Understanding Perpetual Bonds

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Perpetual securities are fixed income securities with no fixed maturity date. Perpetual issues are made using credit from the investment category, preferably with sovereign entity type (SOE) experience. Emissions from stable sectors are well received by investors. However, when markets warm up, they are also open to lower quality issuers. This year, the markets experienced perpetual issues in the high yield segment of companies operating in cyclical sectors such as real estate development.

The coupon rate of these bonds is generally higher than that of other bonds in the longer term. The ability to defer coupons is a feature that allows the issuer to defer coupon payments and is favorable to the issuer. This gives a characteristic equity of bonds, in which no fixed payment is to be made by the company. Investors looking for higher returns may be attracted by the risks. However, they must understand that a higher return may not materialize if the coupon deferral option is exercised.

The rate of increase is a feature that offers some protection to investors. Generally, after a fixed period, for example five years, the coupon rate will be increased by a fixed amount called the mark-up rate. Callability is another characteristic of perps and perps are generally callable after five years. If the rate of intensification is low, there is a risk that bonds will not be called by the issuer. If vouchers have been issued at very low prices and with restrictive covenants, investors bear the increased risk of non-payment of bonds. Fixed income investors must go through the bond detailed prospectus to evaluate the different characteristics of these securities.

Liquidity risk is another risk that investors need to be aware of. Bondholders may not receive their capital if issuers decide not to repay their loans. Second, the marketability of weaknesses in secondary markets offers an exit option. However, the investor group that invests in perpetual documents is limited and, therefore, the liquidity of these bonds in the secondary market becomes essential for perpetual paper buyers to easily sell the paper.

Interest rate risk is another key risk faced by investors. Since the duration of the payments is longer, the risk of interest is also higher. In an environment of rising interest rates, the value of loans will drop significantly and issuers will have no reason to call them. As the US economy picks up, interest rates should rise. Positive data from the United States has raised growing concerns about the reduction of quantitative easing (QE) and has led to an increase in US Treasury yields. Recently, markets have experienced massive sales of long-term bonds and variable-yield securities.

When markets are at their peak, companies are trying to take advantage of setting perpetual low coupon rates and improving the structure of their capital. In 2013, companies managed to place perpetuals with restrictive clauses that were not very binding and considerably in favor of the issuer. Agile Property, a leading real estate credit in China, has issued at par yields. These bonds have underperformed since their issuance and are trading well below average. KWG Property, another Chinese developer, has marketed perpetual securities but has not been favored by investors who have begun to understand the risks involved. The company had to abandon the proposed show.


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