What It Is:
Debentures are bonds that are not secured by specific property or collateral. Instead, they are backed by the full faith and of the issuer, and bondholders have a general claim on assets that are not pledged to other debt.
How It Works/Example:
Let's consider a $100 million default), giving them a little extra assurance that they be paid on time, then the would be considered securitized or asset-backed.
However, if Company XYZ is exceptionally creditworthy (let's say it has significant cash flow and has never defaulted on any of its other debt), then placing liens on $100 million of assets (called encumbering the assets) may not be necessary to attract investors. Company XYZ could debentures instead. Holders of the Company XYZ debentures would have a claim to the assets not otherwise pledged to other . So, if Company XYZ had $300 million of assets, but $100 million were pledged in a previous , then the holders of the debentures could lay claim to the other $200 million of assets in the ainterestent of default.
Debentures often come with several key provisions designed to protect negative pledge clause" keeps from pledging assets for another security if doing so would endanger the possibility of repayment on current dbi. Third, a variety of covenants often require the to maintain certain financial ratios or work within certain financial limits that lower the probability of default (covenants are common in ). Fourth, many debentures require the to pay interest to the before it can make any dividend payments.. First, the size of the debenture is usually limited to the amount of the initial in order to keep the from overleveraging the company and diluting the power of the existing . Second, a "
Why It Matters:
It is important to earnings of the . Therefore, if the were to , the holders of the debenture have a claim on any assets not specifically pledged to secure other debt. If there are no pledged assets or no secured debt, then the debentures have the first claim on all of the company's assets--along with all the other general creditors.that even though debentures are not secured by specific pieces of property or , they do have a general claim on the assets and
Companies that are extremely creditworthy often have no reason to pledge specific assets in order to sell a unencumbered in order to make future financings possible.
However, exceptional creditworthiness is not the reason some companies debentures. If a company has already pledged all of its assets to other creditors and still needs capital, it may have no other choice than to try to sell debentures. In these cases, the debentures are riskier, and they usually rank below all the secured debt the company has already . Debentures in this case usually higher coupons tfo attract investors.
Subordinated debenture are a specific type of debenture that ranks after senior debt, regular debentures, and sometimes even after certain general creditors. They are low on the list of debts to be paid, and thus their have to higher interest rates and even the to convert to in some cases.