What Are Perpetuals in Accounting and Finance?

Perpetual financial instruments are a unique category designed to exist indefinitely, offering a continuous income stream to holders. Unlike most traditional investments with a defined maturity date, the principal amount is generally not repaid by the issuer. This article explains the nature of perpetual instruments, detailing their key features and common forms.

The Core Concept of Perpetuals

A perpetual instrument is a financial security without a fixed maturity date, meaning the issuer is not obligated to repay the principal. This distinguishes perpetuals from conventional bonds, which require principal repayment on a specific future date. Instead, investors receive an ongoing income stream, typically as regular interest payments for debt-like perpetuals or dividend distributions for equity-like ones.

From the issuer’s perspective, perpetual instruments serve as a valuable source of permanent capital. Companies and governments can raise funds without the future burden of principal repayment, optimizing their balance sheets. For financial institutions, particularly banks, issuing perpetuals can help meet regulatory capital requirements, as these instruments may qualify as Tier 1 capital due to their equity-like characteristics.

Perpetuals differ from traditional fixed-income securities and common stock. Unlike standard bonds, perpetuals lack a set maturity date and defined principal repayment. Unlike common stock, which represents ownership and offers variable dividends and voting rights, perpetual instruments usually provide fixed payments and generally do not confer voting rights. This positions perpetuals as hybrid instruments, bridging pure debt and pure equity.

Defining Characteristics

The absence of a maturity date is the most defining feature of perpetual instruments. Investors depend solely on the ongoing income stream for their return, and any recovery of principal would occur through selling the instrument in the secondary market. This characteristic makes perpetuals particularly sensitive to changes in market interest rates, as their valuation relies heavily on discounting an infinite series of future payments.

Payments on perpetual instruments typically involve fixed or variable rates. Many perpetuals offer a fixed interest rate or dividend yield, providing a predictable income stream to investors. However, some perpetuals may incorporate “step-up” features, where the payment rate increases at predetermined intervals, or they may have floating rates linked to a benchmark interest rate.

A common feature found in many modern perpetual instruments is a call provision. This grants the issuer the option, but not the obligation, to redeem the instrument early at a specified price and on predetermined dates. Issuers utilize call provisions to gain flexibility, such as refinancing at lower rates. For investors, the presence of a call provision introduces reinvestment risk, as their income stream could cease unexpectedly.

Perpetual instruments are also characterized by their position in a company’s capital structure, referred to as subordination. They typically rank below senior debt but above common stock in terms of claims on a company’s assets in the event of liquidation or bankruptcy. This lower priority in repayment generally means perpetuals offer a higher yield.

Another important characteristic concerns the treatment of missed payments, distinguishing between cumulative and non-cumulative obligations. For cumulative perpetual instruments, if a payment (interest or dividend) is missed by the issuer, that missed payment accumulates and must be paid to the holders before any payments can be made to common shareholders. Conversely, for non-cumulative perpetual instruments, any missed payments are forfeited and do not accumulate, meaning the issuer has no obligation to pay them in the future.

Types of Perpetual Instruments

Perpetual bonds are debt instruments that do not have a maturity date, meaning the principal amount is never repaid to the bondholder. The issuer commits to making coupon payments indefinitely. These bonds are often issued by governments or financial institutions, particularly banks, to fulfill their long-term funding needs or to satisfy regulatory capital requirements. The coupon payments on perpetual bonds are typically fixed, providing investors with a steady and predictable income stream.

Perpetual preferred stock represents a form of equity that also lacks a maturity date. Holders typically receive fixed dividend payments at regular intervals. These shares generally do not carry voting rights, differentiating them from common stock. A key feature is preferential treatment over common stock regarding dividend payments and claims on assets during liquidation. The distinction between cumulative and non-cumulative provisions, as discussed previously, is particularly relevant for perpetual preferred stock.

While both perpetual bonds and perpetual preferred stock share the characteristic of having no maturity date and providing regular payments, they differ in their fundamental nature and priority. Perpetual bonds are classified as debt, placing bondholders higher in the capital structure than preferred shareholders in the event of a company’s bankruptcy or liquidation. Preferred stock, though having debt-like features, is still considered equity. Furthermore, coupon payments on bonds are generally contractual obligations, while preferred stock dividends, particularly non-cumulative ones, can be suspended by the issuer without triggering a default.