a type of debenture that is supported by collateral.
Secured Debenture Details
Debentures are debts issued to companies or individuals for capital-raising purposes. A secured debenture is one that is backed up by collateral against which the loan provider is secured. If the borrower defaults, the lender can simply acquire the designated assets as repayment. In a typical secured debenture agreement, crucial details include the amount borrowed, the interest rate, the terms of repayment, and, of course, the secured assets.
Banks in particular are known to manage risk and protect their investments through secured debentures, although other types of lenders can also offer the financial product. Besides being an insured loan, secured debentures offer other advantages, such as the zero voting rights requirement, which prevents the dilution of equity shareholders’ control over management.
A secured debenture is also relatively lower in cost compared to equity capital because debenture interest runs parallel with tax deduction. This simply means that the company with a secured debenture need not be taxed for its gains from the loan.
Real World Example of Secured Debenture
Baubble Inc., a milktea franchise company, is at the brink of insolvency. One of the major steps it plans to take is to either sublease or sell one of its biggest commissary buildings. However, there is a problem. The property is tied to a national bank through a secured debenture that has not been fully paid by the company at the current time.
Simply put, Baubble Inc. can neither sublease nor sell the said asset for any purpose until it repays the note in full, but the business owners can try asking the bank to allow a sale or sublease, provided they promise to pay off the loan from the proceeds. Some banks and lenders allow such an arrangement, but Baubble Inc. must first gain the bank’s permission before taking any action. Otherwise, there can be serious legal and financial consequences.
Types of Secured Debentures
Banks and lenders offer secured debentures in two types: fixed-charge and floating charge. In a fixed secured debenture, one or more specific assets secure the loan at a fixed interest rate. Companies commonly use fixed-charge debentures to raise financing capital for certain short-term operations.
On the other hand, a floating debenture requires a whole group of assets as collateral for the loan. And because of the fluctuating values of the mortgaged assets, the bank or lender will generally have no control over them. One example is a food manufacturer with a floating debenture secured against its inventory, which is expected to be in constant flux while still retaining value.
In some cases, floating secured debentures can transform into the fixed type when stipulated in the contract under certain conditions determined by the bank or lender. While there are several scenarios that can lead to such a shift, default and liquidation are the most common.
Secured Debentures vs. Secured Bonds
Secured debentures and secured bonds are both protected by some kind of collateral, but they are not the same. One of their most basic differences lies in the nature of the issuer. Debentures are often provided by private companies, while bonds usually come from financial institutions, government agencies, and the like. Secured debentures are also usually intended for short-term projects while bonds are treated as long-term investments.
Payment structure is another significant point of difference between the two financial products. With secured debentures, the borrower makes periodic payments, depending on the performance of the issuing party. With secured bonds, payments are made on an accrual basis (whether monthly, semi-annually, or annually), regardless of the issuer’s performance. Finally, when it comes to repayment, bonds are almost always given priority over debentures.