* Reliance sells perpetuals at record low yield
* Bonds plunge in secondary trading
* Investors wary that company will never redeem notes
By Christopher Langner
Jan 30 (IFR) - On Tuesday, investors were reminded of the
dangers of investing in perpetual bonds at a time record low
interest rates as Indian conglomerate Reliance Industries
(Baa2/BBB) sold a senior perpetual dollar-denominated that
offered very few guarantees that the principal will ever be
Even as several fund managers and credit analysts warned of
the lack of protection to creditors, the company was able to
sell an US$800m perpetual at 5.875%, the tightest an Asian
company has achieved on a senior secured perp. That yield was
still some 50bp higher than what the company's 2040s were
offering in secondary markets.
However, savvier investors, such as fund managers, stayed
away from the transaction, which was mostly sold to private
banking accounts, traditionally considered less sophisticated.
On their first day of trading, the bonds traded as low as
96.35 after pricing at 100.00, making for one of the worst
performances for an Asian dollar investment-grade bond this
The reason for the drop, according to fund managers, was the
bond's very weak structure. "If they fail to call the bonds in
the fifth year and 30-year US Treasury yields go to 5%, the
yield on these bonds would go to 8%," said one portfolio
The problem is basically on the call, or when the company is
allowed to buy back the bonds. Investors in perpetual bonds
often assume that the bonds will be redeemed on their first call
date, which in Reliance's case is in 2018. However, from the
company's standpoint, it only makes sense to buy back the
perpetual notes if it can refinance them more cheaply.
That happened to be the case for the perps issued before
2007 since benchmark rates dropped steadily and touched record
lows last year.
But this time is different. Yields on benchmarks such as US
Treasuries and German Bunds are on the rise and most analysts
think that they will be much higher in five years than they are
now. "[The trend in rates] means it will be quite challenging
for longer-dated bonds going forward," said a portfolio manager
in Singapore. Hence, the possibility that Reliance will be able
to refinance its bonds at a lower yield is remote.
That is why fund managers were suspicious of Reliance's
perpetuals. If Treasury rates are higher, corporate yields are
probably going to be much higher than they are now. So it is
unlikely that Reliance will want to buy back the bonds by
incurring more expensive debt.
In fact, fund managers have been demanding that companies
include a significant yield hike after the first call date to
give them safety that if the bonds are not redeemed. At least
then their returns will match the new corporate yield reality.
Reliance did not include that and institutional investors
stayed mostly away from it. But this was just the latest example
of how savvier investors are shunning perpetuals without a
Similar notes from Chinese developer Agile Properties sold a
few weeks ago at 100.00 are still trading around 95.00.
Meanwhile, perps with step-ups are doing just fine.
"The argument to buy perps hinges on three things: absolute
yield, rates direction and your bet on the company calling them
or not at the call date," said one credit analyst.
Without the step-up, said investors, the perpetual has very
little upside and a lot of potential downside. The lack of a
maturity date means that the perps could behave like 30-year
bonds. That means a significant potential drop in case benchmark
rates rise. The longer the maturity on a bond, the bigger the
price drop for every percentage point of yield rise.
On the flip-side, in the unlikely event that rates are lower
five years from now, Reliance has the option to call the bonds
and refinance them more cheaply, eliminating the upside for
investors. "If rates collapse they can take the bond back," said
a portfolio manager in Hong Kong. "It is entirely the company's
prerogative to call them, which makes this deal very
opportunistic," said the Hong Kong manager.
Besides the technical arguments, there is also the issue of
what happens if Reliance does not call the bonds 2018. This
problem was evidenced when Deutsche Bank did not call a lower
tier 2 bond in December 2008. The decision caused the prices of
similar bonds to drop up to US$10. It also sparked a 30 basis
points widening in the European iTraxx subordinated financial
index to about 237.5 basis points, while Deutsche Bank's
subordinated credit default swaps widened by about 45 basis
Given the lack of incentive to call, Asian investors were
predicting a similar outcome with Reliance. "Five years from
now, imagine 30-year US Treasuries are at 5% and Reliance does
not call the bonds, you will see the yield on their bonds jump
to 8%," said another portfolio manager in Singapore who did not
buy the bonds. "These private banking investors (who bought
this) are going to get burned," another one said.
(Reporting By Christopher Langner; Additional reporting by