Perpetual Bonds

Perpetual Bonds are a type of fixed-income security that, unlike regular bonds, doesn’t have a maturity date. That means the issuer never has to repay the principal, at least not unless they choose to. Instead, the bond pays interest to the investor indefinitely, usually at a fixed rate.

What is a Perpetual Bond?

A Perpetual Bond is like a never-ending loan from the investor to the issuer. The issuer gets to use the money for as long as they want, and in return, they keep paying interest. These are often used by banks and financial institutions to strengthen their capital base, especially because regulators may treat them as part of Tier 1 capital.

From an investor’s point of view, perpetual bonds can offer attractive returns, but they also come with risks like interest rate changes, credit risk, and the fact that you might never get your principal back unless the issuer decides to “call” the bond (i.e., buy it back).

Features of Perpetual Bonds:

1. No Maturity Date: These bonds do not have an end date. They can theoretically last forever.
2. Fixed Interest Payments: The issuer pays interest (called coupon) regularly, usually semi-annually or annually.
3. Higher Coupon Rate: Because they have no maturity, they often offer higher interest rates compared to normal bonds.
4. Callable Option: Issuers usually have the right to “call” (redeem) the bond after a certain period, like 5 or 10 years.
5. Risk Level: They are riskier than regular bonds because you never get back your principal unless the issuer calls the bond.
6. Price Sensitivity: Their price changes a lot with interest rate movements because of the long (infinite) duration.
7. Used by Banks: Often issued by banks to meet regulatory capital requirements.

How does a Perpetual Bond work?

We will learn about the working of Perpetual bonds using the example of Wonga, an avid investor who wants to invest in a fixed income security for an indefinite period.

After learning about Perpetual bonds, Wonga invests ₹100,000 in a perpetual bond issued by a big bank. The bank promises an 8% coupon rate (Interest Rate). Every year, Wonga receives ₹8,000 (8% of ₹100,000). This continues forever, as long as the bank is healthy and paying.

Wonga knows he will never automatically get his ₹100,000 back. The bond has no end date. After 5 years, the bank says: “Wonga, here’s your ₹100,000 back. We’re closing this deal.”

This is the call option. The bank can choose to redeem the bond on the pre-determined Call date.
Wonga is smart and understood the risk he faced. If the bank faces trouble, it can skip interest payments. If the bank fails, Wonga is paid last, after other loans. He might lose his ₹100,000.

To summarize, Wonga gives ₹100,000, gets ₹8,000 every year forever (or until the bank calls the bond), but there’s no guarantee of getting the principal back unless the bank decides to redeem it.

Why do issuers issue Perpetual Bonds?

Now, from the example of Wonga, you might be wondering why do the Banks/companies issue these bonds and what are the advantages of issuing them over bonds with fixed maturity.

Issuers (like banks or companies) issue Perpetual bonds for a few practical reasons which are mentioned below:

1. To Raise Long-Term Capital

• Perpetual bonds give issuers money without a fixed repayment date.
• This means they can use the funds for a very long time without worrying about returning the principal soon.

2. To Strengthen Capital Structure

• For banks, perpetual bonds often count as Tier 1 capital under regulatory rules.
• This helps them meet capital adequacy requirements and look financially strong.

3. Lower Immediate Pressure

• Unlike loans or normal bonds, there’s no maturity date, so issuers don’t face big repayment obligations.
• They only pay interest regularly, which is easier to manage.

4. Flexibility

• Issuers usually have a call option (redeem after a few years).
• If interest rates fall or they have surplus funds, they can buy back the bonds.

How to calculate the yield of a Perpetual bond?

The yield of a perpetual bond is basically the return an investor earns based on the annual coupon and the current market price of the bond.

Formula:

Yield = Annual Coupon Payment/Current Market Price x 100%

Example:

Wonga owns a perpetual bond of a PSU bank which has issued perpetual bonds at 8% Coupon rate.

Face Value: ₹100,000

Coupon Rate: 8%

Annual Coupon Payment: ₹8,000

Current Market Price: ₹95,000

  Yield = 8,000/95,000 x 100% = 8.42%

Explanation:
If Wonga buys the perpetual bond at ₹95,000, his yield is 8.42%, slightly higher than the coupon rate (8%) because he paid less than face value.

Examples of Perpetual Bonds:

For example, take the 9.55% Tata Capital Limited Perpetual Bond with a call date of 2nd March 2031. This bond doesn’t have a fixed maturity, so Tata Capital isn’t obligated to repay the principal unless they choose to.

However, they’ve included a “call option,” which gives them the right to buy back the bond on or after 2nd March 2031. Until then, investors receive a fixed interest of 9.55% annually. If Tata Capital decides to call the bond on that date, investors will get their principal back. If not, the bond continues to pay interest, potentially for many years beyond. This structure gives the issuer flexibility while offering investors a steady income, though with the uncertainty of when or if the principal will be returned.