Perpetual bonds have been gaining some serious interest among investors. The prime reason being that they offer a higher rate of interest than fixed deposit rates. Raghvendra Nath, MD, Ladderup Wealth Management says “For claiming final receipt, the status of perpetual bonds is just above that of preference shares.”
Many have been interested in such bonds because they see such bonds as quasi debt instruments without a maturity period and issuers pay coupons on this forever. Perpetual bonds by SBI yielded around 8.58% on BSE, which is nearly 7% higher than SBI FDs. However, with greater profits comes greater risks.
Proportionality of profit and interest
Usually bonds are paid the interest irrespective of making profits. But here, in case of a loss or fallout, the issuer has the option to not pay interest to perpetual bondholders. And in case of not receiving interest in a particular year due to losses, the interest rates do not accumulate even on the occasion of making enough profits.
Uncertainty in nature
To meet Basel 3 norms and support capital of banks, banks and NBFCs are issuing perpetual bonds with higher coupon rates. But the fallout of YES bank is pulling the prices down and increasing yields. This indicates that prices and yields are two inversely proportional entities. In the case of the issuer sinking, it is unlikely to redeem these bonds, and finding buyers becomes difficult.
Perpetual bonds are also called as risk absorbing bonds and are not guaranteed even after being issued by a bank because if a bank’s capital faces a crisis, they can choose to skip payment of interest rates and even write down their value like what YES bank did in March 2020.
Repayment of principal value
The tenure of these bonds is said to be spread over the years; hence it does not have a definite maturity. Essentially the maturity is when the bank decides to repay the principal amount, but it is not a compulsion as it is always easier to continue paying interest from the issuer’s perspective.
Liquidity An investment is made in a profitable portfolio so that in case of unforeseen contingencies, these can be liquidated. But perpetual bonds score low when it comes to liquidity. This was the major reason that led to the closure of six debt schemes of Franklin Templeton MF last month.
