hard · Debt Capital Markets bond-instruments-structures
A make-whole call lets an issuer redeem early at the greater of par or the PV of remaining cash flows discounted at the matching Treasury yield plus a fixed make-whole spread (e.g., T+25bp). A seasoned 7-year IG issue traded at a +140bp option-adjusted spread when issued. Two years later, the issuer's credit has improved so its new-issue spread for the 5-year remaining tenor is +45bp, while Treasuries are roughly unchanged.
Why does the issuer still find the make-whole call economically unattractive to exercise despite the dramatic spread tightening?
- The make-whole redemption price discounts the remaining coupons at a yield far below the bond's current market yield, so the call price exceeds market value and the issuer would overpay to retire the debt
- The make-whole spread of 25bp is added to the redemption yield, raising the discount rate above the new-issue yield so the call price falls below par and triggers an accounting loss
- Credit improvement raises the bond's market price, and since the call price is fixed at par the issuer cannot capture the gain by calling at the now-higher market level
- The narrowed 45bp new-issue spread means refinancing proceeds would be insufficient to cover the make-whole premium plus the 25bp spread paid to the calling agent
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