Introduction
Perpetual bonds represent a unique financial instrument that blends characteristics of both debt and equity. Unlike traditional bonds with fixed maturity dates, perpetual bonds have no specified redemption date, making them a distinctive tool in corporate finance and investment portfolios.
Key Features and Clause Design of Perpetual Bonds
1. Indefinite Maturity Period
The defining characteristic of perpetual bonds is their lack of a fixed maturity date. These instruments typically feature:
- Extended duration potential
- Hybrid debt-equity nature
- Higher coupon rates
- Embedded renewal option clauses
2. Special Provisions
Perpetual bonds include several unique clauses that distinguish them from conventional debt instruments:
Renewal Provisions (Redemption & Extension)
Two primary structures exist:
- No predetermined maturity date but with issuer redemption rights
- Specified maturity date with issuer extension rights
Example:
18 Wuhan State-Owned MTN001
"These notes shall remain outstanding indefinitely unless redeemed by the issuer according to the terms."
Interest Rate Reset Mechanism
Three common reset structures:
- New rate = Current benchmark + Initial spread + Upward adjustment
- New rate = Previous rate + Fixed increment
- Delayed upward adjustment (initially no increment)
Example:
17 Wutie Y1
"After the fourth repricing period, the coupon rate adjusts to current benchmark rate plus basic spread plus 200bps."
Deferred Interest Payment Rights
Most perpetual bonds allow issuers to postpone interest payments without constituting default.
Example:
17 Wutie Y1
"The issuer may elect to defer interest payments indefinitely, with deferred amounts accruing additional interest."
Cross-Default Provisions
Increasingly common since 2016, now present in 5.6% of outstanding perpetual bonds.
Bankruptcy Priority
Some perpetual bonds feature subordination clauses, making them junior to ordinary debt but senior to equity.
Market Overview of Domestic Perpetual Bonds
1. Issuance Profile
- First perpetual bond issued in 2013 by Wuhan Metro Group
- Total issuance: 1,711 bonds worth ¥3.05 trillion (as of February 2020)
- Non-financial corporate perpetual bonds: 1,489 issues worth ¥2.10 trillion
2. Issuer Characteristics
- 96.63% issued by state-owned enterprises
- 82% rated AAA
- Primary sectors: Urban investment (¥555.7 billion), Utilities (¥314.4 billion), Construction (¥234.7 billion)
- Average issuance spread: 125bps over conventional bonds
3. Secondary Market Premiums
Average spreads by credit rating:
- AAA: 25bps
- AA+: 75bps
- AA: 190bps
Non-state-owned enterprises show significantly higher premiums (196bps vs. state-owned 90bps).
Financial Institution Perpetual Bonds
Current Landscape
- 33 issues totaling ¥628.3 billion
Categories:
- Commercial bank subordinated debt (92% of total)
- Securities company bonds
- Other financial institution bonds
Bank Perpetual Bonds (New since 2019):
- Strongest "equity-like" characteristics
- No interest rate reset mechanism
- Interest payments may be cancelled without accumulation
- Subordinated repayment status
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Accounting and Tax Treatment
1. Accounting Standards
2019 regulations clarified classification criteria for whether perpetual bonds should be recognized as equity or liabilities. Key considerations include:
- Redemption rights
- Deferral conditions
- Guarantee provisions
- Investor put options
- Contingent settlement terms
2. Tax Treatment
2019 guidelines established that perpetual bond interest generally qualifies for dividend tax treatment unless specific conditions are met regarding:
- Principal repayment obligations
- Defined interest rates and payment frequency
- Investment period
- Redemption provisions
- Accounting classification
Extension and Deferral Risks
Case Analysis
19 issuers have extended principal or deferred interest on 29 perpetual bonds (total ¥44.7 billion). Primary reasons:
- Favorable Terms: 14 bonds with initial periods featuring no rate increases
- Credit Stress: 15 bonds where issuers faced liquidity constraints
Notable Example:
16 Guangzhou Metro Renewable Bond 03
- 6th repricing period: Benchmark + spread + 300bps
- 7th period onward: +600bps
- 2019 extension at lower rate (3.44% vs. original 3.58%)
Investment Considerations
1. Key Screening Factors
Investors should evaluate:
- Interest rate reset mechanisms
- Interest deferral penalties
- Cross-default provisions
- Bankruptcy priority
- Investor put options
2. Subordinated Perpetual Bonds
39 subordinated perpetual bonds (¥76.26 billion) show:
- 5-30bps additional spread compensation
- Primarily issued by high-quality (AAA-rated) issuers
3. Opportunities for Excess Spread
Selected issuers with implied AA ratings or better offer spreads exceeding 150bps.
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Risk Factors
- Regulatory changes affecting perpetual bonds
- Increasing credit risk events potentially widening spreads
FAQ Section
Q: What makes perpetual bonds different from regular bonds?
A: The key distinction is the indefinite maturity period and embedded options that allow issuers to extend the bond's life or defer payments.
Q: Why would a company issue perpetual bonds?
A: They provide long-term capital without maturity pressure and may qualify as equity for accounting purposes, improving balance sheet metrics.
Q: How do interest rate resets work?
A: Most bonds feature periodic rate adjustments, typically increasing by 300bps if extended, though some delay this increment for initial periods.
Q: Are perpetual bonds riskier than conventional bonds?
A: They carry additional risks including extension/redemption uncertainty and potential subordination, reflected in their higher yields.
Q: How common are payment deferrals?
A: Relatively rare (1.64% of outstanding), occurring primarily when issuers face financial stress or when terms make extension advantageous.
Q: What should investors watch for?
A: Focus on reset mechanisms, issuer credit quality, and whether accounting treatment matches economic substance.