Fixed Debenture

What Is a Fixed Debenture?

A fixed debenture, also known as a fixed charge debenture, is a debt that's issued against specific assets. A fixed debenture typically carries a fixed rate of interest for the loan. Fixed-charge debentures are generally used by companies to raise money to finance operations in the short term. Companies sign over specific assets, such as real estate or equipment, to the creditor as collateral for the loan. The collateral is necessary because the loan doesn't have any other form of backing.

Understanding Fixed Debentures

Fixed debentures allow the creditor to place restrictions on the mortgaged assets which back the loan. It's important to clarify that a debenture is a debt instrument that's typically not secured by collateral. In other words, debentures are only backed by the issuer's creditworthiness. However, a fixed debenture is backed by collateral.

For example, a real estate development company might sign over one of its apartment buildings as collateral for a loan. The creditor would, in turn, restrict the company from selling the property, or even leasing units within it, for the duration of the note. The creditor might create these restrictions to prevent the borrower company from making risky or poor financial decisions.

Once the loan is satisfied, the borrower regains full control of their assets. In the meantime, the borrower repays the loan in predetermined increments. These payments include principal and interest payments at a preset rate. If the company defaults–meaning they fail to make their payments–the creditor might allow the borrower to sell or liquidate the building to raise the capital needed to pay back the loan. The creditor could also assume control and sell the asset themselves.

Fixed Debentures vs. Floating Debentures

A fixed debenture is an alternative to a floating debenture, which requires an entire class of assets to be signed over to the creditor as collateral. However, the creditor generally doesn't have control over the mortgaged assets with floating debentures because the assets fluctuate in quantity.

For example, let's say a manufacturing company is looking to borrow money from a bank. The company could use its inventory as collateral through a floating debenture. The inventory would be continually in flux but still have value. With a floating debenture, the company would still be able to produce its products, use its inventory, and sell its stock even though the inventory was signed over to the creditor. The company would regain control over its inventory with the full repayment of the note.

Conversely, if the manufacturing company borrowed through a fixed debenture, they would have to secure the loan with fixed assets such as property, buildings, or equipment. Until the loan is repaid in full, the creditor might restrict the company from selling or subleasing that piece of property.

Floating debentures can also change into fixed debentures. Also, there could be conditions specified by the lender that would cause the debenture to turn from a floating debenture to a fixed debenture. A floating to fixed debenture usually occurs in a situation involving default and liquidation.