Diversity is strength for Pepper

Pepper Money has found ongoing demand for its various funding programmes in 2022 despite a significant change in market conditions. Anthony Moir and Steven Fischer, treasurer and deputy treasurer at Pepper in Sydney, discuss a strategic approach to funding and the new business environment.

Pepper’s issuance is only slightly down year-on-year. How has the company approached funding in 2022?

MOIR In the past, the degree of market volatility we have experienced this year would have resulted in the Australian securitisation market ceasing to operate efficiently. This has not been the case in 2022 – on a positive note, the market has remained open albeit at elevated pricing levels.

This has allowed Pepper to issue through the cycle, which demonstrates the strength of the Australian securitisation market and the robustness of the Australian economy. Pepper is a regular public issuer and we have a diversified funding programme that includes private markets and whole-loan sales. As such, we have the flexibility to tilt issuance toward these alternatives.

FISCHER We also benefit from a large domestic and offshore investor base. These investors have been with us for a long time, and the strength of our relationships and the business allows us to tap different pockets of investor demand. This often varies significantly by country through the cycle.

Pepper began exploring a dual currency trade in July but dropped the US dollar notes. What changed?

MOIR A couple of items changed materially during the course of this transaction. First, on a relative-value basis Australian US dollar denominated RMBS [residential mortgage-backed securities] became less attractive to offshore accounts given the widening of spreads on CLOs [collateralised loan obligations] in the US.

Second, the cost of the basis swap between US and Australian dollars continued to be elevated. As a result, it was no longer attractive for Pepper to issue the US dollar note and we made the decision to drop the note and progress with a smaller

Australian dollar-only deal. While we took the proactive decision not to bring a US dollar transaction, the US market remains very important to our programme and we expect to issue again next year.

What is the outlook for Pepper’s nonmortgage asset-backed securities [ABS] programmes?

FISCHER Our SPARKZ auto ABS programme is very well supported by investors and we executed a A$700 million (US$475 million) public deal in May. Issuance for the remainder of the year will be in private format and our next public transaction is expected in the first half of 2023.

Pepper historically issues more nonconforming than prime volume but the opposite has been true so far in 2022. Is this likely to continue in 2023?

FISCHER The change is a direct reflection of the strength of our prime mortgage originations and the strong demand from investors for these high-quality assets. As interest rates rise and competition in this segment increases, we expect a more equal balance between prime and nonconforming RMBS.

How is the higher interest rate environment and slower housing market affecting the business?

MOIR Pace of growth in the business has slowed due to the rising rate environment and current sentiment in respect to the housing market. This is an industry-wide trend we expect to continue in the short term.

However, we are entering into an unusual period where a significant volume of fixed-rate loans are maturing over the next 12 months. We expect this to open up opportunities for lenders such as ourselves.

FISCHER Our service proposition is also an advantage. We have a range of products and our cascading credit model means a customer has a very high certainty of getting a loan from us through a single application.

Banks are geared to originating very prime loans whereas we assess a customer for our prime product first then, if the applicant does not qualify, we move down to our near-prime and specialist products. Pepper provides more certainty to getting a ‘yes’ for a customer versus traditional lenders.