Apple’s issuance of $3 billion of 30-year bonds at 3.85% at the end of April might yet come to be seen as the high-water mark of the credit market’s recent irrational exuberance. Part of the firm’s record-breaking $17 billion deal on April 30, these bonds were trading at 88 by the end of June – a 12-point loss on their issue price. The $5.5 billion 10-year bond had also fallen to 92 since issue.
The performance of the bonds illustrates not only the risk to investors of buying long-dated bonds at record low yields in an asymmetric interest rate environment; it also illustrates the persistent dearth of secondary market liquidity in a US corporate bond market dominated by primary issuance.
According to a recent report published by BlackRock, new issues have averaged 21% of total US corporate investment-grade debt outstanding over the past decade compared with just 1% for US equities. And trading volume in these bonds plummets by around 50% just four weeks after issue.
The asset manager has long argued that an efficient way for issuers to address the liquidity challenge in the market is to adopt some form of standardization – issuing similar amounts and maturities at set times and reopening benchmark issues.
Euromoney first spoke to Richie Prager, head of trading and liquidity strategies at BlackRock, about this concept in September last year, when he told us: "Borrowers will have to change their behaviour – this goes right back to every issuing entity... they can’t tap every market anymore."
As the Apple deal shows, however, the lure of being able opportunistically to tap a market at record low yields will be hard to resist. But Prager now argues that recent volatility should act as a wake-up call for the market. "This is a call to action for issuers, the sell side, intermediaries and regulators. The last couple of weeks have been a very timely reminder that we need to look through the cycle; a good reminder that the liquidity challenge is real. Something has to change and issuers and underwriters need to start to think through the cycle."
Dealer inventories are now down 76% since 2007 and dealers hold just 0.25% of total investment-grade debt outstanding. When it comes to liquidity, borrowers will have to help themselves.
"There is a need to triangulate the corporate bond market, the cleared derivatives market and the index and ETF market," says Prager. "We know that there is a steady demand for paper, so we need a regular and predictable programme of issuance."
Whether or not the market heeds his words remains to be seen. If Apple had issued a series of benchmark issues along a curve of well-defined nodes, secondary liquidity would most certainly have been better around those nodes. But Apple came to the market with a particular tax-driven incentive and with $100 billion in the bank, so it does not need to worry too much about its ability to tap the corporate bond market in the future. It might, however, be time for other corporates to rethink their strategy.
Prager sees signs that this is happening.
"Frequent borrowers are more open-minded than I expected," he tells Euromoney. "There are some technical issues around refinancing risk, but they could maybe be addressed by bonds being callable within three months of maturity. We are not being prescriptive, we are just putting it out there. We would like to see some other voices in the debate."
Given that the market might now have called time on the era of ever-shrinking corporate yields, that discussion could become more urgent. As Warren Buffett warned on May 4, shortly after the Apple trade attracted over $50 billion of buyers: "We’re not buying bonds of Apple – we’re not buying bonds of anybody. It has nothing to do with them being a tech company. The yields are too low."