Perpetual bonds were a favorite among Asian private bank bond investors because the securities were making a lot of money for them when interest rates were low.
But with interest rates at an all-time high, they’re realizing that the bonds have limited upside, if callable, and are extremely sensitive to interest rate risks. They could be sitting on mark-to-market losses for a very long time. Next to institutional investors, private bank investors are known to have a propensity for perpetuals when it comes to fixed income assets.
Private bank investors, for example, accounted for 36% of the final order book of the perpetual bond component of New World Development's US$700 million dual tranche bond issue that comprise of US$500 million senior green perpetual non-call 3-year securities and US$200 million 5-year senior dated social bonds issued on June 8 2022 in the Reg S markets. Banks and financial institutions accounted for 55%, while, asset managers and fund managers accounted for 9% of investors in the perpetual bond tranche.
Perpetual bonds, or perps, are issued by companies without a maturity date, or with very long tenors such as 50 years. This is unlike a traditional bond which typically matures in five years, 10 years, 15 years, etc. Because of the fixed maturity date in a traditional bond, any previous losses due to rising interest rates will be offset if investors hold the bonds to maturity.
However, perps have a “callable” option. A callable option means the issuer may redeem the bond before it reaches maturity and then issue a new bond at a lower discount. This works well especially in a low interest environment.
But in a rising interest rate environment, the issuer cannot issue new bonds at a lower discount without suffering mark-to-market losses. And since the perp has no specific maturity date, the investor gets stuck with the bonds for perpetuity.
This was highlighted in Korea on November 1 when Heungkuk Life Insurance delayed exercising the call option for its US$500 million perpetual bonds issued in November 2017, triggering a mini crisis among investors in the Korean fixed-income market. The crisis stabilized only when Heungkuk Life issued a statement on November 7 that it will exercise the call option.
Singapore's Mapletree Investments avoided a similar experience when it announced in advance (November 7) that it will not be redeeming S$700 million (US$512 million) perpetual bonds with a rate of 3.95% on their first call date set on November 12 2022.
In a statement, Mapletree said the distribution rate will be reset on the first reset date to the relevant reset distribution rate, which will include an initial spread and step-up margin. However, the first reset date comes only on November 12 2027. There will not be any reset of the distribution rate on November 12 2022, and the distribution rate of the securities will remain unchanged at 3.95%. This means investors will be stuck with Mapletree until at least 2027.
In any case, prospects for investors in perpetuals appear bleak until interest rates stabilize or trend lower, something that is not expected to happen until at least the later part of 2023.
“The perp market was fantastic when rates were low, and we saw a number of issuers across the region, from Hong Kong as well as the Philippines and to a certain extent Singapore tapping the perp product,” says a fixed-income asset manager. “But looking at the last couple of months, I would say there has not really been a true corporate perp priced, given the rising rate environment, and now some of the issuers are not calling them back on the first call date.”
“Do we anticipate perhaps the market to come back? Highly unlikely, against the current backdrop. We have seen some banks do subordinated bank capital instruments, but even that is quite limited. So, until we see rates stabilize and start going on a downward trend, it’s unlikely we will see the market come back to what we've seen over the last two years,” the asset manager says.