Cracks in perpetual bonds

IN what may be a first for the local perpetual bond scene, Tropicana Corporation Bhd is seeking to exchange papers that are due this week with new corporate bonds to be issued, according to sources.

This means that holders of Tropicana’s RM248mil perpetual bonds – which were issued in 2019 – who were hoping to get their cash back at the five-year call date, have to decide if they want to accept a new bond instead.

The situation is illustrative of the nature of perpetual bonds (or perps in short), where issuers have options to push their payments to future dates.

In Tropicana’s case, the holders of the perp, which carries a coupon rate of 7% per annum, are being asked to accept a four-year corporate bond carrying a slightly lower interest rate of 6.25%.

The slightly lower rate is reflective that it is a senior bond, which means it has priority in repayment, coupled with the fact that it will be a rated issuance.

Those who accept will receive a 0.25% interest payment upfront as a sweetener. But it also means they will have to wait another four years to get their money back.

Perps are sought after investment products due to their high yields. The size of Malaysia’s perp issuances totals around RM20bil.

However, as the name suggests, their perpetual nature can put investors in a fix.

These instruments typically have a call or redemption date of five years after issuance, and the issuer then has the option to pay back the bond or incur a “step up” or rise in the interest rate.

While most perps issued by Malaysian corporations have been redeemed without much fanfare, a few recent cases are turning out differently.

In July, troubled property developer YNH Property Bhd decided not to call in their perp and instead incurred a step up interest payment, from 6.85% to 8.85%.

Considering that the company is opting not to redeem the perp, this has raised worries if the company will have sufficient cash flow to be able to make good on the higher interest payments.

Cypark Resources Bhd, which is involved in high capital expenditure solar projects, has deferred two interest payments, one of which was due in March and another in September. Cypark says it has opted to do this in order to free up its cash flow for the delivery of its solar power plant projects in Kelantan and Terengganu.

In Tropicana’s case, the perp holders have been told the reason for the proposed exchange of bonds exercise is for the company to improve its cash flow position to support its growth.

Notably, Tropicana had experienced a downgrade of its bonds last year. It also experienced a shortfall in its perpetual sinking fund – a reserve of money set aside by the issuer to gradually repay the bond’s principal – which got its perp holders jittery.

In the end, the property developer was able to fulfill all its bond obligations last year. Tropicana now says it has managed to de-leverage its balance sheet by selling some land and assets. But it is also embarking on development projects that require capital.

This is likely why it is seeking not to call in its perp.

The perp holders will vote on the matter on Oct 8, sources say.

If 75% of those present at the AGM vote in favour of the bond exchange, then it is a done deal. However, if the exercise does not garner enough numbers, the deal will fall through, although those who vote in favour will get the new bonds and the 0.25% interest sweetener.

What about those who insist on getting their money back? Well, going by the terms of perps, the holders have limited remedies. They will however, enjoy a step up of 2% if their perp isn’t redeemed. That payment though could also be deferred.

Consider the case of Boustead Holdings Bhd, which issued a perp in 2013. While some of the tranches of that RM1.2bil perp have been redeemed, more than half of it remains outstanding.

Those perps today carry an interest rate of 13.6% due to step-ups over the years. It has been six years since the first call date of those perps.

So, should investors jump in and buy those Boustead perps that technically carry a 13.6% interest rate?

That would be risky, as one investment advisor tells StarBiz7.

“This is essentially the risk of perps. Payments, whether return of principal or interest payments, can be postponed indefinitely. So beware the value traps in perps,” he quips.