... A HUGE SEGMENT OF THE MORTGAGE MARKET WAS MASSIVELY UNDER-SERVED BY TRADITIONAL LENDERS. Co-Group CEO Patrick Tuttle

Transcription

1 OCTOBER 2015 i

2 LEFT TO RIGHT: Patrick Tuttle and Mike Culhane Co-Group CEOs at Pepper Group Limited... A HUGE SEGMENT OF THE MORTGAGE MARKET WAS MASSIVELY UNDER-SERVED BY TRADITIONAL LENDERS. Co-Group CEO Patrick Tuttle 1

3 PLANTING THE PEPPER SEED DIGGING MUCH DEEPER THAN THE BANKS IT IS THE IMMUTABLE LAW OF STARTING A SUCCESSFUL BUSINESS FIND AN UNMET NEED, SATISFY IT THROUGH INNOVATION, AND KNOW IT BETTER THAN ANYONE ELSE. For Pepper, that unmet need was Australian home-loan borrowers who did not qualify for a prime home-loan from the banks a loan that a mortgage insurer will insure. These borrowers were typically self-employed, or had a patchy credit record: they may even have been bankrupt in the past. Because these factors precluded them from meeting the eligibility criteria of mainstream lenders, these borrowers could not get a home-loan from a bank. But they could get a home loan if a specialist lender was prepared to do its own credit assessment on them, by digging much deeper than a bank would, and using bank statements and the trading history of the business, rather than tax returns, to verify the income that would support the loan. That was the niche that Pepper spotted: the opportunity to take wholesale funding from the domestic Australian banks, apply its own proprietary credit assessment skills termed alternative income verification, or alt.doc. and offer home loans to self-employed customers and other borrowers who did not conform to prime loan standards. We found a huge segment of the mortgage market that was massively under-served by traditional lenders, including the major banks, says Pepper Australia Co-Group CEO Patrick Tuttle. If they could get a home loan, it was at a punitive interest rate. We had the skills to do a forensic bottom-up review of each borrower s credit, and we could charge a risk premium which was slightly wider than the banks standard variable rate for underwriting that credit risk. For co-founder and Co-Group CEO Mike Culhane, the eureka moment was the realisation that mortgages did not have to come from a bank but they could come from a specialist lender that took bank wholesale funding and manufactured the loans to borrowers that had previously been firmly outside the banks lending criteria. It was a virtuous near-circle, completed by securitising those loans into highly sought-after residential mortgagebacked securities (RMBS) in the debt markets offering debt investors an alternative investment, just as Pepper offered borrowers an alternative. As debt yields ground lower through the 2000s, specialist fixed-interest investors developed a keen appetite for Pepper s non-conforming RMBS, which were higheryielding because of the higher-risk loans in their pool. The eureka moment was the realisation mortgages did not have to come from a bank. Co-Group CEO Mike Culhane The opening-up of the non-conforming market was such a success, competitors sprang up through the 2000s, all offering their own tweak on the non-conforming lending space, with major Australian banks and global investment banks lining up to fund the specialist lenders, and investors clamouring for the RMBS paper on the other side. By August 2007, Pepper was originating $120 million worth of loans a month, and was on track for $1 billion a year of lending, funded largely by its securitisation program. But storm clouds were gathering on the horizon, in strange stirrings in the debt market. 2

4 THE MOVE TO SERVICING WAS TRUE BUSINESS SERENDIPITY. ABOVE: Pepper Servicing Centre (PSC) lounge area, Parramatta, Sydney. WE GOT LUCKY IN THAT WE WERE SLIGHTLY AHEAD OF THE MARKET. Co-Group CEO Patrick Tuttle 3

5 OPPORTUNITY IN CRISIS IN BUSINESS, AS IN SPORT, YOU MAKE YOUR OWN LUCK THANKS TO ITS BOARD, AT THE TIME, BEING PREDOMINANTLY UK-BASED, TUTTLE SAYS PEPPER SENSED SOMETHING WORRYING IN THE AIR IN It was in August that year that the board started to say to us that debt capital markets were getting difficult in Europe, he recalls. Obviously they weren t predicting the Lehman collapse (the collapse of Wall Street investment bank Lehman Brothers and the bail-out of global insurance giant AIG by the US Federal Reserve in September 2008 plunged global capital markets into turmoil) but the board thought it prudent that we cut back lending, so we did. From $120 million of mortgage origination in August 2007, Pepper wound back to $25 million by December 2007, with significant lay-offs of sales staff. But the board s caution proved both prescient and beneficial, says Tuttle. We got lucky in that we were slightly ahead of the market in terms of slowing lending. It was simply a case of us cutting our cloth to the size of the business that we felt we needed to be, but acting when we did certainly put us in a relatively sound position. In business, as in sport, you make your own luck; and if that caution to rein back origination was the first selfmanufactured fortuitous stroke for Pepper, the second was stepping in to the portfolio-servicing void created by the company s competitors dropping like flies. In early 2008, a lot of the non-bank lenders started to fall over, and there were mortgage portfolios all around the market, funded either by the major banks or global investment banks, that required a loan servicer to step in, says Culhane. We thought, we ve got very good loan servicing capabilities, why couldn t that be us? Until that point, says Tuttle, loan servicing had been seen as simply a business process, assigned to the lenders collection desks. What made servicing a natural progression for us was that being a lender ourselves, we have a lender s mindset. Quite naturally, we treat loans that we re servicing on behalf of other lenders as if they were our own. That means, first and foremost, we re thinking in terms of, how should we collect on this loan to get the best recovery and also the best outcome for the customer because it s part of the relationship, it s also about your reputation with the customer. That personal touch was second-nature to us, he says. The move to servicing was true business serendipity all the more stunning, in hindsight, because it came about at the height of a financial crisis. We needed to generate free cash flow, as we were slowing our lending down; there were distressed originators falling over in 2008 and 2009; and we knew how to service loans really well, says Tuttle. It was a natural progression, but it was the state of the market at the time that made it such a wonderful opportunity. Pepper s next piece of serendipity came in 2010, when its major shareholder, Merrill Lynch experiencing, like most major financial names, its own difficulties was bought by Bank of America. This opened the door for Pepper to buy back the business, which the management team did, in 2010, backed by a group of high-net-worth investors, including successful private equity investor, Seamus Dawes. Now in control of its own destiny, Pepper was able to think big, as the turbulent markets continued to throw up opportunities including the $5 billion GE mortgage portfolio in Australia and New Zealand. Only $400 million of the GE portfolio was in the nonconforming space, Pepper s natural market. Most of the portfolio was in Australian prime and New Zealand prime loan assets. But Tuttle says Pepper was encouraged by its bank funders to go for those portfolios. They had seen what we had done with other portfolios we had picked up, they thought we could do a better job servicing the GE book, and they offered to fund us to buy it. Buoyed by its funders faith in it, in 2011 Pepper took the plunge into what was one of the largest whole portfolio transactions the Australian market had yet seen. The GE acquisition was a real game-changer for us, says Tuttle. 4

6 TAKING PEPPER OFF SHORE DEVELOPING PEPPER S SERVICE SKILLS PEPPER IS NOT JUST AN INVESTOR... IT IS ALSO SUPPLYING CONSUMER CREDIT EXPERTISE. SERENDIPITY WAS NOT THROUGH WITH PEPPER YET. All of the progress and learning it had made in Australia in developing its servicing skills now put it in a position to tackle a market that made the turbulence in the Australian market look like ripples in a puddle the European market. The first move offshore was in September 2012, when Pepper bought the GE Money loan portfolio in Ireland (now Pepper Ireland). It followed this with the March 2013 acquisition of Spanish non-bank lender Celeris, now Pepper Spain; and in July 2013, it acquired Oakwood Global Finance, a UK non-bank lender that had been established by Culhane in the early 2000s: it became Pepper UK. All three acquisitions were based on identifying and acquiring strong, highly experienced local management teams, and striking long-term cost-plus servicing contracts to protect its cost base, and give Pepper a base from which to win new third-party business. But implicit in the acquisitions was retaining the necessary infrastructure and expertise to start new lending if and when market conditions allow. In the meantime, we expect those three markets, particularly Spain and Ireland, to continue to provide opportunities because of the prevalence of distressed and poorly performing loan portfolios, says Tuttle. Culhane says Europe represented a very different dynamic to Australia mainly in the sheer level of distress in the mortgage markets. The company found two main themes unfolding in sequence: first, the fire-sale of deeply non-performing core portfolios, to stay alive; and secondly, once balance sheets had improved slightly, the sell-off of non-core portfolios with which the lenders simply do not want to be involved with anymore. Those stages are progressing in different sequence in each of Pepper s European markets, he says. We ve seen that first stage of distress in Ireland over the last several years, and that s really been a big driver of our Irish growth, he says. We saw the same in the UK, over 2008 to It hasn t even really started in Spain, and in Italy, which we re studying closely, they haven t admitted they ve got a problem. The second stage can only occur in a recovering economy, he says. The banks have to have recapitalised enough to be willing to take the hit to move those businesses on. We re taking full advantage of those situations as they unfold, says Tuttle. As that second stage comes about, he says, almost in parallel the capital markets start to open up, because the economy is recovering. Only then, he says, can Pepper start lending. Pepper UK and Pepper Spain started lending in late 2014: Pepper Ireland expects to begin originating late in

7 REFOCUSING ON MORE TRADITIONAL LENDING TO INDIVIDUAL HOUSEHOLDS AND SMALL BUSINESSES. Co-Group CEO Patrick Tuttle ABOVE: Newly established Pepper Savings Bank head office in Seoul, South Korea. In September 2013, the focus of Pepper s initial stage of overseas expansion switched to Asia. After scouting the South Korean market for two years, Pepper bought a small mutual savings bank with about US$150 million in loan assets and two retail branches in and around the Seoul area. Now known as Pepper Savings Bank, it remains the group s only actual bank. We re refocusing the bank on more traditional lending to individual households and small businesses. It s going to use government-guaranteed retail customer deposits to undertake lower-risk lending such as residential mortgages, personal loans and car loans, says Tuttle. a consortium led by China Travel Holdings Company Limited, the financial and asset management arm of Chinese travel giant, China Travel Service (CTS). Pepper is not just an investor in this business: it is also supplying consumer credit expertise, which PrimeCredit with 35 years experience will leverage into the fast-growing Chinese consumer finance market, through its Shenzhen hub. The next plank in the Asian growth platform was added in May 2015, with Pepper s move into the highgrowth consumer finance markets of Hong Kong and southern China. Pepper bought a 12% stake in the Hong Kong and Shenzhen consumer finance businesses of Standard Chartered plc known as PrimeCredit and Shenzhen PrimeCredit as part of 6

8 PEPPER S TIMELINE December September October October June Pepper was founded in 2000 as a specialist residential mortgage lender in Australia. Issued first of many nonconforming mortgage Term Securitisations for $250 million. Pepper is acquired by Oakwood Global Finance SCA. Pepper called Residential Securities Trust No.4 (PRS4). During the Financial Crisis, Pepper was able to call all Term Securitisations at their first call dates and successfully refinanced senior lenders. Pepper is acquired by a group of institutional and strategic investors and senior Pepper management. December Australian nonconforming RMBS market re-opened with the issuance of Pepper Residential Securities Trust No.8 ($250 million). August Purchased GE Capital s Home Lending business in Australia and New Zealand (~$5 billion). 7

9 September Acquired GE Capital s Irish mortgage assets and business platform ( 650 million). February Acquired Celeris Group s Consumer Loan Business in Spain ( 290 million). September Acquired Oakwood Servicing platform in the UK. September Acquired Evergreen Savings Bank, South Korea. (US$150 million) March Pepper settled over $1.0 billion in Australian residential mortgages. May Commenced Spanish lending platforms. September Pepper Ireland migrated the Danske Stone and Shoreline portfolios lifting total AUM north of 10.5 billion. October Pepper Asset Finance commenced lending. February Pepper is awarded Australia s Best Specialist Lender at the 2015 Australian Lending Awards for the 3rd consecutive year. April Pepper commenced United Kingdom lending platforms. May Acquired 12% equity interest in Prime Credit in Hong Kong and China in collaboration with China Travel Services and York Capital. July Pepper Group Limited lists on the Australian Securities Exchange raising ~$145 million to delivery our business strategy and fund future growth. Pepper s ASX code is ASX:PEP July Pepper Ireland awarded the contract to provide third party asset servicing on a portfolio acquired by a group of investors from Lloyds Banking Group ( 3.7 billion) 8

10 POSITIONING PEPPER FOR THE FUTURE DRIVEN BY ENTREPRENEURIALISM AND INNOVATION 14 YEARS INTO ITS JOURNEY, PEPPER IS A MUCH BIGGER COMPANY, BUT ITS BRAND AND PHILOSOPHY HAVE NOT CHANGED. What Pepper stands for, says Culhane, is independent ownership and personalised service, from a financial services firm that is different to a bank. We re not a bank, we offer a different service level to the banks, and we don t really compete against them. We pick market niches where either the banks don t want to play, or they used to play and don t play anymore. And we fill those niches with products that people actually want and need, augmented by a much higher level of service, he says. Chief marketing officer Jo Thrift says the Pepper brand is based on two main values: entrepreneurialism and innovation. At the outset, the name Pepper was designed to showcase what we felt was a unique and confident personality. Through what we have done, the brand has come to represent the core purpose of the company, which is to deliver best-of-breed solutions. Whether that is lending, or advisory, or servicing, or asset management, Pepper is a symbol of the most rewarding relationship that consumers and businesses can have in the financial services industry it s a symbol of confidence, of passion and commitment, says Thrift. Of course, a brand cannot say this unless it is backed and lived by the people who make up the business. This business is people, says Culhane. We ve deliberately set out to make Pepper a very entrepreneurial place. We really want to hire people that we can empower. We want to make sure that they are embedded within our culture and our risk management framework, so they know the outer boundaries, but then they can push the business forward. We want them to come up with that next idea, that next thought that really pushes us to the next level. Tuttle says the culture is high-energy. People love working for the business because it s growing so quickly. That creates opportunity. We also make sure that people can move across divisions, even overseas, between offices. Facilitating all of that makes it quite an exciting place for people to work, he says. As leaders, Culhane and Tuttle know that they must impart this from the top. We re highly transparent, we make sure we stand up in front the whole company, every quarter, and give them a very clear update on what is going on in the business. I think people see our passion for the business, and that s infectious, he says. Building a company from scratch enables Pepper to ensure that its people reflect these values, says Sue Kent, Pepper s head of human capital. We have actually been able to go out and hand-pick and build a team from a blank sheet of paper, which is very rare from an HR perspective. Expansion has brought its challenges, she says. Each of the operating regions has its own ways of operating and it s very unusual for an offshore operation to have an Australian headquarters. But what we have found is what s very important as part of our strategy is to bring on management teams in each of those regions that are, again, very suited to our culture, that can adapt to our culture and have the same values that we do. A Pepper person has energy and passion, and we can say that s the case across the wider group, says Kent. 9

11 PEPPER STANDS FOR INDEPENDENT OWNERSHIP AND PERSONALISED SERVICE. THIS PAGE: Pepper Servicing Centre (PSC), Parramatta, Sydney. 10

12 THIS PAGE: Crowd waiting for game to commence at Pepper Stadium, Penrith, Sydney. IN THE NEAR TERM... TO BUILD SCALE IN EUROPE AND ASIA. Co-Group CEO Patrick Tuttle 11

13 THE PEPPER PROGNOSIS DIVERSIFICATION IS COMING FROM NEWER ASSET CLASSES EXPANSION FOR PEPPER HAS NOT ONLY BEEN GEOGRAPHICAL. The company has also steadily grown its lending presence across multiple asset classes in Australia, to take in near-prime customers that probably would have got a bank loan three years ago, but now fall outside the tightened automated credit-scoring models of the banks and uninsured prime, which are effectively prime standard-variable-rate customers. We ve really become a one-stop shop in mortgages, which is important for our broker channel, because it gives them a greater opportunity to win customers business, says Tuttle. While diversification is coming from newer asset classes and geographic expansion, consumer property lending and asset servicing remain Pepper s core business lines. But with property expertise part of the company s DNA, one of two natural progressions for the group has been Pepper Property (acquired in 2012), which packages all of the company s real estate advisory, capital, sales and asset management knowledge into one bespoke strategic property partner for corporates. The other natural progression for Pepper is into other lending areas: the company sees auto loans, equipment finance and personal loans as areas where it can add value. To that end, Pepper Asset Finance was established in October 2014 to offer a broad range of simple and flexible asset finance solutions at competitive rates across multiple asset types including motor vehicles, motorcycles, commercial equipment and yellow goods. The asset finance arm replicates the unique business proposition on which the business was founded: quick approvals and settlements, direct access to the underwriting team for introducers, competitive rates, flexible terms and personalised, tailored business solutions. Part of this expansion strategy is to launch a directto-consumer channel. In support, Pepper has been building the brand by sponsoring the A-League football team Western Sydney Wanderers winners of the 2014 Asian Champions League and Pepper Stadium at Penrith. We want to be a meaningful-sized nonbank diversified financial institution with a retail focus, so investing in the brand makes sense, says Tuttle. In the near term, the strategy for Pepper is to build scale in Europe and Asia, with expansion into Hong Kong and China planned. We d probably be disappointed if we didn t have a substantial Chinese business in five years time ideally, a business that was public in its own right, he says. We ve really become a one-stop shop in mortgages Co-Group CEO Patrick Tuttle It is an exciting story, of a business that saw under-serviced markets, and backed itself to develop the products and the expertise those markets needed. Now well-established, with global scale and the proven systems and insight to go with it, Pepper has many more under-serviced markets and customer segments to disrupt with its well-honed business model, based on getting to know the individual circumstances of each and every borrower. From that seed that was planted in a niche of the Australian home loan market in 2001, a mighty Pepper indeed has grown. 12