Perpetual Bonds Explained: What They Are and How They Work

When companies plan their long-term growth, they often need a steady source of capital that doesn’t come with a ticking clock. Think of a business that wants to expand its operations but doesn’t want to worry about paying back a loan on a fixed date. This is where Perpetual Bonds come into play. They are unique financial instruments that offer investors a continuous income stream without a maturity deadline.

For investors, understanding what a Perpetual Bond means and how it fits into their investment strategy can lead to steady returns with a risk profile different from that of traditional bonds or stocks.

What is a Perpetual Bond?

Imagine a company issuing a bond that never matures—meaning it never has to repay the principal amount. Instead, it promises to pay interest forever until it decides to redeem the bond. This is essentially what a Perpetual Bond is: a fixed-income security with no maturity date.

Unlike conventional bonds that repay your principal after a set period, Perpetual Bonds keep paying interest indefinitely. The issuer, often a bank or financial institution, holds the right to call (redeem) the bond at specific intervals, such as every 5 or 10 years, but investors themselves cannot demand repayment.

Because these bonds offer regular interest payouts, many investors find them appealing for the steady income they can bring in, like getting a paycheque without doing extra work. But it’s not always smooth sailing. If you ever want to sell these bonds before the bank calls them back, you might find it tough. That’s because they aren’t always easy to trade on stock exchanges. Finding a buyer quickly or getting the price you want isn’t guaranteed, especially when the market is quiet.

Features of Perpetual Bonds

Perpetual Bonds come with unique characteristics that distinguish them from regular bonds and stocks. Let’s break down the key features:

No Maturity Date: These bonds do not have a fixed end date. Investors receive interest payments indefinitely unless the issuer opts to call the bond.
Higher Coupon Rates: To compensate for the indefinite tenure and higher risk, Perpetual Bonds generally offer higher interest rates, often between 8% and 14%*, which is notably better than typical fixed deposits or regular bonds.
Interest Payment Risk: Some issuers, especially banks issuing Additional Tier 1 bonds, can skip interest payments if their financial health falls below regulatory thresholds, making these bonds riskier than many traditional fixed-income instruments.
Subordination: If the issuer goes bankrupt, Perpetual bondholders get paid after other creditors but before shareholders, placing them in a middle priority tier.
Market Sensitivity: Perpetual Bonds are highly sensitive to changes in interest rates, which can cause significant fluctuations in their market price.
Liquidity Considerations: Though listed on exchanges, these bonds may not always be easy to sell quickly or at favorable prices, especially during periods of market stress.

Understanding these features helps investors weigh the benefits and risks, ensuring they make choices aligned with their financial goals.

How Do Coupon Payments Work?

Imagine a company that issues a Perpetual Bond promising to pay interest every six months. If the company remains financially stable and chooses not to call the bond, these payments could, in theory, continue forever. However, the issuer can redeem the bond at predefined intervals, returning the principal and ending the interest payments.

For some bonds, like Additional Tier 1 bonds issued by banks, the issuer may suspend interest payments if regulatory capital requirements are not met. This means investors should be prepared for occasional interruptions in income, depending on the issuer’s financial health.

How Does a Perpetual Bond Work?

Perpetual Bonds act as a long-term source of capital for issuers, especially banks and financial institutions in India, who use them to meet regulatory capital requirements. Investors lend money to these entities and receive regular interest payments. Unlike traditional bonds, the principal is not returned unless the issuer decides to call the bond.

If the issuer faces financial difficulties or regulatory triggers, it may skip interest payments or even write down the bond’s value, which increases the risk for investors.

Who Can Issue Perpetual Bonds?

In the Indian market, Perpetual Bonds are primarily issued by banks and financial institutions, often as Additional Tier 1 bonds. These instruments help issuers maintain their capital adequacy ratios as mandated by regulators.

Corporate or government issuance of Perpetual Bonds is minimal, making banks the main players in this segment.

Additional Read - Why Bonds are the safest investment options right now

Advantages of Perpetual Bonds for Investors

Perpetual Bonds offer several compelling benefits that make them attractive for certain investors:

Regular Income: As long as the issuer remains solvent and does not skip payments, investors receive a steady stream of interest, which can be a reliable source of income.
Higher Returns: Because of their perpetual nature and higher risk, these bonds typically offer coupon rates between 8% and 14%*, outperforming many fixed deposits and traditional bonds.
Portfolio Diversification: Perpetual Bonds behave differently from stocks and fixed-maturity bonds, providing diversification benefits that can help balance risk and reward in your portfolio.
Step-Up or Floating Rates: Some Perpetual Bonds come with step-up clauses or floating interest rates, which can increase over time and offer potential protection against rising interest rates.

Platforms like Bondbazaar provide access to a wide selection of such bonds, allowing investors to earn attractive fixed returns while enjoying the convenience of real-time trading and zero brokerage charges.

Risks of Perpetual Bonds

While the benefits are attractive, it’s important to understand the risks involved:

Interest Payment Risk: Issuers, especially banks issuing Additional Tier 1 bonds, may skip interest payments if their financial health deteriorates or regulatory requirements are unmet.
No Principal Repayment Guarantee: Investors may never get their principal back unless the issuer calls the bond, which could be years or even decades away.
Price Volatility: Due to their sensitivity to interest rates, Perpetual Bonds can experience significant price swings, affecting the market value of your investment.
Subordination Risk: Perpetual bondholders are paid after other creditors in liquidation, increasing the risk of loss.
Liquidity Risk: Selling Perpetual Bonds quickly at a fair price can be challenging, especially during market downturns.

Awareness of these risks helps investors make informed decisions and align their investments with risk tolerance and financial goals.

Additional Read - When is it a good time to buy bonds?

Who Should Invest in Perpetual Bonds?

Perpetual Bonds are best suited for:

Income-Seeking Investors: Those who want regular income and are comfortable with some risk.
Long-Term Investors: Individuals with a long investment horizon who can tolerate price fluctuations.
Institutional Investors: Entities like pension funds and insurance companies manage long-term liabilities.
Portfolio Diversifiers: Investors looking to add a different risk-return profile beyond traditional stocks and bonds.

However, these bonds are generally not recommended for highly risk-averse investors or those requiring guaranteed principal repayment.

Conclusion

The Perpetual Bond meaning revolves around a bond with no maturity date, offering indefinite interest payments. This unique feature makes them attractive for investors seeking steady income and portfolio diversification. However, they carry higher risks than traditional bonds, including interest payment uncertainty and price volatility.

For investors ready to explore Perpetual Bonds and other fixed-income options, Bondbazaar provides a seamless experience. Bondbazaar offers a regulated, transparent, and user-friendly platform where you can buy and sell bonds at the click of a button, without any account opening, brokerage, or maintenance charges. Plus, your bonds are held in demat form, and interest payments flow directly into your bank account, ensuring convenience and security.

By understanding the nuances of Perpetual Bonds and leveraging expert platforms, you can build a well-rounded portfolio that balances income, risk, and growth potential.

Frequently Asked Questions

Q1: What is a Perpetual Bond?

A Perpetual Bond is a fixed-income security with no maturity date, offering indefinite interest payments.

Q2: Are Perpetual Bonds risky?

Yes, they come with risks like skipped interest payments, price volatility, and no principal repayment guarantee.

Q3: Who can invest in Perpetual Bonds?

These bonds are ideal for income-seeking, long-term, or institutional investors with a higher risk tolerance.

Q4: What is an Additional Tier 1 (AT1) Bond?

AT1 bonds are a type of perpetual bond issued by banks to meet capital adequacy requirements under Basel III norms.