Perpetual bonds: Good or bad? (Read comments too.)

With interest rates so low these days, one would not be wrong to wonder why are companies and even a REIT issuing perpetual bonds to raise funds with coupons of up to 7%. To a layman like me with very rudimentary understanding of economics, it could be one of two reasons:

1. The business or REIT concerned is not able to get loans because its business is too risky.

2. The amount of liquidity available in the banking system is drying up.

I do not have the necessary knowledge to do an in depth analysis on the reasons why. Indeed, I do not have the inclination as well. I am more interested in how these bonds might benefit me as an investor.

Generally, investors want to be correctly compensated for the risks they are asked to undertake. So, the riskier the investment, the higher the expected compensation. Otherwise, it is a no go.

However, with imperfect knowledge, investors sometimes get the shorter end of the stick. There are examples aplenty of investments gone sour. With the benefit of hindsight, investors learn to avoid similar experience in future or we hope to anyway.

When something new comes along, relying on past experience becomes impossible. Indeed, investors are sometimes misled through creative labelling. Remember the "mini bonds"? The resulting losses were in no way mini.

Now we have "perpetual bonds". What are these?

Perpetual bonds are bonds with no maturity date and investors are not allowed redemption. A glaring disadvantage of such an instrument is the lack of liquidity. Therefore, people with very deep pockets who would never be in an urgent need of cash are more suitable investors.

No matter the depth of one's pockets, however, there is a universal problem of inflation. With inflation in Singapore at more than 5%, if one should park one's money in a perpetual bond that yields 5% or less, it does not make much sense. Add this to the lack of liquidity of such an instrument, more or less, it amounts to an almost complete loss of control over one's dwindling wealth. Ouch.

Perpetual bonds are a no go for me. However, if the companies and REITs I am vested in should issue perpetual bonds to fund activities which would grow EPS or DPU, I would raise both hands in support.

Like anything in life, whether something is good or bad depends on where one stands.


UPDATES:

The absence of a maturity date means perpetuals usually offer higher yields than bonds with one. Companies are taking advantage of Singapore accounting rules that count the notes as equity and a tax law that exempts interest payments.

The lack of a perpetual's maturity date, in spite of the incentive to redeem at the first call, allows issuers to treat that debt as equity in their books. That reduces the companies' leverage even as interest payments increase.

"The impact on the market is hard to judge" if any issuers choose not to repay, said Dilip Parameswaran, the Hong Kong-based head of Asia Investment Advisors Ltd. "The Singapore dollar market is small and dominated by domestic institutional and retail investors. They may have invested based on an expectation of call, and may be disappointed if the bonds are not called."

As companies consider the cost of refinancing, he said, "if the secondary yields are higher than the step-up coupon, then it makes no sense for the company to call the perpetual."

Source: http://www.businesstimes.com.sg/banking-finance/singapore-perpetual-bond-investors-hope-never-means-three-years


AK says:

What we want to be wary of is also what rising interest rates would do to bond prices. As interest rates rise, bond prices fall. That is the relationship.

For bonds with maturity dates, we just have to hold to maturity and hope that the issuer does not default. We would get back our capital at maturity. With perpetual bonds, there is no maturity date.


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