Small Business Credit Risk

1. October 16, 2007 Small BusinessCredit Risk

2. Seminar Agenda • About Sum2 • Recent Credit and Market Events • How Credit Events Effect Lenders • What Can a Small Business Do

3. About Sum2 • Building Sound Practice Foundations for Businesses and Industries • Sum2 is dedicated to the commercialization of sound practices that address risk management, corporate governance, shareholder communications and regulatory compliance • Founded 2002

4. Product Suite • SMB 360°, Small and Mid-Size Business Risk Assessment and Management Tools • PACO™, Patriot Act Compliance Officer • AlphaSource, Portfolio Risk Analysis • Value Added Distributor

5. Some Partners and Clients

6. 2007 Raging Bulls • Markets Awash in Liquidly • Premium Asset Valuations • Money Chasing Deals / Leverage Buying EBITDA • Kramer Going Wild • Kudlow and Goldilock’s America’s Cutest Couple • China and India Driving Demand

7. Signs of Froth Appear • Stephen Schwarzman’s Birthday Party • TXU, Equity Office, First Data, Sallie Mae and other Mega PE & LBO Deals • IB’s Buying Cash Flow Businesses • Hedge Funds Go Public • Dow Crosses 14,000

8. What Goes Up

9. Submerged Risks

10. Against Backdrop Of • Rising Interest Rates • Declining $ / Balance of Trade • Commodities Rising • Oil • Gold • Geo-Political Risk / War • Deteriorating Housing Market • Ballooning Deficit Spending

11. CRB Index Monthly Price Chart

12. Credit Market Problems • Sub Prime Mortgage Crisis • Commercial Paper Market • Contagion to Hedge Funds • Securitization : Structured Finance / CDOs • Funding Sources : Risk Aversion / Liquidity • Housing Crisis: Housing Bubble or Lending Bubble? • Change in Valuation Metrics/Psychology • Credit Default SWAPS / Level 3 Assets

13. Banks Assuming Higher Credit Risk

14. Kamakura Reports Fourth Consecutive Monthly Decline in Global Credit Quality Kamakura Troubled Company Index Rises to 8.0% in September

15. Anecdotal Observations • Report: More Than 300K Ohioans Trapped In Payday Lending Debt (More than 300,000 Ohioans are trapped in a cycle of debt to payday lenders and are paying more than $318 million in payday loan fees each year) • Private Student Loan Bubble Could Burst • New Century Financial Chapter 11 Filing • Bank Earnings and Write Offs

16. Pascack Valley HospitalImpact of a Credit Default Event • Systemic Event • $100mm Debt • $20mm Outstanding Payables • $80mm In Bonds Outstanding • Shut Down Of Services • Layoff Notices To 700 Employees

17. Pascack Valley Hospital Closure • Pension’s • Local Businesses • Vendors • Spouses of EE’s • Housing Inventory • Mortgage Defaults • Community Tax Revenue

18. Where's Goldilocks? • Recession • Inflation • Deflation • Stagflation • Dollar Based Assets • Corporate Earnings • Taxes, Deficits, Trade • Yield Curves and Equities

19. Bernanke Goes Greenspan Federal Funds Rate

20. Sources of SMB Funding • Existing Shareholders And Directors Funds (“owner financing”) • Overdraft Financing • Trade Credit • Equity Finance • Business Angel Financing • Venture Capital • Factoring And Invoice Discounting • Hire Purchase And Leasing • Merchant Banks (medium to longer term loans)

21. SME Finance Sources • Self Financing • Loans • Bank Loans • Credit Card Debt • People to People • Investment Capital • Grants

22. SME Self Funding • Existing Cash Flow • Assumes Strong Cash Management • Predicable Consistent EBITDA • Predictive Cost of Sales • Margins and Pricing Power • Receivables and Factoring • Assumes Clients Good Credit Risk • More Exacting Factoring Standards • Strong Credit Risk Management Culture

23. SME Self Funding • Personal Capital • 401K • Investment Portfolio • Home Equity Risk Premium On Collateral Valuation And Market Risk

27. Private Equity • Angels • Capital Adequacy • Private Equity • Secure Funding Sources • Credit Risk Premium • Exacting ROI Discipline

28. Banks Response • More Stringent Credit Guidelines • Credit Risk Management Response • Capital Allocation Requirements • Regulatory Response • Consolidation and Rationalization • Market Response

30. Small Business Scoring Solution SBSS 6.0 Fair Isaac

31. SBSS 6.0 • Empirically Derived Scores For Startup Businesses • Credit Offer Index • Size Of Loan Indexed To Industry Experience • Divergence And Kolmogorov-Smirnoff (K-S) • Profiling, Identifying And Scoring Bad And Good Accounts • 60 Other Models That Use Application Data, Sector, SIC And Other Derived Elements

33. Capital Allocation RequirementsRegulatory Response • Capital Adequacy • Define Risk Characteristics Of Business Lines And Market Segments • Allocate Regulatory Capital To Fund That Risk • SMB 360° Product of Basel II SME Initiative

34. FDIC Chart: Capital Adequacy Regulatory Capital to Cover Loan Losses

35. Banking Market • Community Banks Under Pressure • Competitive Landscape • S&L For Retail • Bulge Bracket Banks Commercial • Brokers For Wealth Management • Private Equity • Mortgage Brokers

36. Market ConsolidationRationalization Sum2’s NJ Community and Russell 2000 Bank Study • Acute Competitive Pressure • Concentrated Regional Risk • Slowing Earnings Momentum • Rich Valuations High P/E’s (M&A) • Regulatory And Economic Capital Strain

37. SBA Study Our statistical analysis finds that small businesses receive less credit on average in regions with a large share of deposits held by the largest banks, irrespective of how debt is measured. Notable details about this primary finding are that: When access to credit is measured by credit limits, reductions in lending in response to greater market share by large banks is larger than when credit access is measured by actual credit balances. This means that the market for un-accessed lines of credit is potentially most affected by banking consolidation. Credit reductions appear more severe in total when access to credit is examined through the dichotomous decision to obtain credit, than when the amount of debt as a share of assets is used as a measure. Thus banking consolidation is more likely to affect the decision, by either the small business borrower or the banking institution, to borrow, rather than affect the actual level of debt. *Credit reductions in areas dominated by large banks are found to occur both for firms with positive, and with negative, equity. Bank credit reductions are found to be more

38. SBA Study *Most importantly, we find that non-bank financial institutions are making up part of the credit reduction in terms of the level of credit conditional on borrowing, but not completely in the case of access to credit. *The activity of the non-bank financial institutions appears to be especially important for firms with negative, rather than with positive, equity. These findings are essentially mirrored when we look at the individual credit instruments of lines of credit, and other loans, although with some important exceptions. As we find for total credit limits, non-bank institutions are not able to compensate for lines of credit access reductions resulting from a greater share of large banks. Additionally, non-bank institutions are not able to make up for shortfalls in credit limit levels. In other loans, however, we find that non-bank institutions do compensate for reductions in bank credit, although the finding is stronger for credit levels than credit access. One set of small firms that therefore seems to be affected by banking consolidations are those that use lines of credit for assurances to customers and suppliers, rather than as a source of loan funds. It is possible, therefore, that these small businesses are finding it more difficult to conduct their business with a reduced ability to access credit. This concern is accentuated because we find credit reductions are more significant for firms with positive equity, than with negative equity. Conversely, it is also possible the changes we observe in the market for small business credit do not fully reflect the market for financial insurance needed to conduct some businesses, and another market mechanism rather than traditional lines of credit has arisen which allows small business firms to fully conduct their business in competition with large and established firms

39. The Impact of Bank Consolidation on Small Business Credit Availability By Steven G. Craig and Pauline Hardee Houston, TX For SBA under contract number SBAHQ-02-M-0459 Release Date: SBA Study

40. SMB 360° Risk Assessment & Management Tools Score and Manage Business Threats • Business Strategy & Targets • Business Market & Competition • Business Capability • Business & Financial Planning • Business Risk Management

41. 360° View of Risk and Opportunities Template 1: Market and Competition Assessment Template 2.1: Product Service Grouping, Customers Template 2.2: Product Service Grouping, Suppliers Template 2.3: Product Service Grouping, Competition Template 2.4: Product Service Grouping, Market Dynamics Template 3.1: General Management Template 3.2: Sales/ Marketing Management Template 3.3: Operations and Production Management Template 3.4: Facilities Management Template 3.5: Financial Management Template 3.6: Planning and Information Management Template 3.7: People and Human Resource Management Template 4: Financial Ratios Template 5: Business and Financial Plan Assessment Template 6: Scoring Specific Critical Success Factors Template 7: Scoring Generic Critical Success Factors Template 8: SWOT Analysis Template 9: STEEPLE Analysis

42. Engagement Tools for Bankers and CPAs • Why Did You Choose Them? • Transparency • Good Risk Management • Able Management • Critical Assessment • Understand Business Process • Confidence in Product and Strategy • Risk Factors are Known

43. Why Do SMBs Choose You? • Differentiators • Communication • Shared Goals • Understanding • Delivering Value Add • Prescient Tools • Relevance

44. Steeple Analysis

45. Steeple Analysis Social Risks Columbus parade in Lodi and Garfield Canceled Because Of Pulaski Conflict

46. Steeple Analysis Technological Risks • Lucent Technologies Over Reliance On Central Switching Long Lines Business • VOIP and Wireless • Offset Printers, Film Developers

47. Steeple Analysis Economic Risks • Outsourcing • Manufacturing • IC/Barriers to Entry • Cost of Capital • Weak Dollar • Energy Costs • Recession • Macro/Micro

48. Steeple Analysis Environmental Risks • DEP Releases Ranks Top Risks to New Jersey's Environment and Human Health • Land Use Change Poses a Major Environmental Threat to State, indoor and outdoor pollution, and invasive species as major threats to New Jersey’s environment and people. • United Water’s product has high sodium content due to salt spreaders • Climate Change Opportunities & Threats

49. Steeple Analysis Political Risks • Local Level • Zoning, Community Standards, Education • National Level • Taxes, Infrastructure, Immigration • International Level • Trade and Stability

50. Steeple Analysis Legal Risk • Sarbanes Oxley, Patriot Act, HIPPA, OSHA, DEP, EOE • Product Liability Feds Demand N.J. Tire Importer Pay For Recall Chinese Manufacturer Denies Responsibility