Perpetual Bonds/Sukuk: Juicy Returns but Be Mindful of The Risks

Perpetual Bonds/Sukuk: Juicy Returns but be Mindful of the Risks
By Fakrizzaki Ghazali

Introduction

I was first introduced to perpetual bonds during my stint at one of private bank in Kuala Lumpur, in the midst of the 2008/09 rate cuts frenzy and declining yields. Investors are hungry for high-paying bonds when we saw opportunities in this segment through the USD and SGD markets, soon after Maybank issued the first perp via classic Innovative Tier-1 Capital (IT1CS) in 2008, before other corporates follow suit years later.

Perpetual bonds/sukuk pays higher coupon than normal bond and is technically better than equity from priority of payment, but be mindful of the risks too.

Diagram shows the priority of income distribution by asset-class, where perpetual is ranked higher than ordinary shares which means that the interest payment to perpetual bondholders must be made before any dividend can be paid to the shareholders. On the flipside, senior bond’s interest has to be satisfied first given their superior status than the perpetual but the latter is compensated by enjoying higher coupon rate.



The Key Risk vs Benefits of Investing in Perpetuals
 

 

Perpetual could be Debt or Equity for the Company; but Asset for Investor

Changes by Thailand Accounting Standard (under TAS32) that may reclassify perpetual as liabilities in the company’s balance sheet from next year has been the hot topic among investors in Malaysia as this could result to higher Debt-to-Equity percentage – the main financial ratio  for bonds. As a result, there is a potential breach of covenant and probably rating downgrades on the senior debts eventually. Nonetheless, from perpetual bond investors’ book, it will remain as assets, but with higher chance that company may redeem (repay investors and reissue/cancel) the whole notes earlier (usually at the call date – after 5 year) and investors may need to reinvest at a lower return on declining interest rates environment.

Choose the Perpetual from Company with Strong Cash Generation

Investors need to pick perpetuals issued by the established corporations, preferably listed companies which their financial standings can be easily monitored on quarterly basis. The company’s ability to generate sufficient cashflows from the business are key for them to pay the relatively higher coupon, while one also may want to check the company’s exposure to straight debt (via https://www.bixmalaysia.com/Investor-Tools/Issuer-Search ) which the interest and principal needed to be satisfied first by virtue of the ranking priority. The usual fundamental assessment is a must, at least by identifying their credit rating at senior bond level as most perpetuals are not rated. Make sure that you are fully aware of the key terms such as coupon deferability and reset mechanism, as well as the callable dates, if any.

Visit BIX Malaysia website for details on the perpetual bonds/sukuk

Investors may visit BIX Malaysia website to find important information on the issuer, coupon/profit rate, maturity/call date, rating and the latest trading activities under “Security Information”. In addition, we can also download key documents such as the Information Memorandum (similar to Prospectus for equities IPO) and Trust Deed (similar to Loan Agreement) which detailed the terms of the bonds/sukuk.

https://www.bixmalaysia.com/Security-Info-Page?SBID=6349#security-information-tab2




Author profile
Fakrizzaki Ghazali is a former Fixed Income portfolio manager and analyst in an investment management firm in the Middle East, covering GCC and Global Sukuk markets. He previously worked as a credit strategist at one of Malaysia’s sell-side research house; also used to serve a private bank in Kuala Lumpur with focus on generating bottom-up ideas from both Investment Grade and High Yield bonds in the Asian credits space. Fakrizzaki started as an analyst at a local asset management having debuted his career as an auditor in the Big 3 Firm. The article is his own opinion from experience in the industry for over sixteen years. He believes that retail investors need more high-yield ideas and be constantly guided as there are sufficient low-risk, high-quality bonds/sukuk offered in the market.




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