Make-Whole Call Provisions
What is a Make-Whole Call?
A make-whole call is a type of call provision in a bond allowing the borrower to pay off remaining debt early. The borrower has to make a lump sum payment to the holder derived from an earlier agreed upon formula based on the net present value (NPV) of future coupon payments not paid because of the call.
How is a Make-Whole Call Different from a Regular Call Feature?
A typical call option enables the issuer to benefit by prepaying the debt when market yields decline. In a declining interest rate environment, the settlement amount of a typical call option is less than what the fair value of the debt would have been absent the call option. In contrast, a make-whole provision involves settlement typically determined by discounting the debt’s remaining contractual cash flows at a specified small spread over an appropriate Treasury rate.
The typical make-whole calculation results in a settlement amount significantly above the debt’s current fair value based on the issuer’s current spread over the current Treasury rate. The make-whole provision contains a premium settlement amount to penalize the debtor for prepaying the debt and to compensate the investor (i.e. attempt to make the investor “whole”) for its being forced to recognize a taxable gain upon the early settlement of the bond.
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