KKR-backed Pepper to buy back shares after profit hit

Higher funding costs shrunk margins, and plummeting lending volumes hit the bottom line at the private equity backed-KKR lender. Pepper plans to buy up to 10 per cent of its shares.

Pepper Money CEO Mario Rehayem.

Pepper Money, which counts private equity giant Kohlberg Kravis Roberts & Co as a major investor, will start buying up to 10 per cent of its shares after a big dip in annual profit and a shrinking customer base.

Chief executive Mario Rehayem said the share buyback is a way to return excess capital to investors if the ASX-listed non-bank lender can’t find growth opportunities offering acceptable returns.

“The number one priority and objective for us is to deploy that capital in its most efficient way possible,” Mr Rehayem told The Australian.

“If that means that the market permits us to continue to grow in mortgages and asset finance, our core areas, then that’s what we will do. If the market is not present by way of a good return for the business, then we would look at that optionality of a buyback.”

He also left the door open to using that capital for an acquisition instead.

“The the only other time that we would not look at a buyback is ... if there is an inorganic opportunity for us to look at. That would obviously take preference depending on what the returns would look like,” he said.

ASX-listed Pepper provides slightly more expensive loans to borrowers who don’t usually fit the requirements for mortgages from the big banks, such as people who work for themselves. It listed in 2021 and still counts KKR as its largest shareholder, with a 60.55 per cent stake.

Facing intense competition from major banks in 2023, many Pepper Money customers refinanced their loans elsewhere. This led the company to focus on non-conforming loans, auto loans, and equipment finance loans.

“What triggered that spike in attrition is the banks offering practically loans at below the cost of capital, which has really not been done before,” Mr Rehayem said.

“Over 2024 and 2025, we should start seeing a return to long term averages,” he said. That means attrition should come down to between 35 to 39 percent, he said.

If the buyback goes ahead as planned, it will take about 12 months to complete and would remove an estimated $60m off Pepper’s capital base.

The company also increased the upper limit of its dividend payout ratio range for future periods to up to 60 per cent of NPAT, from up to 40 per cent.

Customer attrition in the mortgage business accelerated to 43.8 per cent, up from 39 per cent a year earlier. Mr Rehayem said that customer defection was already stabilising in the first few months of the 2024 year.

Mortgage sales fell 43 per cent during the year to $3.9bn – despite a 28 per cent bounce back in the second half – with a 20 per cent increase in asset finance volumes to $3.4bn not enough to offset that.

Rising interest rates and volatile expectations about future rate hikes, reflected in interbank rates, also hurt Pepper’s margins.

It’s net interest margin, a key measure of profitability, fell 0.20 percentage points to 2 per cent during the year.

“We had seen for many years stability in BBSW (bank bill swap rate), but the bank bill swap rates were very volatile (in 2023), which then gave us no control of understanding what our true NIM position is going to be.”

But Mr Rehayem said the “narrative” from the Reserve Bank had now changed, injecting stability in BBSW rates. He said the cash rate was likely to stay at 4.35 per cent “for longer” with cuts most likely happening “deep” in the December quarter this year.

Statutory net profit slumped 23 per cent to $108.7m for the 12 months to December 31 from a year earlier, hurt by higher funding costs and volatile swap rates that shrunk margins, and plummeting lending volumes. But the result was better than the $102m feared by analysts polled by Visible Alpha. Proforma profit after tax also fell 22 per cent to $111.1m.

The company will start buying back shares in April. It also declared a 5c dividend per share, down from 5.1c per share a year earlier but higher than the 3c per share expected by the street.

“While NPAT was 22 per cent below the previous corresponding period, this was a solid achievement in a year that saw intense competition and continued global economic and geopolitical volatility,” said Pepper chair Michael Culhane.

“I am proud of the resilience of our company … The business has strong foundations to continue to navigate market challenges with a scaled portfolio that allows us to flex between Mortgages and Asset Finance.”

Shares in the non-bank lender rose as much as 4.9 per cent to $1.48 each after the announcement, outperforming a broader market was half a percentage point higher.