Perpetual Bonds

Perpetual bond is a bond that lasts forever, also refered to as a “consol bond” or “perp,” is a unique type of debt security where an investor receives interest payments endlessly without ever receiving the amount he initially put in i.e. 

the principal. Unlike typical bonds that have a maturity date, a perpetual bond does not have one; hence, it is a bond whose issuer never repays the principal.

 Instead, the bond continues to give out  “coupons,” or interest payments, so long as it is held. This idea makes perpetual bonds a long-term source of steady income for investors.

Perpetual bonds technically are considered debt instruments, they act more like stocks since the investors do not expect to recover any money they initially invested. T

his feature distinct them from traditional bonds which have exact periods and dates regarding repayment of the principal. Perpetual bonds have an advantage over equity (stocks) as their interest payments are guaranteed and are legally binding to the issuer, providing a secure source of income for investors.

How Perpetual Bonds Work in India

In India, only high creditworthiness issuers such as the government, big banks, or companies reputed across the country issue perpetual bonds. 

The reason is that these bonds offer attractive instruments to borrow funds without any eventual burden of repaying the principal amount. 

For example, State Bank of India and HDFC Bank, major Indian banks, raise money through perpetual bonds to meet their regulatory capital requirements.

Key Features of Perpetual Bonds in India

1. No Maturity Date: Perpetual bonds in India have no maturity date. It is not compulsory for the issuer to return the principal amount to the investor. 

2. Instead, the investor keeps getting periodic payment of interest at a fixed rate as long as he holds the bond for the time period. For instance, if a person invests in a perpetual bond of face value Rs. 1,000 with a coupon rate of 7%, he would get Rs. 70 every year, without ever receiving back the principal amount of Rs. 1,000 unless the bond is called.

2. Interest Payments: Another advantage to investors is the provision of certain, stable, regular income in the form of interest payments. These are a fixed and legal liability, so the issuer will have to pay back the interest regularly irrespective of its financial position. Thus, perpetual bonds can be said to be a safe source of income, especially for long-term investors who might have steady returns during the long term.

3. Callable Feature: Most perpetual bonds issued in India are callable, which means after a specified period-mostly 5 to 10 years-their issuer has the option but not the requirement to retire the bond and return the principal to the bondholder. This gives the issuer the flexibility of managing debt, especially at times when interest rates are low or if the issuer simply wants to reduce its liabilities. When the issuer decides to call the bond, then its investors receive their principal, but for this, they lose their future instalments of interest.

4. Creditworthiness of Issuer: Since perpetual bonds do not have returns of principal, investors prefer to issue bonds from very reliable sources: for example, government bonds are highly preferred; bonds issued by large banks, such as the Reserve Bank of India, are highly preferred. Private banks in good financial positions often issue perpetual bonds. Private banks may have relatively higher interest rates than others but possess additional risk. 

5. Market Conditions and Pricing: The interest rates and overall economic environment determine the pricing of perpetual bonds in India. For example, if interest rates are rising, the value of existing perpetual bonds would normally fall because a new bond issued now may be priced with a better rate. If interest rates are falling, then the value of perpetual bonds might rise because their fixed coupon, which was offered when the bond was first purchased, becomes more attractive in that environment.

Risks for Investors

While perpetual bonds guarantee predictable income, they do come with risks. The principal is never paid back so investors have to be comfortable with the possibility of never recovering their original investment unless the bond is called. 

Also, if the issuer is getting into financial trouble, the risk of delayed or missed interest payments is possible. 

Therefore, such bonds are generally suitable for investors who feel they can trust the financial security of the issuer and are seeking long-term stable income without requiring their principal.

Example: In India, perpetual bonds are the “AT1 bonds” issued by banks, especially large public and private sector banks such as SBI and HDFC Bank. 

The AT1 bonds assist the banks in raising capital without maturity dates, thus a source of long-term funding. AT1s are fixed-rate coupon-protected bonds, but conditions are attached to the bonds. In case of financial distress on the side of banks, they can withhold interest payments or even write down principal. 

This perpetual structure continues to generate returns while helping the banks fulfil regulatory capital requirements.

Pros of Perpetual Bonds:

1. Steady Income: Perpetual bonds will have a steady, sure return because the interest payments do not fluctuate and are paid on a regular, perpetual basis.

2. Potential for Higher Returns: Some perpetual bonds offer step-up features – at set periods, the interest rate becomes higher (for example, after 10 years). Such features would be attractive to investors who want to receive higher returns later.

3. Lower Volatility: In comparison to stocks, perpetual bonds could be far more stable investment instrument, especially if issued by entities of great credibility like the government or a large corporation.

Cons of Perpetual Bonds:

1. Credit Risk: Investors do bear the risk of perpetual credit risk; if there is an exposure or defaulting by the issuer due to financial difficulties, then perhaps interest payments will be delayed or missed. That would not be certain compared to traditional bonds, which would stay financially healthy.

2. Callable Feature: Most perpetual bonds are provided with a callable feature that enables the issuer to redeem the bond before its maturity date, usually happens after some time. For example, if such a perpetual bond gets called, it may mess up long-term income plans for investors.

3. Interest Rate Sensitivity: Another effect of the rising interest rate is a decline in the value of perpetual bonds in the market. As the interest rate rises, new bond issues are issued with higher yields nd attract more investors; therefore, the market values of the existing perpetual bonds decline.