What Is a Make Whole Call?
A make whole call provision is a type of call provision on a bond allowing the issuer to pay off remaining debt early. The issuer typically has to make a lump sum payment to the investor derived from a formula based on the net present value (NPV) of future coupon payments that will not be paid incrementally because of the call combined with the principal payment the investor would have received at maturity.
Make Whole Call Explained
Make whole call provisions are defined in the indenture of a bond. These provisions began to be included in bond indentures in the 1990s. Issuers typically don't expect to have to use this type of call provision, and make whole calls are rarely exercised. However, if the issuer does decide to utilize its make whole call provision on a bond, then investors will be compensated, or made whole, for the remaining payments and principal from the bond as noted within the bond's indenture.
Payment to Investors
In a make whole call, the investor receives a lump sum payment from the issuer for the NPV of all of the future cash flows of the bond as agreed upon within the indenture. This typically includes the remaining coupon payments associated with the bond under the make whole call provision and the par value principal payment of the bond. A lump sum payment paid to an investor in a make whole call provision is equal to the NPV of these future payments as agreed upon in the make whole call provision within the indenture. The NPV is calculated based on the market discount rate.
Make whole calls are typically exercised when rates have decreased, so the discount rate for the NPV calculation is likely to be lower than the initial rate included in the offering of the bond, which works to the benefit of the investor. A lower NPV discount rate can make the make whole call payments slightly more expensive for the issuer. The cost of a make whole call can often be significant, so such provisions are rarely invoked.
Exercising a Make Whole Call Provision
While make whole call provisions can be expensive to exercise, requiring a full lump sum payment, companies that utilize make whole call provisions usually do so because rates have fallen. In an interest rate environment where rates have decreased or are trending lower, a company has added incentive to exercise make whole call provisions. If interest rates have decreased, then issuers of corporate bonds can issue new bonds at a lower rate of interest, requiring lower coupon payments to their investors.