While waiting for new information on TGA to give me something to...

While waiting for new information on TGA to give me something to analyse, I was prompted by fraud-risk information on two of TGA's competitors, Silver Chef (SIV) and Scottish Pacific Group (SCO) to think in a general way about risk in TGA's Business Finance segment.

Until recently, Consumer Leasing was so overwhelmingly TGA's business that little focus needed to be given to the risk profile of its commercial-leasing-cum-invoicing-financing business. However, the latter is now a significant percentage of TGA's business, and it is growing quickly.

In FY2016 SIV was a victim of a series of frauds valued at $2.3m by criminals getting finance for non-existing goods purportedly bought by fake customers and fake suppliers. See http://www.theaustralian.com.au/bus...k/news-story/abcbb0ec2e95700b1a92487ca15cbee8, and also http://www.smh.com.au/nsw/political...-underworld-associations-20170512-gw3n5e.html. I am unsure if the second fraud is a subset of the $2.3m series, or not.

An investment blurb written by Nicki Bourlioufas of Canaccord Genuity about Scottish Pacific Group (SCO) mentions that “Like all debtor finance providers, Scottish Pacific is exposed to fraud events. As protection, the company relies on its underwriting experience to identify risks, implement proper credit process and diversify its exposures.” I Google for more information, which I found in the SCO Prospectus at http://www.asx.com.au/asxpdf/20160713/pdf/438jq3n40tr5st.pdf. The Prospectus covered fraud in detail, including two fraud events $3.2m in FY2009 and $1.5m FY2010, plus heaps on historical statistics and fraud mitigation generally. I hope that TGA is as highly aware of fraud possibility and prudent mitigation and provisioning measures as SCO purports to be.

While writing this post, I have concluded that there may be more merit in Klogg's concern about TGA's under provisioning expressed on 29/05/17 (Post # 24977718) than I thought when I first read that post. Klogg wrote:

EPS and PER are very easily manipulated by impairment provisions. The loan books grew hugely, part of this in an area that is only a few years old with horrible returns on capital, yet provisions grew very marginally. I find this extremely concerning, so much so that I can't confidently hold TGA any longer.

Law suits and ASIC penalties are all marginal issues - credit provisioning is at the core of this business. This is what they've historically done very well... but I can't see the justification of recent figures. Couple this with the lower margins across the consumer leasing book, and you get low returns on equity (at possibly increased volumes) with potentially insufficient credit provisioning.

I do not agree with everything above, but I'll not comment, because I do not want to wander from the provisioning matter.

TGA's Consumer Leasing was so dominant until recently, that the “law of large numbers” (see http://whatis.techtarget.com/definition/law-of-large-numbers) allowed for accurate estimating for defaults, and conceptual foibles in provisioning for the relatively few commercial customers' defaults was relatively harmless . With commercial leasing and invoice-backed lending growing rapidly, Management must adjust its thinking on default mitigation, whether flowing from either fraud or commercial customers' financial failures. From TGA's own commercial-finance history, and that of SCO (well detailed in its Prospectus), we know defaults are typically low. However, as SCO experienced in the $3.2m FY2009 fraud event and in the $1.5m FY2010 fraud event (both mentioned in the Prospectus), and SIV experienced in the FY2016 connected series of fraud events, meaningful losses happen. Black-swan events are not rare, so it is prudent to provision for them (in effect, self insure) wherever possible – that is, providing for the average is not good enough, one should build up a meaningful buffer to handle occasional serious fraud events, because they are likely to happen, sooner or later.

When the current acting CEO was the CFO, I talked to him to clarify provisioning for the ASIC matter, and he said that soon after joining TGA,he was “horrified” to learn that there was no provisioning for it. From this I concluded that he had a higher provisioning predilection than his predecessor had. That, and the fact that TGA now has a Chief Risk Officer in Wendy Yip, are two facts that suggest that if provisioning is inadequate for FY2018, it is likely to be improved fairly quickly. I'll scrutinise the provisioning assiduously in FY2018's accounting. Some provisioning initiatives may not be patent, for example, when specific over provisioning for a matter is transferred to boost provisioning of an unrelated matter.