What’s Hard Call Protection?
Hard call protection, also known as absolute call protection, prevents the issuer from redeeming a callable bond before a defined date, often three to five years after issuance.
Knowing Hard-Call Protection
Bond buyers get interest (a coupon rate) for the bond’s life. Bondholders get the face value of the bond as the principal value at maturity. Bond yields rise when bond prices fall, and vice versa. Bondholders desire higher rates for increased interest income, whereas issuers prefer lower rates to cut borrowing costs.
Thus, issuers will retire bonds before maturity and refinance at the economy’s lower rate as interest rates fall. Repair bonds stop paying interest, requiring investors to find interest elsewhere, generally at a lower rate (reinvestment risk). Most trust indentures include rugged-call protection to safeguard callable bondholders from early repayment.
A bond issuer cannot “call” its bonds during strong call protection. Ten years of call protection is typical for corporate and municipal bonds, but five years for utility debt. One example is a bond with 15 years to maturity and five-year call protection. This indicates that the bond issuer cannot redeem the bond by repaying its principal sum during the first five years, regardless of interest rates. While the bond is “free” to call, the rugged call protection assures investors of the stated return for five years.
Since investors assume the risk of early calls, brokers often give yield-to-hard calls and yield-to-maturity statistics for callable bonds. Investors should base their judgments on the lowest of these yields, generally the hard-call date yield.
Soft call protection may partially safeguard the bond after the hard call protection time ends. This functionality requires specific circumstances to call the bond. Soft call protection requires the issuer to pay a premium to par to call in bonds before maturity. On the first call date, the issuer may be obligated to refund investors a percentage of the bond’s face value, such as 105%. Soft call provisions may also prohibit the issuer from calling a bond over its issue price. Soft call protection prevents the issuer from calling the bond for convertible callable bonds until the underlying stock price reaches a specific percentage over the conversion price.
Due to the risk of redemption before maturity, callable bonds yield more. A retail note is a bond that often offers hard-call protection.
Conclusion
- A callable bond with hard call protection, or absolute call protection, prohibits the issuer from redeeming the bond before the stipulated date, generally three to five years after issuance.
- Before the bond’s “free” call, rugged call protection assures investors of the promised return.
- Use yield-to-call to evaluate callable bonds with strong call protection.
