In today’s Daily Reckoning Australia, Callum discusses the housing market, the big immigration development last week, and the stock he likes best for the next two years. Plus, four more ideas for you to buy now…
It can’t be denied that housing credit growth is slowing from the red-hot days of 2021. Now the action is in the refinancing space. This is important.
The big banks are going to move as fast as they can to prevent anyone rolling off a fixed rate loan elsewhere. They will be especially vigilant with great ‘prime’ borrowers.
What does this person look like?
Think a stable job, long in the role, with free monthly cash flow, no credit hiccups, and a loan-to-value ratio of 65% and below.
But not everybody looks like that…
The rise of the non-prime borrower
I’ve gone over the August results for small-cap lenders like Resimac Group [ASX:RMC] and Pepper Money [ASX:PPM].
These have been sold down hard since 2021.
I got caught up in this downdraft because I thought their prodigious profits would protect them in this bear market. They haven’t.
One reason for my mistake was I’m more positive about the housing market than most.
But the share market doesn’t care what I think. And right now, it’s pricing RMC and PPM on about five-times 2023 earnings.
That’s darn low, considering the quality of their management teams and long history of navigating different credit cycles.
I expect them to go sideways, price wise, until sentiment around housing improves and pressure comes off the cost of their funding.
But I don’t see much more downside, absent a wild card development.
All mortgage lenders, from the big banks to the small-fry lenders, are noting that the competition for any prime borrower is intense.
These people are getting fantastic rates because of that competition.
That’s great for them, but it cuts the lending margin razor thin for the lenders.
Where’s the fat?
In the ‘non’-prime borrowers, of course!
Now, there are different and varying levels as to why people are classified differently as credit risks.
It could be because they run their own business. It might be they have a late bill or two in their credit history.
It might be they’re retired, with more than $1 million in assets, but no regular wage income.
Perhaps they went bankrupt years ago and have since rebuilt. It could be they have a modest deposit.
I bring it up because it’s almost certain to me that firms like Resimac and Pepper will absorb more of these borrowers to maintain market growth and pivot away from the big banks.
There are two points to add on here. One: I could be wrong.
Perhaps they don’t.
And even if they do, it doesn’t mean they are being irresponsible, a la the subprime crisis of 2007.
It just means they’re prepared to service a different customer with different risk versus reward metrics.
I tuned into the analyst call for Pepper’s full-year results.
Its CEO said, in spirit, if not these exact words, that the next level down from a prime borrower was much less risky than people assumed.
Why do you and I care? This business can be very profitable!
How to play this situation
My favourite idea is another stock — Australian Financial Group [ASX:AFG].
This too is a lot cheaper than it was in 2021. It also has a lending division with very good margins.
However, what I like about AFG compared to Pepper and Resimac is that is has a very well-established broking division.
In fact, it was a broker before it became a lender.
What’s to like about this?
The volume of potential loans to roll over from fixed to variable from now to the end of 2023 is in the tens of billions.
It’s only natural that people will use brokers to make sense of the changes and get the best rate possible.
This is a huge potential tailwind for AFG’s broking business. But it can also use this to capture more lending growth too.
Now, we know that housing is slowing. It’s in the news every day.
Here’s what my old mentor used to say about this situation: ‘If it’s in the news, it’s in the price.’
Oh, and what’s this?
PM Albanese last week gave the all clear for Australian immigration to rise another 30,000 per year toward 200,000.
More housing demand, anyone?
You’ll also be reading lately that rents are skyrocketing because of poor supply. This is enticing property investors back into the market.
The RBA statistics that came out last week show that’s still going on.
My suggestion is that buying AFG now could pay off handsomely with a two-year time frame.
By the way, every month I release my Top Five ideas to subscribers of my advisory, Australian Small-Cap Investigator.
The ideas I gave in August have been good. Four out of five are up, at least until last Friday, and the one in the red is down 1%. Not bad for a tough market.
Best wishes,
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Callum Newman,
Editor, The Daily Reckoning Australia
