The perpetual bond market is taking off, predominantly in Singapore, but it is likely that corporations from other Asian countries will follow. As investors become increasingly familiar with the structure, the demand for protective covenants has increased to such an extent that if issuers are not prepared to comply, they will need to pay out much higher yields in order to successfully sell their perpetual bonds.
“Investors are demanding more protective covenants, and sometimes some of these are very strict and severe. They have become used to a certain bare minimum covered by the covenant. If corporations refuse this, they will have to pay out a major coupon premium, and if a company is willing to do that then there is probably a serious risk of them breaching the covenant,” said Debashish Duttagupta, head of investments at Citi Private Bank. Coupons on perpetual debt issued year-to-date in Singapore have ranged from 4.3% to 7.0%, according to data provider Dealogic.
“Investors are paying a lot more attention on the structure of a perpetual bond issue. This is especially so in a low interest rate environment, where the structural long-term rise in interest rate will lead to a fall in value of such long duration investments,” added Tan Chin Keong, a Singapore analyst at UBS Wealth Management.
Perpetual bonds are considered hybrid securities. They offer investors debt-like returns with potential equity-like risks. The covenants vary from issue to issue, but investors have become increasingly savvy in their demands.
The market is becoming increasingly limited to issuers of the highest quality. In addition to this, investors are demanding deferral clauses and a coupon step-up of at least 100 basis points, as well as stipulating that if the company changes hands, they also want an increase in the coupon.
Deferral clauses allows issuers to defer coupons payments in certain circumstances but investors are increasingly insisting that the triggers are suitably large and that any deferred coupons are accumulated and paid to investors at a later date.
“For example with the Global Logistics Property, the company will have to pay a 500bp step-up if there is a handover in control,” said Duttagupta
Global Logistics Property is one of six Singaporean names that have issued perpetual debt since the start of 2012, according to Dealogic. The property company issued a US$195 million deal on January 17 this year, which carried a 5.5% coupon. It was a tap of existing bond first issued in December with the first call after five years and a 100bp step up after 10 years.
Mail company Singapore Post, real estate investors Mapletree Logistics Trust (both subsidiaries of Temasek Holdings), real estate company Ascendas, agricultural product supplier Olam International and hotelier Hotel Properties have all come to market since the start of the year, issuing in Singapore dollars. All six companies are rated investment grade.
Investors are also increasingly trying to ensure that the issuer will not be able to convert their perpetual bonds into shares, which could potentially lead to losses.
Concerns have been raised in the past that investment in Asia corporate perps warrents caution, but as covenant features become more familiar to investors, they are growing increasingly nimble at navigating clauses and demanding that corporations comply with their demands.
“It means that for a practical point of view, in my opinion, the companies are unlikely to ever stop paying the coupon,” said Duttagupta.
From an investor perspective, the primary criterion is that the issuer is high quality.
“There were some cases of issuances that didn’t succeed in coming to market so I think investors are looking at this on a name by name basis. Obviously there’s interest but clients are not looking at every single deal that comes to the market,” said one wealth manager based in Singapore. “We see this market as a place for higher quality names to issue.”
“Companies need to have very strong balance sheets that enable them to have a very high likelihood of calling the debt back at the earliest call date,” agreed Duttagupta.
The second thing that investors look at is the coupon structure and how it is related to the call, what the step up quantum is and how the step up feature ties in with the call option. These considerations have become commonplace, and as supply grows, investors may be increasingly at liberty to determine covenants in their favour.
However, according to Neeraj Seth, head of credit at BlackRock, this rise in investor power may be counterweighted by increasing requirements from rating agencies.
“Rating agencies are requesting more and more stringent rules to provide equity treatment which will result in worse terms for the investors, but should also require higher coupons. For example, S&P now requires issuers to have Replacement Capital Covenant active immediately from the date of issue which increases the extension risk of the security,” he said.
As it stands, rating agencies already incentivise corporations to call perpetuals after five years.
“Ratings agencies will only give a company a 50% equity credit assignment on the perpetual for five years. As far as the ratings agency is concerned, after five years, they would see the perp as a debt, and the company could risk a downgrade,” said Duttagupta.
Thus with pressure from both investors and rating agencies, it is yet to be seen whether Singapore’s fast growing perp market will inspire a similar take off in Asia, or whether companies will retreat from the ever increasing demands of investors and regulators.
“As the market develops and we see companies of varying quality tap the perpetual bond market, we expect the structure of each issue to remain a key focus, and the market to price such issues according to the issuers' credit risk,” concluded Keong.