Introduction

A Perpetual Floating-Rate Note (FRN) is a unique type of debt instrument that combines two distinctive features: it has no maturity date (perpetual), and it pays variable interest (floating rate) that is reset periodically based on a benchmark rate. This makes it significantly different from traditional bonds, which typically offer fixed interest and a fixed maturity date.

Perpetual FRNs are often issued by banks and financial institutions as a form of permanent capital, especially in compliance with regulatory capital norms. These instruments are particularly important in India’s banking sector under the Basel III framework, where Additional Tier 1 (AT-1) bonds function similarly to perpetual FRNs.

What Is a Perpetual Floating-Rate Note?

A Perpetual Floating-Rate Note is a bond-like security that:

• Does not mature (i.e., there is no obligation to repay the principal at any specific time).
• Pays interest indefinitely, with the rate reset periodically.
• Links the coupon rate to a benchmark index such as MIBOR, LIBOR, or repo rate, with a spread (margin).

Example:

A perpetual FRN may pay MIBOR + 2% and reset every six months. If MIBOR is 6%, the coupon for that period would be 8%.

Key Features of Perpetual FRNs

• No Maturity Date: These instruments exist indefinitely, unless called back by the issuer under specific conditions.
• Floating Interest Rate: The coupon adjusts regularly in response to a benchmark rate, reducing interest rate risk for investors.
• Callable by Issuer: Issuers often retain the option to call (redeem) the instrument after a certain period.
• Used for Regulatory Capital: Especially by banks as Additional Tier 1 capital, as defined by RBI norms.

Perpetual FRNs 

In India, banks and large financial institutions issue bonds akin to perpetual FRNs to:

• Meet capital adequacy requirements under Basel III.
• Strengthen Tier-1 capital without increasing debt burden on balance sheets.
• A well-known example in India is the issuance of AT-1 bonds, which:
• Are perpetual in nature.
• Have floating interest rates.
• Can be written down or converted into equity in case of severe financial distress.

Benefits of Perpetual FRNs

1. For Issuers:

• Acts as permanent capital without equity dilution.
• Helps meet regulatory capital norms.
• Offers flexibility in interest payouts, especially when tied to earnings performance.

2. For Investors:

• Provides regular income through periodic floating-rate interest payments.
• Lower interest rate risk compared to fixed-rate perpetual bonds.
• May offer higher yields due to their perpetual nature and associated risks.

Risks Associated with Perpetual FRNs

1. No Principal Repayment

• Since there is no maturity, the investor may never get the capital back, unless the issuer voluntarily calls the bond.

2. Credit and Default Risk

• In times of financial stress, the issuer can skip interest payments or write down the bond, especially in the case of AT-1 bonds.

3. Market Liquidity Risk

• Perpetual FRNs may not be actively traded, making it harder for investors to exit early.

4. Coupon Volatility

• Since coupons are tied to benchmarks, interest income can fluctuate significantly over time.

Who Should Invest in Perpetual FRNs?

• Institutional investors looking for long-term yield exposure.
• High net-worth individuals (HNIs) with a higher risk appetite.
• Investors who understand interest rate cycles and can handle variable returns.
• Debt fund managers seeking to diversify portfolios with hybrid instruments.
• Not ideal for conservative investors seeking capital protection or guaranteed returns.

Conclusion

A Perpetual Floating-Rate Note (FRN) is a specialised fixed-income instrument designed for long-term income generation, with interest linked to market benchmarks and no obligation for principal repayment. While it offers attractive yields and protection against rising interest rates, it also carries higher risk due to its perpetual structure and credit sensitivity.

In India, banks rely on these instruments—especially in the form of AT-1 bonds—for capital adequacy, making them an integral part of financial sector funding. For savvy investors who understand the risks and structure, perpetual FRNs can be a valuable addition to an income-generating portfolio.