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Thursday, 18 September 2014

Unyielding

Apple debt shows revival of yield desperation

Apple’s $17 billion lovefest in the debt market on Tuesday shows just how gaga investors are for bonds offering any kind of yield. The 10 and 30-year bonds, which made up half of the tech giant’s record offering, will pay out less than 4 percent annually. Still, that’s more than, say, Treasuries. Lenders are also funding dividends paid out by private equity-owned firms and structures like PIK toggles in return for a little extra interest.

One culprit is central banks sucking up the supply of safe debt and squashing rates. Before the financial crisis, savers could earn more on a five-year CD than Apple is paying on its longest-dated paper. Now, with huge bond-buying programs under way at the Federal Reserve and, most recently, the Bank of Japan, it is becoming hard to imagine interest rates rising in the foreseeable future - just as it was difficult to conceive of home prices falling in the United States in the middle of the 2000s before the financial crisis struck.

The hope is that these central bank policies will boost sluggish economic growth. But they are also encouraging borrowing behavior that echoes the pre-crisis boom. Dividend recaps in recessionary Europe already have reached nearly $3 billion this year - the largest total since 2007, while risk premiums on junk bonds are at record lows.

Investors have little to fear while interest rates are low. Default risk appears minimal. That helps explain why pension funds - natural buyers of 30-year bonds that help match their long-term liabilities - were so eager to buy Apple bonds that deliver only half the return they need to meet their targets. They have little choice but to grab whatever slivers of yield they can find, even if the quid pro quo is more risk.

But rates could rise unexpectedly. There’s also too much confidence in market liquidity. As with flipper-driven housing markets last decade, many investments now only seem to make sense if someone else pays more for them at a later date. That sounds like a Ponzi scheme. As the crisis showed not long ago, both optimism of this kind and market liquidity can evaporate almost overnight.

Low rates and plentiful credit are giving some companies room to lever up again, even before the global economy has extricated itself from the last pothole. Investors shouldn’t forget that such distortions usually end badly.

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Context News

Apple sold $17 billion of debt in a six-part offering on April 30, a record size for a non-bank corporate issuer. Half of the bonds sold will mature in 10 years or longer, paying investors a coupon of less than 4 percent. Apple will use the proceeds to help pay for the $100 billion it has promised to return to shareholders by the end of 2015.

Dividend recapitalizations in Europe reached $2.9 billion in 2013 as of April 29, the largest amount over a similar period since 2007, according to Thomson Reuters.

High-yield bonds yielded 4.55 percent over U.S. Treasuries on April 30, according to a Bank of America Merrill Lynch index. That’s a record low premium for junk bonds, according to Marty Fridson, chief executive of FridsonVision.

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