Perpetual bonds, often called perps, stand out in the bond market for their unique structure. Unlike traditional bonds, perpetual bonds do not have a maturity date. The issuer promises to pay interest to the bondholder indefinitely. This feature makes perpetual bonds a hybrid between debt and equity. Investors seeking long-term income streams often consider these instruments. Let’s explore perpetual bonds, how they work, their advantages, their risks, and the role they play in portfolios.
📌 Key Features of Perpetual Bonds
A perpetual bond functions much like a standard bond at first glance. The issuer raises capital by selling these bonds and agrees to make regular interest payments to the bondholder. However, the absence of a maturity date sets perpetual bonds apart. The issuer never needs to repay the principal, unless it chooses to do so voluntarily through a call option.
Most perpetual bonds come with call options. These options allow the issuer to redeem the bond at specific intervals, often after 5 or 10 years. The issuer usually exercises the call option when interest rates fall or when refinancing becomes more attractive.
Perpetual bonds typically offer higher coupon rates than comparable long-term bonds. The higher rate compensates investors for the lack of principal repayment and the extended duration risk.
💡 How Perpetual Bonds Work
An investor buys a perpetual bond from a government, financial institution, or corporation. In return, the issuer pays interest—usually semiannually or annually—for as long as the bond exists. The bondholder can trade the bond in the secondary market if liquidity exists, or hold it indefinitely for income.
Consider this example. A bank issues a perpetual bond with a 7% coupon rate. The investor pays $100,000 for the bond. Each year, the bank pays the investor $7,000 in interest. The bank does not commit to returning the $100,000 principal, unless it calls the bond.
If interest rates fall to 5% several years later, the bank may redeem (call) the bond and reissue debt at the lower rate. Investors holding the bond until that point would have received the higher coupon for several years, but they would lose the bond and principal would return at par value if the bond terms allow for a call.
🏛 Who Issues Perpetual Bonds?
Governments, banks, and large corporations often issue perpetual bonds. These issuers use perps to strengthen their balance sheets without taking on debt that increases their near-term liabilities. Perpetual bonds help banks meet capital requirements because regulators often treat them as Tier 1 capital or core equity.
For example, Indian banks such as State Bank of India (SBI), Bank of Baroda, and ICICI Bank have issued perpetual bonds under Basel III norms. These bonds help banks maintain the required capital adequacy ratio. Similarly, the UK government and European corporations have issued perpetual bonds to fund long-term infrastructure and operational needs.
🔍 Benefits of Perpetual Bonds for Investors
1️⃣ Steady Income Stream
Perpetual bonds provide regular interest payments that can last indefinitely. Investors looking for predictable cash flow, such as retirees, may favor this feature. The bond generates income as long as the issuer remains solvent and continues payments.
2️⃣ Higher Yields
Perpetual bonds usually offer higher yields than other fixed-income instruments with similar credit ratings. The higher yield compensates for the extended duration and additional risk.
3️⃣ Portfolio Diversification
Investors can use perpetual bonds to diversify their income sources. Perps add exposure to hybrid securities that sit between debt and equity in risk profile.
⚠️ Risks of Perpetual Bonds
1️⃣ Interest Rate Risk
Perpetual bonds carry significant interest rate risk. Because they lack maturity, their duration extends indefinitely. When interest rates rise, perpetual bond prices tend to fall more than conventional bonds. The price drop reflects the market’s adjustment to new yields.
2️⃣ Credit Risk
Bondholders rely on the issuer’s financial health for continued payments. If the issuer faces financial difficulties, it may skip interest payments (especially on bank-issued Additional Tier 1 perpetual bonds). Some perpetual bonds come with terms that allow the issuer to defer or cancel interest payments under stress conditions.
3️⃣ Liquidity Risk
Not all perpetual bonds trade actively in the secondary market. Investors wanting to sell before the issuer calls the bond might struggle to find buyers, especially in times of market stress.
4️⃣ Call Risk
Issuers tend to redeem perpetual bonds when interest rates fall. Investors lose the high-yielding instrument when issuers exercise the call option. They then need to reinvest proceeds at lower prevailing rates.
🌍 Real-World Examples
India’s Basel III Perpetual Bonds
Several Indian banks issue Basel III-compliant Additional Tier 1 (AT1) perpetual bonds. These bonds contribute to banks’ regulatory capital. In 2020, Yes Bank’s AT1 bond write-off during its rescue operation shocked investors. This event highlighted the risk of principal loss in stress scenarios.
UK Consol Bonds
The British government historically issued perpetual bonds known as consols. The government eventually redeemed many of these instruments in the 20th century. Consols represented early examples of perpetual government debt used to finance wars and infrastructure.
📝 How to Evaluate Perpetual Bonds
1️⃣ Review Credit Rating
Investors should check the credit rating of the issuer and the bond. Higher-rated issuers present lower default risk.
2️⃣ Analyze Coupon Terms
The bond’s coupon rate, payment frequency, and deferral conditions deserve close scrutiny. Some perps contain clauses that allow issuers to skip payments without triggering default.
3️⃣ Assess Call Features
Call dates, call premiums, and issuer call patterns affect returns. Investors should analyze whether the issuer has a history of calling bonds at the first opportunity.
4️⃣ Monitor Interest Rate Trends
Since perpetual bonds exhibit high sensitivity to rate changes, investors should remain alert to central bank policy and economic data that influence rates.
🧭 Role in Portfolio Construction
Perpetual bonds suit investors seeking long-term income and comfortable with higher risk. Including them in a diversified portfolio can enhance yields, but investors must balance their exposure. Many experts recommend limiting perpetual bond allocation to a small percentage of the fixed-income portfolio, given the risks.
Financial advisors often suggest pairing perpetual bonds with more liquid, shorter-duration instruments. This strategy provides a cushion against potential market shifts and liquidity needs.
✅ Conclusion
Perpetual bonds offer attractive yields and endless income potential, but they demand careful consideration. These instruments combine features of debt and equity, delivering steady income while exposing investors to credit, interest rate, liquidity, and call risks. Investors should evaluate issuer quality, market conditions, and bond terms thoroughly before adding perpetual bonds to their portfolios.
By understanding the workings of perpetual bonds, investors can make informed choices and harness their unique benefits while managing the risks they present.
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