Speak to our experts
Contents
COVID-19 has exacerbated tensions in pricing. The Official Cash Rate (OCR) is at a record low with negative rates looming. The Reserve Bank of New Zealand (RBNZ) may have delayed its capital adequacy reforms, but uncertainty and risk of borrower default mean that pricing hasn’t dropped and margins remain higher.
Price disparities among Australian banks and between Australian and Asian banks continue. Non-bank lenders are picking up again as banks become more cautious about new lending.
This is the second instalment in our Finance Trends & Insights Series. Read our first release in the series here: Continuing disruption.
How low will the RBNZ go?
RBNZ confirmed that the OCR would remain at 0.25% for at least 12 months when it eased in March. Quantitative easing may be RBNZ’s preferred instrument but, with the Large Scale Asset Purchase already sitting at $100b, negative interest rates with a ‘Funding for Lending Programme’ next year are looking increasingly likely.
Some economists have speculated that RBNZ might drop into negative interest rate territory late this year or very early next year. We would expect that any move earlier than March 2021 would be heavily sign-posted. Operational readiness remains a key principle in RBNZ decision making. Banks are required to provide plans on their capabilities to operate in a negative OCR environment by 1 December 2020. A negative interest rate is unlikely until RBNZ is comfortable that the financial sector is prepared for it.
Zero floors are under examination
Zero floors are now well entrenched in the New Zealand market. However, RBNZ and the Financial Markets Authority (FMA) have flagged this as a potential ‘conduct’ issue, given the expectation that the benefit of negative interest rates will be passed on. As hedging agreements won’t contain zero floors, there’s an increased conduct risk where a bank is both a lender and a hedge counterparty. The regulators are concerned about borrowers being sold swaps where there will be a lopsided benefit.
At this stage, we’re not seeing zero floors generally being removed from existing facility agreements, but it is becoming a point of discussion. While banks are still developing their internal negative interest rate policies, lenders and borrowers may wish to discuss whether zero floors are appropriate in their documents, particularly where there’s hedging involved.
The bond market could be increasingly tempting for corporate borrowers. Low rates have left debt investors hungry for higher yield.
Capital adequacy requirements delayed – but for how long?
RBNZ has delayed the introduction of the higher capital requirements for banks by 12 months – to 1 July 2021. Whether there will be a further delay is an open question.
RBNZ’s COVID-19 stress test highlighted the resilience of the New Zealand banking sector and will help inform RBNZ decisions on the timing of the Capital Review implementation and any changes to dividend restrictions.
The positive findings from the stress test might have been taken as an indicator that the current rules are adequate, but instead have been taken by RBNZ as justification for the decision to increase bank capital levels, noting how swift and unexpected economic shocks can be.
Higher risk, higher margin
RBNZ estimates that bank new funding costs fell by around 80bps in 2020 – but this was offset by higher margins and upfront fees to counter COVID-induced higher default risk.
While banks have been generally supportive of their borrowers, extensions have often been accompanied by ratcheting margins and line fees based on loan to value ratios.
Variation within lenders
Individual banks are pricing much lower or much higher than others. This may be due to lenders prioritising certain sectors. The Chinese and Japanese banks remain cheaper than their Australian and New Zealand counterparts.
Non-bank lenders
Banks have tightened lending standards, particularly across sectors perceived as being more risky in the current environment. This has created more room for non-bank lenders which, while more expensive can offer increased flexibility and a higher risk appetite, particularly on the back of a (so far) more resilient property market.
A number of new non-bank lenders were expected to enter the market pre-COVID. They have not yet arrived but may be tempted in as the present uncertainty becomes the new normal.