Understanding perpetual securities​

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29 Oct 2018 | 10 min. read

Understand how perpetual securities work and what you should know if you are thinking of investing in them.

Key takeaways

  • Perpetual securities are often referred to as "perps", or perpetual bonds and perpetual notes.
  • Perpetual securities have no maturity date, but an issuer may choose to redeem the after a specified period of time.
  • You could end up holding the perpetual securities forever, without any reward.

What are perpetual securities?

Otherwise referred to as “perps”, perpetual securities are also known as “perpetual bonds” and “perpetual notes”. But they are not to be confused with conventional bonds.

Infographic: What are perpetual securities?

How it works

Perpetual securities are often issued with the following features:

No maturity

Perpetual securities have no maturity date. This means the issuer has the right to never return the principal amount to you.

Distributions

Most perpetual securities pay a distribution, say a fixed interest rate at fixed intervals, typically every six months.

But the issuer may choose to stop paying distributions at any time without having to seek your consent. When this happens, it does not constitute a default by the issuer and the non-payment of distributions could continue for an indefinite period.

This means you will not receive any money during this deferred period. It could also negatively affect the trading prices of the perpetual securities and the ease of selling these perpetual securities in the secondary market.

A call schedule

The issuer may or may not redeem the perps on the scheduled call dates. For example, call dates can occur from the 3rd, 5th or 10th year after issue date.

Redemption is more likely when an issuer can borrow more cheaply. But you would have to reinvest your money at lower rates too.

If the call is not exercised, the perps could exist forever and you might not get your principal amount back.

Step-up feature

Some perpetual securities have a step-up feature where the issuer is obligated to pay a higher rate of interest after a certain number of years if the perpetual securities have not been redeemed.

However, this does not necessarily mean that the issuer will exercise the right to call or redeem the securities before the step-up interest rate kicks in.

In situations where an issuer’s financial standing has worsened and its cost of borrowing has risen, the issuer may find it cheaper to pay the step-up interest rate instead of redeeming the perpetual securities.

No voting rights

You can't vote on important corporate matters such as a fundamental change of business or a major acquisition or divestment of assets.

Financial covenants and cross default clauses

Some perpetual securities contain little or no financial covenants which means you will have little recourse when the issuer experiences problems. This is unlike most bond issuances that usually provide for financial covenants and cross default clauses as safeguards for investors.

How financial covenants protect you

Financial covenants may include adherence to a set of financial ratios that an issuer must maintain to demonstrate its continued financial health or profitability. Without them, the issuer has greater flexibility in running its business and is under no obligation to operate in a financially prudent manner.

For instance, the issuer could take on debt beyond a level that is sustainable. This could significantly alter its risk profile and adversely affect its ability to meet its financial obligations including those under the perpetual securities.

What happens in a winding up or default scenario

You may lose some or all of your investment in a winding up scenario. There may be no financial covenants to prohibit the issuer from issuing securities which rank senior to, or pari passu with, the perpetual securities. The issuance of such securities will reduce the amount that holders of perpetual securities may recover in a winding up or liquidation scenario.

For bonds, the inclusion of a cross default clause means that a default by the same issuer in another borrowing could be sufficient to trigger an event of default for the bonds that you hold. This may lead to the bonds becoming immediately due and payable. However, such covenants may not be provided to investors of perpetual securities.

What are the risks?

Perpetuals come with the following risks:

  • You could end up holding the perpetual securities forever
  • You could hold them forever without reward
  • You may be exposed to reinvestment risks if your perpetual securities are redeemed and you have to reinvest your money in a lower yielding market
  • You might be exposed to an illiquid secondary market and you may find it hard to sell your perpetual securities

Note

If you are offered wholesale bonds and perpetual securities in sizes of $200,000 or more, certain regulatory protections may not apply to you.

If the issuer does not call or redeem the securities

You can only exit your investment by selling your perpetual securities in the secondary market, provided there is a liquid secondary market for the perpetual securities you hold.

When intending to sell in the secondary market, you will be exposed to market price fluctuation and liquidity risks.

The market value of securities that are callable may be capped by their redemption value on the next call date. In addition, if the issuer decides to call the securities, it could be redeemed at a price lower than the price you initially paid for the securities.

Why perpetual securities offer higher yields than bonds

Higher yields for higher risks.

Perpetual securities typically pay out higher distributions than plain vanilla bonds* of the same issuer to compensate investors for the higher risks involved. These include holding the perpetual securities forever and the risk that distributions might be deferred and may not accrue interest.

*Plain vanilla bonds usually refer to bonds which are unsecured and rank senior (or equal) to other debt obligations of the issuer during a liquidation.

Assessing the credit quality of the issuer

Assess the credit quality of the issuer of the perpetual securities carefully when you buy the securities and constantly review and assess this throughout the time you hold them.

You must monitor your own investment. If the perpetual securities or the issuer is listed on the Singapore Exchange (SGX), you should keep a lookout for announcements and any news relating to the perpetual securitiesor the issuer.

Financial statements

If the issuer is listed on SGX, its financial statements are required to be announced on a quarterly or half-yearly basis, and its annual report must also be made public.

If the issuer is not listed on SGX but its perpetual securities are listed and available for retail trading, its financial statements must be disclosed regularly as approved by SGX.

You should also refer to the periodic financial statements, the annual report, and other documents the issuer may publish.

News reports

There could also be news reports on the financial position of the issuer, on the issuer’s industry outlook as well as any price movements of the securities. You need to assess whether to hold on to the perpetual securities, or to sell part or all of your investment. Seek professional advice if needed.

Note: If you have some concerns about the company’s compliance with SGX’s listing rules, or about possible market misconduct, you may wish to contact SGX. SGX is the frontline regulator and is required to administer a sound regulatory framework to maintain a fair, orderly and informed market.

Buying and selling perpetual securities

You can buy perpetual securities in the primary of secondary market.

Buying in the primary market

 

Buying perpetual securities in the primary market basically means subscribing to the initial offer from the issuer.

Public offers

Where it is a public offer made to retail investors, investors apply through ATM or internet banking channels similar to an initial public offering for shares.

The offer would be accompanied by a product highlight sheet and prospectus or offer information statement (i.e. offer documents). The offer documents include information about the issuer, the terms and conditions of the securities, as well as the risks relating to the issuer and the securities.

Private offers

For private offers not made to the general retail public, applications for subscription may be submitted through a bank or broker. Such offers would usually be accompanied by an information memorandum.

Tip

You should read and understand the offer documents before investing. If you do not understand the information, you should consider seeking professional advice or refraining from investing in the product. You are responsible for your own investment choices.

Buying and selling in the secondary market

You can buy perpetual securities in the secondary market, if it is traded on a secondary market such as SGX. You can go through your broker and pay the market price of the perpetual securities at the time you buy. You will also need to pay brokerage fees for the perpetual securities.

If you wish to sell your perpetual securities, you can do so in the secondary market via your broking house, just like how you trade bonds and shares.

Otherwise, you can opt to wait for the issuer to call or redeem the perpetual securities, if there is a call feature.

When is a perpetual security considered to be in default?

It is generally not considered a default if:

  • The issuer of a perpetual security does not pay a distribution. This is because the issuer usually has the right to defer payment of distributions indefinitely.
  • The issuer does not redeem the securities at a specific date. The perpetual security may give the issuer an option to redeem the securities at a specific date. This means it has the right but not the obligation to do so.

Do check the documentation you are provided with to see what constitutes an “event of default”. In general, it will only be where a court order has been made for the issuer to be wound up.

As such, holders of perpetual securities are more similar to shareholders as compared to bondholders as there is no assurance of distributions or the repayment of their investment principal.

When an issuer is wound up

When a company is wound up, it ceases to operate its business, and the assets are sold off. The proceeds from the sale of assets would be paid to creditors and shareholders.

Perpetual securities holders usually rank behind senior creditors but ahead of ordinary shareholders, for the return of the issuer’s assets. This means that you may lose some or all of your investment.

Priority of payment

An issuer may structure its debt into different classes – senior debt and junior debt. The priority of payment in liquidation is as follows:

  1. Senior/Secured debt
  2. Junior/Subordinated debt
  3. Perpetual securities
  4. Preference shares
  5. Ordinary shares

Do check where your perpetual securities will be ranked. In general, perpetual securities are junior/subordinated debt. Whether you and other creditors can be repaid all or part of your monies depends on the amount of proceeds available from the liquidation.

Before investing in perpetual securities

Do read the most current documentation available before you invest in perpetual securities. If you are buying the perpetual securities in the primary market you are strongly encouraged to read the offering documents so that you can better understand the offer and make an informed decision.

As for investing in perpetual securities in the secondary market, you can get the offering documents, as well as the latest developments of the companies on the SGX website (if the issuer is listed on SGX) or their respective corporate websites.

Checklist

Are perpetual securities suitable for you?

Perpetual securities are investments that may not be suitable for everyone. Perpetual securities pose risks, including the possibility of loss of principal or capital. You need to assess whether the investment is suitable for you given your own personal circumstances.

You need to understand and be able to evaluate the following:

Are you able to withstand never being repaid the principal?

As perpetual securities do not have maturity dates, you could lose all the money you invested if no calls and no distributions are made and the issuer is wound up or liquidated.

Can you withstand market price fluctuations caused by market conditions?

These include interest rate movements as well as the perceived credit quality of the issuer.

Are you able to withstand a permanent income loss?

Distributions could be deferred forever.

Do you understand the features and risks of the investment?

These include:

  • The ability of the issuer to meet its distribution and other payment obligations.
  • The factors that will impact the market value of the investment.
  • The liquidity risk you are exposed to as it may be difficult to sell perpetual securities in the secondary market, say when you urgently need to free up some cash. You will also be subject to price risk.

How will the investment impact the risk-return profile of your overall investment portfolio?

For example, whether it will adversely impact how your portfolio is currently diversified, especially if the $200,000 you are planning to invest in a perpetual security makes up a significant part of your overall investments.

Other questions you may have

How do returns and risks compare across different investment asset classes for the same issuer?

Here is how the different asset classes for a particular issuer compare:

Returns/Risks Bonds Perpetual securities Preference shares Ordinary shares
Amount of payout
received from issuer

Holders will typically receive the lowest payout compared to securities ranked lower issued by the same issuer.

Holders will typically receive higher distribution payments than bondholders who rank more senior.

Holders will typically receive higher dividend payout than bondholders and perpetual security holders which rank senior.

Dividend payout will depend on the profitability of the company.

Coupon/Distribution/ Dividend payouts

 

Holders will typically be paid before perpetual security holders, preference shareholders and ordinary shareholders.

Holders will be paid after those ranked more senior are paid.

Issuer has the right to defer distribution payments.

Holders will receive dividends after bond and perpetual security holders which rank senior are paid.

Holders will be the last to receive dividends.

Investment risk (underperformance in return and risk of losing some or all of investment)

Usually lowest compared to other securities issued by same issuer

Usually medium

Usually medium

Usually highest

In event of liquidation

Paid before perpetual security holders and shareholders

Paid after bondholders

Paid after perpetual security holders

Last to receive any payout

What is a trustee and what is its role?

A trustee may be appointed by the perpetual securities issuer. Trustees are expected to exercise reasonable care and skill in carrying out their duties.

Where a trustee has been appointed, its duties and obligations are provided for under the trust deed (between the issuer and trustee) and the law. The trust deed also contains provisions for the protection of the rights and interests of perpetual security holders, as well as the procedures for convening meetings to consider matters that affect perpetual security holders’ rights or interests.

Role of a trustee

The trustee acts for the perpetual security holders on the terms contained in the trust deed. Perpetual security holders should read the terms and conditions of the trust deed provided in the offering document.

The issuer is obliged to promptly inform the trustee when it becomes aware of any event of default or when any condition of the trust deed cannot be fulfilled. However, you should note that the trustee does not usually have any obligation to carry out active monitoring of the issuer’s financial health.

It is common for trust deeds to provide the trustees with the right to seek an indemnity and pre-funding from perpetual security holders before taking the action requested by perpetual security holders as the trustees may incur costs (e.g. legal expenses) and could be exposed to legal liability that may arise from taking such action.

Do note also that before a trustee acts on a request from perpetual security holders, it would have to take steps to verify that:

  • The request comes from the beneficial owners of the perpetual securities
  • The value of the perpetual securities held by the instructing perpetual security holders meets the relevant threshold under the trust deed

Where the perpetual securities are held through custodians or nominee banks, the trustee would have to work with these parties during the verification process. This process can take some time.

Last updated on 16 Feb 2019