What You Need To Know Before Investing in Perpetual Bonds

Strong perpetual issuance year-to-date

As of 16 Aug 17, approximately S$15.74 billion of new SGD bonds have been launched year-to-date, representing an insignificant 0.8% year-on-year increase over the same period in 2016. However, perpetual issuance has been on the rise, with S$3.955 billion of new SGD perpetual bonds launched so far in 2017 (as of 16 Aug 17, see Chart 1), representing the highest levels of perp issuances since a "blockbuster" 2012. In terms of the number of new issues, 11 new perpetual issues have been launched so far in 2017, almost matching the total number of new SGD perps launched for the whole of 2012 (13 issues). As shown in Chart 2, perpetuals had a 25.1% share of total SGD new issuance in 2017 so far, significantly higher than any of the previous years (including 2012).

Chart 1: Strong SGD Perpetual Issuance so far in 2017

Chart 2: Sizable representation of total new issuance

11 new SGD perpetuals launched so far in 2017

As shown in Table 1, 11 SGD perpetual bond issues have been launched in 2017 so far (as of 16 Aug 17), for a total of S$3.955 billion raised. The largest of these issues is HSBC's HSBC 4.700% Perpetual Corp (SGD)s (S$1 billion), while Mapletree Treasury launched two perpetual bonds in 1H 17, raising a total of S$1.325 billion via the MAPLSP 4.500% Perpetual Qsov (SGD)s and MAPLSP 3.950% Perpetual Qsov (SGD)s. Making up the rest of the perpetual issues so far in 2017 include bonds from Olam International, ARA Asset Management, Sembcorp Industries, Wing Tai Properties, Wing Tai Holdings, Hotel Properties and Lippo Malls Indonesia Retail Trust

Table 1: SGD Perps launched in 2017

Given the prevailing low yield environment, the universe of perpetual bonds may present an interesting investment opportunity for yield-seeking investors, but there are also risks to be aware of. Here, we identify some key considerations for investors looking to invest in perpetual bonds, with a focus on the SGD bond market.

1. Perpetuals can provide a better yield from larger issuers

As we've highlighted previously, hybrids offer investors the opportunity to gain access to the credit risk of a fairly large company, with the benefit of receiving a higher yield in exchange for less certainty in tenor (typically via a subordinated structure). As can be gleaned from Table 1, issuers of SGD perpetuals so far in 2017 are fairly large companies - the smallest listed companies on the list are Wing Tai Properties and Wing Tai Holdings Ltd (~S$1.2 billion and S$1.6 billion respectively), as well as Lippo Malls Indonesia Retail Trust (S$1.2 billion). At the opposite end of the scale, HSBC Holdings PLC is a S$262 billion financial institution, while Starhub Ltd, Olam International and Sembcorp Industries have market capitalisations between S$4 - 5 billion.

Typically, the yields on "plain vanilla" senior unsecured bonds from these issuers will be fairly low, but the perpetual structure (along with the subordinated nature of most SGD-denominated perpetual issues) offers investors the opportunity to gain ~100bps of additional yield via a perpetual bond structure. As an example, Hotel Properties' subordinated HPLSP 4.650% Perpetual Corp (SGD)s are currently quoted at around 234bps over swaps, representing a 104bps premium versus the company's HPLSP 3.850% 27May2021 Corp (SGD)s which are quoted at 130bps over swap rates.  

2. Note the call features

The perpetual bonds in Table 1 all sport some form of a "call" feature, which essentially allows the issuer to redeem the bonds at some point in the future. Typically, such call features allow for the issuer to redeem the bonds at a selected "first call date"; this is typically followed by subsequent call dates at every coupon payment period thereafter. For investors, knowing about the call features of a perpetual is important for getting a sense of when the bonds are expected to mature (upon an issuer call). However, investors should note that not all perpetual bonds can be called at every coupon period - an example in Table 1 is HSBC Holdings PLC's HSBC 4.700% Perpetual Corp (SGD)s. The HSBC 4.700% Perpetual Corp (SGD)s, which are classified as AT1s (Additional Tier 1 capital, a deeply subordinated tranche of bank debt), are callable at the 5-year mark (8 June 2022). If HSBC doesn't call the bonds then, the next call date is 8 June 2027, five years later.

3. Coupon resets are important!

An important feature of perpetual bonds is the coupon reset, which has the dual function of mitigating interest rate risk for the bond investor, as well as serving as a possible disincentive for the issuer to keep the bonds outstanding. Given that a perpetual bond has no fixed maturity date, interest rate risk can be significant if the bond comes without a coupon reset feature - we've previously alluded to this in the case of "fixed-for-life" perpetuals (see Steep selling seen for recently-issued "fixed-for-life" USD perpetual bonds), which sport an asymmetrical risk-reward profile for the investor - the absence of a coupon reset incentivises the issuer to keep the bonds outstanding if interest rates rise, while a decline in rates would see the issuer call the bonds early, leaving no duration benefit for the bondholder.

In the SGD perpetual market, the majority of issues come with coupon resets, with the exception of OCBC's OCBCSP 4.000% Perpetual Pref (SGD)s and DBS' DBSSP 4.700% Perp/Callable 2020 Pref (SGD) - Retail preference shares, which have fixed coupons - in the unlikely event of a non-call, there is no adjustment to the coupon rates on the two issues. Notwithstanding the lack of a coupon reset, we think the likelihood of a call (at first call date) is very high for both issues, given the high prevailing fixed coupons to be paid, relative to the prevailing cost of funding (which is significantly lower for both OCBC and DBS).

4. Coupon resets may not coincide with first call dates

While the coupon reset feature is typically applied at the first call date for perpetual bonds (eg. LMRTSP 6.600% Perpetual Corp (SGD), where the coupon resets on 19 Dec 2022, which is also the first call date for the bonds), this is not always the case, particularly for the SGD perpetual universe. We've noticed that an increasing number of issuers have issued perpetuals where the coupon reset occurs after the first call date. This creates a situation where the penalty on the issuer doesn't coincide with the first call date, which results in a reduced probability of the issuer calling the bonds until the coupon reset kicks in - consequently, the first call date may not be truly representative of the expected "maturity" for these perpetual issues.

An example is the recently-launched WINGTA 4.350% Perpetual Corp (SGD) which is callable in Aug 2020 (3 years after issue), but the coupon reset (to the 10Y SGD Swap Offer Rate + 308.7bps) only occurs at the 10 year mark (Aug 2027, and every subsequent 10 years thereafter). This means that investors could be exposed to interest rate risk similar to that of a 10-year bond - if interest rates rise appreciably, Wing Tai Properties could elect not to call the bonds until August 2027 (where the coupon rate gets marked to the prevailing, and presumably higher, 10Y SGD Swap Offer Rate). Under such a situation (if longer-term interest rates rise), we'll expect the WINGTA 4.350% Perpetual Corp (SGD)s to trade like a 10-year bond which will be susceptible to a fair amount of interest rate risk.

5. Understand the implication of subordination

In the unlikely event of a liquidation of a company, senior/subordinated factors take on an important role. The majority of the SGD perpetual universe constitutes subordinated debt structures, which are subordinated claims compared to those of senior creditors in the creditor hierarchy. As a holder of subordinated debt, you'll only get paid after senior creditors have been paid first, which represents subordination risk - in exchange for this added risk, subordinated debt offers a higher yield versus senior debt.

In the case of subordinated bank debt, the perpetuals are typically "AT1s", which are a form of loss-absorbing capital for banks - this entails certain write-down possibilities or a mandatory conversion to stock in the event of non-viability of the bank, or in certain cases, where the bank's core equity Tier-1 ratio falls to a certain trigger point. For example, HSBC's HSBC 4.700% Perpetual Corp (SGD)s have a "capital adequacy trigger" when the bank's common equity Tier 1 capital ratio falls below 7% - if that occurs, some or all of the bonds could be converted to HSBC Holdings shares (at a predetermined price of GBP2.70 per share).

In this regard, it's also worth noting that Wing Tai Holdings' WINGTA 4.080% Perpetual Corp (SGD)s and Wing Tai Properties' WINGTA 4.350% Perpetual Corp (SGD)s are "senior unsecured" debt, which are ranked pari passu with other senior borrowings of the respective entities.

SGD Perpetual Bond Ideas

While perpetual bonds may sport various characteristics which could make it a daunting task for investors to interpret, those who take the effort to sieve through the technicalities involved with perpetual bond structures may still be rewarded by a reasonable level of yield, even with credit exposure to a fairly sizable entity. An example is ARA Asset Management's ARASP 5.200% Perpetual Corp (SGD)s, which we felt were offered with a sizable new issue premium (see ARA Asset Management Limited: New SGD Perp NC5 at 5.5% Guidance) given the company's strong balance sheet and income-generating ability (see ARA Asset Management Ltd: Upcoming SGD Perpetual?). While the bonds have outperformed strongly since launch (up +3.25% over the past month), the bonds still offer a decent 4.45% yield-to-call (assuming the bonds are called in Jul 2022). We note that the bonds sport a hefty coupon reset penalty at the 7-year mark (7Y SGD SOR + 6.12%), which increases the probability of the bonds being called by then - the yield-to-call based on an expected Jul 2024 maturity is 4.64%.

We've previously highlighted First REIT's resilient operations last year (see First Real Estate Investment Trust: 5.68% Perpetuals a "Win-win" [20 Oct 16]), and suggested that the FIRTSP 5.680% Perpetual Corp (SGD)s represented a rather compelling investment opportunity. On the back of continued resilience in operations, the FIRTSP 5.680% Perpetual Corp (SGD)s have done fairly well since, and are becoming more difficult to find today, given the small issue size (S$60m) - the bonds are currently indicated at around 102.25 (for a 5% yield-to-call). Sticking with the REIT market, sister REIT Lippo Malls Indonesia Retail Trust (like First REIT, its sponsor is also PT Lippo Karawaci Tbk) has two outstanding SGD-denominated perpetuals - the LMRTSP 6.600% Perpetual Corp (SGD)s and the LMRTSP 7.000% Perpetual Corp (SGD)s, which are currently quoted at YTCs of 5.9% and 5.7% (offer); these represent some of the highest-yielding SGD-denominated perpetuals available in the market today.

For investors looking at higher quality issues (with correspondingly lower yields) within the SGD-denominated perpetual bond universe, Mapletree Treasury's MAPLSP 4.500% Perpetual Qsov (SGD)s and MAPLSP 3.950% Perpetual Qsov (SGD)s are worth a closer look. The bonds, which currently sport YTCs of 3.57% and 3.73% respectively, are guaranteed by Mapletree Investments Pte Ltd, a wholly-owned real estate subsidiary of Temasek Holdings. On a standalone basis (even in the absence of its Temasek linkage), Mapletree is a diversified real estate giant, sporting a sizable asset base (S$36.26 billion, as of end-Mar 17) with S$21.2 billion of equity; debt ratios were also fairly reasonable, with net debt-to-equity at 55% and debt-to-assets at 36% (as of end-Mar 17). 

Mapletree Treasury's MAPLSP 4.500% Perpetual Qsov (SGD)s and MAPLSP 3.950% Perpetual Qsov (SGD)s are callable from Jan 2022 and Nov 2022 respectively, although coupon resets (in the event of a non-call) will only occur in Jan 2027 and Nov 2027 respectively. YTCs (based on a call coinciding with the coupon reset dates) for the MAPLSP 4.500% Perpetual Qsov (SGD)s and MAPLSP 3.950% Perpetual Qsov (SGD)s are 4.01% and 3.8% respectively, representing a decent rate of return for investing in a "blue-chip" credit for an anticipated ~10-year holding period. Investors who expect Mapletree to keep the bonds outstanding until coupon reset date should be looking at the MAPLSP 4.500% Perpetual Qsov (SGD)s which sport a higher YTC (to Jan 2027), despite the higher cash price currently. On a relative pricing basis, we note that the MAPLSP 4.500% Perpetual Qsov (SGD)s and MAPLSP 3.950% Perpetual Qsov (SGD)s (which trade at spreads of around 195bps-200bps over swaps) are even priced more attractively compared to Starhub's STHSP 3.950% Perpetual Corp (SGD)s which are currently quoted at 172bps over swaps.

 

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) has a principal position in FIRTSP 5.680% Perpetuals and ARASP 5.2% Perpetuals. The analyst who produced this report holds a NIL position in the abovementioned securities.