Perpetual Bonds: Meaning, Features & How They Work

Among the multitudes of investment options available, each varying in return potential, risk level, and investment horizon, bonds, particularly Perpetual Bonds, stand out as a favoured choice. Perpetual Bonds are distinctive in that they don’t have a maturity date.

This implies that the issuers are committed to paying a consistent stream of interest until they call back the bonds, leaving bondholders without a redemption option.

Let’s see the different operational dimensions of these bonds in greater detail!

What Are Perpetual Bonds?

Perpetual bonds are bonds that do not have a maturity period, i.e., they do not have an end date. You, as a bondholder, will receive a regular interest payment from the issuers. However, there is no concept of any principal payment on redemption. 

Usually, bond issuers can call back these debt instruments as per the terms and conditions mentioned in the bond offer document. The calling back timeline varies from institution to institution, but generally, it is 5– 10 years. 

Here are some key takeaways about what Perpetual Bonds are and do in a nutshell:

• Perpetual bonds have no maturity date. These bonds are forever.
• Perpetual bonds provide a consistent interest payment until the issuer decides to call them.
• These bonds are also known as colloquially or perp bonds.
• Bondholders cannot redeem these bonds for their money.

Now that you know the meaning of perpetual bonds, let’s find out how perpetual bonds work.

How Do Perpetual Bonds Work?

Perpetual bonds operate as a source fixed income security with no maturity date. These bonds are a kind of debt obligation, but the obligation is not mandatory. If Issuers incur a loss for any year, they may decide not to pay the interest to such bondholders.  

These comprise only a small percentage of total outstanding bonds in the market since very few entities are considered reliable enough to issue such bonds.  

These bonds were issued for the first time by the British Government to fund its wartime expenses during World War 1. In India, these bonds are listed on various stock exchanges. Hence, you can exit these bonds by selling them on the stock exchange. 

10 Best Perpetual Bonds in India

Disclaimer: The above table is sorted as per CRISIL ratings. The data provided is for informational purposes only and should not be construed as investment advice of any kind.

Who Issues Perpetual Bonds?

Primarily, financial institutions and banks are the ones that issue perpetual bonds to the general public. Since perpetual bonds make up a very small percentage of the bond market, the total number of entities that offer these bonds is also small. They are also sometimes offered by corporations and governments.

Why Do Entities Issue Perpetual Bonds?

Generally, banks and other financial institutions issue these bonds in order to fulfill their capital adequacy ratio requirements as per the Basel III norms. A higher capital requirement was seen as a necessity after the grave financial crisis of 2008. 

As per the Basel III requirements, banks must maintain a capital adequacy ratio of 10.875% to insulate themselves against various shocks. Moreover, as per regulations of the Reserve Bank of India, banks can choose to skip regular interest payments of perpetual bonds in case their capital drops below a particular threshold. 

Moreover, banks can choose to call back or redeem these bonds if they find other financing options at a lower cost. It might be the case if the interest rates are falling in the medium to long term. 

Perpetual Bonds Examples

There have been multiple instances of perpetual bonds being offered to the general public across centuries. Some of the ones with the most notable effects are as follows:

English/British Consols: Consols are another synonym for Perpetual bonds offered by the UK government to the general public in the 18th and 19th centuries. They were primarily offered with the aim of raising finances for military expeditions.

Contingent Convertible Bonds: These bonds are commonly referred to as CoCo bonds, which banks offer. They are offered the facility to allow investors to convert their bonds into the bank’s equity when their capital falls below a particular threshold.

AT1 Perpetual Bonds: AT1 stands for Additional Tier 1 bonds, which banks primarily offer for financing their capital requirements, which come under regulatory policies.

Corporation Bonds: These are the perpetual bonds that are offered by corporations in order to finance activities of development, operation and so on.

How is the yield of perpetual bonds calculated? 

Let’s consider an example of a perpetual bond to provide you with an idea about the yield that they offer. It will help you get a better grip of the concept. 

Now, let’s see how you can calculate the potential returns of a perpetual bond.  

Perpetual Bond Formula

Present market yield of a perpetual bond = Regular coupon payment/Bond’s market price

Suppose you have invested in a perpetual bond with a face value of ₹10,000. However, this bond has a discount of ₹500, and therefore, the purchase price stands at ₹9,500. The regular interest payment amounts to ₹550 per year. 

Therefore, the current yield is (550/9500)*100

= 5.78%. 

Therefore, we can see that the yield that you will be getting is 5.78%. 

What Are the Features of Perpetual Bonds?

Some features of perpetual bonds are as follows: 

• Even though issuers of such bonds have high creditworthiness, they can skip payments of interest due to capital falling below required levels. This makes this instrument a risky option. 
• These bonds come with a fixed income that banks shall pay to bondholders till redemption, except in exceptional circumstances.  
• As the risk level is high in these instruments, they offer a higher interest rate than other bonds of similar category, like government bonds. 
• In case the Issuer winds up, the investors in perpetual bonds will be paid last but before equity.
• These bonds are listed on various stock exchanges in India. 

What Are Advantages of Investing in Perpetual Bonds?

Here are some advantages of investing in perpetual bonds:

• Fixed income option 

These bonds serve as a source of fixed income for their investors. As it does not have any maturity date, interest income from perpetual bonds is recurring or evergreen in nature. A continuous flow of income helps in realising investment goals in a more efficient manner. 

• Higher yields 

Traditionally a perpetual bond comes with a higher yield than any normal bond. A high return potential makes it an ideal investment objective since, return or income is the foremost factor that one considers while making any investment decision. 

• Low risk 

Perpetual bondholders are given preference while settlement of dues at the time of liquidation. They are at a lower risk than shareholders of losing their money if the company goes bankrupt. Perpetual bonds are secured assets with a low default risk as securities in which they put the money is of high credit ratings. 

Do the Coupon Payments Go on Forever?

Perpetual bonds have a unique feature wherein they have no maturity date, and the coupon payments are made indefinitely. The term “indefinitely” has been used here because even though the bond has no expiry date, which calls for everlasting coupon payments, the issuer might have to call off the bond in the face of financial difficulties or unforeseen obstacles, thereby ending the coupon payments.

Drawbacks of Investing in Perpetual Bonds

Although perpetual bonds provide several benefits to its investors, it also has some cons that they should keep in mind before investing in it. Some of the drawbacks are discussed below:

• Call option 

Although they are called perpetual bonds, it does not mean that they will run till eternity. Every such bond has a call or redeemable feature that allows bond issuers to redeem these bonds after passage of a certain time period. This call feature is unilateral as bond holders do not have any say or cannot do anything to stop bond holders from exercising it. 

• Inflation risk 

Every investment has some sort of inflation risk and perpetual bonds are no different in that aspect. This risk becomes active when the rate of inflation is higher than the rate of return. It reduces the real rate of return and degrades the purchasing power of your investments. 

•   Interest rate risk 

This bond also suffers from respective interest rate risks. The market interest rate will rise during inflation as central banks will be increasing their benchmark lending rates. A rise in interest rate will lead to a commensurate decline in bond prices. If bond issuers exercise the call option this time, bondholders will receive a lower price for their bonds and incur some losses. 

Who Should Invest in Perpetual Bonds?

These bonds can be ideal for you if you are a retired investor looking for a decent regular stream of income to finance your post-retirement life. However, as the risk quotient in these bonds is a bit high, it is important for you to consider your risk appetite before investing. As it comes with a high-risk band, make sure that these bonds align with your investment goals. 

Where to buy Perpetual Bonds?

Acquiring perpetual bonds is possible through many platforms and sources, and the route you might take depends on the issuer and your investor profile. Here’s a general list:

Financial Institutions and Banks:
Financial institutions, banks, and companies are often the issuers of perpetual bonds. Don’t hesitate to approach them and inquire about any available perpetual bonds.

Brokerage Firms:
If direct dealing isn’t your style, brokerage firms and securities dealers have you covered. They list a variety of bonds for sale, perpetual bonds included. Open a brokerage account, and you’re all set to purchase through a licensed broker.

Online Trading Platforms:
Several online trading platforms and apps are at your service for those who prefer the digital route. They not only facilitate the buying and selling of a diverse range of securities, including perpetual bonds but also provide valuable research and insights.

Bond Dealers:
If specialization is what you seek, there are bond dealers focusing exclusively on bonds. They’re a treasure trove of insights into a bond’s performance and potential returns, and they might just have the perpetual bond you’re looking for.

Secondary Market:
And, of course, if the primary issuers don’t have what you need, the secondary market might just be your playground. It’s where investors trade previously issued bonds, offering another avenue to find perpetual bonds.

Final Word

Perpetual bonds represent only a small percentage of the overall outstanding bond in the market in terms of volume. This is because of the high risk and low demand associated with these instruments. If you are looking to invest in these bonds, it is imperative that you conduct a thorough market analysis and consider different aspects like taxation and return before investing. 

Frequently Asked Questions?

Q1. Who can issue perpetual bonds in India?

Ans. Only government entities and banks in India can issue these bonds to investors. The majority of the bond issue is done by banks to cover their capital requirements.   

Q2. What are the benefits of a perpetual bond?

Ans. The major benefit of investing in perpetual bonds is fixed regular interest payments that serve as a fixed source of income. Moreover, interest payment is perpetual, i.e., it continues without any maturity date. 

The interest earned from perpetual bonds is added to the gross total income of respective bondholders. Therefore, interest income of perpetual bonds is subject to taxation as per the tax slab of the bondholder.  

Q3. How are perpetual bonds taxed?

Ans. If you sell them in secondary markets, all gains shall be subject to taxation as per capital gains tax. If the holding period is less than 12 months, the income generated will be taxed as per your applicable tax slab rate. If the holding period is 12 months or more, long-term capital gains tax will be applicable. The rate of long-term capital gains tax is 10% without indexation. 

Q4. What are the risks associated with perpetual bonds?Ans. Perpetual bonds primarily suffer from two types of risks – interest rate and credit default risk. Out of these two, the interest rate risk can vary as per the prevailing macroeconomic conditions of the country.