KKR-backed Pepper Money shares plummet after profit miss

Investors dump shares in the KKR-backed subprime lender after profit and dividend missed market expectations by a long way amid fierce market competition.

Shares of Kohlberg Kravis Roberts & Co-backed Pepper Money plunged by more than 17 per cent, the sharpest fall since listing, after posting interim earnings that missed expectations as higher cost of funds and bank competition badly hurt margins.

The ASX-listed Pepper provides slightly more expensive loans to borrowers who don’t fit the usual requirements for mortgages from the big banks, like people who work for themselves. It counts KKR as its largest shareholder, with a 60 per cent holding.

But in the first half of the year, mortgage competition among the big banks squeezed Pepper out of the market, with mortgage originations falling 58 per cent from a year ago to $1.7bn. That was offset by higher asset finance originations that rose by $1.8bn.

“We did see not only aggressive rates but that was also coupled with very strong cashback offers. This is what stimulated the heightened attrition,” chief executive Mario Rehayem said.

“Most banks have retreated in the cash back offers, and front book pricing is starting to increase in line with (an increase in) cost of funds.”

The churn in prime mortgages also hurt margins as higher yielding customers left Pepper for other banks.

That attrition has slowed but would continue until November, before normalising back to “long-term averages”, Mr Rehayem said. He said higher nonconforming originations will make up some of that attrition.

As volumes slowed in mortgages Pepper boosted its focus on asset financings such as car loans and novated leases, where margins were 2.62 per cent, compared to 1.83 per cent in the mortgages segment.

It was the first time in Pepper‘s history that asset finance originations surpassed written mortgages over a six-month period, according to Barrenjoey analysts.

The subprime lender declared a 3.5c interim dividend that was also below the 5c expected by analysts and over a third below its interim dividend last year.

Net profit dropped 28 per cent to $52m for the six months to June 30, well down on the $66.5m expected by sell-side analysts polled by Visible Alpha, as higher than expected expenses also chewed through profits.

Shares fell as much as 17.04 per cent to $1.29 each following the result – its most severe plunge since KKR floated the company in May 2021 – in a wider market was half a percentage point higher.

Pepper’s group net interest margin – a key measure of profitability – came in at 2.06, a 23 basis point drop from a year ago, also hurt by a sharp bounce in its cost of funds as the bank bill swap rate spiked. That was far from the 2.23 per cent NIM expected by the street.

“We have never seen such volatility in swaps and that‘s because of the rapid and the frequency of RBA changes to the cash rate,” Mr Rehayem said.

“It’s been an unprecedented number of rate rises and the pace and the frequency in which that has happened that has caused that volatility. The only time we’ve seen anything remotely like it was the GFC.”

With interest rates seen near their peak, that headwind could become a tailwind next year.

“It has already started to normalise and it will become more predictable over the coming months and then hopefully when the RBA feels that what they needed to do has been done we might start to see a bit of rate cuts in 2024,” Mr Rehayem said.

“We will then start to see a benefit coming our way.”

Analysts qualified the result as “soft” and “disappointing” with Barrenjoey saying that beside the higher costs, mortgage competition from banks had impacted the non-bank lender.

The group booked a $24m provision charge to provide for loan and lease losses, which was 77 per cent higher than the first half in 2022 but lower than analysts were expecting.

The increase was also in line with the growth of its book, keeping loan losses at 0.44 per cent of average assets under management, the same as a year earlier.

Loan arrears metrics remained better than long term averages, the company said.

Home loans more than 90 days behind repayments were 1.27 per cent of the book, up 41 basis points from a year earlier but below the 1.69 peak in May 2020. And only 0.19 per cent of loans were behind in the asset finance division, below the long term average of 0.24 per cent.

It said it had reduced its workforce by 3 per cent since December despite seeing record applications for its products, as it was already reaping some of the benefits of its investment in technology.