Fitch Ratings has assigned expected ratings to Pepper SPARKZ Trust No.5's pass-through floating-rate notes.

The notes are backed by a pool of first-ranking Australian automotive and equipment lease and loan receivables originated by Pepper Asset Finance Pty Limited, a subsidiary of Pepper Money Limited (Pepper). The notes will be issued by BNY Trust Company of Australia Limited as trustee for Pepper SPARKZ Trust No.5.

RATING ACTIONS

Entity / Debt

Rating

Pepper SPARKZ Trust No.5

A1-a

LT

AAA(EXP)sf

Expected Rating

A1-x

LT

AAA(EXP)sf

Expected Rating

B

LT

AA(EXP)sf

Expected Rating

C

LT

A(EXP)sf

Expected Rating

D

LT

BBB(EXP)sf

Expected Rating

E

LT

BB(EXP)sf

Expected Rating

F

LT

B(EXP)sf

Expected Rating

G

LT

NR(EXP)sf

Expected Rating

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VIEW ADDITIONAL RATING DETAILS

Transaction Summary

The total collateral pool at the 31 March 2022 pool cut date was sized at AUD600 million and consisted of 16,281 receivables with a weighted-average (WA) remaining maturity of 60.4 months.

KEY RATING DRIVERS

Stress Commensurate with Ratings (Positive): We have assigned base-case default expectations and 'AAAsf' default multiples for each risk tier classification. Our base-case gross-loss expectations are 2.5%, 5.5% and 11.0% for tier A, B and C, respectively. The 'AAAsf' default multiples are 6.00x, 5.25x and 4.50x. The recovery base case is 30.0%, with a 'AAAsf' recovery haircut of 50.0% across all risk grades. The WA base-case default assumption was 4.1% and the 'AAAsf' default multiple was 5.6x.

The Stable Outlook is supported by Australia's management of the Covid-19 pandemic and the recovery after the removal of related lockdown restrictions. We forecast GDP growth to expand by 4.2% in 2022, with an unemployment rate of 4.0%. GDP growth should normalise to 2.3% in 2023, with an unemployment rate of 4.3%.

Excess Spread Supports A1-x Note Repayment (Positive): The transaction includes a class A1-x note to fund the purchase-price component related to the unamortised commission paid to introducers for the origination of the receivables. The note will not be collateralised, but will amortise in line with an amortisation schedule. The note's repayment limits the availability of excess spread to cover losses, as it ranks senior in the interest waterfall; above the class B to F notes. However, the rated subordinated notes still pass at their respective stress rating levels.

Structural Risks Addressed (Neutral): Counterparty risk is mitigated by documented structural mechanisms that ensure remedial action takes place should the ratings of the swap providers or transaction account bank fall below a certain level. Class A1-a to F notes will receive principal repayments pro rata upon satisfaction of pro rata conditions. The percentage of credit enhancement (CE) provided by the G note will thus increase as the A1-a to F notes amortise.

Fitch's cash flow analysis incorporates the transaction's structural features and tests each note's robustness by stressing default and recovery rates, prepayments, interest-rate movements and default timing.

Low Operational and Servicing Risk (Positive): All receivables were originated by Pepper Asset Finance, which demonstrated adequate capability as originator, underwriter and servicer. Pepper is not rated by Fitch. Servicer disruption risk is mitigated by back-up servicing arrangements. The nominated back-up servicer is BNY Trust Company of Australia. Fitch undertook an operational and file review and found that the operations of the originator and servicer were comparable with those of other auto and equipment lenders.

No Residual Value Risk (Positive): There is no residual value exposure in this transaction. However, there is a small exposure to balloon-payment loans.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to negative rating action/downgrade:

A longer pandemic than Fitch expects that leads to deterioration in macroeconomic fundamentals and consumers' financial positions in Australia beyond Fitch's baseline scenario could lead to a downgrade.

Unanticipated increases in the frequency of defaults and loss severity on defaulted receivables could produce loss levels higher than Fitch's base case, and are likely to result in a decline in CE and remaining loss-coverage levels available to the notes. Decreased CE may make certain note ratings susceptible to negative rating action, depending on the extent of the coverage decline. Hence, Fitch conducts sensitivity analysis by stressing a transaction's initial base-case assumptions.

Downgrade Sensitivity

Rating Sensitivity to Increased Default Rates

Note: A1-a / A1-x / B / C / D / E / F

Expected Rating: AAAsf / AAAsf / AAsf / Asf / BBBsf / BBsf / Bsf

Defaults increase 10%: AAAsf / AAAsf / AA-sf / A-sf / BBB-sf / BB-sf / Bsf

Defaults increase 25%: AA+sf / AAAsf / Asf / BBB+sf / BB+sf / B+sf / below Bsf

Defaults increase 50%: AAAsf / AAAsf / A-sf / BBB-sf / BBsf / B-sf / below Bsf

Rating Sensitivity to Decreased Recovery Rates

Note: A1-a / A1-x / B / C / D / E / F

Expected Rating: AAAsf / AAAsf / AAsf / Asf / BBBsf / BBsf / Bsf

Recoveries decrease 10%: AAAsf / AAAsf / AA-sf / A-sf / BBB-sf / BBsf / Bsf

Recoveries decrease 25%: AAAsf / AAAsf / AA-sf / A-sf / BBB-sf / BB-sf / Bsf

Recoveries decrease 50%: AAAsf / AAAsf / A+sf / BBB+sf / BB+sf / BB-sf / Bsf

Rating Sensitivity to Combined Stresses

Note: A1-a / A1-x / B / C / D / E / F

Expected Rating: AAAsf / AAAsf / AAsf / Asf / BBBsf / BBsf / Bsf

Defaults increase 10% and recoveries decrease 10%: AAAsf / AAAsf / A+sf / BBB+sf / BB+sf / BB-sf / Bsf

Defaults increase 25% and recoveries decrease 25%: AA+sf / AAAsf / Asf / BBBsf / BBsf / Bsf / below Bsf

Defaults increase 50% and recoveries decrease 50%: AA-sf / AAsf / BBB+sf / BB+sf / B+sf / below Bsf / below Bsf

Factors that could, individually or collectively, lead to positive rating action/upgrade:

An upgrade could result from macroeconomic conditions, loan performance and credit losses that are better than Fitch's baseline scenario or sufficient build-up of CE that would fully compensate for credit losses and cash flow stresses commensurate with higher rating scenarios, all else being equal.

Upgrade Sensitivity

The class A1-a and A1-x notes are at 'AAA(EXP)sf', which is the highest level on Fitch's scale. The ratings cannot be upgraded and upgrade sensitivity stresses are not relevant. Sensitivity stress results for the remaining rated notes are as follows:

Expected Rating Sensitivity to Reduced Defaults and Increased Recoveries

Note: B / C / D / E / F

Expected Rating: AAsf / Asf / BBBsf / BBsf / Bsf

Defaults decrease 10%/recoveries increase 10%: AAsf / Asf / BBBsf / BBsf / BB-sf

Best/Worst Case Rating Scenario

International scale credit ratings of Structured Finance transactions have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of seven notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of seven notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAAsf' to 'Dsf'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

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