Noncallable

What Is Noncallable?

Noncallable is a financial security or asset with a lock-in period, i.e., these financial instruments cannot be repaid, withdrawn, redeemed, or presented for payment before maturity. A penalty is imposed on the issuer or depositor if such an asset is called in or encashed during the non-call or call protection period.

Suppose a company issues a noncallable bond with a maturity of five years at a 5% coupon rate. Then, the issuer has to pay the investor a 5% annual interest until maturity, even if the market interest rate drops to 4% per annum during this period. Thus, such securities pose interest rate risk and high borrowing costs for the issuers.

• A noncallable is a type of financial instrument that possesses the characteristic of not being callable or redeemable by the issuer before its scheduled maturity date.
• Some common types of noncallable securities are noncallable preferred stocks, bonds, certificates of deposits, and fixed deposits.
• Those prioritizing more stability and predictability in their investments rather than a higher yield might prefer noncallable securities. Also, it is suitable for investors who avoid reinvestment risk.
• On the contrary, callable indicates those financial instruments with an early redemption feature or call provision permitting the issuer to buy back the securities before maturity.

Noncallable Explained

A noncallable refers to a specific type of financial security, commonly a noncallable bond that cannot be redeemed or called back by the issuer before its predetermined maturity date. When an issuer sells such bonds to the investors, they commit to making regular interest payments to the bondholders until the maturity date, at which point they return the principal amount. Once issued, the issuer cannot redeem these securities before the specified maturity date. This provides more certainty to the investors of receiving the regular cash flow from such investments.

Hence, investors seeking stability and a predictable income stream may prefer noncallable bonds due to the absence of uncertainty associated with potential early redemption. Due to this benefit, such securities often offer investors lower interest rates than callable. One can identify the noncallable security feature through the Call Provision stated in the trust indenture or share prospectus during the issuance of such a security.

Some bonds may be noncallable for a specific period post-issuance. This duration is the call protection period. Though it mitigates premature redemption risk for the investors, the issuers of noncallable are vulnerable to interest rate risk and higher debt cost when the market interest rates fall.

Let us find some of the common noncallable financial instruments below:

• Noncallable Bonds: The various municipal and treasury bonds come with a no-call provision or a trust indenture that one cannot redeem before a predetermined period. Say, a 10-year Treasury bond can only be called after five years of its issuance.
• Fixed Deposits: The regular fixed deposits are often noncallable, as stated by the word 'fixed.' The depositors cannot encash the amount deposited in such accounts before maturity. Suppose a five-year FD can only be encashed after the completion of five years from the date of deposit.
• Noncallable Preferred Stocks: The issuer of a noncallable preferred stock cannot forcefully cancel or buy back the outstanding shares at the given price during the call protection period or after a specified date.

Features

The noncallable securities diversify an investor's portfolio due to the following characteristics, which distinguish them from other forms of assets:

• Fixed Maturity Date: Noncallable securities have a specific maturity date at which the investor receives the principal amount back. The issuer cannot call back or redeem the security before this date.
• Penalty: If the issuer redeems such as security before its maturity, a heavy penalty falls on such redemption.
• Price Stability: These securities generally exhibit greater price stability since the investors are confident that the security will remain outstanding until maturity, reducing the price fluctuations due to possible early redemption uncertainty.
• Lower Yield and Interest Rate: Such bonds and other assets have lower interest rates or yield than callable financial instruments. This is due to their call protection period feature.
• Longer Investment Horizon: Noncallable securities are suitable for investors with a long-term investment perspective. This is because they provide a steady income stream until maturity.
• Minimal Reinvestment Risk: These financial instruments have a limited reinvestment risk, protecting them from reinvesting the proceeds (from early redemption) in a potentially lower-interest-rate environment.
• Limited Flexibility and Interest Rate Risk: From the issuer's perspective, noncallable securities provide less flexibility in managing their debt or capital structure since they must pay a specific interest rate to the investors until maturity, even if the market interest rates are low.
• Diversification: These securities add a stable income component with a fixed maturity date to an investment portfolio, diversifying the risk and return profile of the overall portfolio.

Examples

Check out these examples to get a better idea:

Example #1

In noncallable, the security's issuer must have the authority to force the investor to sell it back before the agreed-upon maturity date. On July 22, 2023, Fannie Mae's YTD noncallable debt issuance was reported as follows:

Source

Example #2

Suppose Anne buys municipal bonds issued by the New York State with a no-call provision of ten years from the date of issuance until maturity, i.e., on January 07, 2029. Then, the state government cannot redeem these bonds before January 7, 2029, unless paying a penalty.

Say, if the interest rate of the bond was 7.5% p.a. at the time of issue but declined to 6.2% p.a. as of January 01, 2023, the NY government has to pay 1.3% higher than the market rate. Thus, the government decides to call the bond earlier by paying a penalty of 4% on the overall bond value. If Anne is to receive $1000 on maturity, now she will receive $1040 ($40 being the penalty amount). The NY State reissued these noncallable bonds at an interest rate of 6.2% p.a.

Callable vs Noncallable

In finance, callable and noncallable describe specific financial instruments, like bonds or preferred stocks, based on their redemption or call provision before their scheduled maturity date. Let us now differentiate between these two types of securities:

Basis	Callable	Noncallable
Definition	A callable is a term used for the financial instrument wherein the issuer has the right to redeem the security before its scheduled maturity date but is not obliged to do so.	A noncallable indicates that the issuer doesn't have the right to redeem the security before its scheduled maturity date. If redeemed early, the issuer is liable to pay a penalty on such redemption.
Call Provision	Such bonds or preference stocks have a call provision allowing issuers to redeem the security before it matures.	Such securities don't have a call provision restricting their early redemption.
Premature Withdrawal	Callable FDs allow for early withdrawals without any penalty after a specific period.	Noncallable FDs restrict the premature withdrawal of funds by imposing penalties on the depositors.
Interest Rate and Yield	Such securities have higher interest rates to compensate for the early call provision drawback.	Being more secured, such securities offer lower interest rates.
Overall Returns	The yield of callable securities can be lower due to their early redemption.	The overall return of such securities is comparatively higher since they provide fixed and stable returns till their maturity.
FDIC Insurance	The FDIC usually insures a callable CD.	Such securities are not FDIC insured.
Interest Rate Risk	Limited	Considerable
Reinvestment Risk	High	Low
Debt Refinancing	If the market interest rate decreases, the issuer can refinance the debt after its early redemption at a lower cost.	Not possible
Flexibility	High	Low
Price Stability	Low	High
Beneficial For	Issuers of callable bonds, CDs, or preference stocks	Investors of noncallable bonds, CDs, or preference stocks
Suitable For	Such securities are advisable for investors who seek higher returns over stability.	Such securities are not FDIC-insured.

Frequently Asked Questions (FAQs)

Recommended Articles

This article has been a guide to what is Noncallable. Here, we explain the topic in detail, including its comparison with callable, features, and examples. You may also find some useful articles here -

• Make-Whole Call Provision
• Dim Sum Bonds
• Bonds Payable