I came across an article on the newspaper yesterday morning that Ezion Holdings will be having a meeting with bondholders this coming Monday to present a debt restructuring plan. It reminded me that corporate and perpetual bonds were selling like hot cakes 4-5 years ago offering coupons between 5-7%. I had a chance to meet a relationship manager of a bank who was offering Swiber bonds at 7% at that time. A quick and dirty at-the-back of envelope calculation showed that the annual coupons would be a whopping amount of $17,500. Compare it with a dividend-paying stock like DBS, the capital of $250,000 to pay for a bond would have bought about 16,000 DBS shares around that time when it was trading at $16 per share. This would translate to an annual dividend of only $9,600. It’s a stark difference of $7,900 and this would recur yearly till the bond matures. This big difference in the yield could have tilted the balance to attract many investors into buying bonds than to invest in equities. Even I was salivated after making the comparison, but my sanity got better of me. There were a few things that made me feel uncomfortable about corporate bonds.
1. Corporate bonds were extremely illiquid. Certainly, when the bond coupon is high with a relatively short maturity period, potential bond-holders would want to keep them till maturity. My guess was that most of the potential bond-holders were former property owners who had sold off their properties and had parked the money in the bank. Perhaps illiquidity was not really an issue to them. After all, properties are also illiquid, and they may take months to sell off. Perhaps, many people have overlooked the fact that a property could hold value better than many other types of assets. Even when the price is no good at that time, there would always be a next opportunity to sell some time in future. However, when a company is in distress, the bond value can fall very fast once the bad news goes public. The maturity date may be a further inhibition because potential buyers could calculate the number of expected coupons to maturity. On the buyer side, my inference was that there were not likely many too. Corporate bonds are mainly opened to the high net worth individuals (HNWI) and are not marketed to the mass market. That gave me some inkling that during the times of need, the sellers may have to depress the price significantly in order to attract a buyer. It is unlike a unit trust, whereby there is always a ready counter-party such as an asset management company or the bank, to buy over the financial product at the net asset value.
2. The second thought I had was – if the coupon offered was so good, then why the banks were not taking the first bite on the cherries. In all likelihood, the banks have made loans to these companies to the hilt and that all the company’s assets have already been pledged. This meant that bondholders had no recourse when things go wrong. How much could a company cough out to pay bondholders when there were no unencumbered assets to sell? Even secured lenders like the banks could be affected when the pledged assets could only fetch a fraction of their book value during fire-sales.
3. Then there was another mind-boggling question. Why was the company prepared to pay bondholders at 7% when the banks were paying depositors less than one percent for their deposits? Bond issuers are not charity organizations to dangle a 6% difference in interest just to attract investors to buy their bonds. They probably could have made do with 3-4%.
4. Next is a personal finance question. Most of the target customers were probably HNWI who had sold their properties and parked their deposits in the banks awaiting the next investing opportunity. Or perhaps, they are business owners who had earned enough and parked their money in the bank. For a person, who was not born with a silver spoon or made from property sales and have to work hard to earn every single dollar, it would be difficult to part with a quarter of a million just for a single investment. Frankly, we do not have many quarters-of-a-million to spare to make sufficient diversifications for our portfolio. This would end up with a lob-sided risk concentration. It is really not a way to create a defensive portfolio.
5. When I inquired about the effect on the company if the oil price tumbled, I did not seem to get the comfort that the RM was able to answer me adequately. Of course, at that time, I did not expect the oil price to tank so fast and so drastically from more than $100 per barrel to less than $30 in about a year. It was a naïve question as a time-filler during the conversation, but in hindsight, should have been a pertinent question to ask.
All these thoughts made me think twice about investing in bonds. Given that I still need bonds to beef up my portfolio, I decided that perpetual bond was probably the way to go. While there is no maturity date for perpetual bonds, without the $250k requirement would help me able to apportion out the amount to buy several perpetual bonds or a mixture of perpetual bonds and stocks. After all, there were several perpetual bonds on offer around that time. Genting perpetual bond was one of them. The bonds were offered in two different tranches first to institutional investors and then to retail investors one month later. The coupon rate of 5.125% may not be as attractive, but casino operation is a cash business and it should be less risky compared to an engineering project or service company which is purely dependent on the oil price and the up-stream oil payers.
It has been well and good now that things have fall in place. DBS shares price have appreciated by 25% since then. Also now that Genting has decided to redeem both the institutional perpetual bonds and retail perpetual bonds by September and October 2017 respectively.
On the other hand, many issues related to corporate bonds, especially those related to the offshore and marine sectors, have still not been resolved. To date, most of the bondholders were forced to take deep haircuts. When there is no money on the table, it is likely that all the bondholders and even shareholders may be forced to swallow some bitter pills. As I know, so far two companies namely, Nam Cheong and Ausgroup have proposed to convert the bonds to equities. Perhaps, Ezion would also do likewise in the coming meeting.
Brennen has been investing in the stock market for 27 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.