Pepper Money steps back from prime lending, waits for rates to plateau

The non-bank lender booked an 8 per cent rise in annual profit but is more cautious on the outlook.

CEO of Pepper Money, Mario Rehayem

Pepper Money has stepped back from the prime mortgage lending market as it takes a conservative view on higher funding costs and uncertainty in the housing sector, instead favouring asset finance and nonconforming loans as it watches for rates to plateau.

Speaking to The Australian after handing down its full-year result, showing the non-bank lender delivered an 8 per cent lift in annual net profit, chief executive Mario Rehayem said Pepper was deliberately aggressive with its home lending in the first six months of 2022, knowing that higher funding costs and a softer market were not far off.

After growing above system in the first half, the lender stepped out of the market to grow at 2.5 times below system, right as major lenders pushed further in with competitive rates and cashback offers.

Mr Rehayem said he was comfortable for Pepper to sit on the sidelines, adding that the lender was ready to step back in once funding costs to start to come down.

“When there is a volatility or a wobble in the (cost of funds) we prefer to take a conservative view of making sure that we are originating profitable loans and also have an ability to securitise those loans,” he said.

“We’ve never looked at originating for the sake of originating. There always has to be a certain return hurdle that we have internally and because of the significant competitiveness from the banks with cashback Offers, and the like, we decided to take a step back and focus on diversifying into non conforming (and) asset finance.”

Stepping back into the prime market would depend on where the cost of funding lands, he added.

“We’re seeing positive signs very early in the year with regards to stability in the Bank Bill Swap Rate and we do feel that we’re going to be reaching the peak of rate rises, hopefully by mid year.

“If that’s the case then what that does is then stabilise our funding approach and gives us more confidence to say that we can we can put the foot down a little bit more than what we have in the past six months and work to recoup some of that market share.”

Mr Rehayem added that the lender was seeing “a really strong appetite for growth” in nonconforming loans. These are loans that typically don’t meet major banks’ standard loan criteria.

It has also not seen any big lift in borrower stress as rates have pushed higher, he said.

“We are not seeing anything that is above our long term averages, so we‘re comfortably inside our long-term averages of loan performance. You’re obviously going to get stresses after nine consecutive rate rises … So what we are seeing that in some areas where some customers may have delayed the urgency of changing their discretionary spending habits.

“But what we’ve noticed from the interactions with our customers is that they are still employed, which is a major positive factor. And when we overlay the rising rate markets with what we’ve experienced previously, it is nothing that we haven’t seen before. Customers tend to take three to four months to react and change their discretionary spending habits to be able to accommodate the new rates and the new repayment amounts.”

For the 12 months through to December 31, the non-bank lender’s net profit rose to $140.5m, up 8 per cent on the prior year.

On a pro-forma basis, which includes the acquisition of car loan broker Stratton Finance mid year, net profit jumped to $142m, in line with the prior year.

“Pepper Money rose to the challenges that uncertain and weakening market conditions presented over the year. We entered 2022 with a strong focus on driving volume to support asset under management growth, expecting that the emerging economic trends and interest rate increases would see the market slow over the latter part of the year,” he said.

“We successfully executed on our strategy in the first half of the year delivering above system growth … The second half of the year saw significant softening in the markets in which we operate, as the impact of consecutive rate rises coupled with volatility in capital markets impacted both customer volume and funding costs”.

Pepper reported record originations of $9.6bn through 2022, up 14 per cent on the prior corresponding period, with mortgages up 7 per cent to $6.8bn and asset finance jumping 35 per cent to $2.8bn.

Net interest margin of 2.20 per cent for the year was 36 basis points below the year prior, with NIM compression due to strong competition impacting customer rates, rising swap rates, volatility in BBSW and higher funding costs.

Mortgages NIM of 1.98 per cent for the year declined 35bps but the exit NIM for December sat at 2.03 per cent, reflecting a stabilisation in margin as price increases work through the portfolio, the company said.

Total assets under management rose 13 per cent to $19.2bn.

The board declared a fully franked final dividend of 5.1c a share, bringing total 2022 dividends to 10.5c fully franked.

Pepper shares were up 0.3 per cent at $1.52 in afternoon trade.