Credit conditions

The Reserve Bank conducts a six-monthly survey of banks on aspects of credit conditions, trying to get at things not just captured in headline base bank lending rates.  The last regular survey was conducted in March but, of course, quite a lot has happened since then.  So, to their credit, the Bank has conducted a one-off additional survey in June to try to get a sense of how Covid and the associated economic disruption has changed things.    The numbers and the Bank’s write-up are here.  There is a good series of summary charts at the back of the write-up, some of which I will be using in what follows.

The survey has both current/backward looking questions and questions about the outlook, differentiated by type of borrower (SME (turnover less than $50m per annum), household, corporate, agriculture, and commercial property).   Here is the Bank’s note

The June Survey was completed in the last two weeks of June 2020 by 12 New Zealand registered banks, including all of the five largest banks. The period covers credit conditions observed over the first six months of 2020 and asks how banks expect them to evolve over the second half of the year.

In the face of a severe, unexpected, economic downturn, and a substantial lift in uncertainty about the outlook, you’d probably have expected credit conditions to have tightened.  For any given level of interest rates, banks would be less willing to lend.   That would be an entirely rational response, even if banks were quite confident about their overall financial health based on the existing loan book.  Credit demand –  which respondents are also asked about –  is a bit more ambiguous: credit demand for new activities might reasonably be expected to take a hit, but some borrowers will have a heightened demand for credit to tide them over a sudden unexpected loss of income.

What we see in the survey is, more or less, what one might have expected.  Sadly, the survey hasn’t been running long enough to benchmark the data against developments in previous recessions.

On the demand side, the two competing effects are most visible in the responses for SMEs.

cconditions 1

Working capital demand has increased a lot, and is expected to increase a lot more in the second half of the year, while demand to finance capital expenditure has fallen quite a bit and is expected to fall a lot further.     The picture for bigger corporates is similar, if perhaps not as stark.   Overall demand for credit increased for these two business categories, but fell for all the others.  “Credit availability” fell, as one would expect, across all these subsectors, and is expected to tighten further in the second half of the year.

One of the good things about this release write-up is that the Reserve Bank has released detailed disaggregated data from the survey that they do not usually publish.  Quite why they don’t publish it routinely is an interesting question, but then this is an organisation not exactly known for its routine transparency –  although you’d think that data collected under a statutory mandate, collated at tsaxpayers’ expense, should be routinely published.

Anyway, the data are there this time.    First, there is a distinction between the price and non-price aspects of credit availability, actual and expected.  Higher credit spreads will be the key aspect of price.

For households (mortgage and personal lending) all the actual and expected tightening in credit availability took the form of non-price measures, but for all four business categories the price effect (higher credit margins over base lending rates) dominated.  Here again, as illustration, is the chart for SMEs.

c conditions 2

There is a further degree of disaggregation on the aspects of the credit availability responses, but only for the period already been.  For each subsector respondents are asked about:

  • collateral requirements,
  • serviceability requirements,
  • maturity and repayment terms,
  • covenants,
  • interest markups
  • other price factors.

For households, the only material changes were (tighter) serviceability requirements.  That is interesting –  if not too surprising –  given (a) slightly lower interest rates, and (b) some temporary easing in the Bank’s LVR restrictions.

Here is the chart for SMEs

CC SME

and for larger corporates

CC corporate

There are some interesting differences, but the stark similarity is in the higher interest rate mark-ups.  For both subgroups, covenant requirements appear to have eased – one guesses semi-involuntarily as many borrowers will probably have blown through previous loan covenants.  I don’t know quite what to make of the differences in the green bars –  “other price factors” – but would welcome any comments/suggestions.

What of commercial property loans?

cc comm property

That’s pretty stark.  For every component, policies and conditions have tightened, apparently quite materially.  Perhaps not too surprising –  and in many past downturns –  commercial property loans, especially those on new developments, have been a key source of bank losses-  but interesting nonetheless.

And, finally, agricultural loans.  Farmers keep farming, and –  for the moment anyway –  commodity prices have held up. But in any global economic downturn, commodity prices often bear the brunt. In this case, the adjustment by lenders appears to have been mostly in the interest mark-up agricultural borrowers face.  As the graph shows, credit spreads have been widening for some time, in the face of some mix of factors including the Bank’s markedly increased capital requirements (farm borrowers tend to have alternative sources of finance).

cc agric

The final component of the survey asks about factors influencing the availability of credit.  There isn’t a line for “severe unexpected recession etc”, but here were the interesting aggregate responses to the standard list of items.

cc factors

Cost of funds is almost invisible as an issue –  whether wider credit spreads in funding markets or lower base (OCR etc) rates –  and so is any change in competitive pressures.

Respondents suggested that regulatory changes had been helpful –  presumably this will refer to the temporary suspension of the OCR restrictions, the temporary delay in the increase in minimum capital ratios, and perhaps the temporary reduction in the minimum core funding ratios.  Together these changes have, as one might expect, worked to mitigate a tightening in credit availability, but note the aggregate effect is not that large.   On the other side of course, the two material effects are an adverse change in the banks’ assessment of risk, and in the willingness of banks to take any given level of risk.  Both seem highly rational and sensible responses in a climate like that of recent months.

What to make of it all?   Probably none of the results is terribly surprising, and it will be interesting to see how these results compare with those of the next regular survey in September (when we must hope the Bank will again release more-disaggregated data).

I guess what struck me was the widening in the credit spreads business borrowers have been facing.  The published time series data from the Reserve Bank on business lending rate is pretty lousy –  a single series for “SME new overdraft rate”.   That headline rate has fallen only about 70 basis points this year.   That isn’t too surprising –  since the OCR has fallen 75 basis points, and floating mortgage and bank bill rates not much more.  The credit conditions survey tells us that typical business credit spreads over base rates have risen (probably quite rationally so in the changed economic climate).  But we also know that inflation expectations have fallen quite a lot –  data from the indexed bond market suggests about 70 basis points this year.  In other words, the combination of increased risk perceptions and a passive central bank doing little or nothing, in the face of one of the most severe economic downturns, here and abroad, for many decades, real business lending rates are rising.     That is quite insane outcome, but a choice made by Orr and the MPC, and apparently condoned by the government (and the Opposition for that matter).  It is quite extraordinary, almost certainly without precedent in a country with (a) a floating exchange rate, and (b) a sound financial system, and (c) sound government finances.

One half of the government’s brain seems to recognise the issue.  They just extended the scheme whereby small businesses can get interest-free loans from the government.   Quite why they think those favoured few –  in many cases, probably some of the worst credits –  should be able to borrow at zero while the rest of the economy  (but especially the business sector) borrows at materially positive real interest rates, often complemented by tightening non-price conditions is a bit beyond me.

Oh, and remember that this surveys suggest banks expect credit conditions to tighten further from here.

5 thoughts on “Credit conditions

  1. As you say, no surprises here really… although the size of the tightening in agriculture credit surprised me a bit. Its also worth comparing this with the larger listed companies busily raising new equity to either pay down debt or to smooth their duration…

    Nice if your a large listed company with lots of institutional shareholders busting at the seams with Kiwisaver cash… but for the rest of us…

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  2. Banks remain very down on farm lending. I guess this is from a capital use perspective – risk weighting’s on farm lending – and the bespoke nature of agricultural loans which require significant infrastructure to deliver and manage. But also, I think they remain worried about high LVR’s and weak and volatile debt serviceability.

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  3. Michael
    There is an age-old tendency for banks to restrict credit when times get tough, which has been literally automated c/o rules which now require higher levels of capital to be held against non performing loans. Pricing is somewhat irrelevant at present, but the relationship between risk free rates and bank rates is complicated by banks seeking to maintain their retail deposit basis and their need to back loans with a mixture of different forms of funding/capital.
    In the corporate sector, the situation is reflected in the RB’s credit survey results which show that for corporate/institutional borrowers:
    • Demand +35.3%
    • Availability over the 3 month -32.2%
    • Availability over 3 years -60.0%
    This is only part of the story as corporates often have alternative sources of debt, from offshore lenders and from issuing bonds. Both sources of credit have been moribund this year.
    Perhaps not many corporates will be facing the sort of demand that would encourage investment in hard assets right now, but it makes quite a difference if the credit market is functioning smoothly. Being able to issue 10 year bonds reduces the risk associated with building things. If credit is tight, lets wait and see what happens becomes the board room theme.
    Few in the corporate sector have any great need for more debt right now. Outside of a couple of high profile equity issuers its seems that NZX50 type companies are getting by. But that isn’t the same as actually going out and instigating new construction or purchasing new equipment.And it’s not as if there is any hint that “Shovel Ready” funding will be directed to private borrowers.
    So it will be interesting to see if RBNZ takes steps to either make it easier for banks to lend to corporates and/or smooths the way for corporate issuance of bonds. More available credit may not lead to more investment, but its obvious that a lack of credit is an impediment.
    Tim

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    • Labour governments and Jacinda Ardern’s and Grant Robertson’s idea of shovel ready projects is bungy jumping. Lets save low productivity and low skilled bungy jumping versus high productivity factories and high skilled labour like Tiwai Point smelter and Marsden Point refinery.

      It is an insult to workers to be called the Labour party when they sack 2600 workers at Tiwai Point smelter and 3500 workers at Marsden Point refinery. Jacinda Ardern and Grant Robertson should be sacked from the Labour Party and call themselves the Greens.

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  4. The perception of credit risk – counter cyclical as always. Interesting that (capital market) credit spreads were falling last year suggesting ‘risks’ were low. Yet, the opposite was true – balance sheet efficiency was rewarded, and robustness scorned. Now the opposite. The old saying: “a banker lends you his umbrella when it’s sunny and wants it back when it rains”

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