So I always thought that for a bond to be called normally the rate being paid by the bond must be higher than the issuer can get by get by borrowing via a new issue (my gut also tells me it has to be lower by a good margin to make it worthwhile and cover the costs of new issue).
I have never dealt with callables beyond a textbook reading, however today I heard a reputable investment manager state that they often get called back on the first call date and that issuers can be expected to not disappoint investors and to do it…
Is there any truth to the above, is this limited to certain markets? It seems to defeat the point…
In my experience, I don’t think it gets called on the first call date since there is usually a premium that needs to be paid by the issuer. I don’t deal much in bonds, but I haven’t seen many publicly traded companies pay a premium to call a bond on the first call date (unless as you stated, the interest rate is lower and the Company can refinance). I am sure if this was happening all over the place, the shareholders would be pissed.
However, the bond will usually get called / refinanced prior to the maturity date at par because many issuers are publicly traded and would not like to have that debt balance sitting as a short-term liability.
There is definitely truth to the above. Issuers will often issue bonds with coupon rates that scale up over time, but also callable at those times. If interest rates haven’t risen in line with the bond, then they will be called. So you should evaluate the bond as YTC, not YTM.
I would like to see empirical studies supporting this, but my personal opinion is that callable bonds are not likely to be called in the short-term (the first call date).
This to take place mainly requires that interest rates fluctuate a lot within a year, but this is not true. Quite variables prevent that calling a bond becomes profitable: call premiums, issuance costs, reputation to investors, etc.