Traditional corporate debt issuance continues at low levels in the NZ marketplace. However below the veneer view that corporate balance sheets are in great shape with low leverage, the buy up of NZ companies by private equity funds is creating a stack of new bank debt. As the majority of the private equity funds are Sydney-based, the bank lenders to the large debt funded component of these acquisitions are also Australian-based (e.g. HBOS & RBS).

Typically the private equity funds and the bank lenders write into the conditions of lending that 50% to 75% of the debt has to be fixed for 3 or 5 years. In nearly all cases this debt at the holding company level is entirely new and the operating company below has had low debt levels, therefore the absence of formal interest rate hedging policies. The funding arrangements are designed to maximise the tax deductibility of interest expense, provided the operational cash-flows can support the high debt servicing costs.

The recent $2.2 billion purchase of the Yellow Pages business out of Telecom NZ by Ontario Teachers Pension Plan and CCMP Capital has highlighted the impact on the NZ interest rate swap market when in excess of $1.2 billion of compulsory hedging hits the market in one foul swoop. The 30 point jump in swap interest rates over five or six days after 5 June reveals that there was not much finesse around Yellow Pages' hedging activity. It seems the Aussie-based bank lenders transacting the swaps with the borrower have a poor understanding of the size and liquidity of the domestic swaps market.

The problem for the local banks attempting to off-lay their swap book risk is that the NZ Government Bond market also suffers from very poor liquidity. It is taking some time for this swap fixed rate paying demand to be assimilated into the market.