Of late, Perpetual Bonds have received quite a bit of attention . They have become a buzzword in business magazines especially after the “Perpetual Bonds of Yes bank were written down as per the RBI’s direction” as on March 6th 2020.
(Reference link – RBI’s press release about Scheme of Reconstruction & refer SI.No. 6 – Read More)
Apart from the Yes Bank incident, there have been multiple news items about Perpetual Bonds, especially post the ‘winding up’ announcement of the 6 debt mutual fund schemes by Franklin Templeton AMC. Post this announcement, mutual funds offloaded some of their Perpetual Bonds holdings in order to create liquidity in their debt funds portfolio and due to this excess supply, the yields on these bonds skyrocketed. Strong PSU banks like SBI’s Perpetual Bonds also turned attractive as investments.
Let us understand how Perpetual Bonds work and the risks associated with investing in them.
What are Perpetual Bonds?
As per the regulatory requirement (Basel III norms), banks must maintain a minimum capital ratio at 11.5% of loans. This minimum capital level consists of both equity & debt capital. With regard to debt capital, banks will have to issue “Perpetual Bonds”.
- The name “Perpetual” implies that there is NO maturity for these bonds.
- As per this, banks are liable to pay ONLY the interest portion perpetually or forever and not the capital.
- Banks have the option to ‘call’ back bonds as per their wish and requirement. Usually, banks will ‘call’ back their Perpetual Bonds if the interest rates are seeing a downward trend.
- Perpetual Bonds are also unsecured.
- Here, the yields of such bonds are called as a ‘YTC ‘ or Yield to Call date instead of YTM (Yield to Maturity).
- If there is uptick in NPAs & the capital of the bank should get eroded, this may lead to constraints on cash flows and thereby banks can skip the interest payment & even write down the face value of these bonds.
- The recent incident of Yes bank shows that they can even write down their Perpetual Bonds and it will end up as a complete loss of capital for investors. (As per the Yes bank incident, fixed deposits are protected & Perpetual Bonds can be written down. This has happened as per RBI direction on March 6th 2020 (reference link RBI’s press release about Scheme of Reconstruction & refer SI. No. 6 – Read More)
- The name “Perpetual” implies that there is NO maturity for these bonds.
- As per this, banks are liable to pay ONLY the interest portion perpetually or forever and not the capital.
- Banks have the option to ‘call’ back bonds as per their wish and requirement. Usually, banks will ‘call’ back their Perpetual Bonds if the interest rates are seeing a downward trend.
- Perpetual Bonds are also unsecured.
- Here, the yields of such bonds are called as a ‘YTC ‘ or Yield to Call date instead of YTM (Yield to Maturity).
- If there is uptick in NPAs & the capital of the bank should get eroded, this may lead to constraints on cash flows and thereby banks can skip the interest payment & even write down the face value of these bonds.
- The recent incident of Yes bank shows that they can even write down their Perpetual Bonds and it will end up as a complete loss of capital for investors. (As per the Yes bank incident, fixed deposits are protected & Perpetual Bonds can be written down. This has happened as per RBI direction on March 6th 2020 reference link RBI’s press release about Scheme of Reconstruction & refer SI No 6 – Read More
What are the Risks Associated with Investing in Perpetual Bonds?
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No maturity: Since the name “Perpetual” implies that these bonds do not have maturity date, they are ‘forever’ bonds. Banks are liable to pay only interest. If they choose to ‘call’ the back bonds, we will get back our capital.
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Liquidity Risk: The only way to liquidate these bonds is through selling them in secondary market. Liquidation is also subject to availability of a buyer. Apart from either a ‘call’ back from banks & liquidation through secondary market subject to buyers being available, there is no other way to liquidate these bonds. Since debt market in India are dominated by institutions such as MFs, Insurance Companies, EPFs, Pension funds and banks being the main players, it may become difficult for retail investors to find a suitable buyer.
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Credit risk: As per the Yes bank incident, banks can write down their Perpetual Bonds if under business stress. This will cause complete loss of capital for an investor.
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Unsecured: When it comes to getting back the capital during insolvency, Perpetual bond holders are just one notch above equity share holders. Payment will be made in this order 1) Depositors 2) secured bond holders, 3) Perpetual bond holders and 4) preference share holders & equity holders will be paid in this order during liquidation of a particular company.
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Interest payment risk: As mentioned above, there maybe risk of interest payment not being done if bank is under business and cash flow stress. Since profit & loss and NPAs are cyclical, especially under the current economic stress with Covid 19, there this may become an issue and a risk for investors.
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Concentration risk: Since the minimum funds required to invest in these bonds is Rs.10 Lakh, it increases the risk of concentration (holding your entire investment in single company bond) .
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Risk of Non-Compliance: The issue of writing down of Perpetual Bonds comes into picture when there are higher NPAs and constrained cash flows in the books of Banks/Institutions. Hence, the banks/institutions books must be clean and should have followed strict compliance as per RBI guidelines. The classic example is of Yes Bank which throws light on incidents of non-recognition of NPAs, divergence of NPA numbers between Yes bank books as well as RBI’s audit , etc. which caused loss of capital for Investors of Yes bank Perpetual Bonds.
- The highest credit rating in Perpetual Bonds as of today is only AA+ only and there are no AAA rated Perpetual Bonds trading currently in India as of August 18th 2020 .
Comparison of FD Rates and Perpetual Bonds
Current issues as on August 18th 2020
| NAME OF BANK |
BANK FDS* |
vs |
PERPETUAL BOND ISSUES - as on 18.8.2020 |
| 1 Year FD Rate |
3 Year FD Rate |
Bonds Name |
Expected Call Date |
INTEREST RATE |
YCT (Yield to Call) |
| SBI |
5.10% |
5.30% |
SBI Perpetual Bonds |
22-Nov-24 |
8.50% |
6.90% |
| BANK OF BARODA |
5.10% |
5.30% |
Bank of Baroda Perpetual Bonds |
28-july-25 |
8.50% |
8.20% |
| PNB |
5.25% |
5.30% |
PNB Perpetual Bonds |
13-Feb-2025 |
9.15% |
9.20% |
|
Source NSE, AK capital, BoB, SBI, data as on 18.8.2020 |
Conclusion on Perpetual Bonds
- The risks associated with investing in such Debt instruments in loss of capital . Therefore one needs to clearly understand the above risks before investing in Perpetual Bonds and not just consider the rate of interest you may receive.
- Higher return will come with higher risk and in debt this risk may lead to loss of capital. This is important to understand.
- And , now , since fixed deposit rates have plummeted, many investors may surely be considering investing in these bonds because they offer higher rates of interest .
- Therefore, if you would like to invest in Perpetual bonds, please carefully study all the details, and fine print, and all the above risk factors , and not just the reward of higher interest rates, and then take your
- Conventional bonds with limited maturity period could be a good alternative to Perpetual bonds.
