Perpetual bonds – out of the frying pan into the fire?

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Recently there has been massive perpetual bond issues from major banks and also some city councils These issues are for core capital needs. These bonds have appeared as people have fled finance companies, now they run to the “safe haven” of bank bonds.

But is it out of the frying pan into the fire? Yes I think so!

Why are banks suddenly issuing hundreds of millions in bonds now, especially with the so called “windfall” in deposits coming in, due to people moving funds out of finance companies and into bank accounts. Why do they suddenly need core capital? Simple they are in trouble as their asset backing is shrinking, putting them underwater compared to their loan book. One of the “big four” Australian banks lists its New Zealand operations as having liabilities that are 92% of assets. (I would suspect now they are underwater). So these bond issues are needed but not a good sign for banks. (Or city councils).

These are perpetual bonds, in other words they never need expire, once the bank has the cash proceeds from selling these bonds, they never need to repay that money. (They could, at set times but they don’t need to). The bonds are free trading so you can on-sell them on the open market

I read prospectuses my stock broker sent me from some of the largest Australian banks. (If my stock broker is on my email list please don’t take this personally).But I would not touch them with a barge pole.

Why? Where do I start!

The parent bank uses a sibling company to issue the bonds, the sibling or separate trading company sells bonds and passes proceeds on to the parent bank, the bank then has the cash and may never pay it back. The bank then pays dividends to the issuing company who then distributes those proceeds to the bond holders. The bonds are tradable on the open market so are valued based on the dividend (yield) only, as they may never be refunded. Now here is the kicker, if the directors of the parent bank decided that due to difficult market conditions, or if it would be too detremental for the bank to pay a dividend, they can decide not to pay one at all! (Plus the parent bank does not accept liability for the issuing bank or trading company).

Now how much do you think bonds trade for that don’t pay any dividend, or interest? Not much, if no dividend was paid these bond prices would collapse.

Hundreds of millions of these bonds have been sold in New Zealand alone, I’m very concerned about these bonds. I recommend discussing this issue with friends and family, get the message out to be very careful, read everything!

But will the banks really decide not to pay dividends at some point? Well why not?

I think the current and coming market place may “justify” it for years.

If only people had put money into precious metals instead of finance companies they would be discussing 100% gains instead of lifetime savings lost, now many are running into the next trap. Again why not buy precious metals, they will never be worthless, and in my opinion likely to be worth a lot more in coming years as inflation worsens for things we need, and at the same time overpriced non- productive assets come down.

After reading various perpetual bond prospectuses, I have made a quick check list of issues to look for and consider carefully before investing:

Possible warning signs:

  1. The number of bonds proposed for issue is stated, but there is an option for the bond issue to be increased or is unlimited.
  2. The rate of return (Interest or dividend paid) is set by an independent external statistic they have no control over.
  3. The Interest or dividend payment can be temporarily or permanently stopped by decision from parent companies directors.
  4. The parent company receiving funds from bond issues accepts no liability for the company issuing the bonds.
  5. The company’s asset base compared to liabilities? Consider that a bank, or city council has many property assets, if property falls (and I expect it to for some years), then will their liabilities become more than their assets?

Banks and city councils can and do go broke, I do not consider them crash proof. At this time I recommend treating their prospectuses like any other companies.

I think now and more so in the future people will be looking for a safe haven once bonds are found wanting after real inflation rates are realized. Assets of all types will be sold down to meet debt payments, we are seeing that now. As soon as borrowing stops, the pyramid debt money system falls over.

In my next article I will discuss where all this leads, and what we can do to protect our assets, you can probably guess it will be something to do with gold.

Sincerely

Andrew Palmer

 

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