What is a Secured Bond?
In simple terms, a secured bond is a kind of bond where the issuer offers a particular asset for collateral. Compared to unsecured bonds, a secured bond offers a low rate of interest.
During default, the secured bondholder is obligated to shift the collateralised asset title to the particular bondholder. Some of the examples of secured bonds include:
- Collateralised Debt Obligation (CDO)
- Mortgage-Backed Securities (MBS)
Note: Secured bonds are tradable on the stock exchange. As a result, it provides liquidity benefits to all investors.
Understanding Secured Bonds
Suppose a government issues a bond with the purpose of raising capital for road construction. The bond guarantees future revenue, that will be raised via toll collection. This makes it a type of revenue bond.
Likewise, business enterprises limit their real estate property as collateral in order to defend the first mortgage fund. In case there is a default from the issuers’ side, the property can be sold to compensate for the lost coupon and principal payments.
Now that you understand what a secure bond is, let us now learn about the different types of secured bonds.
Types of Secured Bond
Here is the list of the different types of secured bonds:
- Mortgage Bonds: Such bonds are usually supported by tangible property (like equipment) or real estate holdings. During a default scenario, the mortgage bondholder can sell the underlying promised asset and get compensation for the amount invested. Additionally, a mortgage bond is considered safer than corporate bonds. Such bonds have a low rate of return. It is important to note that during a default, the ownership of the asset/property transfers to the bondholders.
- Equipment Trust Certificate (ETC): Equipment trust certificates, also known as ETC, refer to debt instruments. Such debt instruments permit the issuing enterprise to take ownership. ETCs use the asset and pay the bondholders for the tenure. Even though the bondholders take ownership of the asset, the company can use the property and make income from it. Investors provide capital by purchasing certificates. It helps firms buy assets, which are leased for operations to other firms. If the borrower can address the lender’s payment requirements, the ownership is shifted to the borrower. During default, the lenders get to decide what is required to be done with the assets. Companies are not required to pay property tax on any asset since they have leased it from the investors. As a result, it boosts their profitability from operations.
Note: Such debentures are usually seen in the shipping and airline sector.
- Secured Bonds by Municipalities: Municipalities can raise capital from investors via the issue of such secured bonds for a particular project. The anticipated revenue from that specific project supports the bonds. After revealing the project details and expected revenue, municipal bodies lay ahead the repayment plan or strategy to the investors. Based on the investors’ trust in the projects, municipal bodies can buy such types of bonds.
Advantages of Secure Bonds
Here is the list of the advantages of secure bonds:
- Companies can get tax benefits while buying and escaping property tax on assets leased during ETC deals.
- Interest payments will generate monthly/quarterly/yearly funds for the particular investor.
- Limited risk for the principal repayment by the bondholder during a default. It is because a collateralised asset backs the bonds.
- Investors can promise the bonds to raise funds for trade bonds or banks and get benefits from such trades.
- Companies can reduce the monthly repayment overheads by extending them for a while.
- An investor can display the bonds as long-term investments. They can get tax benefits on their fixed income.
- Purchasing secured bonds that are supported by revenue streams issues funds for investors. The cash flow is generated after the successful execution of projects.
- Companies can use secure bonds to generate additional capital, in case required.
- Convertible bonds allow investors to convert equity and get maximum benefits.
Why Should You Consider Investing in Secured Bonds?
Here are the reasons why you should consider investing in secured bonds:
- Safer than Equity : Investment in secured bonds is safe compared to equity. Not to mention, it offers security against payment defaults.
- Fixed Income : It provides a fixed source of income that is more than savings and fixed deposit rates.
- Efficient Cash Flow Management: It provides a steady cash flow. It can be sold via a Demat account in the secondary market.
Before investing, you must determine the risk appetite, interest, financial objectives, and investment horizon. Secured Bonds are a common form of investment since it offers the best security, and regular flow of income and is considered an ideal financial instrument to diversify your investment portfolio.