call provision

Call provision

An embedded option granting a bond issuer the right to buy back all or part of an issue prior to maturity.

Call Provision

A provision in an indenture that makes a bond callable. A callable bond allows the issuer to redeem the bond before maturity. When the bond is called, the bondholder receives the par value (or sometimes more) and does not receive any more coupons. Callable bonds are issued to allow the issuers to hedge against interest rate risk. That is, if interest rates fall significantly, the issuers can call the bond and issue a new bond at a lower interest rate, reducing their liabilities. However, to protect the bondholder, most callable bonds also include call protection, which prevents the bonds from being called for a certain period of time and thereby guarantees the current interest rate for that time.

call provision

The stipulation in most bond indentures that permits the issuer to repurchase securities at a fixed price or at a series of prices before maturity. This provision operates to the detriment of investors because calls on high-interest bonds usually occur during periods of reduced interest rates. Thus, an investor whose bond is called must find another investment, often one that provides a lower return. Certain preferred stock issues are also subject to call. Also called call feature. See also make-whole call provision.
Case Study Unlike most long-term corporate and municipal bonds, U.S. Treasury bonds cannot generally be called prior to their scheduled maturity dates. The U.S. Treasury last issued callable bonds in 1984 and even these bonds could only be called in the five years prior to maturity. All U.S. Treasury bonds issued after 1984 have been noncallable. The Treasury's inability to call its bonds prior to their scheduled maturities proved to be a bonanza for investors who purchased long-term Treasury securities in the mid-1980s when interest rates were relatively high. The U.S. Treasury was required to continue paying very high interest rates on this debt into the next decade, when market interest rates had declined substantially. If these bonds had been issued with a call provision, the Treasury could have retired bonds with coupons of 11% and 12% and issued new bonds with coupons of 5% and 6%, thereby saving taxpayers billions of dollars in interest expense.
Why should I check a bond's call provision before buying it? Which types of bonds have these provisions?

Bond issuers seem to call their bonds in when bond investors least want to receive their principal back—after interest rates have already dropped. If you pay close attention to a bond's call provisions, however, you can avoid experiencing losses of principal (that is, you can avoid paying big premiums for high-coupon bonds that are about to be called in at lower premium prices or, worse yet, at par). Furthermore, if you are a short maturity buyer (let's use three years for an example), you may be able to earn a higher yield for the three-year period by purchasing a longer cushion bond that is callable in three years instead of buying a bond that matures in three years. Reason: the market will generally reward you with a higher yield to the call on the cushion bond (due to the uncertainty of its actually being called in three years) compared with the yield that the market will provide you on a similar bond that will definitely mature in three years. It is important to mention that if you invest in a cushion bond and it is not called, you will be faced with the choice of either holding a longer bond than you may have intended to hold or liquidating at market value.

Stephanie G. Bigwood, CFP, ChFC, CSA, Assistant Vice President, Lombard Securities, Incorporated, Baltimore, MD

call provision

A clause in a loan instrument that gives the lender the right to accelerate the debt upon the occurrence of certain conditions.These might include filing for bankruptcy (illegal,but it's in all the promissory notes anyway),reduction in value of the collateral,occupancy levels dropping below certain minimum levels in income-producing properties,or the catchall clause “whenever the lender deems itself insecure.”As a practical matter,it would be an unwise lender who relies solely on the “deeming itself insecure”clause,because such action almost always results in litigation in which a jury,usually of the borrower's peers,gets to decide if it was reasonable under the circumstances for the lender to panic.
References in periodicals archive ?
Prior to 1985, about 80% of all public corporate bonds included a call provision.
Inclusion of the call provision is independent of decisions about the other two provisions.
The company expects to reach its first significant milestones over the next three years, coinciding with the call provision.
One example of using the FFI approach as an analytical tool for compound instruments is in the case of bonds that contain a call provision allowing the issuer to buy back the bonds at a specified early date.
However, use of this make-whole call provision remains highly unlikely, since such a call would cost the qualified investment issuer a premium of approximately 130% over current par value.
The innovative characteristic of a make-whole call provision is that the call price floats inversely with risk-free rates.
Thatcher, 1985, "The Choice of Call Provision Terms--Evidence of the Existence of Agency Costs of Debt", Journal of Finance, 40:549-561
There are costs to refinancing, particularly if a company doesn't have a call provision on the bond or if it's not as creditworthy as it was when it first borrowed.
However, use of this make-whole call provision remains highly unlikely since such a call would cost the qualified investment issuer a premium approximately 130-140% over current par value.
Brown-Forman Corporation (NYSE:BFA) (NYSE:BFB), a quality beverage alcohol manufacturer, disclosed on Wednesday that it will redeem all of its outstanding USD250m 5% notes due in 2014 by exercising a "make-whole" call provision provided for in the notes, on or about 25 February 2013.
There are problems with TICs in that they don't have a mechanism for compelling partners in the agreement to put in money, there's no capital call provision," Napoli said.
The call provision is a covenant that is common in one form or another to all debt contracts.