Dissecting the start of the New Zealand easing cycle

• Recent rate cuts in New Zealand (NZ) (-75bps to a 4.75% cash rate) have spurred business confidence to the highest level in a decade, along with stronger intentions for commercial real estate and agriculture activities. However, history indicates that a period of asset price adjustment and reset will come first before these intentions could translate into a normalising real estate market.
• The Merricks Capital Partners Fund’s reduced exposure to NZ from a previously overweight position (7% reduction over the past eight months) reflects the increasing level of transactions allowing borrowers to refinance or exit loans. We anticipate several more NZ$ loans to be repaid in the coming two quarters (~NZD$130 million in total) allowing us to redeploy into new opportunities.
• As the NZ credit market transitions into the easing environment, higher risk-adjusted returns are still required to attract capital due to the ongoing lack of alternative funding solutions in a tighter credit environment at the bottom of its asset cycle. We believe that investors with patience and flexible capital should be looking to capture a higher liquidity premium in NZ due to capital scarcity. This should allow the absolute level of interest rates charged by private capital to remain unchanged despite lower Reserve Bank of New Zealand (RBNZ) rates.
• With high conviction in counter cyclical lending, we continue to maintain our focus on recycling capital into new loans with quality sponsors and assets supported by the tailwind of the easing cycle. We currently have approximately $600m of NZ opportunities in the pipeline, with the majority in residential and retirement villages with forecast net IRRs ranging from 11-14%.
• The forward-looking expectation of very aggressive monetary easing policies by RBNZ (160bps of rate cuts priced for the next 12 months) has resulted in the AUD/NZD 12-month forward rate trading at -56 pts (+200pts peak in 2023) (Bloomberg). The benefit of this reversal will be reflected in minimal NZ$ hedging cost overtime, allowing NZ debt investments to further enhance risk-adjusted returns in AUD given the positive FX carry (rate differential to hedge NZD back to AUD).

NZ Construction Activity Indicators Ticking Up

NZ Agriculture Activity Outlook Trending Higher

Reversal of AUDNZD Forward Rates