A $500 million fixed-for-life perpetual by Nan Fung International Holdings dropped sharply after it began trading on Tuesday in a sign investors may be starting to question the wisdom of structures, which leave them heavily exposed to duration risk.
The Hong Kong property developer’s senior perpetual non-call three-year offering was priced at par on a coupon of 5.5%, but immediately dropped one point when it opened for trading.
In turn, it also dragged down other recent senior fixed-for-life perpetuals by Cheung Kong Properties and Sun Hung Kai (SHK), which are both nearly a point-and-a-half below their mid-May issue prices.
Nan Fung's distribution statistics illustrate why the market turned risk-off just as the deal crossed the line to make 2017 a record breaking year for perpetuals. For while its order book closed with $1.25 billion of demand and participation from 82 accounts, there was a very heavy weighting to Asian private banking investors compared to recent deals.
More than half of Nan Fung’s deal (52%) went to the private banking segment compared to 17% for SHK's issue and 27% for Cheung Kong Property's. Fund managers took 34% compared to 59% for SHK and 54% for Cheung Kong.
Banks were allocated 7% of Nan Fung’s offering, with insurers on 5% and corporates 2%. There was an overall split of Asia 94%, Europe 6%.
Why are investors buying fixed-for-life perps?
Unless investors believe US interest rates will stay range-bound in perpetuity, it is hard to see why they would be interested in transactions which are win-win for issuers and lose-lose for them.
As a number of fixed income analysts have cautioned, this is particularly true for private banking investors, who do not need to match long-term liabilities, or feel compelled to participate in benchmark transactions.
Issuing a fixed-for-life perpetual makes perfect sense for a corporate.
If interest rates go up, they maintain a very cheap source of funding. If they go down, they can call the deal and refinance it at a cheaper level.
For investors the reverse is true.
If rates go down, they will not benefit from the enhanced yield for very long, as issuers will call it away: in Nan Fung’s case after three years.
Conversely, if interest rates go up they will be stuck with the paper unless they are prepared to sell out below issue price given there are no punitive step-ups or resets from fixed to floating to force the issuer’s hand to call the deal.
Instead of holding what are normally classified as an alternative investment to short-dated bonds, they will have an extremely long-dated one instead. This amplifies duration risk since the longer the maturity the greater the sensitivity to changes in interest rates.
What goes up…
Perps, therefore, trade down sharpest as rates go up. This was amply demonstrated during 2013’s taper tantrum.
The same happened again last November, when Donald Trump won the US presidency and the financial markets decided his purported pro-growth policies would spur a sharper rise in rates.
Li & Fung had issued a 5.25% fixed-for-life subordinated perpetual only a few days before, at a time markets expected Hillary Clinton to win. The BBB- rated deal then slid 12 points over the space of a week-and-a-half to a low around the 86% level.
It has never fully recovered and was trading Tuesday around the 91.5% level.
As one banker commented: “Institutional investors have been taking the view they’ll just trade out of these deals as soon as the market shows signs of turning. But someone will be booking a loss.”
However, the Trump administration’s ongoing political problems did open a new issuance window for Hong Kong property developers in April when markets concluded his administration would find it harder than expected implement 'pro-growth' policies.
Now that crop of senior fixed-for-life deals from the likes of Regal International Holdings, SHK and Cheung Kong Properties are all trading under water.
Only Road King’s B1 rated 7.95% senior fixed-for-life deal from February has continued to do well and was trading on a yield-to-worst around the 6.85% level on Tuesday. Fixed income analysts believe its high coupon has insulated it.
Likewise, other 2017 perpetuals for CK Hutchison Holdings, Yanzhou Coal and Lenovo are still trading above issue price as they have more investor-friendly step-ups, or re-sets.
Moody’s classifies Nan Fung’s Baa3 deal as debt. It said that although distributions can be stopped, they are cumulative and compounding, which means the issuer is encouraged to pay the coupon.
If the progress of Nan Fung’s deal encapsulates Hong Kong’s reputation for seesawing investor sentiment, its corporate history is also a close mirror for the Territory’s as a whole.
Like many Hong Kong companies, it started life as a textiles producer under the helm of a self-made businessman, Chen Din-hwa, who fled Mao’s China at the end of the civil war. A few decades later, it moved into property and its current CEO is Hong Kong's former financial secretary, Anthony Leung.
His post-government positions at Citi and JP Morgan also help to explain the deal’s syndicate mix.
Sole global co-ordinator was HSBC , with joint bookrunners comprising Citi, JP Morgan and UBS.