Funding in challenging economic times

There was consensus that the key challenges are increased economic inequality, which is contributing to division within society, high inflation, high interest rates, poor infrastructure, financing challenges for government with tax revenue coming in below expectations, and a likely rise in unemployment later this year into early next year.

None of these problems are unique to New Zealand, nor are there any particularly good overseas examples of governments managing them well.

Cameron Bagrie’s view is that interest rates will continue to rise until mid to late 2024 before beginning to trend down. Inflation will sit around mid to high 6% at the end of 2023 but drop to just below 4% at the end of 2024. The OCR will perhaps peak at 5.75% in the upcoming months. This has subdued business confidence and stoked cost of living pressures.

Cameron thinks brutal change is required to get inflation back to 2%, but questions how much beating up the economy can take right now and whether central banks will be prepared to do it, as unemployment starts to rise. The environment for inflation looks more sticky than what we have seen for the past few decades. There is a wave of new opportunities in the tech/AI sphere which could unlock productivity and, if combined with a good policy platform by any incoming government, may help ease inflation faster than projected. More spending or tax cuts will just add to inflation.

Richard Anderson said the difficult economic circumstances are not likely to be ‘fixed’ quickly or by the results of the upcoming election. This is causing both lenders and borrowers to reassess their existing and required funding needs and makes the lender-client relationship more important than ever.

Several clients have come to Westpac in the last six months to discuss the impact of rising interest rates on covenants. In late 2022/early 2023, these were typically caused by rising rates, but recently more have been caused by earnings pressures.

Liquidity is critical for borrowers, and the recent hiking cycle has caused greater focus on interest rate risk management. Borrowers should communicate early with their lenders in a transparent way and take advantage of the information banks can offer on the economic climate and forecast interest rates. A strong relationship with the bank and good line of sight on lender’s credit processes are always important, but particularly in times of stress. This can be harder to manage with some international lenders.

Diversification of funding was clearly identified by borrowers as being essential in this market with large borrowers looking to spread their debt funding across a range of financial institutions and across different products/markets rather than having ‘all their eggs in one basket’. This results in good management of their interest rate exposure and maturity dates. It also allows for clear planning for their working capital / liquidity funding.

Borrowers are acutely aware that rising interest rates mean more risk will be required to see better returns. Risk management will, therefore, be at the epicentre of a lot of business discussions/strategies in the coming years and the importance of having good governance and management people around the decision-making table is critical. Borrowers are also showing increased interest in new and innovative lending products, especially those with an ESG or sustainability link. Recognising that sustainability linked loans haven’t previously been accessible to all, Westpac has recently created new sustainable small business and agri-loans.

William Meek spoke from the perspective of the energy sector, where the response to climate change is a predominant concern. He said that Mercury considers this in its own operating environment – especially what opportunities and risks have changed, how the business should adapt, what the impacts will be on revenue and costs, the impact on capital plans and how these should be funded.

Debt markets are important to Mercury as its ability to raise equity is constrained by its 51% government ownership. However, the political cycle did not change electricity demand materially and the power sector was in a climate-change driven growth phase as New Zealand decarbonises.

A current challenge for Mercury, and the entire energy sector, is that electricity is relatively expensive. The business is identifying what it needs to do to compete successfully and is investing in new renewables to get NZ electrified and decarbonised.

Cathryn Barber’s view is that although the current environment is more volatile and challenging than usual, she expects to see a continuation of existing funding trends in 2023 rather than sharp changes in direction. For further insights on NZX/ASX Top 50 Funding Composition, read our Trends & Insights 2023.

Key take-outs

• Interest rates will remain elevated through this year before beginning to trend down in mid-to-late 2024.
• Inflation will sit at around 6% until the end of this year but will begin to fall through 2024 to end the year a just below 4%.
• In a difficult economic environment, the borrower-bank relationship is important.
• Borrowers should communicate clearly with their bank to take advantage of the information banks can provide on the economic climate and forecast interest rates.
• Diversification of funding across different lenders, products and maturities can reduce risk.
• The market is growing for innovative borrowing options, especially those with an ESG or sustainability link.