Apple $17 billion bonds lose 9% in six weeks. Will Apple’s $17bn debt sale in April turn out to be the “AOL buys Time Warner”moment of the three-decade bond market bull run?

June 11, 2013 9:53 am

Apple bonds lose 9% in six weeks

By Stephen Foley and Michael Mackenzie in New York

Investors are nursing losses of up to 9 per cent on Apple’s record-breaking $17bn bond offering, less than six weeks after the securities landed in their portfolios.

The technology giant tapped the white-hot bond market for the largest debt fundraising to date on April 30, but a sharp turn in interest rates has caused a sell-off in corporate bonds and wiped hundreds of millions of dollars off the value of the offering.

Apple sold $3bn of bonds maturing in 2043, locking in a low interest rate of 3.9 per cent for the next 30 years, but the market price of these bonds had fallen to 90.36 per cent of face value in late trading on Monday, according to Trace data.Investors in the offering paid 99.418 per cent of face value for the new bonds, but institutional and retail demand was so high that they traded as high as 101.97 in the secondary market.

The debt sale was one of the most frenzied on Wall Street for many years and there were three times as many orders as there were bonds available. Issues by companies with high credit ratings have been among the hottest fixed-income investments because the interest they provide outstrips the meagre yield available on government securities.

However, recent comments by Federal Reserve officials have suggested that the US central bank could soon start to taper its purchases of government debt, thanks to an improving economy, and traders have reacted by sending interest rates on Treasuries sharply higher.

That has reduced the relative attractions of corporate bonds and sent their values sharply lower. Bonds with longer maturities have suffered the steepest falls, though even Apple’s five-year and 10-year debt has declined in price. Its $5.5bn of 10-year bonds now have a market value below $5.2bn.

The price declines are mirrored in other major global corporate bond issues from this spring, including those from Vodafone of the UK and Petrobras of Brazil.

Ashish Shah, head of global credit at AllianceBernstein, said the price moves in Apple were potentially temporary. “The most recent new issues tend to be the most dislocated in a sell-off as they are still quite liquid,” he said.

“Historically we have not had this level of retail investor participation in the market. When retail start losing money, they sell but institutional money is waiting to buy once the market has backed up to higher yields.”

Apple said it would use the proceeds of its bond offering, its first since 1996, to help pay for the return of $100bn to shareholders over the next three years. Although the iPhone maker has $145bn of cash on its balance sheet, only $45bn is held in the US and repatriating foreign reserves would be costly due to tax implications.

June 11, 2013 3:43 pm

Messy bond cocktail stirs talk of market reset

By Michael Mackenzie and Stephen Foley in New York and Michael Stothard in London

Will Apple’s $17bn debt sale in April turn out to be the “AOL buys Time Warner”moment of the three-decade bond market bull run?

Market booms are usually crowned by a moment of investor mania. In 2000, the takeover of a media behemoth by an online start-up heralded the impending burst of the dotcom bubble.

Apple’s debt offering on April 30 was the largest in bond market history and, such was the clamour, it could have sold $52bn of debt had it wanted to.

For much of the past year, bonds issued by the most creditworthy companies in the US and Europe have been heavily oversubscribed. Investors have shunned low-yielding government debt in favour of corporate credits that may be slightly riskier but at least offer higher interest income.

But now an unexpectedly steep rise in long-term interest rates and record outflows from bond funds are proving a messy cocktail for returns on corporate bonds.

“The long-predicted and feared bond market reset may have begun,” says Dan Morris, global market strategist at JPMorgan Asset Management.

For many, this has been a rude education in bond market maths. As interest rates rise, existing bonds with long maturities look less attractive against future new issues that will pay higher annual coupons, so the value of existing bonds falls. Longer-dated bonds, which have higher “duration”, are more sensitive to interest rate swings, and have borne the brunt of the price declines as yields have climbed.

Apple bondholders’ losses are not unique. The $1.4bnVodafone 30-year bond, sold in February as part of the biggest issue of the year by a European company, has fallen sharply, hitting 93p in the pound. The $1.35bn 10-year Diageo bond issued in April is trading at 95 cents, while Statoil’s $900m 11-year bond is also at 95. And investors in a $1.75bn 30-year bond issue by Brazilian oil company Petrobras are sitting on a paper loss of 6.5 per cent.

Returns for every major sector of the bond market have been negative since the end of April and investors have started withdrawing money from bond funds. There was a $4.9bn outflow from longer duration corporate debt last week, according to EPFR.

The worry is this will force money managers to sell more of their holdings in order to meet redemptions, reinforcing the downward trend in prices and rise in yields. An additional concern is that Wall Street banks, which used to provide temporary support to the market by taking unwanted securities on their own books, have pulled away from the business due to tougher capital and risk management rules.

One statistic highlighted by bearish traders: the total return on investment-grade corporate bonds has been minus 2.2 per cent since the end of April. That is worse than the decline of 1.8 per cent for US Treasury debt and of 1.6 per cent for junk bonds. The underperformance runs counter to a popular view earlier this year that, when Treasury yields started to move higher, the move in corporate bonds would be less severe. The risk premium, or spread, of corporate bonds over Treasuries would narrow, the theory went, because it had still not yet returned to pre-financial crisis levels.

In fact, corporate bond spreads have widened, driven by the speed of the jump in Treasury yields and elevation of market volatility. Some fund managers think the risk premium should widen further still, implying continuing underperformance.

“Investors are not getting paid for the risk in 10-year and 30-year bonds,” says Arne Espe, vice-president of mutual fund portfolios at USAA Investments. “The speed of the back-up in rates has been surprising and the absolute level of interest rates is still too low.”

For investors who hold corporate bonds to maturity, today’s low prices may not matter, since the securities will eventually be paid back at face value. For those forced to sell, there will be a level at which buyers are tempted.

“The back up in corporate credit will eventually entice yield-seeking investors back to these asset classes once the policy view and Treasury markets stabilise,” says Edward Marrinan, head of macro credit strategy at RBS Securities.

But, for now, he says, “we see a continuation of the kind of conditions none of us likes very much: rising volatility, diminished liquidity and higher anxiety”.