Perpetual Infratil Infrastructure Bonds (PiiBs)
This page updated December 2011At present Infratil has eight bonds outstanding and about the same number of bank loans. All but one of these obligations has a market value of at least par. Ie in all but one instance if Infratil were to offer to buy back the bond or loan it would be required to pay at least 100 cents in the dollar. The exception is the PiiBs. The market value of these securities is about $0.55 per $1.00.
Outlined below is an explanation of why the PiiBs are such a poorly performing security, why Infratil is limited in its ability to “bailout” PiiB-holders and what may happen in future to their yield and value.
What are PiiBs ?
Key features of PiiBs include:
• PiiB are perpetual, like a share rather than a fixed-maturity bond. Infratil is only obliged to repay them in certain exceptional situations, for instance if Infratil is taken over or is required by its loan covenants to repay all of its debt.
• The PiiB interest coupon is set each 15 November at 1.5% over the one year bank base rate as at that day. Interest is paid quarterly.
• Since their issuance, the PiiB annual coupon rates have been, respectively, 9.00% 10.27% 6.95% 4.97% 4.99% 4.22%. The next reset will be on 15 November 2012.
• PiiBs are traded on the NZDX market. Recently the price range has mainly been between $0.60 and $0.54 per $1.00 face value.
What went wrong?
Investors purchased PiiBs because they were a high yielding bond but as the coupon declined (because the Reserve Bank lowered short term interest rates) this ceased to be the case. PiiB-holders who then chose to sell their bonds found that the price had also fallen.
Today an investor with $20,000 face value of PiiBs will receive $844 of interest over the next year.
Sale of those PiiBs at $0.55 per $1.00 of face value would realize $11,000. If that $11,000 were invested in 8% bonds the return would be $880 of interest over the next year.
Looked at from the perspective of a “new investor” contemplating which security to purchase, the cash earnings would be approximately the same on a new issue bond with an 8% coupon and a PiiB with a coupon of 4.22% and a price of $0.55. The PiiB price has moved so that the cash yield has remained roughly in line with the cash yield on bonds with fixed coupons.
A number of PiiB-holders have noted that it is unfair that the PiiB are returning 4.22% while the latest Infratil bonds are returning 8.0%. This may indeed not be fair, but it reflects market realities. Infratil has a contractual obligation to pay a specified coupon rate on the PiiBs, at present that rate is 4.22%. The offer of new bonds is at a rate which investors require to lend for six years on a fixed return basis, which is 8.0%.
Could Infratil bailout the PiiB-holders?
The investment performance of the PiiBs has disappointed investors and issuer alike. The nature of the New Zealand capital markets makes it generally undesirable for a company such as Infratil to have a large group of disappointed investors, and the investors’ advisers who originally recommended the PiiB would also like to see the lot of investors improved. Two ways are suggested to bring this about. The PiiBs could be repurchased or the PiiB could be swapped for a “better” instrument. These suggestions have not been taken up, for reasons noted below:
1. RepurchaseOver the last 3 years, Infratil has repurchased approximately $3 million face-value of PiiB for about $1.8 million. These repurchases have occurred with the intention of ensuring that the market is liquid. At times in NZ there can be more sellers than buyers for a security and a determined seller could be obliged to accept an absurdly and unfairly low price. To avoid this situation, Infratil has occasionally purchased PiiB, which has given other investors confidence, and has ensured a relatively orderly market.
Investors may not be happy selling at $0.55-$0.60 per $1.00, but at least they are receiving an approximately fair price.
Naturally it has been suggested that Infratil could (or should) buy back the PiiBs at a much higher price.
There are impediments to the Infratil board endorsing this. Today, the market price of the PiiB is $0.55. If Infratil offered to acquire them for $1.00 it would represent a material transfer of value from Infratil’s shareholders to its bondholders. In such a situation, would the directors be fulfilling their duty to act in Infratil’s best interest? What would be the over-riding merits of offering to buy securities with a market value of $130 million for $237 million?
To date it has not been possible to identify how Infratil’s shareholders would benefit to an extent that a substantially “above market” bid for the PiiBs would be warranted.
Any value transfer between one class of Infratil security holders and another must pass the test of leaving neither worse off. The repurchase of PiiBs at an above-market price would be transferring value from shareholders to bondholders rather than creating a win/win.
2. Security swap
Broadly, three security swap deals have been suggested, each idea (and their variants) is flawed:
A. Offer to swap the PiiB to a conventional bond
For instance, offer PiiB-holders the option of swapping into a conventional coupon bond, eg. “$1.00 of PiiB for $1.00 of 8% coupon bonds maturing in 2017”.
The problem with this is the same as the problem with the repurchase. It would represent a transfer of value as Infratil would be issuing a bond with a market value of $1.00 for one with a market value of $0.55.
B. Offer to swap to a bond with other features and a low value
One variation suggested is for Infratil to offer to swap the PiiBs for a bond which pays no interest and matures in 8 years. The zero coupon bond and the PiiB would both have a market value of $0.55 but the swap may be attractive to PiiB holders who are willing to forego interest in exchange for getting their money back, even if it takes 8 years.
The investors who accepted such an offer could feel better, but in reality it would be smoke and mirrors. If they put all the interest they received from their PiiBs into a bank account they would eventually also “get all their money back”.
A range of such swaps have been suggested to make investors feel better.
C. A swap to shares
At present the Infratil share price is $1.80 and the PiiB price is $0.55. Infratil could offer to swap 1 share for 3.27 PiiBs.
There is no impediment to PiiB-holders doing this themselves as they can contact their broker and sell the PiiBs and buy the shares.
D. Hybrid
There are a number of other options which are combinations of the three outlined above. Each suggestion has also run into one of the three flaws: there can’t be a value transfer, or smoke and mirrors, or just a deal which could readily be done in the market without Infratil involvement.
Infratil hasn’t taken steps to "replace the one bad instrument it has issued" because it can't, or because the “fix” would be tantamount to offering a placebo. Some people may end up taking the placebo and feeling better, a bigger group are likely to see the gesture as a deceit.
Someone once said "for every complex question there is an answer that is clear, simple and wrong"; that is the predicament created by the PiiB.
But, as noted below, the situation for holders is not hopeless (even if it is very disappointing).
What next?As described above, what matters for PiiB-holders is the coupon rate. If this rises it will provide a better return, and it may also result in an increase in the PiiB market price. As shown below (see the graph) a low coupon and a low price have gone hand in hand, and probably the converse will also be true when the coupon rises.
What coupon can PiiB-holders expect in future? The current financial environment does not allow confident forecasts as economists and analysts are struggling to anticipate developments. With that proviso, the following table shows the one year bank rate the major NZ banks and the Reserve Bank are forecasting (as at 10 December 2011) for the next three Novembers.
Bank Base Rate + 1.5%
| Nov 2012 | Nov 2013 | Nov 2014 | |
| Current actual | 4.43 | 4.96 | 5.52 |
| Reserve Bank | 5.30 | 5.50 | - |
| Westpac | 5.20 | 6.15 | 6.45 |
| ANZ | 5.01 | 6.24 | 6.49 |
| BNZ | 5.70 | 6.17 | 6.24 |
| ASB | 5.00 | 5.70 | 5.70 |
| Average | 5.25 | 5.95 | 6.17 |
However, as noted above, forecasts have to be “taken with a pinch of salt”. The last 3 coupon have been 4.97%, 4.99% and 4.22% and back in 2009 almost no one was forecasting rates to remain as low for as long as they have.
If the average forecasts are correct:
On 15 November 2012 the coupon will be reset to 5.25%
On 15 November 2013 the coupon will be reset to 5.95%
On 15 November 2014 the coupon will be reset to 6.17%
In other words, the banks believe the most likely course for interest rates is up, but not (in the next few years) back to the average levels of the last decade, which would mean a PiiB coupon rate of 7.75%.
Even the modest increases forecast may not happen. Today it is possible to fix rates in advance and those rates are the top line of the table; they are lower than the bank forecasts.
In New Zealand short term interest rates tend to move in line with inflation. When the Reserve Bank becomes concerned about prices rising it is anticipated that interest rates will be lifted.
If the PiiB coupon rises, will the price follow?
Over 2005 and 2006 when the PiiBs were issued , so too were several other very similar bonds.
| Issuer | Amount | Interest rate terms |
| Infratil | $240m | Coupon rate reset annually on 15 November at 1.5% over the 1 year swap rate |
| ASB | $200m | Rate reset annually in November at 1.3% over the 1 year swap rate |
| ASB | $350m | Rate reset annually in May at 1% over the 1 year swap rate |
| Credit Agricole | $250m | 10.4% until December 2012 when the Coupon is reset at 1.9% over the 5 year swap rate |
| Fonterra | $35m | Coupon rate reset annually in July at 1.7% over the 1 year Government Stock rate |
| Origin Energy Contact Finance | $200m | Rate reset annually in October at 1.5% over the 1 year swap rate |
| Rabobank Nederland | $900m | Coupon rate reset annually in October at 0.76% over the 1 year swap rate |
The graph below shows the relationship between the one-year bank base rate (the red line) and the market price of three of the bonds listed above.
The top, purple, line shows the price of the bonds issued by Rabobank. The blue line is the PiiB price. The green line is the price of the Origin Energy bond. It is apparent that a low base rate (and hence coupon on the bonds) has resulted in a lower bond price. Probably it is reasonable to infer that a rising coupon will increase the PiiB price.
PiiB Returns From Here
An investor who buys PiiB today at $0.55 per $1.00 will receive an overall return determined by both the annual coupon rate and the eventual sale price.
The following table shows a likely range of yields for a three year period from now. To explain the two shaded squares:
• An unfortunate investor who buys a PiiB today at $0.55 and receives the low average coupon over the next three years of 4.54% and sells their bonds for $0.50, will have an average return on the money they invest of 5.4%pa. for the three years.
• A fortunate investor who buys a PiiB today at $0.55 and receives the high average coupon over the next three years of 5.39% and sells their bonds for $0.60, will have an average return of 12.5%pa. for the three years.
The actual yield may be well outside of these ranges, but the table shows outcomes consistent with bank forecasts of coupon rates over the period to the end of 2014 and historic PiiB prices.
| Average Coupon 4.54% pa. | Average Coupon 5.14% pa. | Average Coupon 5.39% pa. | |
| Price =$0.50 | 5.4% pa. | 6.5% pa. | 7.0% |
| Price=$0.55 | 8.3% pa. | 9.3% pa. | 9.8% pa. |
| Price=$0.60 | 11.0%pa. | 12.0% pa | 12.5% pa. |
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