In a class of its own

In a class of its own

Perpetual bond issuance is all the rage, but a changing accounting standard may threaten the parade

CP All Plc, the sole operator of 7-Eleven convenience stores nationwide, issued perpetual bonds worth 20 billion baht in September 2019. SEKSAN ROJJANAMETAKUN
CP All Plc, the sole operator of 7-Eleven convenience stores nationwide, issued perpetual bonds worth 20 billion baht in September 2019. SEKSAN ROJJANAMETAKUN

A recent increase in issuance of perpetual bonds seems to be linked to companies' desire to lock in low interest rates, but the new accounting standards coming into effect next year signal something much more intriguing.

Perpetual bonds, also known as hybrid bonds, have no fixed maturity date and get treated as equities rather than debts. These fundraising instruments, which carry more risk than a company's usual senior debt, are popular because they can return an average of 5%.

Perpetual bonds typically pay out higher distributions than plain-vanilla bonds from the same issuer to compensate investors for the higher risks involved. These include holding the perpetual securities forever and the risk that distributions might be deferred and may not accrue interest.

But changes in the way financial instruments are classified under the new Thai Accounting Standards (TAS 32) may result in perpetual bonds being reclassified from equity to liabilities in financial statements, according to PwC Thailand.

The move could increase the debt-to-equity (D/E) ratio for issuers, potentially leading to a breach of debt covenants and ultimately prompting banks to call in all outstanding loans.

FAVOURED FUNDRAISING TOOL

The market timing supports perpetual bond issuance, as corporations can lock in low interest rates, while investors' investment appetite for these subordinated debts has risen based on relatively high investment returns compared with lower yields offered on deposit accounts and other fixed-income assets.

Perpetual bonds normally have a redemption call every five years.

At five years, issuing companies typically redeem and pay interest to investors, then issue new bonds.

Only well-known issuers or large corporations can issue perpetual bonds, as investors are putting their trust in companies for the long term, mostly choosing firms with good credit ratings, said Ariya Tiranaprakit, senior executive vice-president of the Thai Bond Market Association (TBMA).

In years past, perpetual bond issuers were mostly commercial banks looking to strengthen their capital adequacy ratio.

Since that time, this hybrid instrument has become better known among public companies and corporates, especially SET-listed firms.

PTT Plc, Thailand's national oil and gas conglomerate, was the first company in Southeast Asia to issue century bonds worth US$133 million back in 2012. They were given the highest investment-grade rating of AAA by Fitch Ratings.

The 100-year debentures will mature in 2110, with a 5.85% interest rate for the first 10 years.

A PTT statement said the original issuing size was 3 billion baht. The group has issued perpetual bonds three more times because of healthy oversubscription.

"The deal set a new benchmark for Thai long-term bonds, helping develop the Thai capital market with diverse products to meet the demands of investors seeking long-term investment from companies with sound financial status," PTT said.

Chaiwat Kovavisarach, president and chief executive of Bangchak Corporation Plc, said the company announced an issuance of perpetual bonds worth 6 billion baht and an additional greenshoe option worth 4 billion baht.

The interest rate has not been determined.

"The bond issuance is a win-win deal for issuers and investors because Bangchak has a strong business and investors can have confidence in the company," Mr Chaiwat said. "Perpetual bonds are better than an IPO or other kinds of debentures for us because the company will receive a positive response from investors for the hybrid bonds."

B.Grimm Power Plc, the power generation arm of B.Grimm Group, also announced plans to issue bonds worth 6 billion baht with an additional greenshoe option worth 2 billion baht.

"B.Grimm Power has to raise funds because we have seven power projects to develop in Thailand over the next three years," said B.Grimm Power president Preeyanart Soontornwata.

Although B.Grimm Power's D/E ratio is still less than 1.6, the company must maintain this ratio because it plans to raise funds for new power projects -- both new developments and acquisitions, she said.

"We decided to issue debentures instead of syndicated loans because of the lower financial costs, helping us to maintain our D/E ratio," Mrs Preeyanart said.

GAME CHANGER

As of Sept 30, 2019, eight listed companies in Thailand had perpetual bonds worth nearly 80 billion baht in outstanding principal.

Reclassification may cause short-term volatility in share prices and affect the overall capital market.

Several new accounting standards and principles will come into effect in 2020, including Thai Financial Reporting Standards 9, TAS 32 and Thai Financial Reporting Interpretations 23.

These accounting frameworks will affect how listed companies report their finances, said Chanchai Chaiprasit, assurance leader and partner at PwC Thailand.

For TAS 32, a financial instrument presentation standard, areas that were once ambiguous are addressed with more clarity.

Changes in perpetual bond classification may worsen key financial ratios such as the D/E ratio.

The adjustments might result in liquidity issues and lead to higher finance costs, as they indicate higher credit risk, Mr Chanchai said.

There are two ways to handle the new requirements imposed by TAS 32: the issuer can either revise the term of perpetual bonds, or redeem and reissue new perpetual bonds. But either way will be costly and time-consuming, Mr Chanchai said.

As TAS 32 comes into effect on Jan 1, many may not have enough time, he said.

Bangchak Corporation Plc last week issued subordinated perpetual bonds worth 10 billion baht.

TREAD WITH CAUTION

So far there have been no defaults on interest payments, which has led to bullish sentiment for this type of bond amid the low-interest-rate environment.

Investors should, however, study the conditions for return of payment, as this type of bond does not oblige issuers to make such payment and they can continue to avoid payment if the market environment or financial status doesn't support return on payment.

Under the rules of perpetual bonds, companies will not pay the coupon rate when they cannot pay dividends to stock investors. If they can pay dividends to stock investors, they have to pay interest on perpetual bonds, said Ms Ariya of the TBMA.

"The perpetual bond is an investment product that has garnered momentum amid low interest rates," she said. "Investors can obtain high returns and issuers can manage lower interest costs. The most important thing investors should understand is what they are investing in, as well as the benefits and risks involved."

As perpetual bonds are subordinated debts, holders of these bonds will be categorised as having the third priority of payment behind senior secured debt and senior debt in the event that a company goes bankrupt, said Pichet Sithi-Amnuai, president of Bualuang Securities.

"If investors understand what they are investing in, they can accept the risks and returns of their investment," he said.

DECLINE ON THE HORIZON?

In Mr Pichet's view, corporations will become increasingly interested in perpetual bond issuance because such instruments cause no change to the company's D/E ratio.

This is because perpetual bonds are hybrid bonds that can be booked as equity on companies' balance sheets, in contrast to a liability label for other types of bonds, he said.

This feature lets companies increase their debt without altering the liability ratio.

Veena Lertnimitr, executive vice-president of Siam Commercial Bank, said perpetual bonds have an allure for both issuers and investors, but issuers stand to shoulder a higher issuing cost than for regular bonds because of the required bond credit rating.

Issuers must also offer higher returns because perpetual bonds are defined as subordinated debts, she said.

The lure is that companies' liabilities are not altered by issuing this type of bond, facilitating business expansion or merger-and-acquisition initiatives, Ms Veena said.

Despite the changing accounting standards, perpetual bonds are favourable with large companies because they help them manage financial costs, enabling them to raise funds without having to worry about debt, said Tisco Securities executive chairman Paiboon Nalinthrangkurn.

The return on investment from perpetual bonds has whetted investor appetite amid prevailing lacklustre yields in the low-rate environment, Mr Paiboon said.

But the imminent change in accounting standards could lead to a decline in issuance, he said.

Subordinated perpetual bonds worth 15 billion baht are to be issued by Indorama Ventures Plc in November 2019.


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