Cautious optimism for non-bank lender stocks

The battered valuations of non-bank lenders may present a buying opportunity for investors, even as the sector grapples with sharply higher funding costs.

The Reserve Bank last week estimated about $350bn worth of loans across the industry would roll off ultra-low fixed rates to substantially higher variable rates this year. Picture: NCA NewsWire / Damian Shaw

The battered valuations of listed non-bank lenders may present a buying opportunity for investors, even as the sector grapples with sharply higher funding costs and fiercer competition from banks for borrowers.

Despite the challenges, some analysts and fund managers believe the sharp sell-off over the past year in non-bank lending stocks, albeit with a recent rally, presents investors with selected buying opportunities.

Most ASX-listed non-bank lenders will provide an update on their earnings prospects in coming weeks as profit season gets into full swing. They include Pepper Money, Resimac, Liberty Financial Group, Latitude Group and smaller firms such as Plenti, Harmoney and MoneyMe.

Cadence Capital managing director Karl Siegling believes Resimac is an attractive buy at the stock’s current level, even though he is treading cautiously on making other investments in the sector.

“Resimac at these levels is an opportunity. The stock is very cheap fundamentally,” he said, noting the company had ramped up its lending to less risky prime borrowers, which would provide protection against loan losses climbing this year.

Mr Siegling said for borrowers who had purchased a home more than two years ago, the equity in their home would have markedly risen, but conceded those who purchased at the height of the recent boom may find it challenging.

“The risk of default at the moment is very low, but there is a risk for those that bought more recently on low fixed rates,” he added.

Mr Siegling is less upbeat on other non-bank lenders, having looked at the likes of Pepper, business lender Prospa and Liberty either recently or having assessed their models when they listed.

The Reserve Bank last week estimated about $350bn worth of loans across the industry would roll off ultra-low fixed rates to substantially higher variable rates this year.

Cadence Capital’s Karl Siegling believes Resimac is an attractive buy at the stock’s current level.

That changeover accelerates as economists widely expect the RBA will on Tuesday raise official rates a ninth time as it seeks to rein in inflation. The cash rate rose from 0.1 per cent to 3.1 per cent last year. Banks benefit as rates rise given they source a large portion of their funding from deposits that are not earning much interest.

Economists and analysts are closely monitoring housing and business credit growth as rates continue to rise and demand for finance retreats.

ANZ chief executive Shayne Elliott on Friday said the central bank may have to continue its rate-hiking cycle for longer than expected, particularly if demand doesn’t markedly slow and curtail economic growth.

Macquarie Capital research analysts expect non-bank lender credit growth to normalise to about 4 per cent to 6 per cent in 2023.

“While macro conditions aren’t conducive for the sector’s near-term performance, we believe downside risks to margins are reflected in discounted valuations,” they said in a report. “Embedded in our assumptions is for rate movements to slow in the short term, with two further interest rate hikes forecast in 2023 … we expect non-bank lenders to underperform banks on margins given lack of deposit funding and persistent competitive pressures as banks continue to reinvest some of their margin tailwinds into mortgage pricing.”

But the analysts warned if inflation persisted in the economy there were downside risks to non-bank lenders’ net interest margins, or what they earn on loans less funding and other costs.

“Non-bank lender valuations look appealing at current levels, but pressures from the rising rate environment leave a valuation overhang from rising impairments,” they said.

Macquarie analysts have an “outperform” rating on Liberty and neutral ratings across Pepper, Resimac, Latitude and AFG. They count mortgage broking group AFG as a lender as it has its own direct lending unit. “Our order of preference for the sector is Liberty, AFG, Resimac, and Pepper,” they said.

Macquarie also highlighted differentials in current and expected loan growth rates among the non-banks, some of which have asset finance arms, while others such as Latitude are not present in home lending and focus on credit cards, personal loans and buy now, pay later products.

“We see different trajectories across our coverage in 2023, with Pepper and Liberty driving persistent book growth (circa 6 per cent and circa 4 per cent respectively) given the asset finance focus and, in Pepper’s case, a strong market position in the non-prime segment,” the analysts said. “Resimac remains the book growth laggard (circa 10 per cent decline) as management looks to maintain margin resilience in the face of significant customer churn.”

Financial updates from smaller lenders of unaudited numbers last month showed a big focus on reducing costs, navigating margin pressure and delivering profits.

Personal lender MoneyMe late last month said it had returned to statutory profit and expected to deliver a first-half profit result of more than $8m. Harmoney said its unaudited results showed an interim cash profit of $2.3m, while Plenti had a December quarter trading update that said it delivered “positive cash net profit after tax” for the three months.

On loan losses and impairments, Macquarie analysts said: “Pepper appears to have the highest skew to asset finance as well as non-prime lending, resulting in a higher predicted impairment rate.

“Liberty maintains a higher skew to non-housing related loans than Resimac/AFG, though Resimac has a higher skew to non-prime lending. AFG remains the lowest risk non-bank lender from an impairment perspective.”

The analysts said they were “pleasantly surprised that stress appears benign to date” after analysing loan performance of riskier mortgages bundled up and sold as bonds to investors.