New investors can make two key mistakes. The first is basing decisions on top-down trends and ignoring bottom-up company analysis and valuation.
The second is basing decisions on today’s news rather the next 12 months. In doing so, investors pay a price for responding too late to corporate news.
Consider home lending. High interest rates, rising unemployment and the prospect of greater loan defaults are a challenging backdrop for lenders.
But the big-four bank stocks are up 19-26% in the past 12 months. As I write this column, Commonwealth Bank is capped at a remarkable $200 billion, giving Australia one of the world’s most expensive bank stocks.
Virgin Money, Britain’s sixth-largest bank, will delist from ASX later this year as its shareholders have approved the takeover by merger with Nationwide, a UK building society. Virgin Money is up 42% over one year, after heavy falls in the past few years.
Even smaller non-bank lenders are improving. Judo Holdings, a specialist lender to small and medium-size enterprises (SME), is up 30% year-to-date, albeit off a low base. Judo, once favoured by this column, has tumbled in the past few years, amid market concerns of a jump in SME bad debts as the economy slows.
Pepper Money, a micro-cap lender, is up 22% on a year-to-date basis. More on Pepper Money in this column later.
Other lenders, however, are struggling to attract market interest, Liberty Financial Group and Latitude Group Holdings are slightly down on a year-to-date basis. So, too, Australian Finance Group and Resimac Group.
Yes, percentage changes over short periods can deceive. Several non-bank lenders are coming off several years of poor shareholder returns. Judo, for example, traded around $2.30 a share in late 2021. Now it’s $1.30.
The smart money, however, is paying more attention to mid- and small-cap lenders, judging by share-price gains from their lows this year. These investors must believe the market became too bearish on non-bank lenders.
That brings me back to this column’s opening theme: the need to focus on bottom-up companies and valuations, and not be blinded by top-down trends. Also, the importance of looking forward when investing.
Some non-bank lenders continue to grow their loan book and manage loan impairments, despite Australia’s slowing economy. Less aggressive competition from the big-four banks in home lending is helping them increase their share.
Longer term, it’s likely that more homeowners, individuals and small business owners will turn to non-bank lenders for finance, as the big banks take a more conservative lending approach due to heightened regulatory requirements.
Moreover, while high interest rates are hurting now, the odds favour rate cuts in the first quarter of 2025. Tax cuts this year, lower rates next year and a gradually improving economy should temper the risk of an avalanche of loan defaults and support credit demand.
Yes, all bets are off if rates need to rise again a few times and unemployment continues to climb, making it harder for households to pay the mortgage.
I expect rates to be on hold this year and for the next rate move to be down, probably late in first-quarter 2025. But the risk of persistently high inflation – and the need for more rate hikes to cool price growth – remains.
Australia’s inflation challenge and rate uncertainty explain why I think investors should consider some judicious profit taking, to add to portfolio cash allocations and have more firepower to buy stocks at lower prices this quarter and next.
This week’s hotter-than-expected inflation data reinforces my view, outlined in the column over the past few weeks. Equity market valuations continue to underestimate the persistence of ‘sticky inflation’ and the challenges for the Reserve Bank to get inflation back to the 2-3% target band.
Thus, rotating some capital out of pricey stocks when markets are near their record highs, and waiting patiently to buy undervalued stocks during market corrections or pullbacks over the next few months, remains my view.
Mid- and small-cap non-bank lenders could be an emerging opportunity for experienced contrarians who understand the risks in this part of the market and have a long-term view. Here are two non-bank lenders to consider:
- Pepper Money (ASX: PPM)
Pepper slumped from $2,75 in mid-August 2021 to $1.12 in late 2023, before recovering to $1.50. It’s been years of hard work for Pepper get the price heading north again.
Released in February 2024, Pepper’s CY 2023 result showed a 24% drop in total loan originations to $7.3 billion, compared to CY 2022. Mortgage originations fell 43% while asset finance – a highlight for Pepper – were up 20%.
Pepper’s assets under management – a key plank of the firm’s future profitability – were a record $19.7 billion, thanks to some $1.4 billion assets transferred under its Whole Loan Sale Program. Pepper’s lending book was marginally up on 2022.
Importantly, Pepper’s loan losses as a percentage of total lending assets under management, rose only 6 basis points to 0.28% in 2023. This is partly due to the increase in asset finance within Pepper’s total lending book and also to solid credit-risk management. The latest credit-quality result is within its long-term averages.
At its AGM in May, Pepper said mortgage originations, a weak spot for the business, showed signs of stability as the big-four banks reduce their cash-back offers on home loans to attract borrowers. Pepper’s comments confirm my earlier view that a wind-back of home-loan cashback offers by the big banks this year will make some non-bank lenders more competitive in residential mortgages.
Pepper said: “While still early days, we are starting to see demand for mortgages pick up. For the first quarter of 2024, our mortgage applications increased by 9.5% on Quarter 1 2023. … Customers continue to prove resilient and are managing well in a more challenging environment.”
At $1.50, Pepper Money trades on a trailing Price Earnings Ratio of 6.2 times and yields 5,7% before franking. Both figures appeal, provided Pepper continues to stabilise its mortgage business.
Chart 1: Pepper Money
Source: Google Finance
- Resimac Group (ASX: RMC)
Capitalised at $392 million, Resimac is a minor player in non-bank lending for residential mortgages.
Like Pepper Money, Resimac has been hammered, falling from around $2.60 in early 2021 to 86 cents, before improving this year to 96 cents.
In its 1H24 results presentation in February, Resimac reported home-loan assets under management of $12.5 billion and expected AUM to grow in 2H24.
Resimac’s investor presentation showed strong growth in mortgage brokers in its distribution channel; more brokers submitting their first loan application for Resimac; and sharp growth in home-loan applications.
Resimac also reported +90-day loan arrears at 0.69% of its loan book, which was less than three of the big four banks. Like Pepper, Resimac is doing a good job for now managing credit risk in a sluggish economy.
At 96 cents, Resimac should yield about 7% before franking (by annualising its interim dividend). On Macquarie Group’s numbers, Resimac is trading about 10% below its price target of $1,10. Macquarie’s price target for Resimac is $1,70.
Neither stock is screamingly cheap. But with signs of stabilisation in mortgage lending growth, as big banks wind back their cashback offers to switch loans, non-bank lenders look more interesting at current valuations.
Pepper and Resimac each have an attractive grossed-up yield, meaning investors can earn a decent income while awaiting a recovery in mortgage growth as interest rates are cut and big-bank competition eases slightly.
A recovery could take time given Australia’s economic challenges and the prospects of rates on hold for longer than the market expects. But there’s value in select small-lenders that are weathering the storm.
Chart 2: Resimac Group
Source: Google Finance
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 29 May 2024.
