SGD Bonds Strategy – Rising risk of non-calls April 23, 2020 754

  • After a decline in interest rates, the refix structure of callable bonds, such as perpetual bonds, increases the risk of non-calls and may subject bondholders to lower refix rates and longer holding tenors in the event of non-call. Such callable bonds include Bank and REIT bonds that have no step-ups clauses.
  • Interest rates are expected to stay low given (i) the Federal Reserve’s agreement to hold interest rates for this year, and (ii) low inflation rates from rock bottom oil prices and poor economic conditions amidst Covid-19.
  • Choose vanilla bullet bonds, senior perpetual bonds, and bonds with step up clauses to avoid refix and non-call risk. Step up structures help to mitigate lower refix coupons.


Callable/perpetual bonds: Have a higher risk of non-call if they refix at lower rates

Many callable bonds have refix clauses at call date and their coupon rates reset based on prevailing swap rates plus the bonds’ initial spread at issuance. This presents a higher risk of issuers not calling on call date and allowing bond coupons to reset if the refix coupon rate is lower than the initial coupon. In such cases,  bondholders are left with lower coupon rates and longer holding tenors.

Interest rates have fallen to record lows and are expected to remain so for the year at least. Using SGD swap rates (interest rates) as of 22 April 2020, we show in Figure 1 SGD bonds with upcoming call dates and their refixed coupon rates if any. A lower refix coupon (darker orange shows a greater % fall in refix coupon) could mean higher non-call risk as it presents issuers with a lower cost of debt.


How to avoid refix risk?

Step up clauses: To mitigate lower refix coupons

Figure 1 includes callable bonds with coupon step-up clauses, one of which is the CELSP 3.9% Perp with a step-up of 500bps at its 19 October 2020 call date, resulting in a higher refix coupon of 8.05%. This incentivises the bond issuer CITIC Envirotech Ltd to call and reduces refix and non-call risk for bondholders. This perpetual bond is rare, boasting a Senior Unsecured ranking.


Senior perpetual bonds: With no refix risk

For such bonds, few have been issued in the Singapore bond market and all have been called except for the CELSP 3.9% Perp. Previous senior ranking perpetuals came with fixed coupon and no refix. For example, the CHEUNG 5.125% Perp (SGD) issued by Cheung Kong Bond Securities Ltd in 2011 was ranked Senior Unsecured and had a fixed coupon. This gives bondholders more certainty on their coupons and no refix risk.


Vanilla bullet bonds: Have no non-call and refix risk, however, subordinated bullets do

Bondholders are safe with regards to tenor when choosing vanilla bullet bonds and will receive their principal at maturity barring default. However, bear in mind that some bullet bonds have call dates with refix structures that may subject bondholders to lower refix coupons. Figure 4 shows the list of subordinated bullets that have non-call and refix risk from the list in Figure 1.

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Timothy Ang
Research Analyst
Phillip Securities Research

Timothy covers credit analysis of local and foreign bonds. Previously an equity dealer, he handled equity trade execution and portfolio management. He has presented seminars for organisations such as SIAS, SPH and IRAS, commentated live market updates for 93.8FM, and authored investment articles for the Business Times newspaper. He graduated with a Bachelor of Commerce in Accounting & Finance from the University of Western Australia.

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