Companies in Asia are embracing a niche, high-risk instrument that was once at the very periphery of the region’s capital markets — the perpetual bond.
Perpetual bonds have characteristics of both debt and equity, often getting equity weighting from auditors and rating agencies. For borrowers, the attraction of selling such securities lies in extending the maturity of their debt over a very long horizon.
The surge in Asian perpetual bonds has also come alongside a boom for US-dollar debt issuance from Chinese property developers, banks and insurers all trying to lock in borrowing costs before the Federal Reserve tightens policy further. US policymakers are expected to raise interest rates next week.
US dollar-denominated perpetual bond issuance from corporations in Asia, excluding Japan, is on course for a record year, according to Dealogic. The $8.5bn sold so far this year has already surpassed the $7.8bn sold in 2016. Asian banks have been big drivers of the trend, selling $6.4bn in US-dollar denominated perpetual securities year to date.
“From the borrowers’ perspective, the benefits are quite clear. They theoretically have an indefinite maturity and rates are quite low right now,” says Sandra Chow, a Singapore-based analyst at research house CreditSights.
The attraction for buyers is that these bonds help investors offset long-term liabilities.
There is “rapidly growing demand from insurance companies in Asia,” says Jean-Charles Sambor, deputy head of emerging markets fixed income for asset manager BNP Paribas Asset Management. “You also have more and more European insurance companies and pension funds in search of yield in Asia with the extremely low yields in their domestic market. When it come to the perpetuals, they are pretty attractive for non-Asian investors.”
That appetite has shown up in recent deals. ChemChina’s $600m perpetual bond sale in May drew more than $5bn in orders, and had a final yield of 3.9 per cent. The group also disclosed last month that it had sold $18bn in perpetual bonds to a handful of institutions. Because this was not a marketed deal, it was not reflected in league tables.
Most corporate perpetual bonds are structured to incentivise borrowers to redeem the securities, with the debt’s call dates paired with a jump in the coupon that is often punishing to the borrower.
A case in point is Evergrande, the Chinese property developer that made heavy use of perpetual bonds, partly to minimise the amount of total debt shown in its accounts.
This week, Evergrande announced that it would be retiring all its perpetual debt. The group paid a high price for its debt — CIMB analyst Raymond Cheng estimated an average interest cost of 9.5 per cent — and many analysts counted the securities towards its liabilities. This erased the instrument’s big advantage: to present debt as equity.
In turn, Evergrande shares hit an all-time high after it announced the end to its grand perpetual experiment.
However, this year several large well-known Hong Kong corporations including CK Hutchison and Sun Hung Kai have sold perpetuals without the penalising increase in yield — so-called fixed-for-life products.
The instruments are risky for the buyer in that the seller has no incentive to call the security. That means the bond can remain outstanding for a very long time, beyond the point where an investor can make a reasonable guess on the borrowers’s creditworthiness.
Issuers still need to provide some compensation to buyers for such risk. By way of reference, Cheung Kong perpetuals without a step-up in coupon payment yield about 1 per cent more than those with such a step-up. The yield pick-up has prompted strong demand for the instruments from retail investors and wealth managers this year.
“Institutional investors and private banks have looked at the standard perpetual bonds [with the step up in yield] as a way of diversifying their portfolios,” says Eeswary Krishnan, a director at Citigroup’s Asia-Pacific debt syndicate team.
For investors, the risks associated with standard perpetual bonds are similar to those of normal debt products with fixed maturities. For those who have taken on what could be more than a decade of a company’s risks, buyers have been rewarded.
“The risk the investor [in standard perpetual bonds] is taking is coupon deferral for a limited period of time without much interest rate risk,” says one banker who has worked on these deals this year. “On the fixed-for-life, where the issuer can leave it outstanding for a much longer period of time, the investors are well aware of the risks and are charging for that.”