2018 CCP

CHECKMATE RESEARCH - CREDIT CORP GROUP (ASX: CCP) STRONG SELL RECOMMENDATION Current stock price: $18.75 Expected stock price: $10.00 CREDIT CORP: A WOLF IN SHEEP'S CLOTHING? We are not a payday lender! Credit Corp: The Group does not offer any contentious products such as Small Amount Credit Contracts (SACCs) or ‘payday loans’. Yet, Credit Corp competes with payday lenders, its loans have many features of payday loans, while consumers, journalists and even the marketing department of Credit Corp itself refer to the Company as a payday lender. Our analysis shows that Credit Corp exploits a loophole in the law to avoid regulatory scrutiny and to access cheap bank funding unlike other payday lenders. WE CALL WESTPAC TO FOLLOW ITS POLICY ON PAYDAY LENDERS AND TO PULL FINANCING FROM CREDIT CORP SIMILAR TO WHAT THE BANK DID TO OTHER PAYDAY LENDERS, CASH CONVERTERS AND MONEY3 CORP. Investment opinion - summary: 1) CCP is the only debt purchaser/collector with a payday lending business globally. Our analysis shows that the business model combining debt purchasing and payday lending has not been tested through recessions. In our view this business model may underperform “pure” debt purchasers during a recession. 2) Wallet Wizard (CCP’s lending business) uses a loophole in legislation to avoid being designated as a payday lender. In our opinion Westpac is likely to pull funding from CCP which will face the need to either quit its payday lending business or to urgently seek alternative funding. Both scenarios would be strongly negative for CCP’s share price. 3) Wallet Wizard, CCP’s payday lending business, has one of the lowest lending criteria among the leading payday loan market players. The company lends to unemployed, discharged bankrupts, people employed unofficially (“Cash-in-hand”), recipients of government benefits and even to people who have negative capacity to repay. 4) In our opinion Wallet Wizard may be violating responsible lending obligations by issuing loans to people who are not suitable. Such business practices may result in an investigation by the Australian Securities and Investments Commission (ASIC). In 2016 ASIC ordered Cash Converters, a competitor of CCP in a payday lending business, to pay over AU$12M for the violation of responsible lending obligations. 5) We see numerous evidence of earnings management: reported net margin is too smooth when compared to peers, ASX-listed small cap companies and CCP’s own history; ratio of collections to amortization is too smooth when compared to peers and CCP’s own history; loan loss provision expense/interest income ratio was unchanged at 44.4% for three consecutive years (FY 2015- 2017); in FY 2016 CCP transferred AU$50M of assets from the lending segment to the PDL segment without providing any disclosures; the company understated losses at its US debt purchasing business at least in FY 2015 and FY 2017. 6) We find many reasons why investors should be skeptical about CCP’s system of controls, especially about the company’s auditor Hall Chadwick. Page 2 of 37 Company description: Credit Corp Group Limited provides collection and credit management services in Australia. The company purchases charged-off and delinquent debts and also provides document serving and field call services, debtor location services and legal services (source: Bloomberg). Company share price chart – 15 June 2018 (Bloomberg) Page 3 of 37 CCP IS A TRULY UNUSUAL COMPANY WITH AN UNPROVEN BUSINESS MODEL Credit Corp (ASX: CCP) is a truly unusual company. Until 2012 there was nothing special about this business; its bread and butter were traditional debt purchasing/debt collection businesses: purchasing bad debts at deep discounts and trying to collect them. In 2012 CCP expanded into payday lending in Australia and New Zealand as well as debt purchasing in the United States (US). This expansion into new business areas was largely financed with debt and led to a meteoric rise in the company’s stock price. Entering the payday lending business created an exceptional and unusual combination of a debt purchaser and a payday lender. We checked all major global markets and could not find another debt purchaser with business in the payday lending industry. The list of publicly traded debt purchasing companies Has a payday Company Country lending business? Encore Capital Group USA NO PRA Group USA NO Arrow Global UK NO Intrum Justitia Sweden NO B2 Holding Norway NO Collection House Australia NO Pioneer Credit Australia NO Asset Acceptance Group* USA NO Asta Funding* USA NO SquareTwo Financial* USA NO Credit Corp Australia YES * no longer active (acquired or bankrupt) Source: Companies’ filings The combination of debt purchasing/debt collection and payday lending businesses has not been tested during recessions. While this does not necessarily mean that this business model is not viable, there should be reasons why debt purchasers have not expanded into payday lending. The first and the most obvious reason which comes to mind is that payday lending is not a core competence of a debt purchaser. However, there is another less obvious, albeit not less important reason. Being able to access funding during times of a market distress has tremendous value for debt purchasers. Access to financing gives a company opportunity to buy debt portfolios at cyclical lows and subsequently achieve exceptional returns. However, as lenders frequently report losses during recessions, being in a lending business may substantially limit or even restrict a debt purchaser from access to funding during the period of market distress. As a result, a company may therefore forego exceptional investment opportunities, as compared to its competitors. Page 4 of 37 STRONG EVIDENCE OF EARNINGS MANAGEMENT Our analysis shows that starting from FY 2014 there has been growing evidence of earnings management at CCP. The table below summarizes our findings. Summary of accounting red flags FY 2014 FY 2015 FY 2016 FY 2017 H1 FY 2018 Overly smooth net margin YES YES YES YES YES Overly smooth Collection/Amortization ratio YES YES YES YES Overly smooth loan loss provision to Interest income YES YES YES Questionable asset transfer between segments YES N/A Understatement of losses at the US business YES N/A YES (1) Over the last 4 years CCP has reported uncharacteristically smooth net margins. Since FY 2014 margins have been too smooth when compared to a) industry peers; b) ASX-listed small cap companies; c) CCP own historical margins. Between FY 2014 and FY 2017 the following trends/events affected CCP’s business and profit margins: • Expansion of the lending segment, with a turnaround to profitability achieved in FY 2015. • Expansion into the New Zealand lending market in FY 2016 with material startup losses. • Breaking even of the US debt purchasing segment in H2 FY 2017 after many years of losses. • Acquisition of NCML, a debt purchasing business in FY 2017. • Increase in debt purchases in FY 2016-2017 by 72% as compared to FY 2014-2015. • Increase in financial leverage as measured by debt/equity ratio from 0.24x in FY 2014 to 0.85x in FY 2017. • Exit from SACC business in FY 20161 and introduction of a new lending brand, Wallet Wizard, with the launch of a large-scale and costly advertising campaign. Despite these various trends/events the net margin of CCP remained in a very tight range of between 20.0% and 20.7% during the whole period. Such smooth net margin is highly surprising given that historically CCP had quite a volatile net margin. For example, during FY 2007-2013 net margin fluctuated between 6.9% and 23.4%. Even if we exclude the period of the Global Financial Crisis (FY 2007-2009) and look at FY 2010-2013, the net margin was in the range of 14.5% - 22.4%. However, since FY 2014 the net margin has been almost unchanged. 1 We discuss this issue in a greater detail in a section “IS CCP COMMITTING A LEGAL FRAUD?” Page 5 of 37  CCP net margin AU$ '000 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 H1 2018 Revenue 82,903 84,250 85,619 93,413 113,636 124,590 142,577 173,998 191,049 226,742 265,947 147,586 Net income 19,377 5,788 10,862 13,543 21,024 26,578 31,986 34,765 38,411 45,921 55,158 29,794 Net margin 23.4% 6.9% 12.7% 14.5% 18.5% 21.3% 22.4% 20.0% 20.1% 20.3% 20.7% 20.2% Source: Company Public Filings When we compared CCP net margins with margins of publicly traded peers, we saw the same pattern, with CCP being an outlier during FY 2014-2017. Even the closest peers – Australian debt purchasers Collection House (ASX:CLH) and Pioneer Credit (ASX:PNC) – had materially higher margin volatility during the same period. Net margins of CCP and other debt purchasing companies Range for Average for Company Country FY 2014 FY 2015 FY 2016 FY 2017 H1 FY 2018 2014-2017 2014-17 Pioneer Credit Australia 4.1% 19.2% 19.8% 19.1% 22.0% 15.7% 15.5% B2 Holding Norway 10.2% 18.4% 13.0% 21.9% 11.8% 15.9% PRA Group US 20.1% 17.8% 10.2% 19.9% 9.9% 17.0% Arrow Global UK 16.2% 19.4% 11.0% 12.5% 8.4% 14.8% Intrum Justitia Sweden 19.9% 20.7% 23.9% 15.9% 8.0% 20.1% Encore Capital Group US 9.7% 3.9% 7.5% 7.0% 5.8% 7.0% Collection House Australia 17.8% 17.5% 14.8% 13.0% 13.0% 4.8% 15.8% Peer group average 9.2% 15.2% Credit Corp Australia 20.0% 20.1% 20.3% 20.7% 20.2% 0.8% 20.3% Source: Companies’ Public Filings CCP net margins are not just smoother, they are also higher than the net margins of peers (the only exception is a Sweden-based debt purchaser Intrum Justitia, which has reported high net margins similar to CCP but with higher volatility). Harry Markopolos, a US forensic accountant, thinks investors should be skeptical when dealing with the outstanding performance: “Focus on the manager or the company that is head and shoulders above the rest. Whenever somebody has outstanding performance, Wall Street assumes genius. I assume fraud until genius is proven. Look for the outperformance and investigate there… If the numbers are too good to be true, they rarely are”. CCP also has exceptionally smooth net margins when compared to its small cap peers trading on the ASX. The table below shows that CCP was an outlier in terms of net margin volatility2 over the last 4 years (FY 2014-2017) among ASX 200 companies with market capitalization below AU$1.0B: 2 As measured by coefficient of variation Page 6 of 37  Market Coefficient of Exchange: Company Name Capitalization, variation - Net Ticker USD M margin Credit Corp Group Limited (ASX:CCP) ASX:CCP 664.6 0.0068 GWA Group Limited (ASX:GWA) ASX:GWA 715.3 0.0124 Asaleo Care Limited (ASX:AHY) ASX:AHY 549.9 0.0148 Greencross Limited (ASX:GXL) ASX:GXL 478.8 0.0154 Eclipx Group Limited (ASX:ECX) ASX:ECX 747.1 0.0178 Sigma Healthcare Limited (ASX:SIG) ASX:SIG 558.8 0.0235 Tassal Group Limited (ASX:TGR) ASX:TGR 505.2 0.0280 G8 Education Limited (ASX:GEM) ASX:GEM 840.6 0.0314 Gateway Lifestyle Group (ASX:GTY) ASX:GTY 392.2 0.0340 Mantra Group Limited (ASX:MTR) ASX:MTR 874.7 0.0340 APN Outdoor Group Limited (ASX:APO) ASX:APO 650.3 0.0348 IPH Limited (ASX:IPH) ASX:IPH 610.2 0.0356 Australian Pharmaceutical Industries Limited (ASX:API) ASX:API 487.6 0.0381 Genworth Mortgage Insurance Australia Limited (ASX:GMA) ASX:GMA 832.5 0.0448 Southern Cross Media Group Limited (ASX:SXL) ASX:SXL 695.6 0.0526 Estia Health Limited (ASX:EHE) ASX:EHE 702.3 0.0580 Infigen Energy (ASX:IFN) ASX:IFN 507.9 0.0650 Sandfire Resources NL (ASX:SFR) ASX:SFR 963.3 0.0710 InvoCare Limited (ASX:IVC) ASX:IVC 951.2 0.0930 Resolute Mining Limited (ASX:RSG) ASX:RSG 670.7 0.1017 Automotive Holdings Group Limited (ASX:AHG) ASX:AHG 844.4 0.1453 oOh!media Limited (ASX:OML) ASX:OML 634.8 0.1619 Nanosonics Limited (ASX:NAN) ASX:NAN 579.4 0.1937 Ausdrill Limited (ASX:ASL) ASX:ASL 728.0 0.2080 Bega Cheese Limited (ASX:BGA) ASX:BGA 993.3 0.2191 Charter Hall Long WALE REIT (ASX:CLW) ASX:CLW 717.7 0.2987 National Storage REIT (ASX:NSR) ASX:NSR 666.0 0.3268 Western Areas Limited (ASX:WSA) ASX:WSA 692.5 0.4592 Retail Food Group Limited (ASX:RFG) ASX:RFG 118.4 0.6483 Mayne Pharma Group Limited (ASX:MYX) ASX:MYX 884.8 1.0726 Galaxy Resources Limited (ASX:GXY) ASX:GXY 996.7 1.4321 Source: Capital IQ While the exact mechanics of earnings management at CCP is not clear, one of the ways CCP could be managing earnings is by capitalizing certain costs, for example, transaction and loan origination costs. Although CCP discloses that some of these costs are capitalized, neither the amounts are disclosed, nor are any additional details provided. Below we present those accounting policies where CCP discloses capitalization of expenses. Note 3: Revenue Interest and fee income from consumer lending Interest income is recognised when the payments are received and fees are recognised as income over the life of the loan. Direct loan origination costs are netted against fee income over the life of the loan. Note 10: Consumer loans receivables Consumer loans receivables are initially recognised at fair value of the loan written plus transaction costs and subsequently measured at amortised cost using the effective interest rate method, less provision for expected credit losses. Page 7 of 37  Note 11: Purchased debt ledgers PDLs are recognized at fair value (generally the consideration paid) plus transaction costs and subsequently measured at amortised cost using the effective interest rate method, in accordance with AASB 9 Financial Instruments. In some cases, the amount of such transaction costs can be large enough to affect a company’s net income by dozens of percentage points. For example, in 2016 the leading UK debt purchaser Arrow Global capitalized GBP 22.9M of litigation costs which, if fully expensed, would have reduced the company’s net income by 83%. Another debt purchaser – Australian publicly traded company Collection House – found itself in hot water during 2017 after it was revealed that the company improperly capitalized certain software development expenses. We also note that despite having a smaller business than CCP, Collection House discloses the amount of capitalized legal costs as a separate asset, thereby showing higher transparency. (2) During FY 2015-2017 Consumer loan loss provision relative to Interest and fee income from consumer lending was unchanged at 44.4%. Management of a bank has great discretion regarding the recognition of loan loss provision expense, which may be used to smooth earnings. While we would not be surprised to see low volatility in CCP’s loan loss provision expense, CCP managed to exceed our expectations, recording the same ratio of LLP provisions to interest income over the three consecutive years. CCP loan loss provision expense AU$ '000 2014 2015 2016 2017 H1 2018 Interest and fee income from consumer lending 19,104 35,862 53,418 66,374 37,534 Consumer loan loss provision expense 14,480 15,931 23,705 29,455 15,647 Consumer LLP expense/Interest revenue from consumer lending 75.8% 44.4% 44.4% 44.4% 41.7% Source: Company Public Filings We would like to highlight that the timing when CCP recognizes interest and fee income, and loan loss provision expense does not coincide. While interest income and fees are recognized on a cash basis and over the life of the loan respectively, loan loss provision is recognized at the time when the loan is issued. Accounting policy on revenue recognition: Interest income is recognised when the payments are received and fees are recognised as income over the life of the loan. Accounting policy on consumer loans: Consumer loans receivables are initially recognised at fair value of the loan written plus transaction costs and subsequently measured at amortised cost using the effective interest rate method, less provision for expected credit losses. Given the nature of loans written, a lifetime expected credit loss provision is taken up upon initial recognition of a consumer loan receivable. Page 8 of 37 We do not believe that reporting the same LLP expense/Interest income ratio three years in a row is a coincidence; we think CCP does not follow its own accounting policies by recognizing loan loss provision expense as a function of interest and fee income earned, and not based on the amount of loans issued as per the stated accounting policy on consumer loans. (3) Ratio of Collections from PDLs to PDL amortization was unusually stable between FY 2013 and FY 2017 as compared to peers and CCP’s own history. For a debt purchaser, reporting under IFRS and recognizing revenue according to the effective interest method, revenue is calculated as Collections from PDLs less PDL amortization. While collections are a relatively straightforward metric, calculation of portfolio amortization requires a lot of management’s discretion, including making assumptions about expected return, estimation of remaining collections, and collection curve. As the table below shows, the ratio of collections to amortization for debt purchasers reporting under IFRS generally exhibits certain volatility: it can be affected by a number of different accounting assumptions and operating decisions made by management like the change of return expectations on newly purchased PDLs, purchasing different PDL assets as compared to the existing book, PDL impairments/writeups, etc. Collection/Amortization ratio for CCP and selected peers3 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 H1 2018 Collection House 2.30 2.32 2.36 2.38 2.49 2.45 2.53 2.45 2.59 2.39 Pioneer Credit 3.38 3.15 3.31 4.24 4.34 4.27 Arrow Global 3.34 3.29 3.35 3.03 3.66 3.20 2.95 3.39 B2 Holding 1.43 2.74 3.16 2.81 3.21 Intrum Justitia 2.15 2.18 2.01 2.13 2.14 2.29 2.43 2.49 2.72 2.58 Credit Corp 2.38 2.18 2.04 2.20 2.13 2.10 2.11 2.12 2.13 2.14 2.20 Change YoY Collection House 0.9% 1.5% 0.7% 5.0% -1.6% 3.2% -3.2% 5.6% Pioneer Credit -6.7% 4.9% 28.2% 2.5% Arrow Global -1.5% 2.0% -9.6% 20.8% -12.6% -7.9% 15.1% B2 Holding 92.0% 15.2% -10.8% 14.0% Intrum Justitia 1.3% -7.6% 5.8% 0.8% 6.8% 5.9% 2.7% 9.2% -5.0% Credit Corp -8.4% -6.4% 8.0% -3.6% -1.4% 0.9% 0.4% 0.5% 0.3% Source: Companies Public Filings During FY 2013-2017 CCP reported an unusually stable Collections/Amortization ratio which remained within a very tight range of 2.10 – 2.14. By this ratio CCP is an outlier both when compared to peers and relative to its own history. Like CCP’s net margin, the Collections/Amortization ratio was quite volatile in the past and later became very smooth. In our view the Collections/Amortization ratio staying in such a tight range over five years is statistically improbable and is a strong red flag indicating that these numbers are managed. 3 Only companies reporting under IFRS Page 9 of 37 (4) Questionable asset transfer from Consumer lending to Debt purchasing segment in H2 FY 2016 During the second half of FY 2016 CCP transferred4 c. AU$50M of assets from its Consumer lending segment to the Debt purchasing segment. The amount transferred constituted 45% of the net loan book as of 31 Dec 2016. Transferring of supposedly fully provisioned consumer loan assets to the segment involved in purchase and collection of nonperforming debts looks highly suspicious. In our view, this transaction may indicate that the actual amount of loan loss provisions was understated at the time, and CCP had a much higher share of non-performing loans on its consumer loan book. Subsequently, in the report for the first half of FY 2018, CCP stopped providing disclosure on the segment assets and liabilities. This decreased transparency of segment assets is particularly worrying given the unexplained material transaction observed during H2 FY 2016. CCP segment assets AU$ '000 H1 2014 H2 2014 H1 2015 H2 2015 H1 2016 H2 2016 H1 2017 H2 2017 H1 2018 Assets of consumer lending segment 27,015 47,333 56,213 79,347 97,240 60,461 126,589 131,612 N/A Consumer loans (as per the balance sheet) 27,491 47,935 56,754 79,347 98,109 110,374 125,890 130,839 139,806 Difference -476 -602 -541 0 -869 -49,913 699 773 N/A Assets of debt purchasing segment 169,425 164,888 156,112 177,049 207,790 315,541 330,622 355,500 N/A PDLs and other assets (as per the balance sheet) 164,338 161,504 150,925 170,748 205,263 263,086 326,633 350,167 372,187 Difference 5,087 3,384 5,187 6,301 2,527 52,455 3,989 5,333 N/A Source: Company Public Filings (5) CCP may be misleading investors about the performance of its US business While performing our analysis we found a way to check the performance of the US business during FY 2015-2017. Closer look at notes “33: Cross guarantee” and “23: Subsidiaries” (Annual Report 2017) shows that the note “33: Cross guarantee” includes the financial results of all Australian and New Zealand subsidiaries of the Group5. Subtracting the results of all Australian and New Zealand subsidiaries from the consolidated financial results gives us the performance of the US business (CCP has subsidiaries only in three countries: Australia, New Zealand and the USA). The financial results of the US business calculated by us based on CCP’s audited financial reports substantially differ from the results disclosed by CCP in its presentation for H1 FY 20186. 4 For these calculations we compared segment assets as reported in a footnote on Operating segments with the numbers from the balance sheet. For example, assets of the Consumer lending segment (Note 24: Operating segments in AR 2017) were compared with the Consumer loans line from the balance sheet. The difference between these two numbers was immaterial during the whole period under review except for the H2 FY 2016, which caught our attention. Moreover, the decline in assets of the Consumer lending segment coincided with the increase of Debt purchasing segment assets of similar magnitude, which led us to conclude that CCP transferred assets between these two segments. 5 While Credit Corp Financial Solutions Pty Limited, a subsidiary operating CCP’s lending business in New Zealand, was incorporated on 2 Jul 2015 (FY 2016), according to public sources, this entity was included into the scope of the Cross Guarantee only in FY 2017. 6 For more information, see Appendix 1 Page 10 of 37  Source: Company presentation for H1 FY 2018 According to CCP’s presentation the US business generated net losses of around AU$ 2.9M in FY 2015, AU$ 2.6M in FY 2016 and AU$ 1.0M in FY 2017. Consolidated results AU + NZ business US business (Cross guarantee footnote) (as calculated) AU$ '000 2015 2016 2017 2015 2016 2017 2015 2016* 2017 Revenue 191,049 226,742 265,947 186,817 219,260 249,065 4,232 7,482 16,882 Finance costs -1,332 -3,548 -6,969 -1,332 -3,548 -6,969 0 0 0 Employee benefits expense -80,784 -88,631 -101,876 -73,747 -78,739 -89,452 -7,037 -9,892 -12,424 Depreciation and amortisation expense -947 -1,901 -2,352 -748 -1,712 -2,182 -199 -189 -170 Office facility expenses -12,758 -12,644 -15,267 -11,374 -11,509 -13,381 -1,384 -1,135 -1,886 Collection expenses -10,679 -13,895 -16,372 -9,098 -11,340 -12,954 -1,581 -2,555 -3,418 Consumer loan loss provision expense -15,931 -23,705 -29,455 -15,931 -23,705 -29,286 0 0 -169 Marketing expenses -9,243 -11,759 -9,401 -9,243 -11,759 -9,401 0 0 0 Other expenses -4,261 -4,923 -5,309 -4,413 -3,501 -3,844 152 -1,422 -1,465 Profit before income tax expense 55,114 65,736 78,946 60,931 73,447 81,596 -5,817 -7,711 -2,650 Income tax expense -16,703 -19,815 -23,788 -18,372 -22,146 -24,479 1,669 2,331 691 Profit for the year 38,411 45,921 55,158 42,559 51,301 57,117 -4,148 -5,380 -1,959 * - includes the results of Credit Corp Financial Solutions Pty Limited (New Zealand) Source: Company filings However, our calculations show that in its H1 FY 2018 presentation CCP understated the net loss of the US business in FY 2015 by AU$ 1.24M or by 30%, while net loss in FY 2017 was understated by AU$ 0.96M or by 49%. We could not calculate the net result of the US business in FY 2016, as it includes the results of Credit Corp Financial Solutions Pty Limited (Wallet Wizard NZ), which was included in the scope of Cross Guarantee only in FY 2017, and thus the financial results of the Australian and New Zealand subsidiaries subject to cross guarantee did not include the results of Wallet Wizard NZ in FY 2016. Financial results of the US business AU$ '000 2015 2016 2017 Net loss of the US business (as calculated) -4,148 -5,380 -1,959 Net loss of the US business (per presentation) -2,900 -2,600 -1,000 Difference -1,248 -2,780 -959 Understatement of net loss in presentation 30% N/A 49% Source: Company filings Page 11 of 37 DESPITE MANAGEMENT’S CLAIMS, WALLET WIZARD IS A PAYDAY LENDER In a press release issued on 23 Oct 2015, CCP announced plans to withdraw from SACC lending (small amount credit contract, a legal term used for payday loans in Australia) from 1 March 2016. According to CEO Thomas Beregi this move was a result of “a decision by ASIC to apply the pejorative description “payday loan” to all SACC products regardless of duration, affordability and pricing”. Since then the company highlighted its exit from SACC/payday lending business numerous times. AR 2016: The Group does not offer any contentious products such as Small Amount Credit Contracts (SACCs) or ‘payday loans’. Thomas Beregi on 31 Jan 2017 investors call: Credit Corp does not issue any SACC products. In its communication with investors, CCP regularly points out that it is not in a payday lending business. Source: Company presentation from 18 April 2018 Below we present evidence that Wallet Wizard is a payday lender which makes it subject to huge business, regulatory and litigation risks. Page 12 of 37 (1) When searching for “payday loan”, Google shows ads by Wallet Wizard. Does CEO Thomas Beregi know that his marketing department advertises Wallet Wizard as a payday lender? How can CCP target the same audience as payday lenders if it’s not a payday lender? Source: Google (as of 30 May 2018) In its Google advertising, Wallet Wizard uses such term as “quick cash loan” which is a synonym of a “payday loan”. Ads from Wallet Wizard appear near the ads from such payday lenders as Sunshine Loans and Capfin. (2) CCP lists Nimble as its key competitor. Nimble is a leading payday lender in Australia. Source: Wallet Wizard Page 13 of 37 (3) Journalists call Wallet Wizard a payday lender: Source: smartcompany.com.au Source: rfigroup.com Source: fool.com.au Page 14 of 37 (4) Consumers call Wallet Wizard a payday lender: Source: Twitter Page 15 of 37 (5) Loans provided by Wallet Wizard have many features of payday loans7. According to the website of Wallet Wizard, automatic loan repayments coincide with a borrower’s pay cycle. This is one of the key features of a payday loan as per Wikipedia8. According to the article from Wikipedia on payday loans “the basic loan process involves a lender providing a short-term unsecured loan to be repaid at the borrower's next payday”. Source: Wallet Wizard What are the reasons CCP does not want to be called a payday lender? During 2015 Australian banks pulled out from financing payday lenders. In August 2015 Westpac was the last major Australian bank to stop funding payday lenders - Cash Converters and Money3. At the same time Westpac continued to provide financing to CCP, which although abandoned SACC lending, remained in payday lending business. Westpac should be consistent in their policy regarding payday lenders and withdraw funding from CCP in line with what the Bank did to other payday lenders in 2015. According to Bank’s website, the policy of Westpac is to stay away from doing business with payday lenders. Source: Westpac.com.au 7 We discuss this in a greater detail in a section “IS CCP COMMITTING A LEGAL FRAUD?” 8 Some might think that Wikipedia is not a respectable source, however, this is not true anymore. For example, Howard Marks, the founder of Oaktree Capital, has quoted articles from Wikipedia several times in his famous memos. Page 16 of 37 The other reason why CCP avoids being called a payday lender is due to the risks coming from the expected additional regulation of the payday lending industry. Since the introduction of payday lending reform in 2013 various consumer protection groups in Australia have been lobbying further tightening of payday lending regulation, in particular SACC lending. The government has already completed the consultation process regarding further SACC and consumer lease reform, and presented the Draft Bill in October 2017. The key reform to be introduced: The existing protected earnings amount for SACCs will be extended to cover all consumers and the portion of income that can be devoted to SACC repayments will be 10 per cent of a consumer’s net income. Currently the SACC protected earnings amount only applies to persons who receive 50 per cent or more of their income from Centrelink and the portion of income is 20 per cent of gross income. With this reform the Government proposes to further limit the share of borrower’s income which can be directed towards the repayment of a payday loan. In our view, this will reduce the total addressable market for payday lenders and will result in increased competition for eligible borrowers. Other important reforms related to the SACC market according to the Draft Bill are: • requiring SACCs to have equal repayments and equal payment intervals; • introducing broad anti-avoidance protections to prevent SACC and consumer lease providers from circumventing the rules and protections contained in the Credit Act; and • strengthening penalties to increase incentives for SACC providers and lessors to comply with the law. Initially, this legislation was expected to be implemented by the end of 2017, and later the deadline was shifted to April 2018. As per the latest information according to the assistant minister to the treasurer, Michael Sukkar, the government would progress legislation in 2018. While payday lenders have been able to block the introduction of the new legislation, we think the introduction is inevitable and will have a material effect on the payday lending industry and the lending business of CCP. We also highlight that MACC lenders (medium amount credit contract – loan with amount between $2,001 and $5,000) should be worried as well. As Good Shepherd Microfinance, a non-profit lending organization, puts it, payday lenders have been shifting their business towards MACC market to avoid SACC reforms and this trend is unlikely to stay unnoticed by lawmakers and the regulator: Also concerning is a shift towards the Medium Amount Credit Contract (MACC) market by payday lenders as a means to means to avoid SACC reforms. As the deadline approaches, payday lenders are increasing loan amounts and extending loan terms, with the amount of MACC credit doubling over the past financial year. Good Shepherd Microfinance’s experience with the StepUP low interest loan program has shown that the market for loans between $2,000 and $5,000 includes a significant proportion of people living on low incomes, many of whom are dependent on government benefits. We strongly encourage regulators to pay attention to the MACC market to ensure activity in this category of loans does not lead to consumers being lent more money than they want or need. Source: Good Shepherd Microfinance Page 17 of 37 IS CCP COMMITTING A LEGAL FRAUD? One of the questions which puzzled us is how could CCP so smoothly pull out of the SACC/payday lending business in FY 2016 without even downgrading profit guidance for that year? It turns out that while CCP abandoned SACC lending, the company remained in the payday lending business by finding a loophole in the definition of a SACC loan. A small amount credit contract (SACC) is defined in the National Consumer Credit Protection Act 2009 as a credit contract provided by an entity that is not an authorized deposit institution, where the credit limit is less than $2,000, the term of the contact is at least 16 days but not longer than one year, the debtor’s obligations under contract are unsecured, and the contract is not a continuing credit contract. Here is what Wallet Wizard says on their website: The Wallet Wizard continuing credit contract can provide simple, two-step access to redraw up to your credit limit - anytime, anywhere. The only difference between SACC loan and a loan from Wallet Wizard is that the latter is a line of credit (continuing credit contract). This allows CCP to avoid regulatory burden imposed by National Consumer Credit Protection Act 2009 and an industry regulator ASIC. SACC loan Wallet Wizard loan Provided by an entity that is not an YES authorized deposit institution Credit limit is less than $2,000 YES (provides loans ranging from $500 to $5,000 Term of the contact is at least 16 days but YES (the term of the loan is between 4 not longer than one year months and 2 years) Debtor’s obligations under contract are YES unsecured Contract is not a continuing credit contract NO, Wallet Wizard loan is a continuing credit contract (line of credit) Source: Wallet Wizard website, company filings In our view, by exploiting a loophole in legislation, CCP is conducting legal fraud as defined by Jim Chanos of Kynikos Associates: “While they might be adhering to every aspect of legal requirements in what they were doing, there was still an attempt to mislead and an attempt to obfuscate…” The king of all legal frauds – Enron – was described by Bethany McLean, in her book “The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron”: Such criminal prosecutions are nothing if not complex. That was one of the lessons from Enron. That’s because much of what seems so wrong in commonsense terms is actually perfectly legal, and it’s hard to hold senior executives accountable when accountants and lawyers gave their Page 18 of 37  blessings. Executives exploit this unfortunate reality. As Fastow (Enron’s CFO – CR) explained in Las Vegas, accounting rules and regulations and securities laws and regulation are “complex . . . what I did at Enron and what we tended to do as a company [was] to view that complexity, that vagueness . . . not as a problem but as an opportunity.” The only question was “do the rules allow it—or do the rules allow an interpretation that will allow it?” Fastow insisted he got approval for every single deal—from lawyers, accountants, management, and directors—yet noted that Enron is still considered “the largest accounting fraud in history.” Indeed, in many ways, Enron was a legal fraud. Fastow’s guilty plea—and Skilling’s and Lay’s convictions—were due to specific incidents where prosecutors could show that the Enron executives had crossed the line. But they didn’t speak to the larger fact that Enron’s financials were basically a complete misrepresentation of reality. “I knew that what I was doing was misleading,” Fastow told the Las Vegas crowd. “But I didn’t think it was illegal. I thought: That’s how the game is played. You have a complex set of rules, and the objective is to use the rules to your advantage.” Marianne Jennings, the author of “Seven Signs of Ethical Collapse: How to Spot Moral Meltdowns Before It’s Too Late” describes such behavior as a hallmark of ethical collapse in the organization: Not all the companies that drift ethically have violated any laws. There are many pleas, settlements, and agreements that companies discussed and studied in these pages have reached for the sake of expediency and/or not because of any legal violations. The majority of the reports on settlements indicate that the company involved does not admit any wrongdoing. Indeed, I would be the first to state unequivocally that hung juries and acquittals in these cases are reassurance that the jury system works. The “common man,” when presented with the tasks of finding intent and guilt beyond a reasonable doubt, cannot always conclude that either was present in the complex transactions that often do carry the protection of technical compliance with the law. However, the law was never intended to be the maximum for standards of behavior. The law represents the minimum standard of behavior required. We are permitted to do more than the law requires and less than the law allows. A company can be teetering ethically without crossing legal lines. When an organization collapses ethically, it means that those in the organization have drifted into rationalizations and legalisms, and all for the purpose of getting the results they want and need at almost any cost… They meet legal standards without really considering the long-term implications of technicalities, taking advantage of loopholes, and the resulting impact on the individual and organizational soul. They are concentrating so much on the “Gotcha strategy” of finding the loophole or the easier way around the tough slog of diligent competition that they are no longer managing as effectively, creatively, or successfully as they could. Should Westpac want to protect its reputation and act ethically, it may need to go beyond the legal definition of a payday loan in determining whether CCP is a payday lender and whether to provide financing to this company. As Marianne Jennings puts it: “The law represents the minimum standard of behavior required”. At the same time, the misleading and questionable behavior of CCP with regards to its payday lending business has numerous signs of ethical collapse and legal fraud. Page 19 of 37  Wallet Wizard loan is a continuing credit contract Source: walletwizard.com.au We believe that such behavior of CCP is not sustainable and will be corrected, potentially at a large cost to its shareholders: • It is anticompetitive. While other payday lenders must comply with extensive and costly regulatory requirements for SACC lenders (which were introduced to protect consumers), Wallet Wizard avoids such oversight/regulatory scrutiny which gives the lender an unfair competitive advantage over more responsible payday lenders. Another unfair advantage CCP enjoys is cheap bank funding, despite the fact that Australian banks pulled out of funding SACC lenders back in 2015. We think Australian Competition and Consumer Commission should investigate this matter. • It is misleading. While management makes shareholders believe that regulatory and litigation risks are low, in reality they are large. The legal loophole used by Wallet Wizard may be easily closed during the next regulatory review of the payday lending industry which will considerably increase costs of doing business and regulatory scrutiny of Wallet Wizard, and will most likely cut off funding for CCP. We would like to point out that misleading statements made by management during 2007-2008 led to a lawsuit filed by shareholders. This lawsuit was one of the key factors triggering a 95% decline in share price during that period. Page 20 of 37 RELATIONSHIPS BETWEEN WESTPAC AND CCP In our view, the decision by Westpac to continue business with CCP in 2015 despite huge reputational risks was motivated not only by CCP’s use of a loophole in legislation. Upon closer look it is clear that Westpac and CCP have strong business relationships. 1) Westpac is CCP’s bank: Source: Company website 2) Westpac provides funding to CCP: Source: Company announcement In 2017 this loan facility was further increased to AU$ 215M. 3) CCP purchases bad debts from Westpac: Source: bankreformnow.com.au Page 21 of 37  Source: royalcommission.gov.au 4) Three out of five board directors of CCP, including board chairman, previously held executive positions with Westpac: Director Position Board Committee Association with Westpac memberships Donald McLay Chairman Audit & Risk Committee Was an executive at Westpac Investment Remuneration Committee Management Leslie Martin Non-Executive Remuneration Committee Held an executive role at Westpac Director Richard Thomas Non-Executive Audit & Risk Committee Was a Group Executive, Australian Banking Director Services with Westpac Source: Company filings, open sources So why would Westpac pull financing from CCP given such strong business relations between the companies? Well, because Westpac should care about its reputation and should not want to be known as “the only Big-4 bank in Australia doing business with payday lenders”. In December 2017 Westpac chairman, Lindsay Maxsted, emphasized the paramount importance of the bank’s reputation during the AGM: As we begin our third century, our biggest challenge lies in rebuilding our reputation across the communities in which we operate. If we are to continue to prosper we must ensure the needs of customers and communities are the priority and we must actively demonstrate the value we bring to society and the value we bring to customers every day. In our view, given the huge importance of reputation to Westpac and a relatively small scale of a business Westpac has with CCP, the choice for Westpac looks obvious. Page 22 of 37 CCP EXERTED PRESSURE ON JOURNALISTS WHICH CALLED ITS LENDING BUSINESS “A PAYDAY LENDER” We found evidence of a censorship by CCP regarding the journalists who called Wallet Wizard “a payday lender”. On 1 June 2017, The Checkout, a popular consumer-oriented show on ABC, ran an episode on payday lenders titled “Having A Lend Of Us: Payday Loans” (Season 05, episode 08). According to the commentaries under the video, published on the Youtube channel of The Checkout, the original version of the video contained the Wallet Wizard logo on the list of payday lenders which appears 34 seconds into the video. Later, this version of the video was replaced with a new version without a Wallet Wizard logo: Source: YouTube The screenshot of the currently available censored version of the video from 0:34 does not contain a Wallet Wizard logo anymore: Page 23 of 37  Source: YouTube We note that journalists calling Wallet Wizard a payday lender were correct in substance. A company forcing journalists to be silent is never a good sign. We have seen this pattern before, and such behavior has never ended well for a company. According to a response from ABC to a complaint filed by Wallet Wizard, authors of the episode were confused “because of the way the business positions and markets itself in competition with payday lenders”. Page 24 of 37 Source: ABC Page 25 of 37 HOW HAS WALLET WIZARD GROWN SO FAST? CCP’s payday lending business has shown exceptional growth: it was started in 2012 and by the end of 2017 the company took 20% of the Australian/NZ cash loan market (as per CCP’s presentation): Source: Company Public Filings According to the management of CCP, lower cost of loans is one of the key competitive strengths of the company’s lending business. Annual Report 2017: Credit Corp’s Wallet Wizard-branded fast cash loan is the cheapest and most flexible offering in the segment. All of Credit Corp’s lending products apply interest and fees at rates below the regulatory caps applicable to mainstream lending. This differentiates our products from the heavily scrutinised alternatives marketed by competitors. However, according to numerous industry research studies, payday lenders generally compete not on price, but on qualitative factors like convenience of location, quality of service and ease of obtaining a loan. Competition on price doesn’t exist in the payday loan market because the cost of the credit is a very low consideration for the borrower. People ‘choose’ their payday lender based on the convenience of the location, the friendliness of store staff, and the ease of getting a loan. Source: consumeraction.org.au One of the most recent and expansive studies undertaken in Canada is the Payday Loan Customer Study: Final Report (September 2010) (for the Canadian Payday Loan Association) conducted by Thinkwell Research. This involved a large scale telephone survey of current payday loan customers in Prince Edward Island, New Brunswick and Nova Scotia, asking consumers about their practices, behaviours and opinions in relation to various financial products. The Page 26 of 37  survey resulted in 350 completed interviews. Over half of the respondents indicated that they chose payday loans rather than other financial products because they believed the process was “quick and easy” and that they were able to receive a loan whenever they needed it. Source: aph.gov.au And payday loan customers say they prefer the longer business hours and easier lending requirements of payday lenders, despite the high interest that payday lenders charge (391 percent APR, or annual percentage rate), the study said. Source: ucdavis.edu Customer reviews on Wallet Wizard on a local website productreview.com.au confirm these findings. Most of the customer reviews contain complaints regarding the slow approval process OR regarding being refused a loan by the company. At the same time, we found only a few customer reviews with complaints about high interest rates that the company charges (47.8% APR). In our view, one of the key reasons which differentiates the lending business of CCP – Wallet Wizard – is that the company has one of the lowest lending criteria among its peers. We conducted analysis of lending criteria for Australia’s top payday lenders and present our findings below. The table shows various categories of high-risk borrowers and whether they may obtain a loan from the leading payday lenders in Australia. Lending criteria Wallet Wizard Nimble Cash Converters Sunshine Loans Money3 Unemployed YES NO ("To be eligible for YES* ("Earn at least NO NO a Nimble loan, you $300 per week") need to be working") "Cash-in-hand" YES Not specified YES* NO NO Bankrupt YES (discharged YES (discharged YES* (discharged YES YES* (discharged bankrupts only) bankrupts only) bankrupts only) bankrupts only) Recepients of YES Not clearly stated ("If YES YES ("Sole income YES ("Income from Centrelink you're dependent on must not be from Centrelink must be less Centrelink benefits, we Centrelink payments") than 50% of total will review your income in order to application to see if a qualify for a cash Nimble loan is right for loan") you") Bad credit history YES YES YES YES YES * - according to finder.com.au Source: Companies’ websites, finder.com.au This is not a full spectrum of lending criteria used by the company, as we have evidence Wallet Wizard issues loans to borrowers with negative capacity to repay (more on this later). When we started analyzing the lending criteria of Wallet Wizard, we found that the company has a very few stated restrictions for potential borrowers. On its website WW simply states, “we welcome all applications”, including people on government benefits and discharged bankrupts. Up to February 2016 WW was even issuing loans to current (undischarged) bankrupts, however, since then this practice was stopped. Page 27 of 37  Source: Wallet Wizard When we were analyzing the code behind the Wallet Wizard website, we found a file creditcorp- constants.js. As its name implies, the file contains a list of constants (values that cannot be changed by the program during normal execution). In our view, by not closing access to this part of the code, Wallet Wizard inadvertently disclosed important details about the lending criteria of the company (see the block in red). Source: Wallet Wizard According to this part of the code, there are three reasons to be automatically declined by the Wallet Wizard loan engine: Page 28 of 37  • “Not Permanent Resident” • “Below Minimum Age” • “Single, capacity below threshold (-$100)” The following applicants are being “referred” which means “additional assessment is done by the company staff”. In this case the applicant can be either declined or approved: • “Bankrupt” • “Unemployed” • “Cash in Hand” (e.g. people receiving their income in cash) • “Partnered, capacity below threshold (-$100)” • “Capacity within buffer (-$100 to $100)” If the loan application was referred, the following message appears: Source: Wallet Wizard Being referred means that Wallet Wizard will request more information from a potential borrower to make the final decision. It is our understanding that the term “capacity” as used by Wallet Wizard in the programming code behind its website has the same meaning as in the regulations issued by the industry watchdog ASIC. So, what is “capacity”? Responsible lending obligations introduced by National Consumer Credit Protection Act 2009 require Australian lenders to check if a loan they provide is “not unsuitable” for potential borrowers. Below is an excerpt from ASIC’s Regulatory guide 209 “Credit licensing: Responsible lending conduct” describing what “unsuitable” means: Page 29 of 37  In addition, you must assess a credit contract or consumer lease as unsuitable where it is likely that: (a) the consumer will be unable to comply with their financial obligations under the contract (i.e. they do not have the capacity to meet their payment obligations under the contract), or could only comply with substantial hardship; (b) the contract will not meet the consumer’s requirements or objectives; or (c) if the regulations prescribe circumstances in which a contract is unsuitable, or unsuitable unless the contrary is proved—those circumstances will apply to the contract. Source: ASIC As per Regulatory Guide 209 it is lender’s responsibility to assess borrower’s capacity to repay a loan to make sure a loan is suitable for the borrower. Here is an example of how “capacity” is calculated: Example 10: Regular family expenses In assessing whether a credit contract will cause a consumer to experience substantial hardship, a credit licensee might set one or more levels of realistic family living expenses required to meet the consumer’s (and their dependants’) living costs. The consumer would need to be able to meet these living costs from their income, after deducting the ongoing repayments under the credit contract (and all other repayments and regular financial commitments of the consumer). Below this level, the licensee would, as a policy, not consider the consumer to have the capacity to repay the loan without substantial hardship, regardless of their circumstances. Source: ASIC According to ASIC, a borrower’s capacity should be calculated as “income less living expenses less repayments under the credit contract and other financial commitments”. If CCP complies with ASIC guidance on responsible lending, then how can they not automatically reject borrowers with negative capacity to repay (this means some of them get loans)? We particularly refer to these two categories of borrowers which are being “referred” for additional review, and not being automatically rejected: • Partnered, capacity below threshold (-$100) • Capacity within buffer (-$100 to $100) Issuing loans to unemployed people may also be a violation of responsible lending obligations. Even ignoring the possible violation of responsible lending obligations, how is issuing loans to people with NEGATIVE capacity to repay not a Ponzi scheme? Page 30 of 37 CORPORATE GOVERNANCE AND MANAGEMENT (1) CEO Thomas Beregi is an accountant and is a former CFO of CCP Here is what the renowned veteran investor Jim Chanos says about accountants turning CEOs: Jim Chanos: Well I’m always wary of accountants who become CEOs too. That’s always a bad sign for me. Prior to being appointed a CEO of CCP, Thomas Beregi was its CFO. FT summarizes why CFO is generally not a good choice for a CEO position: The main objection to the apotheosis of the CFO is that he or she doesn’t have the right skill-set or characteristics for the top job. Speaking privately, a US bank CEO told me that when companies need “creative solutions and marketing approaches, [decisions about] adding or discontinuing product lines [or making] acquisitions, [many CFOs] wouldn’t be at the table”. Luke Johnson revealed his own selection criteria in a recent column: “I prefer working with someone fundamentally conservative. Bullish chief finance officers are dangerous. The leader of a business needs to be an optimist, and sales-oriented. But every business needs at least one person at the top alongside them to worry about the downside.” Source: FT (2) CEO Thomas Beregi sits on the board of directors of the Credit and Investment Ombudsman Service (CIOS), an organization offering a dispute resolution scheme to assist consumers to resolve complaints with participating financial services providers. In our view, sitting on the board of CIOS presents a conflict of interest for a CEO of CCP. According to the industry sources, Thomas Beregi uses his position at CIOS for the benefit of CCP. Source: lawanswers.com.au Page 31 of 37 (3) CCP is the largest audit client of Hall Chadwick as measured by market cap A large and important audit client may have too much influence over the opinion of a small audit company. Companies audited by Hall Chadwick with market capitalization over US$ 10M Exchange: Market Capitalization Company Name Most Recent Auditor Industry Classifications Ticker (US$ M) Credit Corp Group Limited (ASX:CCP) ASX:CCP Hall Chadwick Pty Limited Financials 677.7 GDI Property Group (ASX:GDI) ASX:GDI Hall Chadwick Pty Limited Real Estate 504.4 Freelancer Limited (ASX:FLN) ASX:FLN Hall Chadwick Pty Limited Information Technology 144.1 Integrated Green Energy Solutions Ltd (ASX:IGE) ASX:IGE Hall Chadwick Pty Limited Industrials 104.1 Artemis Resources Limited (ASX:ARV) ASX:ARV Hall Chadwick Pty Limited Materials 89.4 Bailador Technology Investments Limited (ASX:BTI) ASX:BTI Hall Chadwick Pty Limited Financials 70.9 Jatenergy Limited (ASX:JAT) ASX:JAT Hall Chadwick Pty Limited Consumer Discretionary 63.3 Wollongong Coal Limited (ASX:WLC) ASX:WLC Hall Chadwick Pty Limited Materials 56.3 Source: CapitalIQ (4) Smaller competitors Collection House and Pioneer Credit use Big-4 audit companies KPMG and PWC respectively. (5) Despite the growing complexity of the business between 2010 and 2017 (launch of lending business; entering the US PDL market), audit fees as a share of revenue have materially declined. In our view, the declining ratio of audit expense to revenue may indicate that the quality of audit services provided by Hall Chadwick has been deteriorating. CCP audit costs AU$ '000 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Audit costs 149 132 131 144 154 171 166 170 181 225 Revenue 84,250 85,619 93,413 113,636 124,590 142,577 173,998 191,049 226,742 265,947 Audit costs/Revenue 0.18% 0.15% 0.14% 0.13% 0.12% 0.12% 0.10% 0.09% 0.08% 0.08% Source: Company Public Filings (6) CFO Michael Eadie sold all his shares in CCP during FY 2017 for the total proceeds of c. AU$ 1.5M. Source: Company filings Page 32 of 37 VALUATION While sell-side analysts prefer to value CCP based on P/E and P/B multiples, we conduct valuation based on the combination of discounted cash flows and P/E and P/B multiples. As a result of our analysis, we arrived at a target share price of AU$ 10.00 or 47% below the current level. DCF valuation AU$ '000 FY 2019 FY 2020 FY 2021 FY 2022 FY 2023 FY 2024 Carrying value of PDLs 361,514 Gross money multiple* 2.16 Gross ERC** 780,870 Collection curve 34.0% 22.0% 15.0% 12.0% 9.0% 8.0% Collections 265,496 171,791 117,131 93,704 70,278 62,470 Portfolio amortization -122,915 -79,533 -54,227 -43,382 -32,536 -28,921 Revenue from PDL portfolios 142,581 92,258 62,903 50,323 37,742 33,548 Carrying value of consumer loans 139,806 96,695 43,111 Interest and fee income/Net loans 56% Income from consumer lending 54,149 12,071 Total revenue 196,730 104,329 62,903 50,323 37,742 33,548 Cash operating expenses***/Revenue 52% 52% 52% 52% 52% 52% Cash operating expenses -102,300 -54,251 -32,710 -26,168 -19,626 -17,445 Net cash flows 314,040 172,722 84,421 67,537 50,652 45,024 IRR 8.0% Discount factor 1.08 1.17 1.26 1.36 1.47 1.59 Discounted cash flows 290,778 148,081 67,016 49,641 34,473 28,373 Sum of discounted cash flows 618,363 Less net debt 219,902 Equity value 398,461 Shares outstanding ('000) 47,709 Share price target 8.35 Current price 18.74 Downside -55% * - based on Collections/Amortization ratio for H1 FY 2018 ** - estimated remaining collections *** - excluding depreciation, loan loss provision expense, marketing expense, finance costs and income tax expense We assume that CCP will collect its existing PDL book over six years, as after this time the lender loses the right to take legal action against the borrower as per Australian legislation (e.g. the debt becomes statute-barred or legally unenforceable). Even extending the collection cycle to 10 years and assuming 2.60x gross money multiple over that period does not change share price target by any material magnitude. We assumed a conservative IRR of 8%, while IRR implied by the current share price is negative 15%. Page 33 of 37  Multiple-based valuation in millions of local Revenue Earnings P/E P/B Country BV Mcap Total debt Cash Net debt currency LTM LTM LTM Last Debt purchasers/collectors Collection House Australia 131 17 192 216 136 0 135 12.4 1.1 Pioneer Credit Australia 69 15 97 201 102 5 96 13.7 2.1 Arrow Global UK 332 41 173 487 978 42 936 11.9 2.8 Encore Capital Group US 1,242 83 602 987 3,607 217 3,390 11.9 1.6 PRA Group US 830 135 1,175 1,877 2,151 101 2,049 13.9 1.6 Intrum Justitia Sweden 5,949 1,520 23,632 28,310 35,426 2,583 32,843 18.6 1.2 B2 Holding Norway 2,200 529 3,875 7,456 7,424 569 6,855 14.1 1.9 Peer group median 13.7 1.6 Credit Corp Australia 284 60 266 894 235 16 220 15.0 3.4 Payday/subprime lenders Curo Group Holdings Corp US 1,001 56 43 1,060 631 131 501 19.0 24.9 EZCORP Inc US 773 41 688 681 314 160 154 16.5 1.0 FirstCash Inc US 1,782 153 1,424 4,191 414 110 304 27.4 2.9 Cash Converters Australia 254 19 271 158 155 99 55 8.5 0.6 Thorn Group Ltd Australia 236 -4 203 102 346 28 318 -28.4 0.5 FlexiGroup Limited Australia 457 -10 597 838 2,048 134 1,914 -81.4 1.4 Money3 Corp Australia 118 31 190 331 77 11 66 10.8 1.7 Morses Club UK 117 13 67 199 0 5 -5 15.2 3.0 Non-Standard Finance UK 108 -10 233 195 199 11 188 -18.9 0.8 Provident Financial UK 1,196 90 535 1,560 2,174 283 1,891 17.3 2.9 Peer group median 13.0 1.6 Credit Corp Australia 284 60 266 894 235 16 220 15.0 3.4 CCP trades at a substantial premium to peers based on P/B multiple and at a slight premium based on P/E multiple. We think CCP should be valued based on the combination of multiples for debt purchasing companies AND payday/subprime lenders. For P/E the closest peers among debt purchasers are Australian companies Collection House (P/E 12.4x) and Pioneer Credit (P/E 13.7x) with the average P/E of 13.1x; among lenders the closest peers are Cash Converters (P/E 8.5x) and Money3 Corp (P/E 10.8x) with the average P/E of 9.7x. The combination of these multiples (80% debt purchasing/20% lending as per H1 FY 2018 results) gives us a target P/E multiple of 12.4x or a target price of AU$15.50. We note that by valuing CCP’s lending business at 9.7x earnings we may be too generous: 1) in February 2018 it was reported that one of CCP’s key competitors in the payday lending industry – Nimble Money – was put up for sale at around 7.0x earnings, without finding a buyer; 2) As we noted in the section on accounting red flags, the quality of earnings is low. For P/B the same approach gives a target P/B multiple of 1.5x or a target share price of AU$ 8.42. The average of these three valuations gives us the target price of AU$10.76 vs the current share price AU$18.74. Valuation Methodologies Est. stock price P/E multiple 15.50 P/B multiple 8.42 DCF 8.35 Average 10.76 Current trading price 18.74 Downside -43% Source: CCP filings, Checkmate Research Calculation Page 34 of 37 APPENDIX 1 Credit Corp Annual Report 2017: Full list of CCP subsidiaries Page 35 of 37 APPENDIX 1 (CONTINUED) This list includes all subsidiaries of Credit Corp in Australia and New Zealand Page 36 of 37 APPENDIX 1 (CONTINUED) Financial results of all subsidiaries in Australia and New Zealand Page 37 of 37