(Oct 28): A recent increase in the issuance of perpetual bonds in Thailand seems to be linked to local 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%.
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Perpetual bonds typically pay out higher distributions than plain-vanilla bonds from the same issuer to compensate investors for the higher risks involved. They 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 the reclassification of perpetual bonds from equity to liabilities in financial statements, according to PwC Thailand.
The move could increase the debt-to-equity ratio (DER) 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, says Ariya Tiranaprakit, senior executive vice-president of the Thai Bond Market Association (TBMA).
In the 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 firms listed on the Stock Exchange of Thailand.
In 2012, PTT Exploration and Production, Thailand’s national oil and gas conglomerate, was the first company in Southeast Asia to issue century bonds, worth US$133 million. 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 says the original issuing size was THB3 billion. 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 says.
Chaiwat Kovavisarach, president and CEO of Bangchak Corp, says the company announced an issuance of perpetual bonds worth THB6 billion ($270.2 million) and an additional greenshoe option worth THB4 billion. 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,” Chaiwat says. “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, power generation arm of B.Grimm Group, also announced plans to issue bonds worth THB6 billion with an additional greenshoe option worth THB2 billion.
“B.Grimm Power has to raise funds because we have seven power projects to develop in Thailand over the next three years,” says B.Grimm Power president Preeyanart Soontornwata.
Although B.Grimm Power’s DER 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 says.
“We decided to issue debentures instead of syndicated loans because of the lower financial costs. helping us to maintain our DER,” Preeyanart says.
Game changer
As at Sept 30, 2019, eight listed companies in Thailand had perpetual bonds worth nearly THB80 billion 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, says 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 DER. The adjustments might result in liquidity issues and lead to higher finance costs, as they indicate higher credit risk, Chanchai says.
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, Chanchai says.
As TAS 32 comes into effect on Jan 1, 2020, many may not have enough time, he adds.
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 does not 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, says TBMA’s Ariya.
“The perpetual bond is an investment product that has garnered momentum amid low interest rates,” she says. “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, says 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 Pichet’s view, corporations will become increasingly interested in perpetual bond issuance because such instruments cause no change to the company’s DER.
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 says.
This feature lets companies increase their debt without altering the liability ratio.
Veena Lertnimitr, executive vice-president of Siam Commercial Bank, says 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 says. The lure is that companies’ liabilities are not altered by issuing this type of bond, facilitating business expansion or merger-and-acquisition initiatives, Veena adds.
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, says Tisco Securities executive chairman Paiboon Nalinthrangkurn. The return on investment from perpetual bonds has whet investor appetite amid prevailing lacklustre yields in the low-rate environment, Paiboon says.
He adds, however, that the imminent change in accounting standards could lead to a decline in issuance.
