It is a clear understanding about Perpetual Bonds that the coupon will be paid only if the bank profits.
Perpetual Bonds, or Additional Tier 1 Bonds, as the name itself signifies, are bonds without a specific maturity date. These bonds have been popular with investors all the time, even individual investors.
This may be due to several factors like the availability of bonds at relatively higher yields compared to other securities, the aura of safety around them being a bank instrument, the impression of short-maturity due to the Call option coming up in two or three years and the persistent recommendation by advisers treating this as an attractive investment destination in addition to the papers being bought and sold so actively.
But some of these notions were challenged by the events that unfolded around Yes Bank and the failure to pay up the AT1 bondholders. While this matter is still under consideration of the courts and there is a feeling that natural justice was denied to the bondholders, it is a clear understanding about Perpetual Bonds that the coupon will be paid only if the bank profits, or only if the bank can dip into permissible reserves and funds, to pay the interest. It also implies that if the entity makes losses continuously, the losses will make the AT1 bonds defunct and it will gradually evaporate.
This peculiar property of the bonds has become clear to investors only after the recent bank case. This makes the case for investment into such bonds an action to be taken after careful consideration of several factors.
Investments should be considered in stable entities that are part of larger groups and who are committed to their business for the long haul. Instruments that are available at very high yields should be evaluated very diligently before any decision to buy is made, as higher yields may be reflective of a lack of interest or low demand in the instrument due to perceptions about the viability of the institution or its business.
It should also be borne in mind that the amount of premium that you may pay should not be too high. If it is too high and the bond is called back in a short time, then the investor may lose the premium which is paid at the time of purchase as there was not enough time to recover the same through periodic coupon receipts.
The inherent message is that the bonds should be invested into by investors who have the risk appetite to absorb the shocks, if any, that may arise some time in the future. To a certain extent, the credit rating of the instrument could be a guide, but the points mentioned earlier about the business prospects of the banks and the challenges it is facing should be considered while investing.
Strong and well-run public-sector banks with improving financials and private sector banks, which are part of larger groups, offer better avenues for investors. There is no point in making sweeping conclusions based on just one event, but it would be wiser to consider all the relevant factors while investing. There are a few portfolios even in the mutual funds space that hold a significant component of these bonds and are doing well.
(Joseph Thomas, Head of Research at Emkay Wealth Management.)Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.