Pepper Money (ASX:PPM): Flexibility is better…if you’re a borrower but what if you’re an investor?

Pepper Money’s (ASX:PPM) promise to borrowers has been flexibility. You may not be ‘good enough’ to match the Big Banks’ standards, but Pepper might be able to help. It had a >20 year history prior to its mid-2021 listing where it raised $500m at $2.89 per share, implying an A$1.3bn market capitalisation. And it has had some growth since its depression, boasting $20.1bn AUM, $9.5bn of which is mortgages.

There are legitimate reasons why investors haven’t embraced it…but there is also cause for optimism.

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Why Pepper Money shares have been underperformed

As a listee during the COVID era it was a victim of the changing market conditions as interest rates rose. This should have meant more interest for Pepper – how can you not make more money on mortgages with 6-7% rates than mortgages with <2% rates?

But consider this. As a non‑bank lender, Pepper doesn’t have access to cheap deposit funding (like the big banks do), so its cost of funds depends heavily on wholesale markets, securitisation, whole loan sales, etc. When interest rates rise, or funding becomes more expensive and that squeezes margins and raises risk.

Given its focus on non‑prime/near‑prime products, or at least a mix, there’s always more risk of defaults or arrears) if economic conditions worsen. And worsen things did with the greatest per-capita recession since the Great Depression.

Consider its NIM is 1.98% and 1.51% for mortgages. CBA is over 2%. That may not appear to be a big gap at first glance, but considering the size of Pepper vs CBA, that means it is far more lucrative for investors to invest in CBA or another major instead.

We’d also draw investors attention to mortgages in 90 day arrears. Pepper has never been below 1% and was over 2% as at the end of December 2024. Now you might say that means 98% of loans are not in arrears and that is true…but CBA has never been above 1%.

Hope on the horizon?

But that was then and this is now. The RBA has commenced a rate cutting cycle, commencing in February 2025 and making 3 cuts. Pepper Money has passed on this cut (i.e. reducing variable rates to borrowers) which helps borrowers and might help demand. Lower interest means higher loans are in reach, and that means more interest income for Pepper.

This showed – mortgage originations in the first half of 2025 were up 53% year on year. In the most recent half, group‑wide NIM improved modestly, helped by growth in financing not to mention cost control, and favourable funding conditions.

Perhaps investors have also paid more attention to Pepper’s dividend paying status. For CY24, Pepper paid a final dividend of 7.1 cents per share, and a total annualised yield of ~8.6% versus 6.4% prior year. For income‑focused investors, that yield is very attractive.

But perhaps the biggest of all is anticipation the company could be taken over. AFR Street Talk reports have suggested that KKR, a private equitor that owns over 60% of Pepper, is looking for suitors and has hired Jefferies to look for bidders.

Even if this comes to nothing, Jefferies has been conducting a strategic review and this could lead to change that helps profitability. There have been rumours Challenger could be one, but it would be difficult to buy the entire company because it is a life company and subject to stringent capital requirements from APRA.

Conclusion

Pepper Money appears to have better times ahead of it in the last 3 years, but the reality is that it’ll never make as much money as one of the Big 4 and will bear more credit risk. Nonetheless, falling interest rates will be a good thing for the company and investors may recognise some upside in this one!