Secured Debentures Meaning: Everything You Need to Know
Secured debentures means that bonds are issued with collateral and a piece of property or other assets are offered to states and bondholders.3 min read
2. Used for Capital Funding
3. A Form of Promissory Note
4. Other Names for a Debenture
5. Purchased Through a Broker
6. Bondholder Protections
Secured debentures meaning: bonds that are issued with collateral. The party issuing the bond offers a piece of property or other assets to states and bondholders along with signed permission for those entities to take possession of the collateral if the issuer doesn't repay the debt. As an example, a city might use future property tax receipts to secure a bond while companies might use their factories as bond securities. Secured debentures have less risk associated with them than unsecured ones. This results in lower coupon rates and cuts the borrowing costs for the issuers.
Secured or Unsecured
All bonds that are backed by collateral have to be repaid before unsecured bonds. Debentures, however, are typically debt instruments that aren't secured by the personal assets or any form of collateral. Debentures are backed only by the reputation of the borrower and bond issuer's reputation unless noted as being secured when issued.
Used for Capital Funding
Government and corporations often issue these bonds as a way to secure capital funding. An indenture is used to document a debenture. This is the common practice for documenting other types of bonds as well. A certificate is issued to note the debenture, and the certificate is a written acknowledgment or acceptance of the debt that the company has taken on in the form of a bond. An advantage of a debenture over a term advance is that the debenture offers more flexibility, and there is more of a variety as related to:
- Exceptional highlights
- Loan cost
A Form of Promissory Note
Another way to describe debentures is to say that they're promissory notes that are issued to debenture holders. Debenture holders are frequently the banks that the firm uses, and they are for a time frame that is agreed upon and a premium rate that is negotiated beforehand. A debenture is the debt instrument that is set up on a medium-term to long-term basis, and big companies use debentures to borrow funds at a fixed interest rate.
Other Names for a Debenture
As a legal term, the word "debenture" was originally the document that created the debt or acknowledged it, but sometimes it's now used interchangeably with the terms:
Purchased Through a Broker
A lot of corporate debt is held as debentures; however, the United States government and many government entities also issue debentures. One example would be Treasury Securities. Investors are able to buy debentures through brokers just like other types of bonds. Debentures are typically available in $1,000 and $10,000 denominations, and they have varying maturity periods.
There are several key provisions in place to protect bondholders who buy debentures. These protections include:
- Limiting the initial bond issuance to keep the issuer from over-leveraging his or her company and to keep him or her from diluting the amount of power held by existing bondholders.
- Requiring the issuer to agree to a negative pledge clause. This makes sure issuers can't pledge assets for another security if pledging that would put repayment of the current debenture, or debt bond instrument, at risk.
- Establishing a covenant that ensures the issuer maintains a certain level of financial ratios and works within the financial limits to reduce the likelihood of default. These covenants are very common in bond issuances.
- It's also common for bondholders to be required to pay interest on the debenture before they can make any dividend payments.
Another important note about debentures is that while they're not secured by any specific property or pieces of collateral, the debt holders do have general claims against the issuers' assets and earnings. Debenture bondholders can still make a claim against any assets that haven't been specifically assigned or pledged as security against another debt.
Different shareholders do, however, have the first claim on a company's assets right alongside the company's other creditors when there aren't any specifically pledged assets and if there is no secured debt. A company that has good creditworthiness typically has no need to pledge any specific assets to be allowed to sell a bond issue because it will pay fairly low interest rates regardless.
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