Perpetual Bonds

Perpetual bonds are bonds with no maturity date. The issuer pays interest (coupon) indefinitely and is never required to repay the principal. Investors receive regular coupon payments as long as they hold the bond, but they can only get their principal back by selling the bond in the secondary market.

What Are Perpetual Bonds?

In a standard bond, the issuer returns the face value on a specific maturity date. In a perpetual bond, there is no redemption date. The issuer commits to paying the coupon forever, but never repays the principal unless the bond includes a call option (which most do).

Most perpetual bonds issued in India are AT1 bonds (Additional Tier 1 capital instruments) issued by banks under RBI’s Basel III framework.

Key Features

– **No maturity date**: interest is paid indefinitely
– **Call option**: most perpetual bonds have a call option, typically after 5 to 10 years, allowing the issuer to redeem them early at face value
– **Higher coupon**: compensates investors for the lack of principal repayment certainty
– **Price sensitivity**: perpetuals behave like very long-duration bonds; highly sensitive to interest rate changes

Perpetual Bond Price Sensitivity

Since there is no maturity, the duration of a perpetual bond is approximately 1/yield. If the yield is 8%, the Macaulay Duration is approximately 12.5 years. This makes perpetuals very sensitive to interest rate movements.

Risk Factors

– **No guaranteed principal return**: if the issuer does not call the bond, investors must sell in the secondary market
– **Write-down risk**: AT1 bonds can be written down to zero if the issuing bank’s capital falls below a regulatory trigger
– **Call risk**: if the issuer does not exercise the call (e.g., due to financial stress), the bond may trade well below face value

AT1 Bonds

AT1 bonds are the most commonly encountered perpetual bonds in India. They are issued by banks as a form of regulatory capital. When Yes Bank and other banks faced distress, their AT1 bonds were written down or fully written off. This highlighted the high risk of AT1 bonds despite their often-high coupons.

Practical Example

SBI issues a perpetual AT1 bond with a 9% coupon and a call option after 10 years. An investor buys Rs 5 lakh at face value. SBI pays Rs 45,000 per year indefinitely unless it calls the bond. If SBI calls after 10 years, the investor gets Rs 5 lakh back. If SBI’s capital deteriorates significantly, the bond could be written down, resulting in complete loss of principal.

Key Takeaways

– Perpetual bonds have no maturity date and pay coupons indefinitely
– Most perpetual bonds have call options after 5 to 10 years allowing early redemption
– AT1 bonds issued by banks under Basel III are the primary perpetual instruments in India
– Write-down risk: AT1 bonds can be fully written off if a bank’s capital ratio breaches the trigger
– High coupons compensate for lack of principal certainty, but these are high-risk instruments