Corporate bonds: Appetite for paper grows

With hindsight, Apple's groundbreaking $17bn bond issue in April may have been the high-water mark in a multiyear rally in corporate bonds.

At the time, the demand for the "iBonds" highlighted the enormous appetite among retail investors for higher-yielding alternatives to government debt after the US Federal Reserve's massive quantitative easing policy had pushed borrowing costs to record lows.

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 sold.

As part of the multi-tranche 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. Investors in the offering paid 99.418 per cent of face value for the new bonds, but institutional and retail demand was so strong that they traded as high as 101.97 in the secondary market soon afterwards.

"Apple's bond sale was an event," says Matt Toms, head of US public fixed income for ING Investment Management. "They were a new entrant, offering debt of several maturities, including long-term, at a time when debt markets were wide open for issuers, and investors were starved for liquidity."

But just a couple of weeks later, comments by Fed officials suggested that the US central bank was going to start to taper its purchases of government debt soon, thanks to an improving economy. Traders across the globe reacted by sending interest rates on US Treasuries sharply higher, causing a sell-off in corporate bonds and wiping hundreds of millions of dollars off the value of Apple's offering.

Bonds with longer maturities suffered the steepest falls, although even Apple's five-year and 10-year debt declined in price.

Some investors were reminded of the basics of corporate bond market mathematics: bonds sold at low yields suffer when rates rise.

At its lowest point, the market price of Apple's 30-year debt fell to 81.59 per cent of face value in September, according to data compiled by Bloomberg. While the price has since rebounded, investors who snapped the company's bonds that day in April are still sitting on losses.

"Unfortunately, some investors forget that bonds, even high-grade ones, can and do lose in value," says Michael at for Prudential Fixed Income.

"That's one problem with buying bonds at very low yields: the risk-return equation is asymmetric."

The sell-off hit other big global corporate bond issues from this past spring, including those from Vodafone of the UK and Petrobras of Brazil. Corporate bond funds experienced large redemptions, and some recorded losses for the first time since the financial crisis.

Analysts started to question whether fixed income assets had lost their lustre as investors favoured the stock markets, where the broad S&P 500 rose to record highs.

But another turning point in the corporate bond market was just around the corner. In early September, the US telecoms group Verizon started to market the largest corporate debt sale in history, seeking to raise funds for its $130bn acquisition of the 45 per cent of Verizon Wireless that it did not already own.

The company stoked demand for the deal by selling the debt at generous levels compared with that of other similarly rated bonds. The group sold its 10-year bond at a yield of 5.19 per cent - about 57 basis points higher than its existing debt for that maturity, a substantial amount for bond buyers.

As a result, investors across the globe lined up to buy the bonds, and orders reached $100bn. That was almost double the size of the order book for Apple's $17bn offer in April. US pension funds and insurance companies, hedge funds and Asian and Middle East investors all bought Verizon's securities.

"It is interesting that these two large deals ended up coming just a few months apart," says Mr Collins. "In terms of pricing, Apple got the low ticket, while Verizon probably got the high ticket."

Verizon sold $49bn worth of bonds in a combination of fixed and floating-rate debt spread across six maturities that ranged from three to 30 years. The bonds jumped in secondary markets, rewarding investors who bought the securities at discount prices. The gains generated up to $2bn in profit for investors on the bonds in 24 hours, analysts estimated.

Verizon's successful sale helped end the summer sell-off and paved the way for an upswing in the market for US corporate bonds. The Fed's decision later in September to keep its bond-buying programme in place added a new enticement to corporate borrowers as well as investors in fixed income assets.

"There were talks earlier this year about a 'great rotation' out of fixed-income and into other asset classes," says Alex Gennis, a credit strategist at Barclays. "Indications point to a very strong and healthy appetite for paper in the corporate bond market. The 'great rotation' has yet to happen."

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