Make-Whole Premium
Hi All,
I am trying to calculate the make-whole fees on a current bond. The bond has a par value of $750, but its current fair value is $823 million.
The current price is also 106.3 and the next call price is 103.06 which occurs in June 2016.
Can someone help me calculate the make-whole fee? It is a bit tricky since the bonds are no where near par value, so not sure how to calculate the make whole....
Make Whole Premium
This make whole premium may be payed if an issuer redeems a bond prior to the bonds maturity date. The following is a formula for the calculation of said premium.
From The make-whole premium is equal to the excess of:
- the present values of each remaining interest payment on the bonds for the period from the redemption date through the end of the non-call period, plus the present value of the redemption payment that would be due if the issuer redeemed the bonds on the first day after the end of the non-call period,
- the principal amount of the bonds.
over
The make whole call premium can be calculated rather simply using Bloomberg.
Calculating Premium of Make Whole Call using Bloomberg
From certified user @mossy695"
Open the bond in Bloomberg and go to the YTC M screen. From there you simply add the T+X MWC spread to the applicable curve (shown on the screen - curve to custom/first call) and enter that in as your YTC, then solve for current price.
The make whole is going to be defined in the bond offering document. The most common ones I have seen involve all future principal/interest payments PV'd back to the date you want to redeem (today) using a PV factor of Treasuries + a spread, but again, this will be defined very clearly in the bond documents. Then to calculate the make whole premium you will just PV everything back to today and see what % of par that is (probably very high considering you are using interest).
Generally make whole provisions just tell you the price, as they are often structured as put options if a change-of-control event happens. If no change of control, you call at the appropriate price, if the bond is callable. If not, you have to wait until first call date.
I actually haven't seen the discount all future cashflows (including interest) at treasury + spread, although it makes some theoretical sense. As you said though it would make the bond functionally uncallable because of the associated make whole expense.
Just to be clear, there are several types of 'make-whole' provisions. I generally think of them in three different categories:
Fixed Premium Make-Whole Provision: While not really a make-whole, it sometimes is a simplified version of one. This is really just a fixed premium paid upon redemption. For example, an issuer held call option that allows the issuer to call the debt at 105 / 103 / 101 / 100 at different dates in the future - perhaps 2 years / 3 / 4 / 5+ after issuance. They aren't indexed to something, but are trying to achieve the same basic economics of compensating the investor for lost cash flows.
Interest Make-Whole: Provision that provides a premium based on remaining contractual cash flows (either till maturity or some point in the future) discounted at a specified small spread (usually 30-60 bps, most commonly 50 bps) over the then-current US Treasury rate. This make-whole amount compensates the investor forgoing future interest payments on the debt after conversion or redemption or some other specified event.
Time Make-Whole (Convertible Instrument): Generally designed to compensate the investor for lost time value related to the remaining term of the conversion option because of the occurrence of certain events that result in early settlement of the instrument. Usually, the number of additional shares to be provided to the investor is based on a table put together with axes stock price and time.
Often these are contingently exercisable upon some predetermined event and the premiums may be different based on which triggering event occurs (change in control, fundamental change, failure to consummate transaction, etc.).
So it really depends on which type you are talking about. Some of these take into account the current fair value of the instrument while others don't, but the feature itself drives some valuation considerations.
Thank you all. That's very helpful. It appears it is a combination of interest and fixed premium. Acordingly, the langusge is as follows:
The make whole price is sum of the present values of (a) the redemption price of such notes at June 15, 2014(103.785%) and (b) the remaining scheduled payments of interest from the redemption date to June 15, 2014 (not including any portion of such payments of interest accrued as of the redemption date) discounted back to the redemption date on a semi-annual basis (assuming a 360-day year consisting of twelve 30-day months) at the Treasury Rate (as defined below) plus 50 basis points;
So, assuming redemption daye is June 15, 2013, I would use the 1 year treasury rate (since next call date is a year from the redemption date) 25bps for simplicity, + 50 bps, for total of 75 basis points as discount rate. (1.0075).
1037.85/(1.0075) + ((5%*1000))/1.0075= make whole price.
Is that correct? Assuming coupon is 5% and par is 1000.
Then the premium is (make-whole price) /(par) -1
Does the analysis change in any way if current bond price is at a 10% premium? Or is there other calcs I should run to determine whether or not t makes sense to take out the bonds.? Thanks for all the help....
The feature you are dealing with is pretty standard. Usually an interest make whole is written such that the premium is the higher of (1) 1% of par or (2) the difference between the carrying amount and the present value of the contractual cash flows etc....
Usually that second piece (which is what you copied out) assumes the redemption value at the particular date in the future. That is, I would bet that whatever debt you are looking at also has a Company held call option at after June 15, 2014 that is a fixed premium call option at 103.785%. Anyway - that is a pretty typical option based on what you've explained.
Calculation That calculation is mostly right. Of course, in theory, I assume that the interest is paid quarterly or semi-annually, so you would use the actual timing of those cash flows. But yeah, the point is to project contractual cash flows and discount them back at the applicable discount rate (treasury + 50 bps). This will get to a positive PV - that is, a PV greater than the carrying amount and the difference is the price of redemption / or the premium paid upon redemption.
I don't think it matters what the current FV of the bond is trading at. You are worried about projecting the cash flows right? That doesn't really have anything to do with the stated rate of the bond vs the market rate and how it is trading. Of course, assuming a transparent market, this option would be factored into the fair value by investors.
Analysis Really, the consideration is this: Does paying the premium (a cash concept) today (likely by issuing new debt and financing the redemption) give me a better answer than paying the stated rate on this bond till maturity? In other words, I assume the reason the bond is trading at a 10% premium is that it has a higher stated interest rate than what market would offer. So what the company is considering is whether they should issue a market rate bond (cheaper interest) and take the upfront cash impact of paying the make-whole premium today. The analysis for that type of decision is really just a DCF comparison.
That is very helpful. Glad it is mostly correct. Would you happen to have a guide / template for calculating the NPV of refinancing savings?
So basically it is probably an overpriced muni with some crap insurance.
Open the bond in Bloomberg and go to the YTC M screen. From there you simply add the T+X MWC spread to the applicable curve (shown on the screen - curve to custom/first call) and enter that in as your YTC, then solve for current price.
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