Private credit is rarely a hold-to-maturity story. A sponsor buys a business, fixes or grows it over three to five years, then sells or refinances. The loan financing the deal may run six to seven years on paper, but in practice it is repaid as soon as the plan succeeds.
Lenders know this, so they negotiate what happens on early repayment. Those clauses change the expected cash flows, which means they change the price. But what are these features and what do they mean for valuation?
Callability and puttability
Callability is the borrower’s right to repay before maturity. In private credit it is rarely free. Lenders protect themselves in a few ways:
- Non-call period. A period during which prepayment is not allowed.
- Prepayment penalty. The fee the borrower pays the lender for repaying before maturity. An NC1/102/101 hard call means no call in year one, 2% premium for repayment in year two, 1% in year three, par after that.
- Make-whole. The borrower compensates the lender for the interest it would have earned. Terms vary: some agreements require the full, undiscounted interest for the first one or two years, others cover the remaining life, discounted at the risk-free rate or risk-free plus a nominal premium, e.g. 50 bps. Terms vary and loan agreements are the source of truth.
The pattern matters: protection is front-loaded and decays. By year three or four, most borrowers can walk away at par.
Puttability is the mirror image, the lender’s right to demand early repayment. It is far less common in private loans, for three reasons. First, floating-rate coupons already shield the lender from rising base rates, which removes the classic motive for a bond put. Second, covenants and events of default give lenders a contractual route out when credit deteriorates. Third, change of control usually triggers mandatory prepayment anyway, which already works like a put at par.
The maths
From the lender’s side:
Callable loan = straight loan − value of the borrower’s call option
Puttable loan = straight loan + value of the lender’s put option
Start with the straight loan. Its price moves inversely to the yield the market demands. When yields fall, because base rates drop (for fixed-rate loans) or the borrower’s credit improves, the cash flows are worth more and the price climbs above par.
[CHART 1 – “Lower yields, higher price” – image upload pending: callable-loan-price-yield-chart.png]
Now imagine the loan had a call option. The value of the borrower’s call option would follow the loan: as the value of the loan goes up, so does the value of the option. While the loan is worth less than the call price, the option is worth little. For example, if the market values the loan at 97, nobody repays it at 101. As the straight loan climbs through 101, the option moves into the money and its value rises increasingly in step with the loan.
That is the key mechanism. Every point the straight loan gains is increasingly offset by a point of option value going the other way. The callable loan’s price flattens and settles near the call price once the loan is callable, however far yields fall.
[CHART 2 – “The call caps the price as yields fall” – image upload pending: callable-loan-call-cap-chart.png]
In interest rate terms, the borrower’s call on a fixed-rate loan is a receiver swaption, Bermudan where there are several call dates: the right to swap its fixed coupon for floating, which is the same as repaying and refinancing at today’s lower rate. Valuers typically price it on an interest rate tree, checking at each call date whether repaying beats continuing, then working back to today. Most private credit floats, though, so falling base rates give the borrower little reason to call. What moves is its spread, and the same approach is applied with spread as the variable.
In practice
When remaining life is short, say a year or two, with the premium near zero, valuers typically take a shortcut: if the DCF value would exceed the call price, they cap it at the call price. With little time left, the time value in the option is less significant, hence the shortcut. With a longer time to maturity, however, the option’s time value may start to play a role.
An example: why it matters for valuation
Take a deliberately optimistic example: a five-year loan issued at par at Euribor + 450 bps to a single-B borrower, with NC1/102/101 call protection. Eighteen months in, the business has deleveraged and now looks like BB+ credit. Comparable spreads sit around 250 bps (illustrative).
Run a plain DCF on the remaining three and a half years. Roughly 200 bps of excess margin, discounted at the new, tighter rate, puts the loan around 106.5 (illustrative).
Now add the call option foreseen in the loan agreement. The borrower can refinance at Euribor + 250 and repay at 102. No rational buyer pays 106.5 for a loan that can be taken away at 102. Fair value sits close to the call price, not at 106.5.
Ignoring callability does not just add noise. It systematically overstates the best-performing loans in the book, the ones a valuer is least likely to challenge. Loan valuation is not just about looking at spreads, it’s about keeping the bigger picture in mind.
Related pages
- Interest Rate Engine: arm’s length interest rates and credit spreads — Credit Spreads Pro, the rating tool and the bond database
- Introduction to loan valuation and the private debt market — how private loans are valued where no market quote exists
- Private credit: rating unrated borrowers — the credit side of the same loan book
- Pricing loans with warrants attached — another embedded option that changes a loan’s value
- Valuation approaches for loans and borrowings — DCF and fair value methods for debt instruments
- Grounding / Facts — entity definition, data provenance and methodology
