Singapore has recently seen a surge in the issuance of perpetual bonds. As the name suggests, these are bonds that can last in perpetuity with no maturity date. Most perpetual bonds have a “call” date when the issuer may redeem the bonds, usually at a premium. However, redemption is not an obligation, and so most perpetual bonds have a “step-up coupon” feature that increases the coupon payment investors receive if the bonds are not called.
Singapore dollar perpetual bonds have been very well received by both local and foreign investors, most likely due to their hunt for yield in today’s low-interest-rate environment. The outstanding perpetual bonds currently yield 5 to 7 per cent, which compares quite favourably with the less than 1 per cent deposit rate offered by local banks. The outlook for a stronger Singapore dollar, combined with the Government’s “AAA” sovereign rating, has also attracted foreign investors to the perpetual bond market here.
But perpetual bonds do not just benefit investors and the blue-chip companies that have joined the issuance bandwagon. Singapore real estate investment trusts (REITs) also have a lot to gain from the development of the perpetual bond market, which could potentially create a win-win situation for the investors and the REITs.
Lower-risk, lower-cost source of capital
Because REITs are required to distribute most of their cash flows as dividends, they do not retain much of their earnings and have to periodically tap the banks or the capital markets to refinance their maturing debt. This means they face significant refinancing risk, especially during episodes of credit crunch. REITs, particularly those with high debt levels, also have to periodically raise equity capital through placements or rights issues to fund potential asset acquisitions. Such an exercise normally results in an overhang on the REIT’s share price.
The development of the perpetual bond market helps minimise these risks for the Singapore REITs. Perpetual bonds provide an additional source of long-term funding that more appropriately matches the long-term nature of their property assets. The bonds also help diversify their funding base by reducing their reliance on banks and straight bonds as funding sources, which then helps lower their refinancing risk.
Furthermore, perpetual bonds help Singapore REITs avoid the risks associated with equity capital-raising. Instead of issuing new equity which may reduce the value of their existing shares, REITs may choose to issue perpetual bonds to finance a potential acquisition. By doing so, they avoid diluting shareholders and creating a near-term share-price overhang. This option makes all the more sense considering that a perpetual bond is also considered a form of book equity – and, therefore, reduces an issuer’s gearing level – but is cheaper to finance than ordinary equity.
In addition, Singapore REITs have generally already lowered their gearing levels since the 2008-09 credit crunch. One may argue that lower gearing results in less efficient balance sheets and lower returns on equity (ROE), especially in a low-interest-rate environment. But because perpetual bond issuance is an easy and cost-efficient way of raising capital, it may encourage Singapore REITs to make more yield-accretive acquisitions and boost their ROEs and dividends.
Thus, given these benefits, investors may see more Singapore dollar perpetual bond issuances from Singapore REITs. This would be a welcome development. Investors win with higher-yielding assets while REIT operators gain from having a more-diversified, lower-cost funding base.
By Tan Chin Keong – analyst at UBS Wealth Management Research.
Source : Today – 4 May 2012