealed.

The Company’s persistent stock sales to retail investors (through an at-the-market (ATM) offering),
while overstating both earnings and book value, and dramatically misrepresenting the credit
performance of its loan portfolio, is a Securities and Exchange Commission (SEC) issue. But Newtek’s
regulatory risk appears to go far beyond potential SEC sanctions. In this report, we present clear
evidence that the Inspector General (“IG”) recently put the SBA on notice to reign in lenders like
Newtek, who abuse SBA guarantees. Should Newtek lose its SBA Preferred Lender Status, the result
would be catastrophic to earnings.

On October 1, 2019, Newtek confessed it would materially miss its SBA loan origination guidance. When
Newtek announced its Q3’19 results on November 6, 2019, the Company disclosed the SBA had forced
the repurchase of $6.5 million of nonperforming, previously sold SBA loans at par. According to former
SBA employees, including Lender Relation Specialists, the significant spike in compelled repurchases of
severely delinquent loans is a clear sign the SBA is focused on the underwriting deficiencies and
deteriorating performance of Newtek issued loans.3 Further, we do not believe it was a coincidence that
Newtek’s lending shortfall and forced SBA loan repurchase occurred at the same time the Inspector
General was seeking information from the SBA on how it handles high-risk lenders like Newtek. But the
scathing IG report and possibility of SBA action may actually be the least of Newtek’s regulatory
concerns.

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The Department of Justice recently indicted five former officers and employees of banc-serv Partners
LLP, a wholly-owned subsidiary of Newtek, for their alleged $10 million scheme to defraud the SBA.4
Considering the breadth of misrepresentation and manufactured earnings that we believe exists at
Newtek, the alleged fraud at bank-serv may be the tip of the iceberg, even if the abuses took place prior
to its control. In our opinion, the scope of Newtek’s unscrupulous business practices warrants
investigations by multiple regulators responsible for protecting diverse stakeholders. As such, we have
delivered our findings to the SEC, the SBA’s Office of Credit Risk Management (OCRM), the Office of
Inspector General at the SBA, the Administrator for the Atlantic Region of the SBA, and the Office of
Representative Judy Chu (D-CA), Chairwoman of the House Small Business Subcommittee on
Investigations, Oversight and Regulations, which is charged with oversight of the SBA and the SBA
Inspector General.

Putting aside Newtek’s substantial regulatory risk, we believe its business model will ultimately collapse
from gravity alone. As we illustrate throughout this report, Newtek is sprinting on an unvirtuous, ever-
accelerating treadmill. At this point, a graceful dismount seems impossible. Simply put, Newtek:

1. Originates subprime commercial loans primarily through unaffiliated brokers and referral
agents,
2. Immediately recognizes more than 100% of the loan economics by selling a government
guaranteed participation in the loans,
3. Retains a growing portfolio of first loss, unguaranteed participations in the loans it originates,
4. Dramatically mismarks those assets to show book value growth – despite atrocious credit
performance in its money-losing subprime loan portfolio,
5. Declares dividends based on overstated operating earnings,
6. Then raises capital to (a) cover the shortfall between operating cash flow and the dividends
declared, and (b) originate even more subprime commercial loans to keep the cycle intact.
As Newtek repeats this cycle every quarter, the distortions become more pronounced: the toxic credit
portfolio gets larger, requiring even more nonsensical asset marks, and the gap between what the
Company pays out in dividends versus what it actually earns becomes wider and wider.

The Newtek story is remarkably similar to the subprime mortgage originators a dozen years ago. They
too made loans to poor credits, front-end loaded earnings recognition while deferring credit expenses,
and were forced to accelerate the process every year just to stand still. Like its subprime mortgage
originating cousins, the question for Newtek is “when, not if” the game ends badly. Considering
Newtek’s 30-day+ delinquency rate of 18.9% on September 30, 2019 was the highest of any public
lender in the country, we believe the “when” is fast approaching.5 The victims of management’s choice
to obfuscate, overstate and embellish will ultimately be retail investors who have been misled into
believing they own a stable, low leverage, income vehicle.

We believe at least 50% downside exists in Newtek’s stock.

Below, we summarize the sections of our first Newtek Business Services report. Each of these sections is
discussed in more detail in the body of the report:

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1. Newtek in Brief and a Crash Course in SBA Lending (pg 14)


Newtek is a Business Development Company (BDC) focused on Small Business Administration (SBA)
loans. The Company converted to a BDC in 2014, which allowed the balance sheet and income
statements of its wholly owned “control companies” to be deconsolidated. We document how
management has methodically used this exemption to manufacture earnings to create the perception it
earns the dividends management declares and boost book value to mask pervasive credit losses.

A BDC is a Registered Investment Company (RIC). The SEC requires RICs to disclose the name, cost basis
and fair value of each of its investments on a quarterly basis. This disclosure allows investors to track
portfolio performance, lawsuits, bankruptcy filings, delinquency trends, and non-accrual migrations
within Newtek’s loan portfolio. However, the structure also allows Newtek to materially manipulate the
value of its investment portfolio because there is no observable market for SBA loans or its control
companies. We examined over 2,000 of Newtek’s individually listed SBA loans and found a troubling
pattern of aggressive, often ridiculous asset value distortions (sections 3 and 4 of this report).

Our analysis indicates Newtek is operationally incapable of monitoring credit deterioration on a timely
basis and has systematically deceived investors about the performance and health of its SBA loan
portfolio. We show how these contortions materially overstate earnings and net asset value (NAV),
which is consequential because Newtek constantly raises capital on these misstated financials to stay on
its treadmill.

The second part of this section provides salient background to understand the Small Business
Administration, pertinent characteristics of SBA loans, and lender business models in this asset class.
Unsurprisingly, Newtek has chosen the most aggressive, highest risk strategy available to SBA lenders,
premised on 1) selecting the riskiest borrowers amongst a pool of risky borrowers, 2) front-loading
reported earnings, while 3) deferring and/or excluding the most significant expenses.

2. Operating Cashflow Does Not Cover the Dividend… In Fact, it’s Not Even Close (pg 17)
Newtek’s stock promotion relies on aggressive definitions of income and preposterous valuation marks.
This is a requirement because Newtek’s operating cash flow falls significantly short of reported
operating income, and by extension, operating cash flow doesn’t cover the dividend. Since the beginning
of 2018, Newtek’s dividend payments have exceeded adjusted operating cash flow by $29.7 million. We
would note that our analysis generously adjusts the Company’s presentation of operating cash flow
UPWARD to give credit for the accounting increase in the cost basis of loans. Considering 2:1 BDC
leverage limits,6 the $15 million of equity Newtek raised in recent quarters allowed it to also raise $30
million of additional debt. These raises bridged the $29.7 million cash flow shortfall relative to the
dividend, while also providing capital to sustain the treadmill with additional SBA loans.

Exhibit 1: Even When Adjusted Up, Cash Flow Falls Far Short of the Dividend

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$s in thousands 2018 2019


Q1 Q2 Q3 Q4 Q1 Q2 Q3

Operating cash flow ($20,818) $8,180 ($36,906) ($24,122) ($17,140) ($9,572) ($18,961)
Add: Increase in cost basis of loans and investments $14,475 $16,977 $21,190 $27,827 $15,812 $16,370 $36,195
Net adjusted operating cash flow ($6,343) $25,157 ($15,716) $3,705 ($1,328) $6,798 $17,234
Cumulative adjusted operating cash flow ($6,343) $18,814 $3,098 $6,803 $5,475 $12,273 $29,507
Cumulative dividends paid ($7,202) ($14,839) ($23,383) ($32,433) ($39,787) ($48,269) ($59,168)
Cumulative delta between cash flow and dividends ($13,545) $3,975 ($20,285) ($25,630) ($34,312) ($35,996) ($29,661)
Source: Newtek filings

Given the lack of cash income, stated leverage since the beginning of 2018 has increased from 0.78 to
1.34 debt-to-equity, or 72%. When factoring in Newtek’s fictional asset valuations, economic leverage
has increased significantly more.

3. Reported Earnings Are Manufactured and Distort Newtek’s Economic Reality (pg 19)
Newtek’s management points investors to “adjusted net investment income” (ANII) as the metric to
measure its operating performance and indicator of dividend capacity. Based on the Non-GAAP ANII
calculation, it would appear Newtek covers its dividends. Since the beginning of 2018, Newtek has
reported $3.59 of cumulative ANII per share, while paying $3.24 in dividends. However, Newtek’s
reported earnings are not representative of the Company’s cash flow or economics.

As is the case with most pyramid schemes, a lack of operating cash flow can expose the integrity
deficiency of adjusted operating earnings. Specific to Newtek, the deficiency is the result of non-cash
levers management uses to manufacture and inflate “reported” earnings. This misconduct does not
impact the cash flow statement.

Newtek uses multiple techniques to manufacture and inflate “adjusted net investment income”
including, but not limited to:

• Recognizing interest income accrued on bankrupt borrowers


• Roundtripping dividends from “control companies”
• Charging wholly owned control companies rent, classifying the rent as income to the parent, and
then raising the rent to provide extra income
• Charging “managerial assistance fees” to control companies and recognizing those fees as ANII
(but then adding those fees back when valuing its control companies)
• Including non-cash capitalized servicing gains in ANII when it sells SBA loans and then later
writing those gains down through unrealized depreciation outside of the ANII calculation.
• Failing to recognize significant credit losses (Section 6 is devoted to this shenanigan)

4. Management’s Approach to Valuing Assets Means Stated Book Value is Disconnected from Reality
(pg 27)
Newtek would like investors to believe its valued at 140% of Net Asset Value. However, extensive
diligence suggests Newtek’s accounting schemes and unrealistic portfolio marks result in a materially
overstated published book value. We believe if Newtek accurately reflected its economic book value, or
used a more conventional approach to asset valuation, book value would decline substantially. Their

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systematic approach to overstate asset values affects more than just optics. It increases the statutory
borrowing capacity stipulated by BDC regulations and is therefore consistent with other management
strategies to ensure access to capital necessary to stay on its treadmill.

Of its 2,058 performing loans, Newtek has marked an unimaginable 1,235 at a premium to par.7
Included within the loans carried at a premium to par are 442 loans that are marked in-line, or at a
premium to where the Company sold the guaranteed portion of their SBA loans. This defies financial
logic and is just one material driver of the overstated book value. Specifically, these unguaranteed, first
loss tranches carry no prepayment penalties, warrants, or other mechanism that would allow Newtek to
receive more than the interest and principal due from the borrowers. The credit quality of these loans is
extremely poor considering borrowers are participating in a government subsidized lending program. In
fact, the first line of the second paragraph of the SBA 7(a) regulations states, “No financial assistance
shall be extended pursuant to this subsection if the applicant can obtain credit elsewhere.” There is no
justification for Newtek to carry these unguaranteed loans at a premium to par.8 To the contrary, every
loan Newtek holds has an economic value less than par once the 75% guaranteed portion is sold.
Valuing, first loss participating, nonguaranteed loans at a premium to face is not only unprecedented
among SBA lenders, but completely illogical.

A few representative examples of the type of loans and marks Newtek carries include:

• The unguaranteed loans to Purple Cow House of Pancakes at 115% of face


• Little Tree Huggers Child Care at 114% of face
• Sixteen different bowling alley loans at significant premiums to unpaid principal

Little Tree Huggers Purple Cow House of Pancakes

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Beau’s Billiard, Bowling, and Arcade

We encourage investors to peruse the 1,200+ examples of premium marked loans Newtek discloses in
its 10Q and discover for themselves that we have not cherry-picked examples; and that nonsensical
valuations are a defining feature of the portfolio.

As preposterous as the premium marks on Newtek’s performing loan portfolio appear, management’s
subjective valuation of its non-performing loans is even worse. Our examination of Newtek’s non-
performing loan portfolio found dozens of examples of loans being carried at or near par, despite the
borrower having filed for bankruptcy protection.

Newtek’s aggressive and systematic overstatement of book value extends beyond its SBA loan portfolio.
Consider Newtek’s 50/50 joint venture with Blackrock TCP Capital Corp, which became operational
during Q3’19. In the first quarter the JV was operational, Newtek recognized a 44.3% annualized
return on its $12.2 million cost basis investment by immediately marking up loans and the equity
allocated to the JV. Newtek’s mark was a 150% premium to the more conventional mark its 50/50
partner took on the exact same asset.

Newtek’s aggressive approach to overstating book value appears cultural. In the third quarter of 2019
alone, Newtek took the following marks on wholly unguaranteed loans the JV had originated over the
previous three months:

• Two floating rate loans totaling $11.1 million on real estate for a youth soccer complex. Newtek
marked the loans at a 9.6% premium to principal just a few weeks after origination.
• A $2.3 million unguaranteed loan to 10 28th Ave SW Associates LLC, which appears to be a Planet
Fitness gym in Minot, North Dakota. This loan was marked to a 10.3% premium a few weeks after
origination.
• A $436,000 loan marked up to 108.9% on a suburban office building in Cocoa Beach, Florida, housing
what appears to be a derivatives trading company.

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• An $11.5 million loan on warehouse space that houses a movie and video camera rental business in
North Hollywood, California, which was immediately marked up by 4 points.

Finally, in this section we discuss how Newtek values its “control” investments, which are also
systematically overvalued and misrepresented.

5. Is Newtek the Riskiest or the Worst Lender in America? Perhaps Both. (pg 41)
At September 30, 2019, Newtek’s non-performing loan portfolio was 11.6% of total loans (Note: Newtek
reported their non-performers at 9/30/2019 as 10.23%, however, the Company inexplicably excluded
$6.5 million in non-performing loans it was forced to repurchase from the SBA). According to S&P
Global, there were only three other public lenders in the country with non-performers exceeding 10%.
Incidentally, the other three were: RAIT Financial (RASFQ) – which filed for bankruptcy, World
Acceptance (WRLD) – a troubled deep subprime lender who shares an auditor with NEWT, and AG
Mortgage Trust (MITT) – which only qualifies because their business model is acquiring non-performing
loans at deep discounts to par. Looking more broadly, only ten other lenders had non-performers
exceeding 5%. Four of the ten have business models that acquire non-performing loans, which leaves
only six other public lenders in America with non-performing ratios on originated loans that exceeded
5%.

Exhibit 2: Highest Non-Accrual Rates Among Public US Lenders

Nonaccrual Loans/
Total Loans

Colony Credit Real Estate, Inc. 5.49%


Enova International, Inc. 6.63%
New Residential Investment Corp. 6.68%
Ellington Financial Inc. 6.74%
On Deck Capital, Inc. 7.29%
E*TRADE Financial Corporation 7.33%
SWK Holdings Corporation 9.70%
AG Mortgage Investment Trust, Inc. 10.12%
World Acceptance Corporation 10.91%
RAIT Financial Trust* 18.75%

Newtek Business Services 11.62%

* Filed for bankruptcy protection


Source: S&P Global

While Newtek’s credit record is uniquely terrible, the trend will further deteriorate based on its 30-day+
delinquency rate of 18.9% at September 30, 2019. According to S&P, Newtek has by far the single

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highest delinquency rate of any public lender in the country. Only seven other US lenders have
delinquency rates over 5%, which includes companies focused on purchasing delinquent loans and RAIT
Financial, who is bankrupt.

Exhibit 3: Highest Delinquency Rates Among Public US Lenders

30-Day+
Delinquency
Rate

Alliance Data Systems 5.13%


Nicholas Financial, Inc. 6.76%
RAIT Financial Trust* 8.56%
Chimera Investment Corporation 10.80%
Nelnet, Inc. 11.49%
Consumer Portfolio Services, Inc. 12.40%

Newtek Business Services 18.90%

* Filed for bankruptcy protection


Source: S&P Global

Newtek’s asset quality is not just bad, it is historically bad, especially in the context of a healthy
economy. At the height of the Great Recession (9/30/08), S&P Global tracked only 18 lenders with non-
performers exceeding 10%. Of the 18, only 3 survived – $24 million market cap Citizens Bancshares
(CZBS), $31 million market cap Oxford Bank (OXBC), and iStar Financial (STAR) which survived because of
significant unpledged real estate assets.

For perspective, Newtek’s abysmal credit performance is unique to Newtek and not just the
consequence of the asset class on which it is focused. In section 5 below we compare Newtek’s credit
record with that of Live Oak Bancshares, a top three SBA originator. The contrast is illuminating to say
the least.

6. Newtek Refuses to Recognize Credit Losses (pg 51)


In its most recent quarter, Newtek reported trailing-twelve month charge-offs of just 0.87%.9 However,
this metric is blatantly misleading due to Newtek’s irresponsible policy towards recognizing losses,
which detract from its ANII metric. By deferring the recognition of losses indefinitely, Newtek hides a
material expense from ANII.

This policy also helps to explain why Newtek has the worst delinquency rate in the country, as
delinquent loans are never charged off. Once a borrower stops servicing debt, Newtek’s policy is to
categorize the loan as non-performing and maintain that status for years, even when clear and

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indisputable evidence exists that a credit loss is inevitable. If Newtek ONLY recognized the $19.3 million
of unrealized depreciation identified in its current portfolio of non-performing loans, credit losses
running through ANII over the last 12 months would have increased by 600%. Even this example
materially understates the magnitude of embedded losses Newtek will eventually suffer. At
9/30/2019, Newtek had 63 of its 185 nonperforming loans marked at over 90% of par, with the
majority of those marked at over 95%. Loss severities on unguaranteed SBA loans will be orders of
magnitude larger once these loans are ultimately charged off.

Newtek’s loss recognition policy, in concert with its promotion of ANII, paints a brazenly false profile
of Newtek’s profitability. For example, Newtek made two loans to Calhoun Satellite, totaling $913,000.
Calhoun filed for Chapter 11 bankruptcy protection on August 22, 2017.

Exhibit 4: Calhoun Satellite Communications Chapter 11 Bankruptcy Filing

Source: United States Bankruptcy Court

Despite Calhoun’s 2017 bankruptcy filing, Newtek had not realized its loss on these loans two years
later, only recognizing “unrealized depreciation” which never hits ANII.

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Source: Newtek Q3 2019 10-Q

If Newtek realized the loss content on the Calhoun loans, this single borrower would have reduced ANII
by $0.05 per share and increased the trailing 12-month charge-off ratio by 28.4%. Just one loan among
2,240 total loans, 185 non-performing loans, and 285+ delinquent loans. An examination of Newtek’s
portfolio reveals dozens of obvious unrealized losses being unscrupulously kept from the income
statement (eg - Bear Creek Entertainment: $1.1 million of losses; Europlast: $330,600 of losses despite
becoming a non-performer in 2015; Capstone Pediatrics PLLC: originated in Q2’15, filed for bankruptcy
in Q4’15 and has still not been written off).

7. The SBA Has Been Put on Notice to Reign in Newtek (pg 53)
On November 12, 2019, The Office of Inspector General submitted a report summarizing the results of
its “Audit of [the] SBA’s Oversight of High-Risk Lenders.”10 Per the IG report, the “objective was to
determine whether SBA performed effective oversight of high-risk lenders to identify and mitigate
risks.” Based on the volume of originations and the default rate of the lenders the IG studied in its audit,
the conclusion is that the SBA’s Office of Credit Risk Management (OCRM) failed to stop lenders like
Newtek from abusing the SBA 7(a) lending program. In fact, there is evidence to suggest Newtek was a
case study for the IG’s findings.

The audit and subsequent report found the “OCRM did not always perform effective oversite of high-risk
lenders to identify and mitigate risks.” Specifically, the report found OCRM did not perform the lender
and loan file reviews that most effectively uncover abuses. The IG found that as a consequence of the
OCRM deficiencies “there is an increased risk that lenders with repeated identified systematic
deficiencies will continue to participate in SBA’s 7(a) and 504 loan programs, which could jeopardize
the integrity of the programs and increase the risk of financial loss to the $120 billion loan portfolio.”11
We believe the IG may as well have referred to NEWT by name. In its response to the IG report, the
SBA agreed with the critiques levied against it by the Inspector General and will implement six
recommended remediations.

While not totally apples-to-apples given Newtek’s tendency to defer the realization of credit events in
order to inflate ANII, the divergence between the delinquency rate of Newtek originated loans and
those of the SBA 7(a) program are dramatic. While Newtek delinquencies have been steadily climbing to
its 18.9% rate reported at 9/30/19, the delinquency rate for the overall 7(a) programs declined to 0.7%
as of the last available disclosure.

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Based on Newtek’s underwriting performance and credit trends, it seems clear the SBA would be better
off if Newtek’s preferred lender status was revoked. We have delivered documented summaries of our
findings to Inspector General Hannibal Ware and Assistant Inspector General for Audits Andrea
Deadwyler, Steve Bulger, the Administrator for Region II of the SBA (Newtek’s region), and the office of
Representative Judy Chu (D-CA), Chairwoman of the House Small Business Subcommittee on
Investigations, Oversight and Regulations which is charged with oversight of the SBA and the SBA
Inspector General.

8. Management’s Promotion & Obsession with NEWT’s Stock Price (pg 54)
CEO Barry Sloane’s obsession with NEWT’s stock price is akin to a penny stock promoter. Considering
Newtek requires access to the capital markets to keep the house of cards standing, we believe the
promotion and misrepresentations are intentional and coordinated. Several recent examples of
Newtek’s efforts to promote its stock price include:

• During the broad market sell-off in December 2018, Mr. Sloane abruptly scheduled a public
conference call the day after Christmas to encourage investors to buy the stock.
• On December 17, 2018, Newtek announced a 300,000-share stock repurchase plan to encourage
investors to buy the stock. Not a single share was repurchased and Newtek was selling its stock
again the following quarter (Q1’19).
• Also, on December 17, 2018, the Company issued an 8-K to alert investors NEWT had been removed
from the relatively obscure KBW Nasdaq Financial Sector Dividend Yield Index, suggesting the
weakness in NEWT’s share price was a technically driven buying opportunity.
• Management published preposterous statements meant to deceive retail investors into believing
Newtek is not just a subprime commercial lender, but in fact develops and uses better CRM
software than Salesforce.com and is now an investment play on cloud computing.
“In addition, we have developed a financial and technology-based business model that
enables us and our controlled portfolio companies to acquire and process our SMB clients in
a cost-effective manner. This capability is supported in large part by NewTracker®, our
patented prospect management technology software, which is similar to, but we believe is
better than the system popularized by Salesforce.com.”12

“We can compete against Google and Microsoft Azure in this space.” 13

Exhibit 4: Barry Sloane; Newtek commercial

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Source: Newtek Television Advertisement

9. Lack of Independent Board Oversight and Tier 3 Auditor (pg 57)


For the last fourteen years, Newtek’s auditor has been RSM US, LLP. The business model of RSM
provides little oversight to marginal accountants who may not have the qualifications to find
employment at more reputable firms. Considering Newtek’s seemingly aggressive and subjective
accounting policies, we’d note RSM was recently sanctioned for its failure to oversee the conduct of its
accountants14 and appears to be the go-to firm for subprime finance companies utilizing “non-
traditional” accounting policies.15

Newtek’s Board is comprised of just five members, two of whom are non-independent directors (the
CEO and the Chief Lending Officer). Of the three “independent directors,” Mr. Salvatore Mulia has
partnered with Mr. Sloane for 15 years. We believe significant conflicts exist between Board members,
related executives and control companies, which includes the employment of Mr. Sloane’s brother and
nephew in leadership positions.

Newtek’s aggressive and misleading accounting may explain why Mr. Sloane has refused to hire a Chief
Financial Officer. In lieu of a CFO, Newtek relies on its Chief Accounting Officer to report its finances. Yet
even the CAO role appears unstable after Jennifer Eddelson abruptly resigned in 2019 and was replaced
by her 33-year-old subordinate. Ms. Eddelson’s departure followed the abrupt resignation of her
husband, Adam, who served as the controller of multiple Newtek unconsolidated subsidiaries.16 Oddly,
despite the 2019 proxy disclosing Mr. Eddelson resignation, he still lists Newtek as his employer.17

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Assuming Newtek can continue as a going concern, avoids sanctions from the DOJ, SBA and SEC, is not
further implicated in the fraud its former employees allegedly committed, is spared the challenge of
managing its credit portfolio in an economic slowdown, continues to convince its auditor to sign off
on its misrepresentations, omissions, and exaggerations, all while maintaining constant access to the
capital markets to fund cash flow deficits…. Even then, we still see at least 50% downside in Newtek’s
shares as maintaining the façade of economic health becomes untenable under the weight and
velocity of the Company’s deficiencies. We see much more significant downside if/when one of the
levers in its scheme breaks.

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Section 1:
Newtek in Brief and a Crash Course in SBA Lending

One silver lining of the financial crisis of 2007-2009 was that fatally flawed business models, and less
than scrupulous management teams, generally did not survive the significant uptick in credit events and
decrease in liquidity. As a result, individual investors have been largely sheltered from the mischief that
was taking place heading into the upheaval. However, as the crisis fades further into the rearview
mirror, impaired and unsustainable business models run by management teams willing to deceive
investors have returned. Unfortunately, many of these companies attract retail investors. Enter Newtek
Business Services.

Don’t let Newtek’s name fool you. This is not a “business services” company. It is a subprime commercial
lender. In fact, Newtek’s business model has more in common with the pre-crisis subprime mortgage
securitizers such as New Century Financial and NovaStar Financial than it does any business services
company. Like the pre-crisis subprime securitizers, Newtek is on an accelerating treadmill characterized
by front-loading earnings recognition from originating loans to subprime borrowers. The ruse requires
faster growth every year, so credit costs never catch up.

Newtek is a Business Development Company (BDC) focused on Small Business Administration (SBA)
loans. BDCs were created by Congress in the 1980’s through amendments to the Investment Company
Act of 1940. BDC’s must substantially comply with rules and restrictions of the Investment Company Act
with a few exceptions, the most notable being their ability to employ a limited amount of leverage;
initially 1-to-1 but recently increased to 2-to-1. In exchange, the BDC is a pass-through entity that can
avoid paying corporate taxes by passing through its income to investors in the form of unqualified
dividends. For purposes of this investigation into Newtek, the relevant attributes of BDC regulation are
the leverage restriction, the requirement to list the cost basis and fair value of every investment, and
the ability to hold control positions in portfolio investments without consolidating their financials.

Newtek’s decision to convert to a BDC in 2014 had countervailing pros and cons from the perspective of
a management team willing to push the bounds of reason when it comes to the presentation of its
financials. Justifying the conversion was the ability to wholly own “control companies,” yet not
consolidate each subsidiary’s balance sheet or income statement. This gives management levers to pull
when earnings need to be manufactured to cover a core operating shortfall, or boost book value to
make up for a loss in another part of the business. Further, as there is no transparent market for SBA
loans or their control companies, Newtek has wide latitude to discretionarily value assets. This
“flexibility” is regularly on display each time Newtek reports results or files a 10Q or 10K. Please see
Sections 3 and 4 for examples and a discussion of some of the strategies Newtek employs to manipulate
its results.

Unfortunately for management, as a Registered Investment Company (RIC) the BDC is compelled by the
SEC to disclose the name, cost basis and fair value of each investment on a quarterly basis. With this
disclosure, investors have the ability to judge how the portfolio is performing, track lawsuits, bankruptcy

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filings, delinquencies, and non-accrual migrations. We examined more than 2,200 Newtek loans and
noted a clear pattern of deceit. There is a systematic pattern of misrepresentations, dramatic
misevaluations, willingness to ignore and/or defer obvious credit impairments, to accrue income on
loans that stopped paying and will never be collected, and even an operational inability to monitor
credit deterioration on a timely basis. A granular analysis of Newtek’s portfolio leads to one undeniable
conclusion: the portfolio is rife with very serious problems.

As we discuss Newtek’s business, it is necessary to understand how the most prominent SBA lending
program works, the pertinent characteristics of SBA loans, and the various business models
incorporated by lenders focused on originating SBA loans.

The largest SBA lending program is the SBA 7(a) Loan Program. Under the 7(a) program, originators can
make loans that are 75% guaranteed by the SBA. The guaranty allows small businesses that would either
not be deemed credit worthy by traditional lenders or would have to seek out expensive hard money
lenders, to borrow at reasonable rates.

Originators of SBA 7(a) loans can be divided into two categories; 1) portfolio lenders and 2) gain-on-sale
(GOS) originators. Portfolio lenders treat their SBA originations like they would any commercial loan.
They hold 100% of the loans they originate on their balance sheet and gradually earn income as the loan
hopefully performs as expected. These lenders take significant credit risk on the 25% of the loan that is
not guaranteed, but possess the comfort knowing as long as they complied with SBA underwriting
guidelines, their potential loss on any one loan is limited to 25% of the balance. Incidentally, we are not
aware of a single portfolio lender that holds whole SBA 7(a) loans at a premium to face, even though
they own the guaranteed portion.

GOS lenders like Newtek take a different approach. Rather than generate income over time by holding
on to 100% of the originated loans, Newtek immediately sells the 75% guaranteed portion of each loan
for a significant premium. Those premiums have averaged 11.73% over the last several years.18 The
benefits of the GOS model are clear. Rather than earning a return over 5-7 years by patiently earning
interest, most (we will argue more than 100%) of the economics of loans are recognized in the quarter
in which they are originated. Therefore, the more borrowers a lender can find, the more that can be
earned today.

There are very significant drawbacks to the GOS model. First, by front-loading earnings recognition,
companies that would like to show consistent earnings growth are forced to constantly increase
originations. This severely limits management’s ability to look at the lending environment or economic
outlook and determine that the prudent thing to do would be to pullback on lending. This is evident in
Newtek’s results as the Company is constantly driving to lend more than it did the year before to (1)
overcome a higher share count and higher debt load, and then (2) show earnings per share growth.

Put another way, if management decided that for one reason or another it was prudent to cease, or just
slow the growth of the unguaranteed SBA loan portfolio, earnings would plummet, and the dividend
would be cut materially. This was the “challenge” faced by subprime mortgage originators in 2007, as
well as other since defunct BDCs such as American Capital Strategies and Allied Capital (which

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incidentally unraveled in part from an investment in a rogue, top 10 SBA lender19). In fact, it is the
dilemma of all lenders that pursue a capital-intensive business model which front loads revenue, but the
capital intensity and credit risk are long-term.

The second drawback is the lender is left with the 25% unguaranteed, high risk, low yielding (relative to
the credit risk) participation in the loans it has sold. Over the course of the last several years Newtek has
collected over 2,200 of these low-quality assets, of which 18.9% are delinquent, and 11.6% are
nonperforming.

The third drawback is in order to drive the immediate gratification of GOS revenue, Newtek must be
willing to increase the size of its toxic, money losing unguaranteed SBA loan portfolio. The residual-risk
loan portfolio grows at a materially faster rate than the Company can grow GOS revenue, piling up on
the balance sheet, losing money and consuming capital. Worse still, the delinquent and non-performing
loans are growing at an even faster rate than both originations and loans. This is the definition of
unsustainable and yet the treadmill continues to accelerate.

Exhibit 6: Unsustainable “Business Model”

How Much Longer Can This Last?


12/31/2016=100
350.0

300.0 50.6% CAGR


250.0

200.0
24.3% CAGR
150.0
17.7% CAGR
100.0

12 month trailing originations Portfolio at cost Non-performing loans

Source: Company documents

It’s worth noting a couple other mechanics of SBA 7(a) lending. The SBA’s guaranty is contingent on a
number of underwriting and documentation criteria.20 Under normal conditions a lender can only lose
money on the participation it keeps. However, when the SBA determines its very specific guidelines
were not followed it can revoke its guaranty and force the originator to buyback the loan at par, without
the benefit of a guaranty. The SBA directs a lot of resources to audit the underwriting of loans that stop
performing and is very willing to put nonperforming loans back to the originator. As such, if a lender is

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not adhering to the SBA’s rules and regulations, the lender may have credit exposure equal to 4-times
what it shows on its balance sheet. This is exactly what is happening when Newtek is compelled to buy
back loans from the SBA, and these forced loan repurchases have been spiking.

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Section 2:
Operating Cashflow Does Not Cover the Dividend… In Fact, it’s Not Even Close

This report is full of descriptions of how Newtek chooses to define its income, examples of preposterous
valuations and illustrations of laughable stock promotion by management; all the while begging the
question, how do their accountants and investors let them get away with it? Newtek does not and
cannot generate sufficient cash to cover the dividend its largely retail investors value so dearly. In fact,
we generously adjust the Company’s presentation of operating cash flow UPWARD and find internally
generated cash is still insufficient to pay its dividend, which necessitates external capital to cover
payouts to investors.

Over the last seven quarters (since the beginning of 2018), Newtek has paid $29.7 million more in
dividends than it has generated from adjusted (upward) operating cash flow. The delta has
incontrovertibly been financed with equity and debt issuance. Until recently, BDCs were limited to 1-to-
1 leverage. It is not a coincidence that over the period illustrated here, Newtek raised just over $15
million of equity, which allowed it to raise an additional $15 million in debt. Combined, the $30 of
capital raised perfectly bridges the $30 million dividend coverage shortfall.

Exhibit 7: Even when adjusted up, cash flow does not cover dividends

$s in thousands 2018 2019


Q1 Q2 Q3 Q4 Q1 Q2 Q3

Operating cash flow (as reported by NEWT) ($20,818) $8,180 ($36,906) ($24,122) ($17,140) ($9,572) ($18,961)
Add: Increase in cost basis of loans and investments $14,475 $16,977 $21,190 $27,827 $15,812 $16,370 $36,195
Net adjusted operating cash flow ($6,343) $25,157 ($15,716) $3,705 ($1,328) $6,798 $17,234
Cumulative adjusted operating cash flow ($6,343) $18,814 $3,098 $6,803 $5,475 $12,273 $29,507
Cumulative dividends paid ($7,202) ($14,839) ($23,383) ($32,433) ($39,787) ($48,269) ($59,168)
Cumulative delta between cash flow and dividends ($13,545) $3,975 ($20,285) ($25,630) ($34,312) ($35,996) ($29,661)
Source: SEC documents

Newtek’s third quarter 2019 cash flow tables unequivocally show Newtek used $45.6 million of cash
flow from operations. To bridge the cash flow shortfall relative to its dividend, Newtek has raised $42.2
million of cash from financing (selling debt and equity). As seen in the table below, and discussed in this
section, a material shortfall exists even when adjusting cash flow from operations upward by adding
back the increase in the cost basis of investments.

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Exhibit 8: Operating cash flow

Source: Newtek September 30, 2019 10Q

Since the beginning of 2018, generously adjusting cash flow for increases in the cost basis of
investments would add $148.8 million to the $119.3 million in negative operating cash flow reported. As
such, the adjusted “economic cash flow” would still be just $29.5 million over the last 7 quarters. By
comparison, Newtek declared and paid $59.2 million of dividends over the same period, resulting in a
$29.7 million cash flow deficit relative to the dividend.

Given the lack of cash income, stated leverage since the beginning of 2018 has increased by over 70%,
from 0.78 debt-to-equity to 1.34 debt-to-equity. Economic leverage has increased significantly more if
the Company’s fictional asset valuations are considered.

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Section 3:
Reported Earnings Are Manufactured and Distort Newtek’s Economic Reality

Perhaps it goes without saying, but when operating earnings consistently appear to cover dividends, but
operating cash flow consistently does not, something is wrong with one of the two measures. Newtek
has a plethora of levers it pulls to manufacture earnings, while the cash flow statement is not subject to
shenanigans such as intracompany payments or the exclusion of cash expenses in adjusted income
definitions.

With most Pyramid Schemes, operating cash flow generally exposes integrity deficiencies in metrics such
as adjusted operating earnings. Newtek management promotes “adjusted net investment income”
(ANII) as the best gauge to measure operating performance and its ability to distribute dividends.
Unsurprisingly, ANII appears to cover the dividends Newtek declares. Since the beginning of 2018,
Newtek has reported $3.59 of cumulative ANII per share, while paying $3.24 in total dividends. However,
as discussed in the last section and as illustrated in this section, Newtek’s reported earnings are not
representative of the Company’s cash flow or economics. The difference between the two metrics is the
result of management’s tools to manufacture and inflate “reported” earnings. This misconduct does not
impact the cash flow statement.

Some of the tools management uses to overstate Newtek’s reported earnings include:

•Failing to recognize significant credit losses (Section 6 is devoted to this shenanigan)


•Recognizing interest income accrued on severely delinquent and even bankrupt borrowers
•“Roundtripping” dividends from “control companies”
•Subleasing office space to wholly owned control companies, classifying the rent as income to
Newtek, and then raising the rent to provide extra income
• Charging “managerial assistance fees” to control companies and recognizing those fees as ANII
(but then backing those fees out when valuing their control investments!)
• Capitalizing non-cash servicing gains through ANII and then writing those gains down through
unrealized depreciation which never flows through ANII. This is another method Newtek uses to
exclude credit losses in its operating income calculation as defaulted loans erode the value of
the capitalized servicing asset.
Newtek has a tacit policy of only recognizing credit expenses through ANII after all efforts have been
made to fully resolve a defaulted loan. As such, the inherent losses in loans like:

• Mojo Brands Media which filed Chapter 11 on May 1, 2015


• Custom Software, Inc which filed for bankruptcy protection on February 5, 2016
• T&B Boots which declared bankruptcy on June 4, 2018
• B&B Fitness and Barbell which filed bankruptcy on June 6, 2016
…and dozens of other companies that have filed for bankruptcy, or ceased operations, have yet to be
recognized through ANII.

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If we GENEROUSLY assume the losses imbedded, but not yet realized through earnings at Newtek, are
ONLY equal to the net unrealized depreciation the Company acknowledges through its highly
questionable valuation methodology, we can identify $19.3 million of credit losses that have been
hidden from investors. Realized credit losses will ultimately be much higher than $19.3 million as this
figure only includes the unrealized depreciation management acknowledged thus far and as
documented in this report, management never chooses to value an asset conservatively when there is
an option to be aggressive. Further, this cohort of nonperforming loans includes dozens of severely
delinquent, and even bankrupt borrowers, for which Newtek continues to value their unguaranteed
participation at or very close to par. Finally, the $19.3 million does not reflect any of the inevitable losses
from the 100+ loans that Newtek categorizes as performing, despite significant delinquency.
Nonetheless, illustrating how severely Newtek overstates its results by hiding credit losses, the $19.3
million equates to $1.00 per share of fictitious “earnings.”

Another technique Newtek uses to overstate earnings and the health of its credit portfolio is accruing
interest income from borrowers who are severely delinquent. Newtek acknowledges that 18.9% of its
unguaranteed SBA loans are delinquent, with the vast majority severely delinquent. Specifically, more
than 84% of Newtek’s delinquent loans, or 15.9% of total loans, are greater than 90 days delinquent.
Incredibly, many of these loans are still deemed current and performing by Newtek. In its third quarter
10Q filing, Newtek disclosed only 11.6% of loans are on non-performing status (i.e. not contributing to
ANII), which means Newtek is accruing interest income on the 4.3% of its loan portfolio that is over 90
days delinquent (Note: in its investor presentation, NEWT inexplicably states nonperformers are 10.2%
of loans, which excludes nonperformers the SBA has forced the Company to repurchase at par). But it
gets even more dishonest. We found 37 loans in the third quarter 10Q where Newtek continues to
accrue interest despite the fact the borrower filed for bankruptcy protection.

Exhibit 9: 18.9% delinquencies at 9/30/2019

Source: 9/30/2019 10Q

Exhibit 10: 11.6% nonperformers once you read the fine print

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Source: Newtek Investor Presentation; 11/7/2019

The timing and amount of dividends Newtek pays itself from portfolio companies is another scheme
designed to manipulate earnings. For example, and as seen in Exhibit 11, Newtek paid itself $8.975
million in dividends from Newtek Merchant Solutions (NMS) through the first three quarters of 2019.
And as is apparent in Exhibit 12, the result of these dividend payment was a $3.8 million decline in the
equity account of NMS, indicating dividends through the first nine months of 2019 exceeded income by
$3.8 million. This dividend income was included in ANII, driving “operating earnings” $0.20 per share
above what NMS actually earned through the first nine months of the year.

Exhibit 11: Dividends from control companies

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Source: NEWT 10Qs

Exhibit 12: NMS balance sheet

Source: NEWT 10Qs

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Using controlled portfolio companies to “juice” results was not isolated to 2019, but rather is an
enduring fixture in the Newtek scheme to overstate income. In both 2017 and 2018, “Total members
equity” for NMS declined (net of a capital infusion from merging NMS with another Newtek control
company), and we suspect it declined in previous years as well before Newtek had to disclose NMS’s
balance sheet considering at year-end 2016, the wholly owned portfolio company had negative equity
and appears to have required a capital injection.

It would be incorrect to assume the value Newtek assigned to NMS declined over the first three quarters
of the year since it drew down NMS’s capital account to pay the parent a dividend. As seen in Exhibit 13,
despite a decline in the capital account, Newtek management wrote the valuation of the company UP by
$5 million over the first nine months of 2019.

Exhibit 13: Value of NMS Written Up While the Capital Account Goes Down

Source: 9/30/2019 10Q

There does not appear to be any correlation between what Newtek dividends itself from its control
companies and the net income of those companies. Further, Newtek does not appear to consistently
account for intracompany transactions that should be netted to zero: expenses at the portfolio
companies often become fee revenue at Newtek Hold Co (contributing to ANII). But this is not the way
Newtek accounts for its control companies. In some cases, Newtek charges its wholly-owned portfolio
companies rent and “managerial assistance fees,” which are then reported as operating income
accounting entries for NEWT, even when the portfolio companies are losing money.

Exhibit 14 shows that through the first nine months of 2019, Newtek had charged its control companies
$485,000, or $0.03 per share, in rent for office space in NEWT’s Lake Success, New York office building.
This rental income was a 38% increase year-over-year. We do not believe rental rates in the Lake
Success office leasing market have increased by 38%. Nonetheless, this accounting scheme allows
Newtek to overstate its economic profit, despite no benefit to cash flow as monies simply move from
one NEWT pocket (control companies) to the other (NEWT Holdco).

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Exhibit 14: Charging its Control Companies Rent

Source: 9/30/2019 10Q

In addition to rent, Newtek charges its control companies “managerial assistance fees” for the time
NEWT estimates its officers spend providing “managerial assistance.” Through the first three quarters of
2019 these managerial assistance fees amounted to $1.7 million, or $0.09 per share (Exhibit 15). These
fees are a contra expense, contributing to ANII on a dollar-for-dollar basis by reducing Newtek’s
“Salaries and benefits” expense line. In aggregate, overstating reported income by $2.2 million has some
materiality, but it is more indicative of the misleading reports and culture Newtek embraces., while
helping to illustrate why such a material delta exists between cash flow, ANII, and dividends.

Exhibit 15: “Managerial Assistance Fees” have offset 14% of Newtek’s compensation expense through
three quarters of 2019

Source: 9/30/2019 10Q

Capitalized servicing income is yet another shenanigan Newtek uses to overstate results. When Newtek
books a gain for the sale of the guaranteed portion of SBA loans, part of that gain is the net present
value of the net revenue Newtek expects to receive for servicing the loan over the life of the loan (non-

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cash on Day 1). This non-cash capitalized gain is reflected on the balance sheet as “Servicing assets, at
fair value.” Therefore, unrealized appreciation of the servicing asset would occur if Newtek was
conservative in the assumptions it employed to value this future revenue stream. Conversely, unrealized
depreciation would occur if Newtek were too aggressive in estimating how much it will earn from
serving its loans. Unsurprisingly, Newtek has been consistently overaggressive in its estimates, and as a
result, has recognized “unrealized depreciation” to its serving asset every year since 2014 (when it
converted to a BDC). Simply, it means the gain-on-sale run through operating earnings has been
overstated for the last five years. And despite overstating its operating earnings by overestimating the
value of servicing, Newtek (nor its auditors) have taken steps to provide more accurate assumptions.
Why? Because the offsetting correction, unrealized depreciation, DOES NOT run through ANII.

And make no mistake, the overstatement is material:

• The 2017 “adjustment” accounted for $0.20 of the $1.77 of ANII Newtek reported
• The 2018 adjustment accounted for $0.30 of the $1.94 in ANII reported
• The first three quarters of 2019 adjustment is equal to $0.28 of the $1.65 in ANII reported

Exhibit 16: Unrealized depreciation of the servicing asset through three quarters of 2019

Source: 9/30/2019 10Q

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Exhibit 17: Unrealized depreciation of the servicing asset for 2018 and 2017

Source: 12/31/2018 10K

This significant overstatement of ANII is yet another example of how Newtek’s accounting shenanigans
have insulated reported operating income from its disastrous credit performance. Management may
suggest that its SBA gain-on-sale income has been overstated because of faster repayment speeds than
what was assumed when they estimated the value of servicing revenue. What they will be less willing to
reveal is that SBA loan defaults are treated as repayments since the SBA pays out the holder of the
guaranteed portion of the loan the principal upon default. As such, it is Newtek’s terrible credit
performance that is driving increased “repayment rates,” which in turn causes future cash flow from the
serving asset to be reassessed.

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Section 4:
Management’s Approach to Valuing Assets Means Stated Book Value is Disconnected from Reality

On paper, Newtek appears to be valued at 140% of Net Asset Value. However, Newtek utilizes even
more dishonest creativity to value its assets than it does to manufacture earnings. A more conventional
approach to asset valuation that only considers the most egregious instances of overstatement suggests
NEWT currently trades north of 180% of its net asset value (NAV).

We’ll start with the unguaranteed SBA loan portfolio. Lenders always face legitimate questions about
whether to mark down the value of seemingly impaired loans on their balance sheet. We believe
Newtek may be the only lender in the country willing to mark floating rate, subprime, residual credit risk
loan participations at a premium to par.

Simply put, the non-investment grade participations Newtek holds are by definition worth less than par.
For purposes of an illustration, let’s assume a newly originated $1 million SBA loan, made in a highly
competitive market, for which the guaranteed portion has NOT been sold, is worth par. In other words,
it is worth the sum of the value of the guaranteed portion and the value of the unguaranteed portion. In
the real world, this loan would be worth slightly less than par because a bank would have to put a loan
loss reserve against it, but to be conservative we will assume par is reasonable. Now consider that
Newtek sells off the 75% guaranteed portion at the market clearing premium of 12%. This implies that
the fair value of the 75% guaranteed portion of the loan is worth $840,000. If the whole loan is worth $1
million, and the guaranteed portion of the loan is worth $840,000, this would imply the fair value of the
unguaranteed portion is worth $160,000. In its simplest form, the seller of the guaranteed portion of the
loan would book a gain of $90,000 for the premium received on the 75% of the loan they sold, and the
$250,000 participation piece would be marked down by $90,000, to $160,000. As a result, the
participation piece would trade be worth 64% of face (160K / 250K) to keep the fair value of both pieces
at $1 million.

Exhibit 18: Sum-of-the-parts illustration

Face value of SBA 7(a) loan $1,000.0


Guaranteed portion (75%) $750.0
Unguranteed portion (25%) $250.0
GOS premium available 12.0%
Value of the guaranteed portion to a buyer $840.0
Value of the unguaranteed, first loss position $160.0
Value of the unguaranteed portion as a % of par 64.0%
Source: Copperfield Research

This is admittedly a stylized illustration that ignores some of the value of servicing SBA loans and that
preferred lender platforms can generate some value if they can originate SBA 7(a) loans with reasonable
credit performance. But the example broadly illustrates that the risky 25% participation of SBA loans

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that participate in the first dollar of credit loss are NOT worth MORE than par immediately after
origination.

With this basic algebra in mind, consider at 9/30/2019, Newtek valued 1,216 of its 2,058 performing
loans at a premium to par! This includes over 400 loans that are marked in-line or at a premium to
where Newtek was able to sell the guaranteed portions of their SBA loans. This is incredible! Despite
no prepayment penalties, or warrants, or any other mechanism which could allow Newtek to receive
more than the interest and principal it is due from its borrowers, management has deemed its
unguaranteed, first loss loan participations worth more than the face value of the loan… AND often
Newtek values this unguaranteed piece at a premium to the government guaranteed portions.
Considering the fact 7.12% of Newtek’s performing loans are delinquent, there is simply no justification
for Newtek’s aggressive approach.

The only reasons a loan made in a competitive market should be worth more than par are if the credit
has improved materially from when the loan was made or that the loan carries both a fixed rate and
prepayment protections and interest rates have fallen implying a higher than market yield on the loan.
Neither of these are the case. The interest rate of every loan marked above par floats with Prime, does
not carry any prepayment protection, and has not shown any credit improvement whatsoever.

In the Executive Summary of this report, we provided a few examples of the types of loans Newtek had
determined were worth well north of par, including unguaranteed loans to Purple Cow House of
Pancakes (114.6%), Little Tree Huggers Child Care (114.4%) and 16 of their 20 performing bowling alley
loans. In an effort to demonstrate we did not cherry-pick those examples, we’ll add to the list:

Dink’s Market at 115.9% of par-

Indigo Hair Studio and Day Spa at 115.8% of par-

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And Pitts Package Store at 115.6% of par-

This is not to say these are not good businesses, owned and run by productive entrepreneurs. The point
is there are no circumstances that would support these loans being carried significantly above par.

In fact, despite being the primary servicer of every SBA loan it originates, it is clear Newtek has no idea
as to whether its borrowers are prospering or struggling. We can cite multiple instances, like Ameritube
LLC to which Newtek had extended two loans, valued at 104.7% and 114.6% of par respectively at
September 30, 2019…

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Source: Newtek 9/30/2019 10Q

…and then filed for Chapter 11 bankruptcy protection 48 days later…

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Source: US Bankruptcy Court

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Source: US Bankruptcy Court

There is ample evidence that Newtek does not have the systems in place to understand how its
borrowers are doing, much less determine that loans are worth more than the principal owed. We can
cite multiple recent examples of Newtek’s borrowers filing for bankruptcy without the Company
realizing their borrower was even in trouble.

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Consider Allied Welding as a not particularly unusual example. As of June 30, 2019, the loan is listed in
NEWT’s 10Q as performing and is marked at 110.8% of par.

Source: 6/30/2019 10Q

The problem is that seventeen days later (7/17/19), Allied had filed for Chapter 11 Bankruptcy. Newtek
did finally get the message with the bankruptcy filing as the loan had been deemed “Non-Performing”
by the time Newtek filed its September 30 10Q. Amazingly, the loan was only marked down to 94.5%.

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Source: US Bankruptcy Court

Conference Services International was listed as a performing loan in Newtek’s June 30 10Q…

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Source: 6/30/2019 10Q

…but had filed for bankruptcy protection 3 weeks earlier. Remember, Newtek is the primary servicer of
every SBA loan it originates, yet they seem completely oblivious to the credit profile of their borrowers,
including filing for bankruptcy protection in a U.S. court!

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Source: US Bankruptcy Court

A few more examples among the dozens we have found:

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In Q4 of 2019 two related companies, Cardinal Homes and Alouette Holdings filed Chapter 11
(December 2nd), despite showing up on Newtek’s books at just under $1 million and 105% of par on
September 30th.

Or Recycling Revolution which was marked at 112.6% of cost at 9/30/19 and filed Chapter 11 on
11/7/19. We’ve even found 37 loans to bankrupt companies that Newtek still has categorized as
“Performing.”

Aside from incompetence or fraud, we believe there is simply no other explanation to justify Newteks’s
carrying values. While loans secured by collateral, often real estate, could provide some protection and
recovery, this would not support carrying loans of bankrupt borrowers at, near, or in some cases above
par. For example, Evergreen Pallet LLC, which filed for bankruptcy on September 17th, 2019, just two
weeks before Newtek closed the books on the third quarter. While Evergreen appears to be a troubled
loan for which Newtek has a lien on some collateral, how can a loan to a borrower that has filed Chapter
11 still be accruing interest and marked at 103.7% of par at September 30th…. Especially considering the
vast majority of Newtek’s exposure is unsecured (Exhibit 19), behind the IRS in terms of priority, and in
the same category as other subprime lenders such as Kabbage and hard money lenders such as SRS
Capital. (Note: The difference between the claim listed on the bankruptcy filing and the amount listed in
Newtek’s 10Q is due to sale of the 75% SBA guaranteed interest on this loan.)

Source: Newtek 9/30/2019 10Q

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Exhibit 19:

Source: US Bankruptcy Court

Newtek may claim their loans are often secured by real estate which is one reason investors need not be
concerned by their dramatically poor credit statistics. What we’d point out is that when loans are
secured by real estate, the vast majority of the real estate pledged are single tenant, owner-occupied,
non-centrally located properties worth very little without a viable business paying rent.

It is worth noting, the irrational valuations discussed thus far describe loans that (at least until recently)
were purportedly performing well. What does that say about the true economic value and probability of
repayment of loans this management team has valued at 99% or 85% of par? And what should we make
of the 65 non-performing loans the Company has marked at 90% or higher? We believe the culture of

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deception and exaggeration permeates this organization making any financial presentations subject to
skepticism.

But it is not just the value of its SBA loans that Newtek appears to overstate. In the September 2019
quarter, Newtek’s 50/50 joint venture with Blackrock TCP Capital Corp (TCPC) became operational (the
strategy is to make conventional – as in not guaranteed by the SBA – loans). In its first quarter of
operations, NEWT paid itself a $428,000 dividend and marked up the value of its investment in the JV by
7.5%. Contrast this valuation approach with its 50/50 JV partner, TCPC, who marked up their 50% share
of the JV by 3.0% and did NOT take out a dividend (Exhibit 20). On an annualized basis, Newtek
recognized a 44.3% return on its $12.2 million cost basis investment in its first quarter of operation.

Exhibit 20: Same asset. Different valuation

Source: NEWT and TCBC September 30, 2019 10Qs

Incredibly, the aggressive marks extend to the loans within the JV as well. Consider:

• Two floating rate loans totaling $11.1 million on real estate for a youth soccer complex. Newtek
marked the loan at a 9.6% premium to principal just a few weeks after origination.
• A $2.3 million unguaranteed loan to 10 28th Ave SW Associates LLC, which appears to be a Planet
Fitness gym in Minot, North Dakota. This loan was marked to a 10.3% premium a few weeks after
origination.
• A $436,000 loan marked up to 108.9% on a suburban office building in Cocoa Beach, Florida, housing
what appears to be a derivatives trading company.
• An $11.5 million loan on warehouse space that houses a movie and video camera rental business in
North Hollywood, California, which was immediately marked up by 4 points.

It is as if the concept of lending money and then earning a return as the money is successfully paid
back with interest is foreign to a Newtek’s management who, due to the way it runs its SBA lending
business, is accustomed to recognizing a significant return as soon as it wires proceeds to its borrowers.

Specific to the JV with TCPC, the aggressive accounting and income recognition does not impugn the
integrity of Newtek’s financial statements. Instead, it is just another example of the aggressive and
arbitrary approach Newtek uses to value assets. At least on its Q3’19 conference call, CEO Barry Sloane
seemed to acknowledge the shaky accounting of this new, conventional lending business, equating their
valuation scheme to the method that leads to the nonsensical SBA loan valuations.

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Casey Alexander (Compass Pointe): Alright. So I'm kind of unfamiliar with the process of a DCF analysis
on a loan that creates a mark as soon as the loan is made, that doesn't have a government guaranty
related to it, that marks 105.6 as soon as it goes on the books. Can you give me some more color on how
that process works?

Barry Sloane (NEWT CEO): Sure. The way the process would work, Casey, and it's the same way that we
mark our 7(a) loans. You see, Casey, you look at our Ks and Qs every quarter, right, for the last 5 years?
And when you look at our uninsured portions of our loans, Casey, those are nonguaranteed loans, right?
Is that a yes?

Casey Alexander (Compass Pointe): Yes

Barry Sloane (NEWT CEO): Okay. We use the same methodology to mark these loans as those loans. In
other words, they have no guarantee on it. They are effectively conventional loans in nature because
they're not guaranteed. We take a 100% of the risk on that uninsured portion of the loan portfolio. So
what we do is we're unique in that we use the securitization market. We know where A trade, BBB-
trade, BBs, and we spread the market clearing yield to the value of the loans. Based upon what we
believe will be a 20% cumulative gross default, a 40% severity, which is what we've experienced in the
7(a) world over 17 years. Although we do believe the quality of these loans will be higher, to come up
with a price based upon discounted cash flow. That's how you do it. I mean, you know discounted cash
flow. And it's nothing that we haven't done in the uninsured portion of the 7(a) portfolio. So it's risks. It's
the same credit box. It's just the loans are larger. It's the same ecosystem. It's the same referring parties.
There is nothing different to it.21

Moving on from TCPC, Newtek’s management has also employed a strategy of exaggeration, omission
and tortured definitions to portray Controlled Investments as worth more than their actual value. For
example, Newtek Merchant Solutions (NMS), which has a cost basis of $16.4 million, is listed with a “Fair
Value” of $121.3 million on Newtek’s balance sheet. NMS is an Independent Sales Organization (ISO),
pursuing a business model that involves signing up merchants with banks and processors to offer credit
and debit card purchases. Newtek presents the value it has placed on NMS at 7.6x FY 2019 forecasted
Adjusted EBITDA, which seems reasonable when compared to a selection of payments companies with
EBITDA multiples ranging from 13.6x to 33.3x (Exhibit 21). But there are multiple issues with this
comparison.

1. NMS is NOT a fintech company. Its business is only casually related to the “comparable”
companies management lists as its peers. NMS is soliciting sole proprietor retailers to allow NMS
to bring in a third party’s hardware and connect with another network, so payments can be
processed by someone else. The companies Newtek uses as comps are integrated
software/hardware/networking companies building out payments platforms integrated into the
software applications of restaurants, physician practices, grocery store chains and so on.
2. The multiple Newtek calculates is based on the equity “fair value” of NMS, not the enterprise
value as is presented for the comps.22 The comparables have significant debt and would look
much cheaper if we compared EBITDA to equity value. While Newtek does not disclose how

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much debt NMS has, we do know it has some and believe including it (which is the right way to
look at valuation) would increase NMS’s EBITDA multiple by at least 1 to 2 turns.
3. The multiples of the comparables they present are materially misleading. For example, Newtek
presents Global Payments (GPN) as trading at 36.8x 2019 EBITDA without disclosing that GPN’s
enterprise value includes the $25 billion acquisition of Total System Services that had closed on
9/18/2019, but the 2019 EBITDA figure was based on nine months of GPN-standalone
operations. The meaningful measure of GPN’s valuation is nowhere near 36.8x. We were also
left scratching our head that in a presentation dated December 10th, 2019 they included
Worldpay, Inc. as a comparable trading at 22.2x EBITDA even though Worldpay’s acquisition by
Fidelity National Information Services had closed on 7/31/2019. We looked for a footnote at
least. There was none.
4. The “adjusted EBITDA” figure Newtek uses for NMS is not comparable to the “peers” it
identifies. It backs out the “managerial assistance fees” Newtek charges NMS for the time
management spends on NMS (as noted earlier, management includes the fees for Newtek
Holdco, but now excludes the expenses when valuing NMS). Either management is providing
real service to NMS and the fees should not be backed out or they are an artificial way of
goosing Newtek’s ANII in which case they can be backed out since management is not really
doing anything. If this is the case, Newtek has an IRS issue because it is artificially suppressing
the income of a tax paying subsidiary by transferring income to the non-tax paying BDC.

Exhibit 21: Not comparable

Source: Newtek Investor Deck; 11/7/2019

The valuations of Newtek’s other control companies are also a web of obfuscation. Many no longer
operate and have been written down to zero, including the loans NEWT the BDC provided Newtek’s
wholly owned control companies. In typical Newtek fashion, they have not been completely written off
because that would require admitting to a realized loss which would impact ANII. Others appear on their
way to zero. While NMS accounts for over 60% of “Control Investments” value, there does not appear to

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be any meaningful value in the entire portfolio. Instead, these control investments appear to exist for
the sole purpose of providing management another lever to manipulate the income and book value of
Newtek the parent.

Exhibit 22: “Control Investments”

Source: Newtek 9/30/2019 10Q

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Section 5:
Is Newtek the Riskiest or the Worst Lender in America? Perhaps Both.

Newtek’s non-performing loan portfolio at September 30, 2019 was 11.6% of total loans. We would
note Newtek reported their non-performers at 9/30/2019 as 10.23%, however, the Company
inexplicably excluded $6.5 million in non-performing loans it was forced to repurchase from the SBA.
According to S&P Global, there were only 10 other public lenders in the US with non-performers over 5%
and only three that exceeded 10%. Incidentally, the three with non-performers exceeding 10% include
RAIT Financial (RASFQ), which has filed for bankruptcy, World Acceptance (WRLD), which is a deep
subprime consumer lender that has the same tiny auditor as NEWT (RSM), and AG Mortgage Trust
(MITT), which is in the business of acquiring non-performing loans from other lenders at a deep discount
to face. Four of the other ten lenders with non-performers that exceed 5% actually have business
models focused on acquiring non-performing loans.

Exhibit 23: Highest Non-Accrual Rates Among Public US Lenders

Nonaccrual Loans/
Total Loans

Colony Credit Real Estate, Inc. 5.49%


Enova International, Inc. 6.63%
New Residential Investment Corp. 6.68%
Ellington Financial Inc. 6.74%
On Deck Capital, Inc. 7.29%
E*TRADE Financial Corporation 7.33%
SWK Holdings Corporation 9.70%
AG Mortgage Investment Trust, Inc. 10.12%
World Acceptance Corporation 10.91%
RAIT Financial Trust* 18.75%

Newtek Business Services 11.62%

* Filed for bankruptcy protection


Source: S&P Global

Newtek’s 30-day+ delinquency rate was 18.9% on September 30, 2019. According to S&P Global,
Newtek’s delinquency rate is the single highest of any public lender in the country. Only seven other US
lenders have delinquency rates over 5%, and again that group includes companies which focus on
purchasing delinquent loans.

Exhibit 24: Highest Delinquency Rates Among Public US Lenders

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30-Day+
Delinquency
Rate

Alliance Data Systems 5.13%


Nicholas Financial, Inc. 6.76%
RAIT Financial Trust* 8.56%
Chimera Investment Corporation 10.80%
Nelnet, Inc. 11.49%
Consumer Portfolio Services, Inc. 12.40%

Newtek Business Services 18.90%

* Filed for bankruptcy protection


Source: S&P Global

For perspective, Newtek’s asset quality is not just bad, it is historically bad, especially in the context of a
healthy economy. Looking back to the height of the Great Recession, S&P has record of only 18 lenders
with non-performers that exceeded 10% at 9/30/2008. Of these 18 lenders with non-accruals on par
with Newtek, only 3 survived… and just barely: $24 million market cap Citizens Bancshares (CZBS), $31
million market cap Oxford Bank (OXBC), and iStar Financial (STAR)23 which survived because of
significant unpledged real estate assets.

Newtek’s abysmal credit performance is unique and can’t be attributed to the SBA asset class. This
becomes clear when comparing Newtek to other SBA lenders for which credit statistics are available. A
comparison with Live Oak Bancshares, one of the three largest SBA originators in the country, is
illuminating. As seen in the exhibits below, assuming 100% of Live Oak’s unguaranteed nonperforming
loans are associated with its unguaranteed SBA portfolio, we can calculate a nonperforming loan rate of
2.24%. This implies Newtek originated loans go bad at more than 5-times the rate of this “peer.” And for
the record, Live Oak carries its SBA portfolio at a discount to par.

Exhibit 25: Live Oak Bancshares credit statistics

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Source: Live Oak Bancshares Third Quarter, 2019 Results Press Release; 10/23/2019

Exhibit 26: Live Oak Compared to Newtek

$000 9/30/2019
Live Oak Bancshares
Guaranteed loans serviced $2,802,073
Implied unguaranteed loans on the balance sheet* $934,024
Nonperforming loans $20,959
NPL/Unguaranteed SBA loans 2.24%

Newtek Business Services


Unguarnateed SBA loans (cost) $397,745
Nonperforming loans $46,015
NPL/Unguaranteed SBA loans 11.57%

*Assumes 25% unguranteed participation


Source: Company documents

One explanation for why the credits Newtek originates perform so poorly is Newtek appears to focus
on the worst possible businesses. More than 90% of Newtek’s originations (2,033 out of 2,300 loans)
are Prime +275, which is the SBA mandated maximum yield allowed for the 7(a) program. The maximum
yield fetches the highest price when Newtek sells the guaranteed portions of its originations, but it also
means the Company is left with first loss participations of the riskiest borrowers, within this risky asset
class. Further, SBA borrowers that become better credits will immediately refinance relatively expensive
SBA loans, which never carry pre-payment penalties per SBA guidelines. This suggests Newtek suffers
from a self-inflicted adverse selection process, where the loans that reside in its portfolio are credits
more traditional lenders will not touch.

Worse still, there are indications Newtek’s credit underwriting is getting worse as the company stretches
for growth. The migration of loans from origination to delinquency to nonperforming appears to be
quickening.

Take the single largest SBA loan in Newtek’s portfolio as an example. Newtek originated a $5 million
loan to Simkar LLC Neo Lights Holding Inc in the fourth quarter of 2018 and immediately wrote the
unguaranteed portion up to 109.8% of par (Exhibit 27). Less than one full quarter later, on March 6th,
2019, Simkar LLC filed for bankruptcy protection. Two day later Neo Lights Holding followed suit (Exhibit
28). It appears as though the borrower then attempted to transfer a small amount of cash out of the
bankrupt companies and into the third legal entity to which Newtek lent, but the Bankruptcy Court
Trustee quickly sued Kalco Lighting for Fraudulent Transfer which may provide some insight into the
type of borrowers Newtek has courted (Exhibit 29).

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Amazingly, Newtek appeared in the dark (or worse) as the Simkar loan was further written up to 111%
of par as of the March 31, 2019 10Q (Exhibit 30)! Newtek was eventually alerted to the fact its borrower
had filed bankruptcy as the loan was subsequently classified as nonperforming (Exhibit 31). But by the
end of the third quarter of 2019, the $4.5 million portion of the loan Newtek had sold found its way back
on Newtek’s balance sheet as the Company was compelled to buyback the guaranteed portion of the
loan ($4.5 million) from the SBA at par (Exhibit 32). To recap, Simkar went from a $500,000 loan carried
by Newtek for $555,000, to a $5 million nonperforming loan, to a bankrupt borrower! It is important
to note that the reason Newtek would need to buy the guaranteed portion back is that underwriting did
not meet SBA standards and if that’s the case, it follows that the $4.5 million Newtek repurchased will
not end up being guaranteed by the SBA. And again, this is not an isolated incident. With 35 bankruptcy
filings in 2017, 45 in 2018, 61 in 2019 and given the fact that the majority of loan defaults do not even
involve bankruptcy court, there are many tales similar to the one described above and illustrated below.

Exhibit 27: Newtek Originates a Loan to Simkar LLC, Neo Lights Holding Inc Kalco Lighting LLC in Q4,
2018 and Immediately Marks the Loan to 109.8% of Par

Source: Newtek 12/31/2018 10K

Exhibit 28: The Borrower Almost Immediately Files for Chapter 11 Bankruptcy Protection

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Source: US Bankruptcy Court

Exhibit 29: The Borrower Attempts to Protect Some Cash

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Source: US Bankruptcy Court

Exhibit 30: After the Bankruptcy Filings Newtek Marks the Loan Up Further. It is Still Classified as
Performing

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Source: Newtek 3/31/2019 10Q

Exhibit 31: Newtek Finally Gets the Message That Its Borrower is Bankrupt, Downgrades it to
Nonperforming and Marks Down the Fair Value

Source: Newtek 9/30/2019 10Q

Exhibit 32: Newtek is Compelled to Buyback the Guaranteed Portion it Sold Back in Q4, 2018

Source: Newtek 9/30/2019 10Q

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The SBA and Newtek investors are not the only victims of Newtek’s inability to underwrite good
credits and manage the poor credits. Counterparties that acquire the guaranteed portion of Newtek
originated loans are also harmed. These investors pay significant premiums for their guaranteed
participation in Newtek originations with the assumption they will earn interest on these loans for many
years. However, the rapidity by which many of these loans default leaves some investors with no choice
but to litigate, a route Newtek seems all too willing to pursue.

In a typical case, an investor pays an 11-13% premium for an SBA guaranteed loan that defaults within
90 days of purchase. The default is treated as a prepayment by the SBA as it makes the investor whole
on principal and accrued interest but not on the premium paid or the interest the investor expected to
earn over the life of the loan. To protect purchasers, sales agreements typically include language
protecting the investor should a loan default within 90 days of settlement. Under most circumstances,
this will be a non-binding protection as the chances of a loan default within such a short time period
should be miniscule, but as the facts reveal, Newtek is not an example of a typical lender. We have
found numerous examples of Newtek originated loans defaulting within a quarter of origination, and
even some defaulting so quickly that investors have the opportunity to exercise their rights to be made
whole on the premium they paid Newtek. Even then, Newtek does not want to acknowledge or pay for
its mistakes. (Exhibit 33)

Exhibit 33: Newtek Investors and the SBA Are Not NEWT’s Only Victims

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Source: U.S. District Court, Western District of Tennessee

For the record, Newtek settled with BCMHIF a year later and three years after originating and selling the
loan. While we are not privy to the settlement terms, court records suggest Newtek paid most, if not all
of what was owed. We believe many more lawsuits could follow as Newtek’s credit performance
continues to be the worst in the industry.

The importance of Newtek’s abysmal credit performance can’t be overstated. We believe the SBA is
aware of Newtek’s reckless lending policies and the risk Newtek presents to the SBA program. The
dramatic increase in loans the SBA appears to be forcing Newtek to repurchase suggests the SBA is
looking hard at Newtek and whether it deserves its preferred lender status. Losing said status would be
catastrophic to Newtek’s revenue.

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Section 6:
Newtek Refuses to Recognize Credit Losses

Management is quick to point out that despite their disastrous underlying credit statistics, net credit
losses have been contained. In its most recent quarter, Newtek reported trailing-twelve month realized
charge-offs of 0.87%. This metric is not just misleading, it is wantonly irresponsible to use it as
reassurance given the putrid credit statistics. Management has a misaligned incentive to keep charge-
offs as low as possible, even if it means violating accounting norms.

Realized losses are a component of the ANII metric management uses as its primary measure of
operating performance and dividend capacity. Indefinitely deferring this material expense leaves
investors with the impression Newtek is far more profitable and healthier than is the case. Accurately
reflecting the economics of its loan portfolio would be catastrophic to its scheme to convince investors it
earns its dividend. Unfortunately for Newtek’s retail investors, the losses exist and will eventually be
reflected, whether Newtek extends its charade for another quarter or another two years.

Consider Newtek currently has $19.3 million of “unrealized depreciation” in its current portfolio of non-
performing loans. Had Newtek simply recognized these embedded losses, credit losses running through
ANII over the last 12 months would have increased by 600%. And this illustration materially
understates the magnitude of losses Newtek will eventually suffer (or to be more accurate…eventually
recognize, as the actual losses have already occurred). At 9/30/2019, Newtek had 63 of its 185
nonperforming loans marked at over 90% of par, with the majority marked at over 95%. This is absurd as
loss severities on unguaranteed SBA loans will be orders of magnitude larger once these loans are
ultimately charged off.

Newtek management will undoubtedly argue that its loss recognition policy is a function of BDC
accounting. There are two reasons why this is a disingenuous defense. First, Newtek distinguishes itself
from all other BDCs by including gain on sale revenue in its definition of operating income. It argues
these gains are central to its business model. We don’t dispute this. But given the horrendous credit
performance of the thousands of Newtek originated loans, it is just as true that credit losses are a
central feature of its business model and are an unambiguous drain on cash and capital. An earnings
definition that includes 100% of gains but defers indefinitely 90% of credit losses is disingenuous and
misleading.

Second, Newtek defers loss recognition even when all of the criteria necessary to charge-off a loan exist.
For example, Newtek currently lists a $4.8 million loan to E & I Holdings, PL & PA Farm Products LLC
amongst its long list of nonperforming loans. E & I is another loan for which Newtek ended up with
400% of the credit exposure it expected, as it had to repurchase the guaranteed portion from the SBA
(presumably due to shoddy underwriting). E & I filed for Chapter 11 Bankruptcy on December 28, 2015
and exited bankruptcy on August 1, 2018. As the loan has been on nonaccrual for over four years, any
cash Newtek received from this borrower would be allocated to writing down the cost basis of the loan.
As such, we can track the proceeds Newtek would have received from the borrower. With the

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reorganization settled, the progression of the cost basis of this loan (red boxes in Exhibit 34) indicates
the borrower is paying Newtek about $1,800 per quarter. That equates to 0.15% per year. While we
don’t have access to the final court settlement, it’s difficult to believe no charge off is warranted for a
balance that will take 600 years to pay off at the current pace.

As an aside, we could have included E & I as an example in Section 5 (Stated Book Value has Little
Connection to Reality). How does a management team that claims it “come(s) up with a price based
upon discounted cash flow24 justify its “fair value” of $2.8 million for a loan to a recently bankrupt
borrower that makes payments of $600 per month (blue box)? Newtek makes a mockery of reasonable
accounting, valuation and financial presentation.

Exhibit 34:

Source: Newtek 10Qs and Ks

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Section 7:
The SBA Has Been Put on Notice to Reign in Newtek

On November 12, 2019, The Office of Inspector General (IG) completed a report titled “Audit of SBA’s
Oversight of High-Risk Lenders.”25 The investigation’s objective was to determine whether the SBA
performed effective oversight of high-risk lenders to identify and mitigate risks. The IG’s report and
conclusions are definitive, unambiguous, and we believe create material near-, and long-term risks for
Newtek.

The audit and subsequent report found that “OCRM (the SBA’s Office of Credit Risk Management) did
not always perform effective oversite of high-risk lenders to identify and mitigate risks.” Specifically, the
report found that OCRM did not perform the lender and loan file reviews that most effectively uncover
abuses. Further, the IG report found OCRM did “not always…communicate loan deficiencies they noted
during their high-risk lender reviews to SBA approval and purchase loan centers” (the section of the SBA
that approves and revokes loan guaranties and lenders like Newtek that have been granted delegated
authority to close loans). The IG found that as a consequence of the deficiencies, “there is an increased
risk that lenders with repeated identified systematic deficiencies will continue to participate in SBA’s 7(a)
and 504 loan programs, which could jeopardize the integrity of the programs and increase the risk of
financial loss to the $120 billion loan portfolio.” In other words, the IG concluded there must be
processes in place to ensure lenders like Newtek are not permitted to continue participating in and
jeopardizing the loan guaranty program.

In its response to the IG report, SBA management agreed with the criticism levied by the Inspector
General and agreed to implement each of its six recommendations. After studying the lending methods
and credit performance of Newtek, we struggled to understand how such inadequate lending could be
tolerated by the SBA. It now appears processes were not previously in place to curb Newtek. Based on
the IG report, and subsequent changes at the SBA, it appears checks will now be in place to significantly
curb the risks Newtek’s poor credit performance poses to a program that, if properly administered, will
funnel capital to deserving borrowers.

We have delivered documented summaries of our findings to Inspector General Hannibal Ware and
Assistant Inspector General for Audits Andrea Deadwyler, Steve Bulger, the Administrator for the
Atlantic Region of the SBA (Newtek’s region), and the office of Representative Judy Chu (D-CA),
Chairwoman of the House Small Business Subcommittee on Investigations, Oversight and Regulations
which is charged with oversight of the SBA and the SBA Inspector General.

Our communication with the various parties charged with oversite of SBA lenders may prove to be
redundant. Based on the volume of originations and the default rate of the pool of lenders the IG
studied in the course of its audit, we believe it is possible Newtek was one of the high-risk lenders
studied that led to the IG report’s conclusions and recommendations. The $1 billion “originated and
disbursed” by the five lenders on which the IG focused and the “average default rate of 19% for loans
approved and disbursed in FYs 2015-2017” dramatically narrows down the list of possible subjects. We

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cannot know if Newtek was directly responsible for the report’s finding so we are not definitively
drawing that conclusion. However, we believe the spike in Newtek loan repurchases and lowered
origination guidance, during the period in which the SBA was reviewing and commenting on the IG
report, is unlikely to be a coincidence.

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Section 8:
Management’s Promotion & Obsession with NEWT’s Stock Price

Newtek’s CEO seems more interested in managing his stock price than managing his business. We
believe Mr. Sloane’s rhetoric and investor relations strategies are consistent with a Company that
highlights manipulated, purposefully misleading non-GAAP financial presentations designed to hide
actual economics and profitability. In our opinion, Mr. Sloane’s obsession with the valuation of NEWT
shares is just another indication the Company relies on constant access to the capital markets to keep
the house of cards standing.

We encourage investors to listen to archives of earnings calls and conference presentations to acquire a
flavor for the manner in which Mr. Sloane promotes NEWT’s stock and dismisses reasonable questions.
Newtek’s efforts to promote its stock are typically found among penny-stock promotions.

Examples include:

• Mr. Sloane abruptly scheduled a public conference call the day after Christmas, 2018, during a very
broad market selloff, to encourage investors to buy the stock. A management team compelled to
take such an action is one that recognizes the confidence of individual investors is critical to staying
on their treadmill. On the call Mr. Sloane made the intention of the call clear when he stated,
“Hopefully a few good trading days to improve final pricing on the final day of the year.”26 This
would be important to a CEO that starts most communication with the public with a recap of how
his stock has performed.

• On December 17, 2018, Newtek announced a 300,000 share stock repurchase plan that we was
meant to encourage investors to buy the stock. We did not believe at the time, nor do we now, that
Newtek had any intention of letting capital leave its balance sheet considering fresh capital is what is
needed to prolong its “strategy.” Unsurprisingly, not a single share was repurchased even though
the stock price continued to decline in the midst of the broad market selloff. Also unsurprisingly,
Newtek was selling its stock again the following quarter (Q1’19).

• During December 2018, Newtek issued an 8-K to alert investors it had been removed from the
relatively obscure KBW Nasdaq Financial Sector Dividend Yield Index. We believe the Company’s 8-K
was meant to suggest the weakness in NEWT’s share price was a technically driven buying
opportunity. While factually accurate, the suggestion that this was material information requiring a
Newtek issued 8-K was preposterous. More absurd was Mr. Sloane’s suggestion on a subsequent
conference call that perhaps they were being eliminated from the Index because they had
performed too well, “What really made sense was our price was too high relative to the dividend,
and given that other BDCs, REITs and MLPs are going on hard times, they were trading at significant
discounts to NAV or higher-yielding alternatives. We might have actually been eliminated from the
index because of performance.”27

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• Mr. Sloane’s refusal to hire a chief financial officer also points to his need to control the narrative, “I
will tell you I have, as the primary face of the company, kind of maintained a lot of the Investor
Relations contacts… I'm good at it, and the company has had good results. So I'm going to be willing
to make that change when it kind of makes sense... Everyone's been asking for a CFO for 5 years. So I
think that it's a good question. We don't have one. We can afford it. We don't need it.”28

• Management publishes preposterous statements meant to deceive retail investors into believing
Newtek is not just a subprime commercial lender, but in fact develops and uses better CRM
software than Salesforce.com.
“In addition, we have developed a financial and technology-based business model that enables
us and our controlled portfolio companies to acquire and process our SMB clients in a cost-
effective manner. This capability is supported in large part by NewTracker®, our patented
prospect management technology software which is similar to but we believe is better than
the system popularized by Salesforce.com.”29

Newtek has also tried to convince investors it is a play on cloud computing! Although Mr. Sloane hinted
at Newtek’s opportunity to offer cloud solutions for several years, the salesmanship accelerated late in
2016. On Newtek’s third quarter 2016 conference call, Mr. Sloane proclaimed, “I want to continue to
point out that we are extremely constructive about the marketplace for selling cloud solutions and
technology solutions to small- to medium-sized businesses. There is no question, whether you look at
Gartner, Forrester, every investment bank believes technology and cloud spending is going to continue to
increase, and there are estimates out there that it would be close to a double spend in three years.”

And then in December 2016 to an audience of small cap investors at the LD Micro investor conference
Mr. Sloane promotionally stated, “If you look at Gartner or Forrester studies, there's going to be a huge
movement to the cloud. And it hasn't even touched the small- and medium-sized business market yet.
Would we do well as we manage a Tier 3 data center? Extremely well. We answer the phone 24-seven.
We can compete against Google and Microsoft Azure in this space.”30 Similar promotion about Newtek’s
opportunity in the cloud became a regular aspect in Newtek communications with investors going
forward.

Unsurprisingly, Newtek failed to deliver on the promise of cloud computing. Newtek Technology
Solutions has been written down from what was once 148% of NEWT’s cost basis to 83% of its cost
basis. We suspect the true fair value is a fraction of where it is held on the balance sheet today. In fact,
the performance has been so poor that even CEO Sloane acknowledged the disappointment,
proclaiming on a recent call, “Newtek Technology Solutions, although we haven't talked about it for a
while, one of my investors likes to affectionately refer to me as Jeff Bezos as a joke because this has been
a tough business for us for a long period of time.”31

Exhibit 35: The Cloud Authority?

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Source: Newtek television commercial

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Section 9:
Lack of Independent Board Oversight and a Tier 3 Auditor

For the last fourteen years, Newtek’s auditor has been RSM US, LLP. The business model of RSM
provides little oversight to marginal accountants who may not have the qualifications to find
employment at more reputable firms. In light of Newtek’s seemingly aggressive and subjective
accounting policies, we find it disturbing that RSM was recently sanctioned for its failure to oversee the
conduct of its accountants32 and appears to be the go-to firm for subprime finance companies utilizing
“non-traditional” accounting policies.33

Newtek’s Board is comprised of just five members, two of whom are non-independent directors (the
CEO and the Chief Lending Officer). Of the three “independent directors, Mr. Salvatore Mulia has
partnered with Mr. Sloane for 15 years. In future reports, we will delve into the realm of BDC conflicts
between Board members, related executives and control companies. As a preview, Mr. Sloane’s brother,
Warren, is employed by a Newtek controlled company and was paid at least $120,000 in 2017, while his
nephew, Kyle was paid at least $120,000 last year by Newtek’s subsidiaries. Mr. Sloane’s relatives may
have been paid much more than $120,000, but that figure is the threshold trigger requiring disclosure.

As discussed briefly in Section 7, Newtek’s aggressive and misleading accounting may in part be enabled
by Mr. Sloane’s refusal to hire a Chief Financial Officer. In lieu of a CFO, its Chief Accounting Officer
reports its finances. Yet even the CAO role appears unstable after Jennifer Eddelson abruptly resigned in
2019 and was replaced by her 33-year-old subordinate. Ms. Eddelson’s departure followed the abrupt
resignation of her husband, Adam, who served as the controller of multiple Newtek unconsolidated
subsidiaries.34 Oddly, despite the 2019 proxy disclosing Mr. Eddelson resignation, he still lists Newtek as
his employer.35

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1
Newtek Business Services Corp. Analyst and Investor Day; June 27, 2019
2
We document that NEWT has funded current dividend payments with funds raised from new investors
via its at-the-market equity selling plan as well as the debt the Company can raise as a direct result of
the equity it sells.
3
Pages 45-121 here: https://www.sba.gov/sites/default/files/2019-03/Small_Business_Act.pdf
4
https://www.justice.gov/opa/pr/former-officers-and-employees-indiana-loan-packager-and-servicer-
charged-alleged-10-million
5
S&P Global
6
Small Business Credit Availability Act. Page 1999 here:
https://docs.house.gov/billsthisweek/20180319/BILLS-115SAHR1625-RCP115-66.pdf
7
Newtek September 30, 2019 10Q
8
The only reason one of these SBA non-guaranteed loans could conceivably be worth more than par
would be if the credit has improved materially from when the loan was made or the loan carries a fixed
rate & prepayment protections in an environment of falling rates. None of these circumstances prevail.
9
Newtek Third Quarter 2019 Financial Results Conference Call deck; page 26
10
https://www.sba.gov/sites/default/files/2019-11/SBA-OIG-Report-20-
03.pdf?utm_source=January+21%2C+2020+Daily&utm_campaign=061319+Daily&utm_medium=email
11
ibid
12
Included in Newtek’s 2014 10K. and in every 10K and 10Q since March 15, 2016
13
Presentation by Barry Sloane at the LD Micro Main Event; December 7, 2016
14
https://www.sec.gov/news/press-release/2019-161
15
RSM audits World Acceptance Corporation (WRLD) which utilizes the consumer unfriendly Rule of 78s
to calculate interest on consumer debt, Ebix, Inc. (EBIX) has been investigated by the European
Commission and the Securities and Exchange Commission over various accounting and tax practices,
Medley Management which manages credit impaired Medley Capital and has been sued by multiple
parties for the ill-gotten gains of its twin brother founders (see:
https://www.institutionalinvestor.com/article/b1htf1chpg537f/Two-Harvard-Twins-No-Not-Those-
Twins-Run-One-of-the-World-s-Worst-BDCs-They-re-About-to-Get-Rich) among other questionable
financial services focused businesses.
16
Adam resigned in 2018 according to the 2019 proxy
17
https://www.linkedin.com/in/adam-eddelson-98347714a
18
Newtek Third Quarter 2019 Financial Results Conference Call deck; page 20
19
https://www.nytimes.com/2008/08/03/business/03gret.html
20
pages 45 to 121 https://www.sba.gov/sites/default/files/2019-03/Small_Business_Act.pdf
21
Third quarter, 2019 Conference Call Transcript; 11/7/2019
22
Newtek Third Quarter 2019 Financial Results Conference Call deck; page 35
23
S&P Global
24
Third quarter, 2019 Conference Call Transcript; 11/7/2019

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25
https://www.sba.gov/sites/default/files/2019-11/SBA-OIG-Report-20-
03.pdf?utm_source=January+21%2C+2020+Daily&utm_campaign=061319+Daily&utm_medium=email
26
12/26/2018 Conference Call Transcript
27
ibid
28
Transcript of Newtek Business Services Corp. Analyst and Investor Day; 6/24/2019
29
See note xiii
30
Presentation by Barry Sloane at the LD Micro Main Event; December 7, 2016
31
Third quarter, 2019 Conference Call Transcript; 11/7/2019
32
https://www.sec.gov/news/press-release/2019-161
33
RSM audits World Acceptance Corporation (WRLD) which utilizes the consumer unfriendly Rule of 78s
to calculate interest on consumer debt, Ebix, Inc. (EBIX) has been investigated by the European
Commission and the Securities and Exchange Commission over various accounting and tax practices,
Medley Management which manages credit impaired Medley Capital and has been sued by multiple
parties for the ill-gotten gains of its twin brother founders (see:
https://www.institutionalinvestor.com/article/b1htf1chpg537f/Two-Harvard-Twins-No-Not-Those-
Twins-Run-One-of-the-World-s-Worst-BDCs-They-re-About-to-Get-Rich) among other questionable
financial services focused businesses.
34
Adam resigned in 2018 according to the 2019 proxy
35
https://www.linkedin.com/in/adam-eddelson-98347714a

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