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RETAIL RESEARCH

BONDS

02 JULY 2016

Perpetual Bonds
Prologue:
Perpetual bond, which is also known as a perpetual or perp, is a bond with no maturity date. The issuers pay coupons on
perpetual bonds forever, and they do not have to redeem the principal (except on call/put option activation date). Perpetual
bond cash flows are, therefore, those of perpetuity.
In common, fixed income securities are as debt instruments issued with definite maturity period, paying the coupon amount at
regular intervals during the whole tenure and eventually repaying the principal at maturity. Once the tenure is over, these bonds
dont exist. Unlike this, perpetual bonds are debt instruments issued with similar nature of the normal bonds but without defined
the maturity date. They continue to pay the interest amount to the bondholder forever.
History:

Perpetual bonds have a long history. One of the oldest examples of a perpetual bond was issued in 1648 by the Dutch
water board of Lekdijk Bovendams. It is currently in the possession of Yale University and interest was most recently paid
in 2015. Likewise, The British government is often credited with creating the first one way back in the 18th century.

The idea of issuing perpetual bonds has a certain appeal during troubled times. At its most basic, issuing perpetual bonds
would permit a fiscally challenged government to raise money without ever needing to pay it back.

Most perpetual bonds nowadays are deeply subordinated bonds issued by banks. The bonds are counted as Tier 1 capital
and help the banks fulfill their capital requirements. Most of these bonds are callable (by the issuer), but the first call date
is never less than five years or ten years from the date of issue.

Scenario in India:

In India, in the past 4 years period, banks mainly state-owned and a few companies have raised close to Rs 19,000
crore (Source: news reports) through perpetual bonds.

Banks raise the money to meet their tier-1 capital needs as per Basel-3 norms. Banks with lower capital adequacy ratio
have been issuing perpetual bonds at rates as high as 11% and more. Bank of India, one of the first issuers of 'perps' in
2014, raised funds at 11%. United Bank, Bank of Baroda, IDBI, Indian Overseas Bank and Canara Bank have raised funds
through perpetual bonds. Mostly, Perpetual bonds are issued by the banks and institutions which are lower rated.
Among private players Cholamandalam, Capital First, Dewan Housing and Tata Capital are some of the companies that
have issued such bonds in the past.

Provident funds were the biggest buyers of these bonds till recently but fresh restrictions on debt investments have
reduced their appetite for the instrument (The new PF guidelines restrict investments in lower rated papers). Apart from
them, insurance companies also prefer to invest in such bonds, though, insurance regulator has not given any clarification
on Tier-I bonds (perpetual bonds).

These bonds are issued with face value of Rs. 1/5/10 lakh. An investor can buy one bond or in multiples of one bond
directly from the issuer or thereafter from the secondary market especially from WDM (Wholesale Debt Market segment
in NSE or BSE). Since these are privately placed, bond lead managers also subscribe to them in bulk and sell them to
individual investors in smaller lots.

Perpetual bond, though not tax efficient offers a higher coupon, when compared to other bonds having a similar rating.
The investor has to pay tax as per his/her tax bracket for the interest income generated from the perpetual bond.

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However, as compared to tax-free bonds, post-tax yields on perpetual bonds are similar or higher than that of tax free
bonds. But perpetual bonds carry relatively higher risk than tax-free bonds.
Advantage of investing in Perpetual bonds:

Perpetual bonds are of interest to investors because they offer steady, predictable source of income over a long period of
time.

They offer relatively higher coupon rates (which are generally 250-300 bps higher for better rated companies and 350400 bps for lower rated companies) than the yields of 10 Year G sec benchmark securities in India.

Investors who buy during falling interest rate scenario will get benefit over periods in terms of better current yield and
YTM and also chance of appreciation.

Many PSU banks issue Perpetual bonds to fulfill their capital requirements, though may be lower in credit rating
(assumed to be backed by sovereign support).

Some Perpetual bonds come with a step up feature that increases the interest payment at a predetermined point in the
future. For example, a perpetual bond may increase its yield by 1% at the end of 10 years if it does not call the bonds at
that time.

Disadvantage of investing in Perpetual bonds:

Perpetual period exposes the investor to credit risk over an extended period of time. As time passes, bond issuers,
including both government owned and private corporations, can get into financial trouble and even fail.

Perpetual bonds may also be subject to call risk, which means that the issuer can recall them. This raises the reinvestment
risks. (reinvesting the proceeds from the high yielding bonds if they are called during falling of lower interest rates
scenario into lower yielding bonds/securities).

Another significant risk associated with time is that general interest rates may rise as the years pass. If rates rise
significantly, the interest rate paid by a perpetual bond may be much lower than the prevailing interest rate, meaning
investors could earn more money by holding a different bond. Given the lack of liquidity/exit (or exit at a loss) switching
out of a perpetual bond may be painful for an investor.

Above all, these are exposed to liquidity risk as one cannot redeem them from the issuer before the call date (and that
too only if the issuer chooses to do so). Although these bonds are listed on WDM of BSE/NSE, the liquidity/depth may not
be as good as required on particular days.

Some of Perpetual bonds traded in the WDM segment of BSE and NSE in the last 1-2 weeks period:
Exchange

Traded
Date

Security Code/ISIN

BSE
BSE
BSE
BSE
BSE
BSE
BSE
BSE
NSE
NSE

28-Jun-16
28-Jun-16
20-Jun-16
28-Jun-16
28-Jun-16
28-Jun-16
23-Jun-16
23-Jun-16
21-Jun-16
22-Jun-16

1075IDBIOCT2024
1040VBPERPETUAL
1050CAPFIRPERP
1150BOIPERP
1150BOIPERPE
1210MAGMAPER
948BOMPERP
986TATACPERP
INE084A08052
INE084A08052

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Issuer Name
IDBI BANK LIMITED PERPETUAL
VIJAYA BANK
CAPITAL FIRST LIMITED
BANK OF INDIA
BANK OF INDIA
MAGMA FINCORP LIMITED
BANK OF MAHARASHTRA
TATA CAPITAL FIN SERV
Bank of India 11% Perp
Bank of India 11% Perp

Coupon
(%)
10.75
10.4
10.5
11.5
11.5
12.1
9.48
9.86
11
11

Maturity
Date
17-Oct-24
31-Mar-99
27-Feb-26
22-Jun-50
23-Jun-50
31-Dec-99
30-Dec-99
09-Feb-26
08-Aug-24
08-Aug-24

Weighted
Average
Price
98.92
98.3
107.8
100.02
99.96
99.9
100
102.2
98.5204
98.35

Weighted
Average Yield
(%)

Turnover
(Rs. lacs)

9.27
0.88
12.09
9.48
9.48
11.27
11.30

50
40
110
2630
1320
25
4260
800
30
10

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RETAIL RESEARCH
NSE
23-Jun-16
NSE
24-Jun-16
NSE
28-Jun-16
NSE
24-Jun-16
NSE
27-Jun-16
NSE
28-Jun-16
NSE
21-Jun-16
NSE
27-Jun-16
NSE
22-Jun-16
NSE
23-Jun-16
NSE
28-Jun-16
Source: NSE & BSE.

INE084A08052
INE084A08052
INE084A08052
INE121A08NS6
INE121A08NS6
INE121A08NS6
INE077A08072
INE077A08072
INE306N08136
INE306N08136
INE306N08136

Bank of India 11% Perp

Bank of India 11% Perp
Bank of India 11% Perp
CHOLAMANDALAM RST PERP S-PDI17
CHOLAMANDALAM RST PERP S-PDI17
CHOLAMANDALAM RST PERP S-PDI17
DENA BK10.20%PERP T1BIIIBDSIII
DENA BK10.20%PERP T1BIIIBDSIII
TATA CAPITAL FIN SERVSR-D 9.86 PERP
TATA CAPITAL FIN SERVSR-D 9.86 PERP
TATA CAPITAL FIN SERVSR-D 9.86 PERP

Analyst: Dhuraivel Gunasekaran (Dhuraivel.gunasekaran@hdfcsec.com)

11
11
11
12.9
12.9
12.9
10.2
10.2
9.86
9.86
9.86

08-Aug-24
08-Aug-24
08-Aug-24
17-Dec-99
17-Dec-99
17-Dec-99
18-Mar-20
18-Mar-20
09-Feb-26
09-Feb-26
09-Feb-26

98.6098
98.35
97.7167
111.4267
108.6928
105.3436
97.55
97.54
103.2516
102.1972
102.0933

11.25
11.30
7.57
10.69
11.19
10.89
10.99
11.00
9.31
9.48
9.49

10
10
150
130
820
200
10
10
1300
930
1050

Source: NEWS Papers, NSEIndia and BSEIndia.

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Disclaimer: Bond investments are subject to risk. Past performance is no guarantee for future performance. This document has been prepared by HDFC Securities Limited and is meant for sole use by the recipient
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This report has been prepared by the Retail Research team of HDFC Securities Ltd. The views, opinions, estimates, ratings, target price, entry prices and/or other parameters mentioned in this document may or may
not match or may be contrary with those of the other Research teams (Institutional, PCG) of HDFC Securities Ltd.

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