LUCAS Demand fundamentals have obviously turned and we will probably go through a period where the outlook is slightly weaker. Starting with housing, we have seen a reduction in house prices over the last nine months, which naturally flows through to lower credit growth in this sector. On the business side, growth was negative through 2020 and quite strong in 2021, and we are just starting to see the data turn and growth slowing.

Agriculture has been reasonably stable. Farmers are taking advantage of higher export volume and prices that have been good for the last few years. Some farmers have used these conditions to deleverage and repay debt.

On the supply side, banks have had access to the funding for lending programme (FLP) and deposit markets have remained robust. Banks got into a particularly strong position through 2020 and 2021, with very good aggregate deposit growth across the sector, and we have managed to maintain these positions with continued deposit growth.

As we go into a higher interest rate environment, there are concerns about high input cost, labour market shortages and macroeconomic factors that will potentially cause some businesses to pause on their debt plans. But, so far, the capital market space has been particularly strong in the last 12 months through corporate borrowing across subordinated and senior debt. Issuance is up 30-40 per cent on a year-to-date basis relative to last year.

TURNER Banks have more capital than ever and there is a lot of liquidity, so it is the demand side that has been driving the slowdown. Pre-COVID-19 and before the RBNZ put restrictions on dividends, bank treasurers were worried about how they would meet capital rules. But the accumulation of capital through this period has meant all of us can achieve the requirements from retained earnings over the period without too much drama.

Banks will still be willing to lend, despite the slowdown. Asset quality is still relatively good and there are no signs of stress coming through. The pace of the shift in monetary policy and increase in rates have been a surprise and we are waiting for the stress to start showing up in the book, but it hasn’t yet. This is a function of relatively conservative, through-the-cycle lending policies, with banks stress testing mortgages at higher rates, and customers building up buffers and getting ahead of their credit limits.

It also helps that the RBNZ, economists and the market are all pricing in basically the same trajectory for interest rates – we are reaching a consensus on where rates will end up. When interest rates started going up it caused huge uncertainty, and the consequent fear and panic drove a lot of negative sentiment.

Most of the credit growth we have seen on the business side over the last 18 months has been working capital. There has been pressure on supply chains and a need to grow inventories because of COVID-19 related disruption. But there has not been a lot of investment, and businesses have been very pessimistic.

With a bit more certainty around where rates are going, we should start seeing more business investment. Our economists are still picking relatively robust GDP growth; things are actually not that gloomy. Credit is there if it is needed – we just need confidence to come back.

ZHANG Based on our RBNZ dashboard and the bank’s balance sheet, we are in a very strong position. Our liquidity and capital positions are sound, and we are ready to lend to customers.

ZHANG The performance of our home lending portfolio remains strong and housing delinquencies are at a very low level. A few factors are supporting this, and the serviceability test is one of them.

Our test interest rate is currently 7.5 per cent, well above what we have offered in customer mortgage rates across all tenors. We had an applied interest rate of more than 6 per cent throughout the pandemic, even when the official cash rate was at 0.25 per cent. We regularly review our applied interest rate and we want to ensure buffers are in place so debt serviceability continues.

A significant portion – about 90 per cent – of our mortgage portfolio is fixed-rate lending, and it takes time for these customers to re-fix onto higher rates. Currently, less than half our existing fixed-rate borrowers have done so. Tighter monetary policy will take time to work through, which means our customers will take time to adjust to higher rates.

Another factor is repayment rate. Many of our customers are ahead on their repayments, which provides flexibility when they eventually move to higher rates. Finally, employment is strong, as are household savings built up over the lockdowns. This also provides a buffer to household balance sheets.

Having said all this, the housing market has slowed and, with tighter monetary policy and financial conditions, debt serviceability will be a focus for us in the coming years.

DELL A good proportion of our customers have already rolled onto higher rates this year. Fixed-rate borrowers get some warning about when they are coming off the fixed rate, so they have time to prepare. A lot of customers kept their payments the same, even in the very low interest rate environment, and that has given them a buffer now as we move to higher rates.

TURNER About half Westpac’s book has repriced onto higher rates and we have not seen any material change in portfolio performance through this period. There have been some mitigating factors to higher costs, such as people staying ahead of their payments and wages keeping up with inflation. People talk about the cost-of-living crisis, but we are actually seeing reasonably strong wage growth. Banks assess people’s salaries at origination, and if salaries go up it also provides a buffer toward serviceability. It will be interesting to see what happens when the second half of the book reprices.

TURNER It is certainly there: we are seeing soft sales and price numbers. I think everyone expected this: the market was getting overheated with appreciation, and even with this pressure valve prices have not yet corrected to where they were before the start of last year.

The bright-line test for investors means there is suddenly a tax consequence for selling to lock in capital gains. This has been a disincentive for investors to sell, which has probably prevented the housing market from declining as rapidly as it otherwise would have.

In addition, banks have been very conservative with their LVR [loan-to-value ratio] standards. About 94 per cent of our book was originated at less than 80 per cent LVR – and higher prices over recent years mean LVRs are probably much stronger than this. Price appreciation has improved the buffer, so it is only people at the margin – who bought at the top of the market and then had a change of circumstances – that have been running into trouble.

ZHANG We are all going offshore and traveling again. About 80 per cent of our funding comes from offshore markets, and maintaining this and our domestic investor base is key to our funding strategy. The lack of face-to-face interaction has been a challenge. We are all looking forward to traveling more and re-engaging with investors.

The FLP helps mitigate volatility and it took the pressure off us needing to go to the wholesale funding market in a stressed environment. From our perspective, the FLP has certainly lowered cost and limited the cost of funds passed on to our lending rates.

We have used the FLP as a programme to support some specific low-cost lending initiatives, such as the “good to grow” programme. This supported customers from a productivity, growth and sustainability-linked lending perspective.

Even so, we kept a market presence while the FLP was available, issuing in the domestic and offshore markets. It is incredibly important for us to keep market presence and keep investor lines open.

DELL It was also important to us to keep our market presence, and we have been active in offshore funding markets. We went back to the US in June last year and have been back to Europe as well. The FLP has allowed us to be a bit more patient and wait for windows in those challenging markets.

TURNER I definitely think it did not. FLP provided certainty of and access to funding; it was linked to the OCR and allowed for 100 per cent transmission of monetary policy. When the FLP was implemented it was necessary because of the uncertainty in the market. There is no impediment to monetary policy because there has been 100 per cent transmission of OCR increases.

DELL We have taken a pretty conservative approach to FLP, and the growth in our home loan book far surpasses how much we have done under the FLP.

LUCAS We had 12 per cent growth in home lending assets in financial year 2021. The FLP is a small component of this. The housing market piece is not unique to New Zealand – we have seen similar dynamics and factors at play across the globe relating to the change of customer behaviour as a result of COVID-19. This stems more from the low interest rate environment than from the FLP.

LUCAS Investors were very interested in the capital adequacy framework the RBNZ has established and wanted to understand the rationale behind going for a more simplistic style of transaction for tier-two. Their interest really stepped up relative to discussions we have had about senior debt, including asking quite detailed questions about the capital framework for the tier-two deal.

Tier-two capital is a very simple instrument that essentially is just subordinated debt. The onus is on the banks to obtain legal opinions that it will comply. Because we wanted to make sure we did our first tier-two deal correctly, we walked through the process with the reserve bank prior to the transaction. Overall, it was an interesting exercise and it was well received – in the end, we had about US$2.7 billion of bids for a US$600 million trade.

DELL We have been quite busy in the capital instrument space. We did a domestic tier-two subordinated transaction in September last year and our inaugural US market transaction in August. We had added tier-two capability to our US programme at the end of last year to make this option available to us.

The major difference between the two was the backdrop we issued into. Last September was a time, before the conflict in Ukraine, when the words ‘inflation’ and ‘transitory’ were commonly used in the same sentence. This was certainly not the situation in August when we went to the US. But we received a very good reception from both markets. There was an education piece, because the New Zealand instrument differs from tier-two instruments in other jurisdictions. But investors seemed comfortable with this once we had the conversation.

DELL There was absolutely an education piece, on our part as well as for investors. We needed to explain the features of the instrument, including that it is perpetual, constitutes equity not debt and does not have the convertibility clauses that AT1 instruments we had issued in the past had. It was a pretty extensive process just to get to the start line, given this was the first time we were issuing this sort of equity instrument.

It was very challenging given the backdrop. The time between announcing the deal to the market and pricing was two weeks, and two weeks is a long time in financial markets at the moment.

LUCAS There was a lot of interest in the capital reforms, both in the transition process and where capital requirements ultimately land. Providing a view of the harmonised approach versus a normalised one gives investors an idea of where we sit on a multijurisdictional basis.

The banks have all substantially increased capital over the last two years: on a ratio basis many of us are fairly close to the CET1 [common equity tier one] requirements although there is still work to do in the AT1 and tier-two spaces. It is likely that all the banks are adjusting their allocation models as the impacts of the capital reforms become clearer.

ZHANG We still lean more toward the IRB [internal ratings-based] approach for capital allocation, simply because it provides risk sensitivity and better flexibility from a credit offering perspective. But we currently operate within the constraints of the standardised floor overlay.

ZHANG The challenging macroeconomic backdrop and geopolitical risk have not gone away, to which we must now add the tightening of financial conditions and inflation. The world’s central banks were synchronised on monetary easing and they are now synchronised in tightening monetary conditions.

There is an increasingly narrow pathway for central banks to bring inflation down by hiking rates without sacrificing growth and causing recession. If we look at history, there is a good correlation between spreads widening and economic activity slowing. I think we will continue to experience volatile market conditions in the medium term.

TURNER One of the challenges has been originating green assets. We still have not landed on a universally agreed definition of a green mortgage, yet mortgage lending is the bread and butter of New Zealand banks. Coming up with a universal standard on what constitutes a green mortgage would really help this space.

There is a lot of growth in the sustainability-linked lending space, which is slightly different from green products. It is a real focus at Westpac and we are thinking about ways we can continue to invest and grow this part of our business.

LUCAS We have been active in green and sustainability-linked loans over the last 12-18 months. We have been using our funding-for-lending allocation to pass the benefit through to customers. It creates a great opportunity when we go to refinance down the track.

DELL We announced a green business loan product last week, and a couple of months ago we launched a “good energy” loan that can be used for EV [electric vehicle] purchases, solar energy and the like. We are very much focused on the customer side and what we can offer them.

LUCAS Housing is key at the moment, and we are getting questions about the resilience of the book, what trends we are seeing and where arrears are going. We have experienced a very large uptick in house prices over 2020 and 2021 and an easing since, which offshore investors are acutely aware of.

ZHANG Our central bank was one of the first to hike rates and offshore investors will be looking very closely at this approach to ensure they develop a deep understanding of the impact it has on asset quality.

DELL Questions about our exposure to China and what a slowdown in China potentially means for New Zealand come up quite a lot in investor meetings.

TURNER We often get asked about our sustainability strategy – investors are increasingly focused on this. Along with the housing market, which comes up a lot, investors are increasingly discriminating based on how sustainable they think issuers are.

DELL It has been a pretty challenging year from an offshore funding perspective and investors are definitely being a lot more cautious. As a result, we need to be nimble and prepared to act when windows open. They do not always come up quite when we want them to, and sometimes this means sitting on the sidelines and waiting for the right moment to execute.

In our discussions with investors, there are more and more questions about our direct exposures to the situation in Ukraine and Russia, and how the conflict is affecting New Zealand on an economic level.

LUCAS Spreads in the European market are moving much wider than the US, particularly in the secondary space. Supply has moved more toward covered-bond activity in Europe, and a number of Australian banks have executed in this format. But there are pockets of liquidity and investors are still active. When we did our tier-two transaction, it was a case of navigating around certain events and watching headlines closely.

TURNER It is very difficult to time the market or be opportunistic in this environment. It is therefore important to be prudent and get in front of funding tasks. We now see a good deal as one we can execute at the volume we want, rather than getting too choosy about price and how far the deal tightens.

I suspect much of the volatility has been driven by the market getting wrong-footed on yield. As yields stabilise, access to markets is likely to be more predictable.