Getting to know perpetual securities

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#1
Identify the risks, and soon people will find that perps are not as attractive as they are made out to be.

The Straits Times
May 20, 2012
Getting to know perpetual securities

They offer regular payouts at fixed rates, but are not like regular bonds

By Yasmine Yahya

They might sound a bit complicated but perpetual securities have been selling like hot cakes over the past few months as retail investors queue up to get a slice.

And who can blame them? In an economy where interest rates are near zero and stocks are becoming more volatile, we are all thirsting for simple financial products that can bring us steady returns.

But there is a catch: Regulators are saying that the 'perps', as they are commonly known, might not be as simple as many assume.

The Monetary Authority of Singapore (MAS) warned investors last Wednesday that perpetual securities are not like regular bonds and, therefore, are riskier.

An earlier Reuters report citing unnamed sources said that the MAS had held two informal meetings with bankers in recent weeks as it is worried that local retail investors might be taking on too much risk or buying perps without a full understanding of the product.

The Sunday Times spoke to several experts to nail down the nature of this new kid on the investment block.

What is a perpetual security?

A perpetual security acts much like a bond, giving the holder regular payments at a fixed rate.

For example, the perpetual security issued by Genting Singapore last month will pay investors 5.125 per cent of their investment a year.

And like bonds, the company that issues the perps will likely redeem them at a certain point - in Genting's case, in 10 years' time - and return the initial sums to investors.

But note that word 'likely'.

Unlike with bonds, the company is not legally obliged to pay out a regular distribution. It can choose to defer a payout, and do so indefinitely.

The company also has a right to never redeem the bonds - hence the term 'perpetual'.

Perpetual securities also rank lower than bonds in terms of their claim on the company's assets.

If a firm collapses and has to be wound up, bondholders are paid first from whatever assets that have been liquidated.

Holders of perpetual securities would be next in line - if there is any cash left.

Investors holding preference shares come next and finally, holders of common stock - again, if anything is left in the kitty.

Perpetual securities also take precedence over common stock when it comes to dividends and distributions. The company must distribute payouts to perpetual securities and preference shares holders first, before it can declare a dividend for its shares.

DBS Bank's head of fixed income Clifford Lee notes: 'As long as the company doesn't pay coupons on the perpetual security, it can't pay dividends to shareholders. If it decides that it wants to pay dividends on its common shares, then it also has to pay out all the deferred coupons accumulatively.'

That means a company has to pay out its latest distribution plus any distributions that it had previously missed.

What are the risks of perpetual securities?

First, the company might defer all distributions and choose not to redeem the perpetual security, which means zero returns on your investment.

It is also harder to sell a perpetual security than a common or preference share.

There is also the risk that an investor might not be able to get out of the investment when he wants to. These investments typically do not have as much liquidity as shares or equities.

'Compared to conventional straight bonds which have maturity dates, investors in perpetual securities are subject to risks in the secondary market which are mainly market, credit, liquidity and price risks,' Mr Marcus Teo, the head of HSBC Singapore's high-net-worth channel, says.

Third, there is interest rate risk.

If interest rates rise rapidly over the next several years, the distribution rate on existing perpetual securities would not look attractive any more.

In such a situation, the issuing company might also be less motivated to redeem the perpetual security.

'Why should they if they are getting funds from you at a lower rate than the market interest rates?' notes Mr Mano Sabnani, chief executive of financial consultancy firm Rafflesia Holdings.

And at that point, it is likely that the value of the perpetual security would fall, he adds.

'With bonds, you could still look forward to getting your capital back.

'Say you bought a bond with a 2 per cent coupon and then interest rates rose. The value of the bond would fall but when it is nearing the maturity date, people would still buy it because they could buy the bond at a cheap price and make money when the company returns the principal amount.

'But with perpetual security you can't look forward to that as they may not call it back and return the principal.'

Given such an environment, most people would be looking to sell while few would want to buy - so investors would be stuck with their perpetual securities.

What are the advantages of perpetual securities?

HSBC's Mr Teo has a straightforward answer: 'Compared with equities, perpetual securities tend to be less volatile and provide a regular stream of income.'

No doubt, the payout rates being offered by the companies issuing perpetual securities definitely beat the interest rates investors would get in a savings account.

And given that the stock market is becoming ever more volatile, being able to receive regular fixed payouts a few times a year does sound attractive.

Of course, there is that risk that the company might just decide to defer all distributions indefinitely.

However, Mr Lee of DBS says this is unlikely with big firms.

'The ones which have issued perps so far are top-tier names, such as Global Logistic Properties, SingPost and Hyflux,' he notes.

'If they defer their coupon payments, their stock price will plummet because a coupon deferment means no dividend, so it's quite punitive for them to defer the payouts.'

This means it is vital for investors to choose perpetual securities very carefully, he adds.

'Investors must only look at companies whose credit they are very comfortable with.

'They should also check the dividend history of the company - if it has been paying regular dividends over many years, that gives a lot of assurance that the company will continue to pay a dividend, and therefore, the chances of it deferring a coupon are lower.'

yasminey@sph.com.sg
My Value Investing Blog: http://sgmusicwhiz.blogspot.com/
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#2
just check where will this perpetual securities be mentioned in a typical financial statement / AR of a listed company?
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#3
(20-05-2012, 10:46 AM)pianist Wrote: just check where will this perpetual securities be mentioned in a typical financial statement / AR of a listed company?


They will end up in the equity

http://www.singpost.com/download/AboutSi...sgxnet.pdf
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#4
Quote:
"DBS Bank's head of fixed income Clifford Lee notes: 'As long as the company doesn't pay coupons on the perpetual security, it can't pay dividends to shareholders. [b]If it decides that it wants to pay dividends on its common shares, then it also has to pay out all the deferred coupons accumulativel[/b]y.'"

Unquote:
This is not correct if the perpetual security is issued as "Non-Cumulative Preference-Shares". Besides, there may be other terms attached not so beneficial to buyers. Not all perpetual securitities are issued with the same terms. "Caveat Emptor".TongueTongue
WB:-

1) Rule # 1, do not lose money.
2) Rule # 2, refer to # 1.
3) Not until you can manage your emotions, you can manage your money.

Truism of Investments.
A) Buying a security is buying RISK not Return
B) You can control RISK (to a certain level, hopefully only.) But definitely not the outcome of the Return.

NB:-
My signature is meant for psychoing myself. No offence to anyone. i am trying not to lose money unnecessary anymore.
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#5
A company can stop paying dividend for say 3 years and then on 4th year accumulate them and gives huge dividends to shareholders.
NCPS holders would have lose out 3 years of good fixed returns and on the 4th year just received the regular... true ?

Just my Diary
corylogics.blogspot.com/


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#6
(20-05-2012, 09:35 PM)corydorus Wrote: A company can stop paying dividend for say 3 years and then on 4th year accumulate them and gives huge dividends to shareholders.
NCPS holders would have lose out 3 years of good fixed returns and on the 4th year just received the regular... true ?

that's correct. i can think of other sinister things that they can do like issuing bonus shares every year and shareholders can sell in open mkt and derive their dividends. only cumulative pref shares is by hyflux. a big difference between cum and non-cum.
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#7
(20-05-2012, 09:35 PM)corydorus Wrote: A company can stop paying dividend for say 3 years and then on 4th year accumulate them and gives huge dividends to shareholders.
NCPS holders would have lose out 3 years of good fixed returns and on the 4th year just received the regular... true ?

I assume it is the case by the definition of the NCPS

One important point should be included in the discussion. Everytime issuer defer/opt out the interest payment, the credit rating of the issuer suffer. It will cost much more to borrow next time, either from banks and investors.
“夏则资皮,冬则资纱,旱则资船,水则资车” - 范蠡
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#8
(20-05-2012, 09:53 PM)Jacmar Wrote:
(20-05-2012, 09:35 PM)corydorus Wrote: A company can stop paying dividend for say 3 years and then on 4th year accumulate them and gives huge dividends to shareholders.
NCPS holders would have lose out 3 years of good fixed returns and on the 4th year just received the regular... true ?

that's correct. i can think of other sinister things that they can do like issuing bonus shares every year and shareholders can sell in open mkt and derive their dividends. only cumulative pref shares is by hyflux. a big difference between cum and non-cum.

Yes! There is a big difference between cum and non-cum. And some Sifu in this forum had pointed out in the past why some company like Hyflux has to choose to issue cum and not non-cum. i think D. O. G. is the "Sifu".Smile
WB:-

1) Rule # 1, do not lose money.
2) Rule # 2, refer to # 1.
3) Not until you can manage your emotions, you can manage your money.

Truism of Investments.
A) Buying a security is buying RISK not Return
B) You can control RISK (to a certain level, hopefully only.) But definitely not the outcome of the Return.

NB:-
My signature is meant for psychoing myself. No offence to anyone. i am trying not to lose money unnecessary anymore.
Reply
#9
Is there no way for company to bypass cum ? Can they stop paying dividend and then do share splits. after 10 years i can foresee their CPS value almost nothing. And the company do buy back on the CPS at low price ?

Just my Diary
corylogics.blogspot.com/


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#10
(20-05-2012, 11:33 PM)corydorus Wrote: Is there no way for company to bypass cum ? Can they stop paying dividend and then do share splits. after 10 years i can foresee their CPS value almost nothing. And the company do buy back on the CPS at low price ?

Ordinary shares all have standard features like voting, dividend entitlements, pro-rata participation in rights issues etc.

In contrast, every hybrid security is unique. Some vote, some don't. Some count as equity, some count as debt. Some have fixed payments, some have variable payments. Some can skip payments, some can't. Some have cumulative payments, some don't. Some are convertible, some are not. Some have a put option, some have a call option, some have neither. Some have a fixed maturity, some don't. Etc.

Anyone who invests into hybrid securities without reading and understanding all the terms and conditions is likely to eventually get a nasty surprise.
---
I do not give stock tips. So please do not ask, because you shall not receive.
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