Fixed Debenture: What it Means, How it Works

What Is a Fixed Debenture?

A fixed debenture, also known as a fixed-charge debenture, is a loan that's issued against specific assets. A fixed debenture typically carries a fixed rate of interest on the debt. Companies generally use fixed-charge debentures to raise money for short-term operations, signing specific assets, such as real estate or equipment, over to the creditor as collateral for the loan. The collateral is necessary because the loan has no other form of backing.

Understanding Fixed Debentures

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

When we think of a mortgaged asset, we tend to think of a residential home loan issued to a borrower by a mortgage lender with the home used as collateral in case the borrower defaults on the loan, meaning they fail to make the payments.

Business loans operate in a similar fashion. However, the loans can be short or long-term, and the collateral can vary since companies have various types of assets that can be used to secure the loan in case of default.

Example of a Fixed Debenture

A real estate development company might sign one of its apartment buildings over 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.

When the borrower satisfies the loan, they regain 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, 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 a borrower to sign an entire class of assets 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 company repays the loan in full, the creditor might restrict it from selling or subleasing that piece of property.

Floating debentures can also change into fixed debentures. Also, the lender could specify conditions 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.

U.S. vs. U.K. Debentures

Debentures refer to slightly different instruments in the American and British financial worlds.

In the U.S., a debenture is a medium- to long-term debt instrument issued to a company that's seeking an investor's funds. It is usually not backed by the borrowing company's assets or collateral. In the U.K., a debenture is also a debt instrument a capital-extending investor or lender uses—but it is backed up by the company's assets, often specifically designated assets. In the U.S., a debenture functions more like an unsecured loan; in the U.K., it's more akin to what Americans call a corporate bond.

So, fixed debentures in the U.S. are the equivalent of basic debentures in the U.K.

The Bottom Line

A fixed debenture is a short-term loan issued against specific assets that usually has a fixed interest rate. Companies sign over specific assets, such as real estate or equipment, to the creditor as collateral for the loan. The collateral protects the creditor if the borrower defaults on the loan. Fixed debentures are different than floating debentures, which use a class of assets as collateral for the loan. Inventory would be an example of the assets used to secure a floating debenture.