A debenture is an agreement that is understood between a borrower and a lender that is positioned against your company’s assets.
It usually includes all of the company assets and it is called a floating charge debenture. This is because in lots of cases, the assets are changing daily.
For instance, the stock in a business is changing daily.
Debenture loans are put in place in order to secure any assets if the company fails. In this event, the charge will become fixed at any point of time.
A debenture does not rely on collateral. For this reason, they are required to rely on the reputation of the issuer.
These loans are often used to raise funds by governments or corporations. Read on for more information on debenture loans!
Secured Debentures
Secured debentures are when banks secure your interests. This is required whenever someone is providing finance for something where they believe they may be at risk of losing money.
In most cases, the debenture will be fixed which means that the bank will become a secured creditor. This is organized on a floating charge basis as this provides the banks with extra security.
What Are The Risks Of Debenture Loans?
Debenture loans provide security to the bank when your circumstances change.
This is so that they are protected if anything happens that changes the nature of the relationship between you and the bank.
This means that the bank is able to put administrators in place if the company ends up encountering any problems.
There are a few risks that come alongside debenture loans, these include:
Strategic Use
Directors have the chance to use debentures strategically. They are able to use the debenture loan to look after their own interests when they are lending to a company.
The way this works is that if the debenture is registered at the Companies House during the time of the loan then the debenture is able to secure the assets of the company for the director of the company,
Investing In Debentures
It is possible to make money off debenture loans. This is because, in recent years, investments in debentures have grown in popularity.
While it is still risky to invest in debentures, it is slightly less risky than investing in stocks.
This is because the debenture loan means that you are guaranteed payments with great interest rates. This is the case until the maturity period is over.
You will be making money on the interest rather than the value that the stock holds.
Features Of A Debenture Loan
When you are issuing a debenture you will first need to have a trust indenture drafted. This is the agreement between the trustee and the issuing corporation.
This agreement is the management technique of the bank to manage the interest of the investors.
Below are some of the features of a debenture loan that it is important to understand:
Interest Rate
The interest rate is either a fixed rate or a floating rate. Usually, a floating rate will be tied to a benchmark.
This is usually something like a 10 year treasury bond. These will often change with the benchmark.
Credit Rating
The loan will be based on the company’s credit rating. Ultimately, the credit rating will impact the interest rate that certain investors will receive.
The credit rating agencies will be measured in terms of the government and corporate issues.
These provide investors with an understanding of the risk that they are taking by investing.
Maturity Date
The date of maturity is a very important feature when it comes to debenture loans. The date that they give for maturity is an important feature.
This date means that this is the date when the company has to pay back the debenture. Companies will be able to choose which form the repayment will take.
It is usually redeemed from the capital of the company. In other cases, the payments will be taken each year until the full amount is reached.
Pros And Cons Of Debentures
Debentures are long term instruments for dealing with debt. In lots of cases, the companies will issue debenture loans in order to raise capital for the business.
In this case, investors are able to enjoy interest payments that are safer than investing in shares in their stock.
Debentures are unsecured bonds that are issued by corporations. They are put in place to raise the debt capital.
They are more risky than secured loans. Because they are unsecured, they are not supported by any collateral. They are more risky than an identical note.
Their lack of security doesn’t mean that a debenture is more risky than any other bond.
Below are some of the pros and cons of a debenture loan:
Pros
- Debentures offer regular interest rates to investors
- They can be easily converted to equity shares
- The debenture is paid before common stock shareholders
Cons
- When it comes to fixed-rate debentures, these loans have interest rate risk exposure. This is the case in areas where the interest rate is rising
- The creditworthiness is very important when it comes to dealing with the underlying issuer’s viability
Is A Debenture Different From A Bond?
A debenture counts as a type of bond. In most cases, it is unsecured and it is issued by a firm. This means that it is not protected by any collateral like secured bonds.
These are backed by assets which can be seized if you need to pay back creditors. Unsecured debentures do not have any collateral protection.
Final Thoughts
Debentures are a type of unsecured loan. They are issued by governments and corporations.
They are very different to secured bonds because they are not backed by collateral.
They are riskier in the way that they don’t have any collateral, so if something goes wrong there are no assets to claim.
They are given solely on the creditworthiness of the person who is taking out the loan.