Pepper Money Limited (PPM) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to Pepper Money Limited's Calendar Year 2023 Full Year Results Presentation. My name is Gordon Livingstone, Investor Relations at Pepper Money. Now, I would like to begin by acknowledging the traditional custodians of the land on which we meet today, the Gadigal people of the Eora Nation. We pay our respects to each of their Elders past, present and emerging. Following a business update from Pepper Money's CEO, Mario Rehayem; Pepper Money's CFO, Therese McGrath, will walk us through the financial performance. After some closing remarks from Mario, there will be an opportunity to ask questions, which can be either via the phone or submitted via the portal. I will now pass over to Pepper Money's CEO, Mario Rehayem.

Thank you, Gordon. On behalf of my team at Pepper Money, I would like to thank everyone who has joined us today. As I'm sure you have heard me say, at Pepper Money, our mission is simple. It's to help people succeed. We focus on creating financial inclusion by challenging the way loans are designed and distributed and our values provide the guide to how we do business and how we interact with our customers, stakeholders and each other. The strength of our 4 pillars: customer, business, people and brand, are all supported by over 23 years of data and through the cycle experience. As a business, we know when to drive volume, when to flex the margin and how to price for risk. Our strong values are the foundation that set the expectations for behavior that guide and guard the business. Our core competencies have really come to the forefront when faced with the macroeconomic and market conditions experienced over the last 18 months. It is the consistent application of our strategy that has seen the business continue to navigate through these challenges and to deliver results in 2023 that reflect our ability to respond to market conditions, deliver on customer needs, leverage our diversified business portfolio to balance cyclical trends and to successfully identify and deliver on inorganic opportunities. If we now turn to 2023 business highlights on Slide 4. As I spoke about at the half year, we were expecting the softening in Mortgage originations seen in the second half of 2022 to continue into 2023, and this was the case. But we were prepared and responded by accelerating the growth in Asset Finance, which has achieved again record results. This has helped counteract the current cyclical trend experienced in Mortgages. We delivered originations of $7.3 billion and while 24% lower than prior comparable period, Asset Finance originations of $3.4 billion, up 20% on PCP, were the highest the business has ever achieved. Mortgage originations at $3.9 billion were down 43% on 2022. However, as I will cover later, as market conditions started to show signs of stability over the latter part of calendar year 2023 and major banks started to wind down cashback offers, the decline in Mortgage originations started to plateau and our second half Mortgage originations of $2.2 billion grew 28% on the first half of 2023. Total AUM, which is a key foundation of future profitability, closed 2023 at $19.7 billion, the highest the business has achieved in its history. Lending AUM at $18.3 billion was marginally up from 2022 close. Servicing AUM, which includes the AUM transferred under the whole -- our whole loan sale program at $1.4 billion, was up 43% on prior comparable period. Funding is a core competency of the business. Over 2023, we raised a record $5.4 billion in public markets, up 7% on 2022. In addition to our 7 public securitizations, we raised further $1.6 billion in private term securitizations and whole loan sales. Warehouse capacity closed the year at $9.3 billion, down 18% on December 2022, given lower mortgage originations. We continue to maintain 4 to 6 months headroom, meaning we are well positioned to capture growth as it returns. The diversification of the portfolio continues to deliver benefits as we were able to capture growth opportunities in Asset Finance as market conditions remain soft in Mortgages. Asset Finance has grown to contribute 43% of total operating income in 2023, up from 37% last year with Mortgages now at 55%. We continued to be disciplined in credit risk management. The increase of 6 basis points in loan loss as a percent of lending AUM on PCP was driven by mix with Asset Finance AUM as a percent of total lending AUM increasing 26% in 2022 to 31% in 2023. Loan losses as a percent of AUM remain within long term averages. Customers are at the forefront of how we do business given our mission to help people succeed. Our customer well-being forms part of this mission. Alongside welcoming over 89,000 new customers to Pepper Money over calendar year 2023, we also ensure we found ways to help our existing customers navigate increasingly difficult economic conditions, which we all experienced over the last year as both interest rates and inflation rose. Our customer value proposition is demonstrated through our customer net promoter scores. In 2023, we saw increases in product advocacy across all core Pepper Money products, with results considerably ahead of the industry. I've spoken in the past about how we have built a scaled technology platform supporting automation. This, coupled with our disciplined approach to cost management, saw normalized pro forma operating expenses increase by 1% from $155.9 million in 2022 to $157.7 million in 2023. Normalizing removes the impact of Stratton acquired 1 July 2022 from the operating cost base, as well as the pro forma cost of acquisitions. Pro forma NPAT for 2023 at $111 million is 22% below PCP with lower volumes in Mortgages coupled with swap rate volatility, increased provisioning for loan losses as Asset Finance AUM grew all impacting profit flow through. On top of this, expenses have increased on PCP given we analyzed impact of Stratton. So 2023 has an additional 6 months of costs now reflected over and above PCP. As we enter 2024, I am encouraged by several trends, from easing inflation to stability returning to funding spreads. Likewise, as I noted earlier, we are starting to see demand in Mortgages pick up. The Board has declared a fully franked final dividend of $0.05 per share, representing a 37.5% payout ratio. For 2023 in total, covering interim and final dividend, we are returning $0.086 per share, representing an annualized yield of 6.4% and a payout ratio of 34%, up from 32.5% in 2022. Pepper Money remains, as always, disciplined in respect to capital. We have been able to grow our Asset Finance business over 2023 and capture opportunities, such as the acquisition of the HSBC New Zealand residential mortgage portfolio, given our capital management strategy. In the short-term, given likelihood of lower Mortgage origination growth across the market, as well as some moderation in the growth of Asset Finance, the capital needed to fund the business will likely moderate. As such, the Board has considered opportunities to return capital to shareholders and today announced via a separate announcement its intention to commence an on-market share buyback from April this year. In addition, the Board has amended the company's dividend policy, increasing the annual payout ratio to 30% to 60% of pro forma NPAT from 30% to 40% effective from the 2024 financial year. Now to business performance starting on Slide 5. Pepper Money operates in a large addressable market covering $2.6 trillion of credit outstanding for Mortgages and $221 billion of credit outstanding for Asset Finance. There is a breakdown of the total addressable market included in the appendices. Our 3 core segments remain: Mortgages, made up of residential in Australia and New Zealand, commercial real estate in Australia, and in 2023, we launched Super Smart, our self-managed super fund product in Australia, which is already gathering momentum. Our next key segment is Asset Finance, a business we have organically built and is now one of the largest asset financiers in the country. Our focus is small balance lending in both consumer and commercial whilst also increasing our share in the Novated Leasing segment. Our third segment, loan and other servicing, encompasses our servicing of loan portfolios, generally via our whole loan sale funding program where we sell loans that we have originated to a third-party but retain the customer service and operations of these loans. In quarter 4 2023, we exited the small broker administration business we started under COVID-19 as it is no longer seen as core. Turning now to the performance of the key business segments, starting with Mortgages on Slide 6. The market has been tough for Mortgages. Equifax reported the total mortgage inquiry volumes were down over 7% in the 12 months to December 2023. At the same time, as demand was down, banks were competing to gain market share and were offering very compelling rates and cash backs were the norm for most of the year. As I discussed at the half year, our focus over 2023 for Mortgages has been to leverage our position in a non-conforming segment as an area banks do not play in. While originations have slowed down, we have skewed the mix to Near Prime and Specialist, which accounted for 63% of Mortgage originations in the year up from 48% in 2022. Pepper Money started over 23 years ago as a non-conforming lender and today, we continue to have strong market position in this space. Mortgage AUM dropped 7% on PCP to $12.6 billion. Other than the lower origination rate, we have also seen high customer attrition across our mortgage portfolio as customers sought lower rates and capitalized on cashback offers from the banks. Our disciplined credit risk management has seen indexed LVRs protected with 72% of loans now sitting in LVR bands below 70%. We moved our customer rates within 2 weeks of when the RBA announced an increase to the official cash rate. However, there is a negative lag impact as we are required to provide customers 20 days' notice before their repayment amount can increase. The largest adverse drivers of Mortgage NIM continues to be swap rate volatility and customer attrition. While our average customer rate increased 264 basis points on PCP driven in part by pricing changes following rate rises and in part by business mix moving towards non-conforming, BBSW volatility eroded this price gain by 255 basis points. A detailed NIM walk will be covered in the financial section, and likewise, Therese will walk you through our credit performance. Before turning to Asset Finance, I think it is worthwhile looking at Mortgage performance second half 2023 versus first half as the downward pressures on this business segment are starting to stabilize, so turning now to Slide 7. As I noted, as market conditions started to show signs of stability over the latter part of calendar year 2023 and major banks started to wind down cashback offers, the decline in Mortgage originations started to plateau and second half Mortgage originations of $2.2 billion grew 28% on the first half of 2023. Our Red Hot promotion, which we ran from August to end of October, delivered on the objectives we had established for the campaign, namely to enhance Pepper Money's position with our brokers and to support volume for our non-conforming products. Non-conforming originations in the second half 2023 were $1.4 billion, up 21% from the first half. The campaign objective of enhancing our position with our brokers helped to accelerate prime originations as well, which had $843 million in the second half of 2023 were 40% higher than the first half. This was at a time where Equifax reported an 8% decline in Mortgage inquiries. Growth was not at the expense of our credit performance. Our weighted average indexed LVR for the second half was 56%. Customer pricing was more stable over second half 2023 as RBA only increased the official cash rate once in the 6 months to December versus the 4 interest rate increases experienced over the first half of 2023. Now to Asset Finance starting on Slide 8. Our Asset Finance business continues to outperform the market, growing 1.4x system over 2023. We delivered originations of $3.4 billion, up 20% on prior comparable period. Novated leasing continued to grow well ahead of system with originations at $1 billion, up from $276 million in 2022. Our investment in systems and processes meant we could continue to efficiently drive scale and productivity in Asset Finance. We were able to capture growth in Asset Finance as our capital management allowed us to be able to deploy the capital needed. Asset Finance has a higher credit enhancement than Mortgages, so requires more cash to support new business. We were able to bring forward planned ABS securitizations to support growth and over 2023 we completed 2 SPARKZ transactions raising $1.4 billion. Given the scale that we have now achieved in Asset Finance, with AUM growing past the $6 billion mark in September 2023, we also undertook our first Asset Finance whole loan sale in December, which complements our ABS funding program. Whole loan sales have since 2016 been part of our funding and capital management in Mortgages and allows us to recycle capital release behind new originations growth. AUM for Asset Finance closed 2023 at $5.7 billion, growing 21% on PCP. Adjusting for the whole loan sale in December where the AUM is transferred to our loan and other servicing segment, Asset Finance would have closed at $6.2 billion, a growth of 31% on December 2022. As always, we were disciplined with the type of risk we took on, 63% of originations in 2023 were Tier A clean credit customers and originations were up 28% versus prior comparable period. Asset Finance net interest margin experienced compression over 2023, reducing by 41 basis points from 2.91% to 2.50%. While pricing initiatives supported 127 basis point increase in portfolio customer rates, the mix of novated leasing, a lower margin product, coupled with swap rate volatility and the wind down of favorable funding margins from 2020 and 2021 drove the reduction in NIM. As a business, we hedge our Asset Finance pipeline every second day. However, swap rate movements were ahead of our hedging program, particularly at the end of June. As we enter 2024, we are seeing frequency of swap rates starting to stabilize. On to credit performance for Asset Finance. We have increased credit provisions by $7.9 million year-on-year. This is in part driven by the increase in AUM and in part by an increase in late-stage arrears and insolvencies. The increase in insolvencies is a return to historic trends following the removal of government protections implemented under COVID-19 that seized at the beginning of 2023. Total loan losses as a percent of lending AUM for second half 2023 closed at 0.81%. There is some distortion in the year-end exit 90-plus arrears for the portfolio which at 0.31% looks elevated. This is due to the whole loan sale in December. Adjusting for the whole loan sale, 90-plus arrears were 0.28%. Turning now to second half performance for Asset Finance on Slide 9. From a half-on-half perspective, growth in Asset Finance marginally slowed down, given the pressure on households and businesses alike from rising rates and inflation, it was expected that the pace of growth would lessen. In the second half of 2023, Asset Finance delivered originations of $1.6 billion and while down 12% on the first half of the year, the business grew by 21% on the second half of calendar year 2022. Growth came from novated leasing and Tier A products. Now turning to funding on Slide 10. You've heard me say many times funding is a core strength of Pepper Money. Over 2023 we have raised a record $5.4 billion from the public markets. We completed 7 public term securitizations in total, 4 non-conforming RMBS totaling $3.2 billion, 1 Prime RMBS for $750 million, and 2 ABS totaling $1.4 billion. We are a frequent and programmatic issuer. And alongside the 7 public term securitizations completed, we raised a further $1.6 billion in private term securitizations and whole loan sales. Given our mortgage volumes, we reduced warehouse capacity limits by $2 billion, bringing total warehouse capacity at 31 December 2023 to $9.3 billion, down 18% from 31 December 2022. We have again started the year strong and our first RMBS for the year, a $750 million PRS non-conforming raise, settled yesterday at margins that are inside those experienced in 2023. PRS39 had a weighted average margin of 1.66% compared to PRS35 in February 2023 at 2.23% and PRS38, which settled in September 2023 at 1.93%. Now to Slide 11. Sustainability has been an inherent part of Pepper Money's foundations as we have built our business on the mission to help people succeed. We seek to create sustainable value for our customers, employees, the communities in which we work and for our shareholders. Over 2023, we continue to make significant progress on building a sustainable business model which will benefit, not just Pepper Money, but all our stakeholders. To highlight just some of the work achieved over 2023. Our diversity, equity and inclusion strategy is underpinned by our guiding principles of Allyship, Celebrate, & Educate, or ACE. Diversity and inclusion have always been part of our DNA, 45% of our senior managers are female and we compared very favorably to the average for the financial services and insurance sector in Australia, which was 38% in 2023. Our people continue to be highly engaged and again, our employee engagement at 75 for Australia meant we continue to be in the top 10% of companies globally. We continue to support our communities largely through our Pepper Giving initiative, which gives, not just dollars, but also time. Our employees continue to give back to the community through regular volunteering opportunities. Examples include gardening days at Women and Girls Emergency Centre and making sandwiches for children experiencing food insecurity through Eat Up Australia initiative. For the organizations that we support, the volunteering effort by our employees is meaningful. Our forefront position in EV lending has seen the business finance 8,986 electric vehicles in Australia since we commenced this program in 2015. Based on the average vehicle distance traveled in lifecycle emissions, we have, through financing efforts, helped save more than 39,000 tonnes of carbon emissions in 2023 and will offset up to 236,000 tonnes of carbon emissions over the lifetime of these vehicles. We pride ourselves on being a responsible business. It starts with how we develop our products through to how we manage all aspects of our business to ensure our customers can achieve the best outcomes. Let's turn to Slide 12, our customers. Our mission to help people succeed supports our customers' financial needs. Through our focus on providing innovative home loan and asset finance solutions to customers who are typically underserved by traditional lenders. We welcomed over 89,000 new customers over 2023 and since 2004 have helped over 455,000 customers. We regularly monitor what customers tell us they need by listening through various customer effort and net promoter score surveys and monitoring our operational metrics, such as call center wait times, time-to-yes and system outages. It is the time we put into listening to customers and responding with scaled platforms and processes that supported our net promoter scores across all asset classes, outperforming the industry average. Our annual customer NPS survey saw increases in product advocacy across all core Pepper Money products with Asset Finance NPS of 50, 27 points higher than the industry average and the NPS for home loans was 9 points higher than the industry average. 2023 was a difficult year for many people, our customers included, as household income was impacted by ongoing rising interest rates and inflationary pressures and consumer confidence deteriorated. To support customers in making the right choice, we have developed a suite of digital resources and tools with the aim to uplift and enhance financial literacy. Over 2023, more than 15,000 users accessed our Customer Support Hub and over 2,700 users accessed our financial hardship and money management articles. Turning now to Slide 13. Our positive customer experience is underpinned by efficient technology. Our technology is scaled. We continue to be focused on automation and streamlining processes. In Mortgages, the efficiency of our originations platform is demonstrated by the uplift in normalized application volume each credit employee can process, as well as the uplift in origination volume per settlement FTE. These gains of 45% and 56%, respectively, have been achieved through the continued development of our Sage platform. Likewise, our customer service platform Apollo is delivering significant improvements in how we serve our mortgage customers, demonstrated through 15% gain in AUM per servicing FTE. In Asset Finance, our Solana originations platform continues to support our partners and customers alike. Automation and API connection direct to our partners CRMs has seen auto approval apply to 34% of commercial loans and 78% of novated leasing loans over 2023. The speed-to-yes is a key driver of customer and partner satisfaction. And as like Mortgages, our customer service platform Apollo is delivering benefits to our Asset Finance business with a 37% gain in AUM per servicing FTE. I will pass now to Therese, who will run through the full year financials for 2023 and then I will close out with some comments on outlook before handing back to the operator for Q&A.

Thank you, Mario. Good morning, everyone. As Mario has covered off the volume trends experienced by the business over the last 12 months, I will focus today on net interest margin, credit performance and expense management. If we turn first to net interest margin on Page 14. While our net interest margin continued to compress, the primary driver of the downward trend was swap rates. Total NIM for 2023 at 2% was down 20 basis points versus PCP. While our pricing initiatives saw customer rates improve by 230 basis points. This gain was eroded by adverse swap rate spreads, which drove NIM down by 217 basis points. NIM was further impacted as funding margins have increased markedly over the last 18 months, driving a further 34 basis points compression in NIM. Turning now to Mortgages, which is the chart on the bottom left-hand side. As the RBA increased interest rates, we implemented both back and front book price increases across our Mortgage portfolio. Over 2023, we increased on average the back book by 143 basis points and the front book by 128 basis points for Prime and 131 basis points for non-conforming. These rates flowed through to support the average customer rate improving by 264 basis points when compared to 2022. However, as we have noted, there's a delay between the date of notification of increase and when it takes effect. This lag causes NIM to compress by around 10 basis points. But what really continued to impact mortgage NIM was the volatility in BBSW, which reduced NIM by 256 basis points. When the impact of BBSW is added to the deterioration in our funding margin of 31 basis points, customer rate increases could not be fully recovered and as such mortgage NIM decreased by 21 basis points year-on-year. I will cover off Mortgages in more detail on the next slide. Our Asset Finance business, which is the graph on the lower right-hand side, saw NIM compress due to 2 key drivers, swap rates and business mix. The volatility in swap rates over 2023 cost NIM 125 basis points. As our Asset Finance products are fixed rate, we hedge the book almost every 2 days, which does allow for some protection. What we continued to experience, however, was swap rates moving faster than even our hedging program, particularly around the half year. This was also a time when we saw volume accelerate as commercial customers sought to capitalize on financial year-end tax incentives. But like Mortgages, customers and partners come to Asset Finance given our service levels, speed-to-yes and ease of doing business. These attributes have helped to accelerate growth in our novated leasing business segment, which now represents 18% of Asset Finance AUM. Novated leasing has a lower NIM. And so, as it grows, the average customer rate is impacted through mix. However, as novated leasing customers salary sacrifice, it has virtually no credit losses, so margin after losses are maintained. I'll cover the favorable impact of novated leasing on our credit performance in slide 17. We are not a price leader in Asset Finance and over 2023 pricing initiatives saw our average customer rates increase 128 basis points net of mix. However, adverse cost of funds eroded the delta between the customer rate increases and swap rate movements. Turning to look at Mortgage NIM movements in more detail on Slide 16. Starting with the drivers of NIM compression 2020 to 2021. This was a period of stable customer rates. Strong origination growth in Prime over this period caused our customer rate to reduce. BBSW was low and our cost of funds were benefiting from positive market conditions. However, from around quarter 3 2021, we started to see heightened customer attrition as banks rolled out fixed rate loans at 2% to 3% as they had funding benefit from the TFF injection made by the government under COVID. From 2022, our cost of funds started to increase as capital market conditions deteriorated and measures implemented under COVID were rolled back. Market uncertainty drove extreme volatility in BBSW, which rose from 1 basis points in 2021 to 132 basis points in 2022. On top of swap rates, competition amongst the banks for market share intensified, with extremely attractive rates, as well as high levels of cashbacks on offer. This saw our customer attrition accelerate and the customers we were losing were typically from pre-COVID vintage who were on higher rates. The situation from mid-2022 was aggravated further by rising inflation, which the RBA sought to control via 10 consecutive rate rises from May 2022 to March 2023. And while we increased customer rates when the RBA moved the OCR, there is a constant need to balance between managing margin and causing higher customer attrition if customer rates increase too sharply. But moving to the chart on the bottom which shows 2023 by quarter, the price increases taken over the last 18 months are working through average customer rates. While BBSW remained heightened over 2023, as we moved into 2024, we've seen stability start to return and the market now believe interest rates will not increase further. Likewise, we're starting to see funding margins improved and as Mario noted, PRS39, which settled yesterday, enjoyed the best rate we have achieved since March 2022 for non-conforming mortgages. So as we exited 2023, we started to see NIM stabilize and the rate of compression did start to slow over quarter 4. Now on to our credit performance, which is on Slide 17. The performance of our portfolio continues to show the strength of our credit and underwriting processes. Total credit expense increased by $6.6 million in 2023 versus the prior comparable period. Given lower originations over the last 18 months, as well as elevated customer attrition, the reduction in mortgage AUM resulted in a release into both collective provision and a reversal of $5 million of the post-model overlay. This is seeing mortgages report a debit for loss expense in 2023. We do continue to hold $8 million provision in post-model overlay for mortgages at year-end as we consider this to be correct as the full impact of interest rate rises coupled with inflation are still to be fully reflected in customer disposable income. Asset Finance loss expense increased $17.3 million when compared to 2022. While strong AUM saw underlying collective provisions increase, a recalibration give a higher portfolio mix from novated leasing, which attracts near 0 losses as its salary sacrificed and provision release following the whole loan sale completed in December 2023 saw collective provisions reduce by $7.3 million year-on-year. Specific losses for Asset Finance increased given a marginal uplift in late-stage arrears over quarter 4, coupled with the increase in insolvencies as government protections implemented under COVID-19 were removed at the start of the year. Insolvency trends have now reverted to pre COVID-19 averages. And over 2023, we further released $6.1 million of COVID-19 and other related post-model overlays in Asset Finance. At the end of December, we have total provisions of $119.6 million adjusting for post-model overlays, we have a coverage ratio of 0.61% of assets under management, up from 0.56% as at December 2022, reflecting both AUM growth and Asset Finance, partially offset by business mix. Loan losses as a percent of lending AUM, excluding post-model overlay are 0.28% and continue to be inside the long-term average. The business is well covered. And we continue to monitor early indications of potential future loss through 90-plus days arrears as per the charts on the bottom right-hand side. 90-plus days arrears for our Mortgage portfolio at 1.3% is well inside the long-term average of about 1.45%. And for Asset Finance, the provision release taken following the whole loan sale in December as loans sold were skewed to Tier A customer distorts the December position. Adjusting for the whole loan sale, 90-plus days arrears for Asset Finance at year-end was 0.28%. And at the end of the year, we continue to hold total post-model overlays of $8.7 million. Turning to expense management on Slide 18. While reported pro forma operating expenses at $191.4 million, increased $20 million on PCP and reported pro forma total expenses at $238.1 million grew by 16% due to corporate interest expense, we need to look at the underlying performance after normalizing for Stratton, which was only included in 2022 financials for 6 months. Normalizing for Stratton, pro forma operating expenses grew 1% on PCP with staff expenses increasing 3%, marketing reducing by 21% and technology declining 9% year-on-year. Normalized pro forma total expenses grew 8% on PCP given the increase in corporate interest of $11.4 million as a result of movements in BBSY and higher drawdown of the corporate debt facilities. The ability of the business to manage costs and drive efficiency is demonstrated when comparing second half 2023 expenses to first half 2023 and to second half 2022, as all these periods include Stratton for the full 6 months. Second half 2023 pro forma operating expenses reduced by $6.1 million or 6% when compared to the first half of 2023. All operating expense size realized savings half-on-half. In a high inflation environment, disciplined cost management, benefits from investment in technology, processes and automation coupled with scale growth in Asset Finance allow the business to derive strong efficiencies. Pro forma total expenses decreased by 5% over the same period with the flow through of savings in our operating expenses, partially offset by higher corporate interest expense. Probably the best way to see how the business has managed inflation is to look at second half 2023 expenses of second half 2022. Operating expenses increased 1% over this period and while external wage inflation averaged around 3%, our employee expenses only increased 2%. Our core lending FTE reduced by 5%, lower FTE coupled with a constant reinvestment rate has seen our technology costs reduce by 5% second half 2023 on second half 2022. Other operating expenses include a one-off impairment of $0.5 million booked in the second half of 2023 following a reassessment of our equity investments. And while operating expenses reduced second half on second half, total expenses did increase by 4%. This was due to increased corporate interest expense and new property leases which drove right of use, increasing depreciation and amortization by $2.6 million. Turning to our pro forma income statement on Slide 19 of our investor presentation. While the soft market conditions in Mortgages were partially offset by record growth in Asset Finance, ongoing NIM compression, coupled with increased loan loss expense, given Asset Finance AUM growth and the annualization of Stratton on operating expenses, all contributed to EBITDA at $198.7 million, contracting 16% on PCP. When we add to EBITDA, the increase in depreciation and amortization which I just covered, and the adverse impact of movements in BBSY on corporate interest expense, pro forma NPAT at $111.1 million contracted 22% on PCP and our statutory NPAT at $108.7 million contracted 23% on 2022. For completeness, I provided our core metrics on Slide 20 which have already been covered off. So turning now to the balance sheet on Slide 21. The main movement, as you would expect, has been in loans and advances, which at $18.4 billion for 31 December 2023 have followed the movement in AUM, including whole loan sales net of loan loss provisions. We originated $7.3 billion in new financial assets over 2023. Asset growth was financed by the issuance of 7 public term securitizations of $5.4 billion and a further $1.6 billion in private term securitization and whole loan sales. Given the soft mortgage market, we reduced warehouse capacity by 18% to $9.3 billion at year-end. Net assets at 31 December 2023 grew 3% on 2022 with cash and cash equivalents at the end of the year of $1.5 billion and unrestricted cash balances of $121.1 million, up 6% on 2022 close. Retained earnings reflect the profit delivered by the business net of dividend paid, and as usual, we continue to manage capital, balancing between holding sufficient levels to manage in uncertain markets and knowing when and where to invest. Thank you. And I'll now hand back to Mario to close.

Thanks, Therese. The start of 2024 has been encouraging. Inflation is moderating, the rate of interest rate rises has slowed, hopefully stopped and while I expect rates to be on hold over 2024, there are strong indications that from 2025 we may start to see rate reductions flow through. Immigration is a positive. It helps with economic growth and has always been a stimulus for housing demand. And specifically for our business, we are seeing funding margins start to come in, and as I mentioned before, PRS39 we settled yesterday at an average margin of 1.66%, was well inside PRS38, which settled in September 2023 at 1.93%. We continue to keep a close watch on customer arrears and hardship as the flow through of rate rises is still being felt and as inflation is still outside target range. Household disposable income has reduced alongside saving ratios, which are now just above 1% from a peak of over 20% in June 2020 and versus a long term average of 5%. While unemployment remains low, which is a positive, we do need to balance this with low productivity and growth, and sadly, in today's world, geopolitical uncertainty remains a constant. But even given these detractors, we as a business feel more confident as we enter 2024 and we are prepared to capture more opportunities as they become available. Over the 23 years we have been in business, we have successfully managed through all cycles, our credit performance remains strong, we have managed our customers through the rate rises and we have maintained the quality of our portfolio and we are well provisioned. Our technology and processes have scaled and we have the funding headroom available. We are best positioned to capitalize on growth as it returns. I would like to close by reflecting on the history of Pepper Money. We started over 23 years ago as a specialist mortgage non-bank lender in Australia. We have successfully navigated that business through multiple economic cycles. We have built a business with strong core competencies in credit and underwriting, distribution, funding, data and technology. We are diversified both in terms of the scale of our 2 core lending businesses of Mortgages and Asset Finance, as well as the ever expanding range of products we offer. But we are also disciplined, whether it be how we manage credit, expenses or capital. With $20 billion in assets under management today, we remain strong and have the ability to capitalize on opportunities as they emerge. Thank you. And I will now hand back to the operator for questions.

[Operator Instructions] The first question today comes from Andrew Lyons from Goldman Sachs.

Mario, in the past, you've spoken about the relative elasticity of your customer base, which would have provided some protection to shareholders as rates and therefore, funding costs started to rise. However, despite shifting the book into higher margin, non-conforming lending in recent half, your mortgage NIMs are more than 1/3 lower than the second half '20 peak. So, I guess, my question is, has your customer base been more rate elastic this hiking cycle than you would have expected?

So with regards to that, we have to put a lot of focus around the attrition. And with regards to the attrition, the way that you got to look at it is because of where the market was and we had slowed down originations because of the competition in the market with regards to where the banks were priced with the cashback offers, it actually -- if you look at the way the last 4 quarters, we were actually originating less than what the attrition was. And because of that, that didn't allow us to be able to bring in new book pricing to influence the NIM in any way, shape or form. So we are and have experienced significant attrition just like the rest of the industry. But with us, because of the premium that we were charging prior to that, which was in the growth spurts of 2020 and 2021, where we were generating higher NIM than the market. This actually played very well with regards to the banks being able to win new business fairly easily with the cashback and the low rates. Outside of that, because also we had a significant uplift in '20 and '21 with regards to Prime Mortgages and we had priced Prime Mortgages roughly around 60 to 80 basis points wider than the banks at the time. So, again, it played very well to the bank's strategy of very low rates and high cashback offers. We have seen that significantly come down now and the attrition rates across Prime and non-conforming have slowed down. The other piece to add as well is that, we had a surgence in Near Prime Clear and clean credit Near Prime volume that came through the door during that 2021 period and 2022. That again played well because they are predominantly bank credit customers. Hence the reason why we saw that increase in attrition during last year, especially. But I think the positive thing to note is last quarter, for the first time across the last 4 quarters is, we had actually settled or we brought in, we settled more than we actually had by way of attrition. So in other words, we had net growth on our AUM with regards to attrition. And that's the first time in 4 quarters that we had achieved that. So, we are starting to see that slowdown and it coincides with banks pulling away from cashback offers. It coincides with the banks really starting to ease off the TFF. And for us, we see a very positive mix coming through in this year. Year-to-date, just to give you a bit of a heads up. So year-to-date volumes for us are up. And you can see that because of the second half, we saw an uptick in applications coming through and we are seeing already settlements for year-to-date in comparison to PCP, we're around 20% up on settlements and north of 50% up in applications. So we are seeing a very strong turnaround year-on-year.

That's great, Mario. And then just a second question, just staying on the volume side of the equation, your commentary through the presentation and even in answering that question certainly appears to be suggesting some improvement in your momentum into the second half and the beginning of this year. But I just wanted to juxtapose that against Slide 28, which does suggest some declines in system inquiries. Is this just purely a function of you picking up share? And I'd just be keen to understand the extent to which you believe that?

Is that the [ appendices ]

Yes. That's total market.

Yes. That's total market. That's not Pepper Money.

No. So the question is, are you picking up share? Is that...

Correct.

Yes, correct. I think Mario made comment around the Red Hot program that was put in place, and part of that was to go back and to test to the market that we could accelerate our share versus non-bank peers.

That's right. And when you look at the NIM, in particular, the Mortgages, if we really look at historically prior to the tailwinds that we received around 2020 and 2021. Historically, funding costs were around at 380 basis points. Currently, where we have it, it sits roughly at around 600 basis points. So you can actually see the significant uplift in funding costs. But yet, the NIM average prior to those tailwinds of 2020 and 2021 sat at around that 195 to 200 basis points in mortgages. And today, it's sitting roughly at around that 160 to 170 mark. When you look at that in perspective and then you look at where the impacts are, competition has played a massive part, not only just on front book, which I probably put front book competition sitting at around 10 basis points. The main one is the attrition rate, replacing the back book with new loans coming through the door, which really hits at around 36 basis points. So as you start to see the attrition start to slow down, it'll go from around 3 basis points a month down to 2 basis points, down to 1 basis points, and back to historical averages, which usually attrition is sitting between 10 to 20 basis points, not the 36 basis points, 40 basis points that we're seeing at the moment.

The next question comes from Jeff Cai from Jarden.

This is follow up on the -- if I look at sort of Slide 30, it looks like the loan discharges have accelerated in the second half. And whereas your peers talk about run-off stabilizing or improving half-on-half. So just interested in what's going on in that half. And then looking ahead, how much has attrition sort of improved in January and February to date?

So the attrition itself has slowed down in around December, January, Feb year-to-date. We're comfortable that we're starting to see in certain areas of the business, especially around Prime and non-conforming. You do need to also be mindful that our -- when you look at our attrition and that particular walk that you're looking at, that there is a whole loan sale that was done there as well. So that adds to that number with regards to the attrition number, because we are selling those. But you should see that transfer coming out from an AUM, from a lending AUM perspective, into the bucket of the loan and servicing area on our P&L.

Okay. And then on Slide 15, just interested on the asset financing margin slide, looks like the margin sort of fell 20-odd bps half-on-half, but then sort of rebound at 28 bps to the exit NIM of 2.6%, which seems like quite a lot of volatility. So can you talk a little bit about that? And then sort of looking forward, how should we think about the margin outlook for this business going forward, given these sort of volatility and your changing book mix?

Yes. So the first one last year we had, especially around midyear, there was significant volatility in the swap rate, which did impact our margins at that point in time. And it was at a point in time where we wrote the most loans in that particular period due to a promo that we had in flight. So that was a bit of a compounded effect. Then you've got the whole loan sale, which also impacts the actual NIM that comes through. And then you've got novated leasing as a percentage of total mix has increased significantly and that actually plays part in the NIM. But you've got to remember that novated leasing has a very, very low proportion or exposure to loan losses. And then you've got your typical competition. But we actually started to focus really heavily on recouping that margin that we had lost because of the swap rate volatility. And that's why you've seen that slight rebound. And that rebound has continued into 2024 as well.

The next question comes from Tom Strong from Citi.

I just want to ask on the -- around the capital management and the buyback and the increased payout ratio. I mean, if I look at the second half, you've reduced the capital intensity of the business through the whole loan sale in the Asset Finance business. I mean, how are you considering the trade off of the ROE of keeping those loans on balance sheet versus buying off your first buying back stock?

Yes, I think the way that we look at, and the way that I look at it is, the buyback is purely an optionality play. And the way you got to think of it is that, our #1 objective is obviously to deploy the capital towards our core segments, being Mortgage originations and Asset Finance originations. And we've got a set return that we would like to hit. If we feel that the market and where the competition lies at the time doesn't allow us to hit certain hurdles internally, then we have the option to be able to deploy that capital back to our shareholders. Last year, we were preparing, obviously, for the purchase of the HSBC book, so we knew that we needed to preserve that capital for the acquisition, and also when we think about the Stratton component as well, the acquisition of Stratton. So there was other reasons behind us not looking at a buyback as an optionality play previously. Again, I will caveat that this is an optionality play. Our number one objective is to make sure that if the market permits and there is good returns to be had, that we will focus on the growth on Mortgages and Asset Finance. The only other thing that would deter us from actually looking to do a buyback is, if there, again, is another inorganic opportunity that comes our way that we believe is better return for the shareholder over time.

No, that's very clear. And if I just could ask one more question. Just around the originations in the Asset Finance business, I mean, there's a big swing towards novated lease in this half out of commercial. Is that just reflecting the returns more attractive and novated? I mean, we hear that competition in commercial has been quite strong.

Yes, look, I think for us, novated has been a hero product. We aimed to enter this segment of the market and we have one business purely on the back of our technology, purely on the back of ease of doing business, and consistency in our credit decisioning. So it has grown probably more so than we expected. But that's not a bad thing, because first and foremost, it is a very well performing asset. And we're very comfortable in this particular market to be able to load up our assets under management on good performing assets. Yes, there is a yield trade off to that, but you're also getting the trade off with regards to loss performance. The other thing with novated as well is, it is not just the highlight of our growth in novated, it is showing that we have pulled back in other areas, predominantly in commercial, because of where competition is and where the returns are. We do see that turning around already this year and we're starting to see that there is more opportunities for Pepper to be able to grow in that area. But again, it is all going to come back down to the returns.

Tom, in the first half of the year as well, we saw commercial across the market be elevated because the tax incentives that were in place were rolling off on the 30th of June. We had an exceptionally high June for commercial, for Asset Finance because of that. And also, as Mario said, because of our technology capability, we could continue to support partners to originate right up until the last day of the month, whereas most people actually had to stop their origination profile, funding profile around the 25th to the 28th of the month.

[Operator Instructions] The next question comes from Jason Shao from Macquarie.

Just a question on your Mortgage interest rates. So you've listed your front book Mortgage rates looks like about 20 to 30 basis points half-on-half. And on average, it also looks like these are above your back book rates. But I'm worried these are averages. So what proportion of your back book currently is above or below front book rates at the moment? And are you still expecting any pressure on the front, back book here?

Actually, the back book -- we actually are pretty tight between our front and our back book and we purposely do that. We don't like to have a large deviation there purely because of the stigma around loyalty tax and the likes. So we do monitor that very closely. Again, front book rates are going to dictate where the market is, where the competition lies, and where we see funding costs over time. We are very selective and very disciplined on where we put our front book pricing, irrespective sometimes of where competition is, but more so where the market is. And what I mean by that is, we look at what is our opportunity when we term out in our RMBS, whether it be Prime, whether it be whole loan sales, or whether it be non-conforming. And we look at that and that is part of the funding mix on how our front book portfolio or our front book rate is. Our portfolio predominantly is variable, and that is set in a way whereas the RBA moves up, that'll move up in line with that. So really they are 2 very different metrics to look at. But remember that the front book rates at last year's originations curve really hasn't had much of an impact to the back book, purely because the attrition was higher than what we were originating. So that is fundamentally one of the biggest differences compared to any other year that we've had where attrition was higher than new originations coming in. We are starting to see that turnaround, and that's very important for people to know.

Jason, if it helps as well. On Page 7, we give the portfolio and the front book for both halves and in the appendices, it's there for the prior comparable period as well. And as you can see from what Mario said, we manage it very, very tightly. There's like 7.3% on the portfolio for Prime, 7.5% on the front book.

And another question on capital. So you've obviously announced the buyback in the less payout range. So how do you think about the trade off between book growth and a capital required on that growth? So where payout ratio is really small in the past due to your -- as you said, expectations of potential inorganic opportunities? Or are you also partially thinking about a stabilization of book growth and potentially lower capital required to fund that growth, or a mix shift towards potentially more capitalized mortgages?

I want sort of that COVID period we listed 2021. So to be quite honest, you always want to make sure that you have really good, strong capital management strategies in place when you're new to market. So that's one of the reasons why the payout ratio was established by the Board at the time of IPO to be 30% to 40%. We believe that to be prudent. The other thing, though, in doing that, we did have the opportunity to truly accelerate growth opportunities when we actually saw market conditions being very favorable in terms of funding and growth opportunities being there. And we actually had record originations in our Mortgage portfolio for the years of both 2020 and 2021. So it's that flexibility and that optionality that Mario was talking about in terms of our capital management strategy that allowed us to accelerate growth in mortgages in 2021 and has actually allowed us to be able to capture the market opportunities in Asset Finance that we saw over 2023. So where we are now in the cycle? We're 3 years post IPO, coming up to 4 years post IPO. This is all part of the evolution of the company, where we've got stability. We understand exactly what the growth opportunities are in organic growth opportunities, and we're focusing on how we really manage for value and returns for shareholders at the same time as having the optionality to be able to grow.

Thank you. At this time, we're showing no further questions. I'll hand the conference back to Mario for any closing remarks.

Thanks, everyone, for joining us, obviously, today, and thank you for your questions. Looking forward to talking and seeing you guys during the week. All the best, and thank you very much.

Thank you.

Thank you. That does conclude our conference for today. Thank you for participating. You may now disconnect.