Make-whole amount: Overview, definition, and example
What is a make-whole amount?
A make-whole amount refers to a pre-determined sum of money that is paid to a lender or bondholder if a borrower or issuer decides to repay a debt or bond early (before the maturity date). The purpose of the make-whole amount is to compensate the lender for the lost interest income that would have been received had the debt or bond been held until maturity. The make-whole amount is typically calculated based on the present value of the remaining interest payments that would have been made on the debt, discounted by a specific rate, often the yield on U.S. Treasury securities or a similar benchmark.
In essence, the make-whole amount ensures that the lender or bondholder is made "whole" in terms of the anticipated interest income, even if the borrower decides to pay off the debt early.
Why is a make-whole amount important?
A make-whole amount is important because it protects lenders and bondholders from the financial disadvantage of early repayment. If a borrower repays a loan or redeems a bond before its maturity, the lender would lose out on the interest payments they were expecting. The make-whole amount compensates the lender for this lost income, allowing the borrower to repay early without significant penalty while ensuring fairness to the lender.
For businesses, agreeing to a make-whole provision in a loan or bond issuance can make the borrowing terms more favorable, as it assures lenders that they won’t lose expected interest income if the loan or bond is paid off early.
Understanding the make-whole amount through an example
Imagine a company, XYZ Corp., issues a bond with a 10-year maturity and an interest rate of 5%. After 5 years, XYZ decides to pay off the bond early because interest rates have dropped and it can refinance at a lower rate. The bondholders would typically lose out on the remaining interest payments they would have received if the bond had matured as planned.
To compensate for this, the bond agreement includes a make-whole provision. The make-whole amount is calculated by determining the present value of the remaining interest payments (5% annually for the next 5 years) discounted at a rate equal to the yield on U.S. Treasury bonds of similar maturity. This ensures that the bondholders are compensated for the lost interest payments.
In another example, a company might have a loan agreement with a make-whole provision. If the company wants to repay the loan early, the make-whole amount would be calculated based on the remaining interest payments that would have been due over the remaining term of the loan, ensuring the lender is "made whole" for their expected interest income.
An example of a make-whole amount clause
Here’s how a make-whole amount clause might appear in a loan or bond agreement:
“In the event of early repayment of the loan, the Borrower shall pay a make-whole amount, which shall be equal to the present value of all remaining scheduled interest payments, discounted at the yield of U.S. Treasury securities with a similar maturity, plus 50 basis points.”
Conclusion
A make-whole amount ensures that lenders or bondholders are compensated for the loss of interest income in the event of early repayment of a debt or bond. By paying the make-whole amount, the borrower can repay early while making sure the lender is fairly compensated for their expected returns.
For businesses, understanding and negotiating the terms of a make-whole amount provision is crucial for managing potential early repayment scenarios and minimizing costs associated with refinancing or restructuring debt.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.