Supply and demand dynamics on the move for New Zealand banks

LEVY Central bank policy continues to drive funding strategies and has been instrumental in forecast monetary policy changes, in particular by the US Federal Reserve.

One of the main discussions in Europe had been whether the European Central Bank (ECB) would be able to act ahead of the Fed. We, as did markets globally, forecast the ECB would take the first step down at its June meeting. Given how widely held these expectations were, there would only have been  a significant impact on market function if there was no rate cut.

After the June meeting, our forecast is for two rate cuts in total by the end of the year. This will have an impact in a few ways. It will affect investor behaviour and, accordingly, have an impact on credit spreads – which have been tightening very significantly.

The environment has, to this point, been prompting issuers to front-load their funding plans. For instance, Natixis CIB’s parent company, Groupe BPCE, has an annual funding programme of more than €25 billion (US$26.8 billion) and the task for the current financial year is 70-75 per cent complete, the group having accessed a range of asset classes including covered bonds.

BPCE is just one example: many issuers have been increasingly moving in the same direction during the first half of this calendar year. There has been a knock-on effect on funding and liquidity.

Considering that base rates will decline at some point, investor preference is to go longer on the curve to achieve higher returns. This means another common theme is a lengthening of average maturities.

At the first rate cut, the primary consideration for investors will be overall return rather than credit spread. This likely explains the fact that spreads are still moving tighter and the market continues to improve. Investors are still active and cash is still coming into the market.

LUCAS The Reserve Bank of New Zealand (RBNZ) was out with its May announcement last week and it is fair to say this was more hawkish than the market expected. The RBNZ is very much focused on getting the inflation outlook under control first and foremost, before moving on to other economic fundamentals. This approach is somewhat lagging that taken in some other jurisdictions.

In saying this, there is weakness in our economy that we expect to see earlier than is being predicted. But I think the reserve bank is keen to get market pricing out and elevated versus the swap curve.

TAMARELLE It was a bit of a surprise: I don’t think anyone expected a hawkish tone. In a higher-for-longer environment, the big question for investors is what the impact on the economy will be and how aggressive an approach to investing the environment demands.

For instance, in Europe and the US last year, investors decreased duration because of lack of certainty about the path and timing of rate cuts. If investors cannot be certain that a central bank will not be supportive, it is quite tricky for them to be aggressive and to lengthen duration. By the turn of this year, the majority of investors in Europe were predicting seven rate cuts – although by now it is more like two.

In January, the investor community was very aggressively seeking to go longer in order to crystallise yield ahead of upcoming rate cuts. This aggressive spirit from the investor community is the main reason for lengthening duration on all products in the euro market.

Last year, a ‘long’ covered bond was one with a maturity of 5-6 years while this year covered bond maturities have extended out to 15 years. This is a significant increase in duration appetite on the part of investors. There has also been a significant increase in orderbook volume. To give you an idea, last year an average orderbook was perhaps €1-1.5 billion whereas two weeks ago we printed a 10-year covered bond for BPCE with a €6 billion orderbook.

This may be the reason why a more hawkish RBNZ may have an impact on investor perception of the region. It is fair to say European investors were surprised by the level of hawkishness.

ROSS Global investors understand that New Zealand is often ahead of the curve when it comes to global macroeconomic trends. However, recent economic data points in our region suggest it is not just New Zealand that will be slow to cut. For example, comments from the Reserve Bank of Australia (RBA) have led some investors to price in potential hikes as well as delaying potential cuts well into 2025.

DELL Because New Zealand was leading the way back in 2021, global markets appear to be looking at us now to take the lead once more. But it doesn’t feel like we will this time; we are at the other end of the monetary policy spectrum at the moment.

ZHANG For New Zealand, inflation coming down has been a slow process and it is worth noting in this context that the RBNZ has a single mandate: it needs to have confidence that inflation is traveling down to the 2 per cent mid-point target.

ROSS It was very clear in Europe that [ECB president] Christine Lagarde did not want the ECB to be the first to cut.

TAMARELLE This was a big debate among the European investor community, which was convinced she would lead the world in monetary policy. Now Lagarde is being forced to be the leader. It is a massive responsibility.

VOLPICELLA There are similarities between New Zealand and Australia, and in both jurisdictions our balance sheets are holding up very well. We are very well positioned for a period of more moderate economic conditions, including having the highest capital and liquidity levels we have seen in recent history from a New Zealand and a group perspective.

The other point to make is that an environment of high and accelerated rate rises is one that is typically preceded by very buoyant credit growth. But the experiences of COVID-19 in Australia and New Zealand mean we didn’t observe this – and this is even more the case in New Zealand, where macroprudential standards are very stringent.

For example, the majority of prime investment mortgages were limited to a 65 per cent loan-to-value ratio (LVR) for a considerable amount of time. Measures such as LVR limits on mortgages and investment loans support bank underwriting standards and financial system performance.

Coming into this period very well positioned, our expectation was that credit issues were likely to remain very manageable. It still feels this way, notwithstanding a rise in mortgage arrears – there has been some lift, off historical lows. Investors will be encouraged by the extent to which the environment is holding up in New Zealand and, from a group perspective, in Australia.

We are well prepared for pockets of stress to continue to emerge as the economy and consumer spending slows. But, overall, employment continues to hold up and this is supportive of credit outcomes.

ZHANG The concerted effort of central banks putting liquidity into the system during the pandemic didn’t necessarily generate the irrational exuberance seen in other cycles. Banks maintained prudent lending standards, while businesses used the opportunity to pay down debt. Businesses have kept balance sheet discipline and are going into the slow patch better prepared.

ROSS One of the bigger concerns for investors earlier this year was financial stability risks stemming from commercial real estate exposure specifically. Given New Zealand banks are not affected by this, investors have all the benefits of the additional yield pick-up with none of the risks the market is concerned about.

LUCAS Rates transmission has been discussed a lot in New Zealand. I assume it also gets a lot of air time in Europe and the US given the prevalence of fixed-rate mortgages and the slow transmission of rate rises through to end customers.

This component is probably why the RBNZ got ahead of the pack. It is also why spending has remained so robust for the past 18-20 months – it has supported the economy quite comfortably from an unemployment perspective. When it comes to our balance sheets, it has been a case of very low arrears growth coming off a very low base; the trajectory has been quite smooth.

But the transmission is coming through now. We are getting into the territory of 6 per cent mortgage rates for most of the portfolio and this is starting to have an impact. To the point about the robustness of the economy, the RBNZ has said New Zealand can sustain rates at current levels.

As for transmission through deposits, interest rates have changed depositors’ behaviour. During 2020-21, average term deposit rates were less than 1 per cent; they are now a very healthy 5 per cent. It is probably common across bank balance sheets that we saw an inflection at 3-4 per cent, with deposits being shifted from on-call into higher yielding, term products.

DELL What is interesting about this dynamic is retail investors’ move toward on-call deposits from term deposits in the low interest rate environment, which happened at pace. Although we have had rapid increases in the OCR [official cash rate], unwinding this has taken much longer and we are still not back to where we were. Unwinding retail investors’ change in preferences has been much more of a grind.

LUCAS There may also have been an element of holding on to cash through times of uncertainty.

ZHANG Prior to the hiking cycle in 2021, banks had experienced strong lending growth predominately through the housing channel. Despite low rates, bank deposit growth was steady – though, given the strength of housing, it was ultimately dwarfed by lending growth through 2021. Term deposits as a percentage of total deposits fell sharply as deposit money diverted into cash and, partially, into other investments outside deposits.

As we moved through the hiking cycle, lending notably slowed – though system lending still grew faster nominally than deposits. Depositor preferences began to tilt back toward term deposits, but the return came through at a much slower rate than the fall.

As we moved to peak rates, business lending stalled and housing growth also slowed substantially through 2023 as the economy slowed. Some banks will have experienced deposit growth up to 2023 coming through before lending growth, providing opportunities for a pay-down in wholesale debt.

Despite peak rates in financial year 2023, customer balance sheets have shown resilience with very limited defaults and modest increases in days past due. Customer preference for term deposits continued through 2023 and funds are still trinkling in through 2024.

VOLPICELLA While we are not seeing a material uplift in the ratio of deposits to loans, there has been improvement in our liquidity coverage ratio (LCR). This is because the type of the deposit that is favoured offers more value from an LCR perspective, being more stable and longer duration. For instance, at-call and savings deposits have been moving into term deposits. This is consistent with many offshore jurisdictions.

ZHANG Net overseas migration has been the main driver of population growth. Bearing in mind that New Zealand implemented probably one of the world’s strictest pandemic polices – with foreign arrivals largely cut off after March 2020 – the balance of migrant flows fell sharply and had turned negative for a period of time. When the border reopened, net migration started to normalise – and reached a peak late last year.

While increased net migration and stubbornly high construction costs added fuel to house price inflation, there are offsetting factors such as restrictive monetary conditions and an easing labour market. Meanwhile, net migration has eased considerably over the past few months.

VOLPICELLA Population growth will continue to create buoyancy in the housing market. Our house view is that New Zealand house prices will rise by about 6 per cent overall during the 2024 calendar year and by 7 per cent during 2025.

Balancing the stickiness of inflation with subdued economic growth, the RBNZ’s decision to keep rates on hold for now makes sense. What the reserve bank is clearly trying to avoid is reducing rates too quickly and thus running the risk, if it’s the wrong move, of inflation picking up again. We currently expect rate cuts to start next year – and for this to provide some additional support to the housing market.

ROSS We spend a lot of time talking with investors in Europe about our region. European investors are increasingly comfortable with New Zealand and Australian banks. After the Silicon Valley Bank and Credit Suisse failures, many investors did a regulatory deep dive, jurisdiction by jurisdiction, and they have come to understand that our regulatory regime is robust and offers more investor protections than the US and Europe.

From a credit and economic perspective, European investors are more comfortable with the region and the banks, given the New Zealand economy is not affected by many of the factors being experienced in Europe currently. There is a sense that geographic location is benefiting New Zealand. Furthermore, the recent group credit upgrades from the rating agencies have added to investor appetite for the major banks.

Less issuance in the euro market by the Australian parents also increases the demand for New Zealand bank paper. What has happened is investors often opening lines on the New Zealand entities as they can’t get the paper they want from the Australian parents.

One issue that can’t be overcome is the relatively small balance sheets and funding programmes of the New Zealand banks. Investors are often time and resource constrained so many small-to-mid-sized investors, which are often the least price sensitive, don’t have the bandwidth to cover New Zealand banks given their relative lack of issuance. This mindset is slowly changing given the positive catalysts I have just mentioned, though.

Overall, our sense is that European investors that have previously skipped New Zealand bank trades on the basis of geography and lack of funding needs are now looking at them more closely.

DELL A few years ago, geography was a clear disadvantage. But the geopolitical backdrop means it has become a real positive for New Zealand.

ZHANG This came through quite clearly during our recent roadshows. Investors are much better informed and up to date with the regulatory and economic landscape here in New Zealand. They see that the New Zealand story provides a solid diversification play in their investment mix. It is our responsibility to take our case to offshore investors, with regular briefings on the economy, our credit fundamentals and changing regulatory requirements.

TAMARELLE I met with several investors just last week to get their feedback on New Zealand. They are particularly seeking covered bonds as the region presents a real advantage for investors looking for diversification, especially outside Europe. They are also aware that the scarcity effect will protect them against volatility.

VOLPICELLA During COVID-19, the provision of government and central bank support, and liquidity, tended to skew the market away from credit fundamentals, supply and demand dynamics, and the like. What we are seeing now is the reintroduction of credit fundamentals and differentiation.

At the end of the day, this benefits Australia and New Zealand because we are highly rated banks issuing from highly rated jurisdictions, and our offshore issuance – particularly from our collective Australian parents – has been relatively limited.

We also provide diversification for investor portfolios. While we are never going to be completely immune to geopolitical risk, we are more distant and therefore often less correlated.

LUCAS Issuer strength is crucial. The New Zealand banks have good fundamentals, robust underlying balance sheets, and relatively straightforward products and instruments that are well managed. The regulatory environment is also supportive, while Australian and New Zealand banks have good track records of stable earnings.

VOLPICELLA My view is that issuance markets continue to be very robust. One interesting phenomenon is access to funding for the major-bank complex. Our capacity to access funding has increased meaningfully and in several different ways – one of which is the ability of our Australian parents to issue into their domestic market.

The Australian domestic market has grown materially. A few years ago, a A$1-2 billion (US$665.1 million – US$1.3 billion) transaction was a large benchmark trade for the market. Now, the major banks are issuing A$3-5 billion per deal. There is also significantly more appetite beyond the senior-unsecured space, reflected in deal size and tenor in tier-two and additional tier-one capital issuance.

From a New Zealand perspective, I believe we can benefit from this reduction in our parents accessing global markets. For instance, when Westpac New Zealand issued a US dollar senior trade earlier this year the peak orderbook was in the region of US$6.8 billion. I don’t think it would have been as large as this if the Australian banks had issued regularly into the US market ahead of our deal.

LUCAS The New Zealand domestic market has benefited from the recent growth in the Australian domestic market. Some New Zealand issuers, including the semi-governments, have gone to Australia for funding and this has created more demand for New Zealand dollars domestically on the basis of lower supply.

The fact that the Australian market is larger and is attracting more interest from Asia as well as domestic superannuation funds increases interest here, as does the inclusion of New Zealand government bonds in the WGBI [FTSE World Government Bond Index].

VOLPICELLA Over the last 5-10 years, it was very unusual for euro transactions to price in line with domestic trades on a swapped-back basis – but we are currently finding exactly this across some parts of the curve. This opens up another viable global market, which further supports diversity in our programmes.

DELL ANZ New Zealand issued in euro senior format in January, for the first time since 2021. We were keen to restore our presence given we hadn’t accessed the market in several years and it is important that we keep our options across funding markets open by regularly issuing into them. Even in January, pricing in Europe was closer to domestic funding costs than it had been for several years.

ZHANG Wholesale funding diversification is an important part of the bank’s funding considerations and the euro market has been one of the core options for us. BNZ has been consistently issuing into the euro market in the senior and covered-bond formats.

LUCAS ASB Bank has had a US 144A programme since 2018. It requires us to do more work than our euro programme but it also provides the ability to leverage additional markets for investor diversification, issuance capacity and pricing advantages.

The New Zealand banks have been going through a low supply period to the US market. But it is advantageous to have the option for diversification during periods of lower deposit or higher credit growth.

Particularly during times when other global markets may not be open to us, for access or pricing reasons, the advantage of the 144A programme is the ability to accommodate the immense Asian investor base in orderbooks. We have also experienced an increase in investors from the Asian region in our euro books.

VOLPICELLA We recommenced the Westpac New Zealand US 144A programme and issued a three- and five-year US dollar senior trade in 2023. One benefit of doing so was the ability to expedite building a US dollar curve.

We consider many factors when thinking about what market we issue into or what product we issue. In relation to the recent US dollar trade, continuing to build our presence was one of them.

ROSS While it could have been an idiosyncratic year, in 2019 82 per cent of the New Zealand majors’ issuance was in euros and 7 per cent in US dollars. As we entered the pandemic in 2020, a year which obviously had its own challenges, 71 per cent was issued in US dollars with a small portion of Swiss francs and the remainder in euros. This highlights the challenge with Europe – which is that it can often be uncompetitive from a price and tenor perspective in times of high volatility.

In 2022 and 2023, issuance volume was split more or less equally between New Zealand dollars, euros and US dollars – which is very beneficial from an issuers’ risk perspective. It is interesting that the New Zealand banks have all pivoted into the US dollar market. With the domestic market effectively being reborn, the New Zealand banks have had access to a very well-diversified issuance platform for the last couple of years.

DELL Even with a bigger NZDM programme, I don’t think there are any meaningful capacity concerns for senior debt in the near term. We have accessed the domestic market in multiple formats of late. Feedback is that there is demand for senior debt but our domestic deals have focused on our transition to meet the RBNZ’s revised capital requirements.

LUCAS Market capacity has marginally increased because of some of the market dynamics that are in play. Around two-thirds of NZDM bonds are going to offshore investors and the read we get from the domestic market is that there is ample appetite for bank bonds. Investors generally understand the banks’ stories well.

On the other hand, the relatively low credit growth environment reduces supply and will likely do so next year as well.

VOLPICELLA It is hard to predict the outlook for next year. We will assess global markets across a range of factors at the time of issuance. We will not only consider price and volume but also capacity and liquidity, as it is important for us to maintain regular access to the markets we are active in.

The domestic market has been one of the most resilient. This, and the fact that we have not issued much locally, provides us with confidence that we will have capacity in the local market even if we experience a downturn in the global issuance environment. It is not just about what we do today but planning for what we might do down the track if circumstances change.

DELL ANZ NZ accessed NZ$3.5 billion with no significant concentrations of maturities, so we consider we can repay this amount from within a business-as-usual funding task. There is an impact on cost of funds, although not significant. We are talking about NZ$3.5 billion of funding relative to NZ$135 billion of customer deposits. Term deposits are clearly a much more significant driver of cost of funds.

LUCAS We accessed NZ$5 billion originally and we have been able to repay around one-fifth to date without accessing term markets – as, to Penny’s point, deposits have been strong this year.

FLP stands out from some equivalent international programmes in the sense that the RBNZ made it a condition that our borrowings had a staggered maturity profile across a two-year horizon. The capacity and resilience FLP built into balance sheets, together with additional deposit gathering over the last two years, has enabled us to repay term debt, too. It is a comfortable position to manage, especially given the current state of markets.

DELL It is an interesting product. It is an equity instrument that we subsequently list on the NZX debt market. It comes with some unique features – there are some real positives, for example not having a point of nonviabilty (PoNV) structure – but it is undoubtedly made more challenging by the equity component.

In saying this, we can have up to 2.5 per cent of AT1 product in our capital ratio and we have issued more than N$800 million in the domestic market so far. We view this as good progress.

ZHANG BNZ has also issued a perpetual preference share (PPS) in the domestic market, and it has been a great market discovery process for us. This is a product that has yet to go through a full lifecycle, and investors will have better familiarity and understanding of its unique features over time.

DELL Outstanding legacy instruments, of which this is one of ours, are progressively being phased out under the new capital regime. That instrument was issued by ANZ London Branch and then backed into the New Zealand branch of ANZ Banking Group. The equity nature of the new capital instrument makes offshore AT1 issuance complex because it would introduce foreign currency volatility from a regulatory capital ratio and also a profit perspective.

VOLPICELLA AT1 is reasonably unique to Australasia. Some offshore jurisdictions have made their AT1 instruments tax deductable. In New Zealand, the old-style tier-one capital issued out of New Zealand was deductable for tax, which created opportunities to issue offshore. However, the new PPS structure is not.

As a result, we cannot viably issue PPS transactions offshore. There is no issue with attracting investors. The issue is that offshore investors cannot take advantage of franking credits. This makes PPS, as a potential funding avenue, prohibitively expensive and therefore limits us to the domestic market. This is the case for Australia, too.

Australia had to build up its AT1 market but it is now mature, whereas New Zealand is still in its early stages. We need to build the New Zealand market and it will take time to do so.

Therefore, New Zealand PPS pricing is not directly comparable with Australia, which has already gone through the ramp-up stage and is at the point where demand outstrips supply. National Australia Bank’s recent A$750 million AT1 had a book of more than A$3 billion, and this is pretty typical: with generally around 60 per cent of notes taken up by existing noteholders of rollover trades, demand from new investors is high and new money supply is limited. New Zealand is in the ramp-up stage and the price should reflect this.

VOLPICELLA Tier-two issued by New Zealand banks is debt for tax purposes, therefore it is treated in the same way as senior debt from a tax perspective. This enables the banks to issue the product offshore efficiently. The only challenge is our funding requirement, which is around NZ$1.6 billion. We wouldn’t want to issue this in a single call profile, so our preference for tier-two is to issue a number of smaller transactions.

ROSS We receive frequent reverse enquiries from investors for tier-two private placements from New Zealand banks, which works well given the limited funding need – as Guy highlights.

DELL The tier-two product is very well received offshore given its features, including the absence of PoNV. It also carries a single-A rating from S&P Global Ratings, a pick-up over senior debt and supply will be limited – which are all positives from an offshore investor perspective.