Perpetual Bonds

Perpetual bonds are those debt securities that do not have a maturity, i.e., the issuer is not obligated to repay the principal amount to its bondholders. The issuer keeps paying steady coupon payments to the bondholders till perpetuity. These bonds are also known as a perpetuity bond or a perp bond.

The issuer has the option to ‘call back’ the bond and investors then get their principal back. If not, the bond continues to pay interest indefinitely, offering steady income but with uncertainty about when, or if, the principal will be returned.

• No maturity date: The issuer is not obligated to repay the principal, unless a call option is exercised.
• Coupon payments: Investors receive interest payments indefinitely.
• Subordinated debt: These bonds rank lower compared to other debt securities in case of liquidation or bankruptcy, but above equity.
• Higher coupon rate: AT-1 bonds carry a higher coupon rate to compensate for the higher risk. These bonds are an important source of quasi-equity capital for banks globally.

The yield of a perpetual bond is calculated based on the coupon payments and the current market price of the bond.

Yield of Perpetual Bonds = C /P; C = coupon payments; P = current market price

ABC Ltd. has issued a perpetual bond with a face value of Rs 1 lakh carrying a coupon rate of 9% p.a. The bond is currently available in the market at a price of Rs 90,000. Calculate the current yield of the perpetual bond.

Given:

Face Value: Rs 1 lakh

Coupon Rate: 9%

Annual Coupon Payment (C) = Rs 9,000

Current Market Price (P) = Rs 90,000

Calculation:

Yield = (9,000/90,000) × 100% = 10%

As the investor purchases the perpetual bond at Rs 90,000, which is below its face value, the yield earned on the bond, i.e., 10% is higher than the coupon rate of 9%. The current yield of the perpetual bond changes as the market price of the bond fluctuates.

In India, perpetual bonds are primarily issued by banks and financial institutions to meet regulatory Basel III capital requirements and strengthen their capital base. Perpetual bonds, structured as Additional Tier 1 (AT1) bonds, help banks to raise long term capital and meet capital adequacy requirements to protect against systemic risk. These bonds are listed and traded on the stock exchanges. Banks such as State Bank of India, Bank of Baroda, Canara Bank and Punjab National Bank have issued AT1 bonds (often Additional Tier 1) to meet capital adequacy norms.

Well established companies with strong credit ratings can also issue perpetual bonds to finance major long-term projects. Government entities like the Indian Renewable Energy Development Agency (IREDA) recently issued several perpetual bond offerings to fund green energy projects.

Additional Tier 1 Bonds, commonly known as AT-1 bonds, is an unsecured perpetual bonds regulated by RBI. These bonds are issued by banks to strengthen the external capital base to be used in times of a financial emergency and fulfill their capital adequacy requirement. Investors can invest in AT1 bonds, perpetual bonds in the primary market, i.e., initial private placement, or in the secondary market. The bank has the right to skip the interest payout if under financial stress. High risk appetite investors can consider investing in AT1 bonds.