What is a Secured Bond? Meaning, Example, Advantages & Everything You Need to Know

When you hear secured bonds, you must be thinking that such loans or bonds must be safe or the payments of secured loans or secured bonds will be secured by some kind of security.

Well, that is the most straightforward understanding of what a secured bond can mean. Before diving into the technicalities of Secured Bonds, let’s first understand how bonds work.

Bonds are debt instruments that are issued by governments and private/public corporations to borrow funds from the general public and repay them at a later date, called the “maturity date.” When you lend money through a bond, you become entitled to receive periodic coupon payments (interest earned).

But how can you trust the bond-issuing entity with your hard-earned money? The trust in the repayment of the bond comes from two things: one is the collateral if any, that the issuing entity has set aside for funds borrowed. The other is its creditworthiness, which is examined by credit rating agencies. Secured bonds are those bonds that are backed by some form of collateral. Therefore, even if the issuing company defaults, the amount you lent (or at least a part of it) can be recovered by liquidating/dissolving the collateral.

Let’s dive deep into the term, ‘secured bonds’ and understand how they work, their types and other important features. 

Secured Bond: Meaning and Example

A secured bond is a type of bond which comes with a security of collateral in advance. It gives the buyer a layer of trust and greater security that his investment is safe. This collateral pays the debt in case the issuer defaults on the payment.

The collateral may be in inventory, real estate, manufacturing units, machinery, equipment or stocks. Since the issuer’s assets secure the bonds, these debt instruments are relatively safer than equity instruments. 

How do Secured Bonds Work?

Secured Bonds are a class of bonds backed by assets to offer the investor a particular standard of security. With the multitude of bonds in the market, here’s how they work in a general sense:

Issuing of the Bonds:

An entity that wishes to raise capital can issue secured bonds. However, given the highly secure nature of these bonds, they are largely backed by assets or collateral on the issuers’ part as a gesture of good faith and financial security.

Purchasing of the Bonds:

Investors acquire bonds, essentially extending credit to the issuer. Each bond carries a face value, representing the sum that will be returned to the bondholder upon maturity. Additionally, bonds feature a particular interest rate or coupon rate, which is usually given out semi-annually or annually to the investor. The bond also has a set term that culminates with the repayment of the bond, marking its maturity.

Interest Payment and Maturity of the Bonds:

Throughout the bond’s life, bondholders obtain interest payments at a pre-established coupon rate, which can be either fixed or variable based on the bond’s terms. Upon reaching maturity, the issuer must return the principal, which is the bond’s face value, to the bondholder. Bondholders can claim the collateral to recuperate their investment when the issuer fails to meet the bond payments.

Defaulting:

If the issuer defaults on the original amount, you are legally within your rights to liquidate his set collateral when purchasing the bonds. Depending on the offset between collateral and bond value, you may not retrieve the entire amount you initially invested.

10 Best Secured Bonds in India

Understanding Secured Bonds with an Example

Let’s say the government issues a bond to raise funds for the construction of a road. The bond is secured by the future revenue that will be earned through toll collection. These are a type of revenue bond.

Similarly, corporations demarcate their real estate property as collateral to secure first mortgage bonds. If the issuer defaults, they can sell the property to make up for the lost principal or coupon payments. 

For instance, UGro Capital raised secured bonds worth Rs. 50 crores backed by nearly Rs. 62.5 crores of loans. The loans here are assets serving as collateral. 

However, the risk of being backed by collateral is that if the value of the collateralised asset falls below the investment amount, the bondholders may face losses.

Advantages of Secured Bonds

For Investors

Here are a few reasons why you should consider Bonds investment:

• One of the major advantages of investing in a secured bond is that they are relatively safer than equity and provide security against failure to repay the invested amount. 
• Secured bonds offer regular fixed income to the investor, although the interest rates can be lower, as compared to equity.
• Since secured bonds are asset-backed and offer regular income, they provide investors with a steady cash flow to manage their cash flow more efficiently.

For Issuers

• Even newer companies and municipalities can raise funds through secured bonds despite not having a lot of credibility in the market.
• Issuing secured bonds saves the cost of funds for the company as they have to pay lower coupon rates on them as compared to unsecured bonds.

Types of Secured Bonds & Who Issues Them?

Secured bonds are largely and most typically offered by municipalities, corporations and government entities and organizations. The cause of issuance ranges from building infrastructure, expansion towards new projects, repayment of other loans, and other needs to be met.

As for the types of Secured Bonds that are available in the market, the most typical class of bonds are as follows:

Corporate Secured Bonds:

Corporate entities offer corporate-secured bonds backed by assets or collateral like equipment, patents, real estate, or inventory. The assets may be tangible (like supplies, equipment, or real estate) or intangible (like patents or trademarks).

ABS:

ABS stands for Asset-Backed Securities. These secured bonds are of the nature wherein they are collateralized by a pool of income-generation assets such as receivables, royalties and loans. They are all put together in one portfolio and are offered as bonds to the general public. The income generated by these assets is used to dispense interest payments to the investors.

Municipal Revenue Bonds:

Municipal entities offer Municipal Bonds through the life-span of various public projects such as roads, toll booths, schools and hospitals. These are public intensive, and the cash flow from the various projects is used to pay out interest and principal amounts for the investor.

Risks Involved in Investing in a Secured Bond

These bonds involve specific risks that you must know of before investing in them, and in case of borrower default, the money would be realised post the bankruptcy proceedings of the entity (this process can take time).

• You may lose your money if the collateral becomes unsaleable or its value drops in the market; 
• If the issuer of the bond offers collateral with the intention of fraud, you may lose your money in such a case.
• The interest rate fluctuations in the economy will affect the value of the bond in the secondary market and it can change if someone is looking to sell it before maturity and if someone holds the bonds till maturity, the coupon and principal will be paid;
• These bonds come with a lock-in period, and you might not be able to redeem them. In such a case, you can face a liquidity risk where your money will be stuck when you need it.

Also, note that the secondary market for these bonds is limited, so one should invest to hold till maturity.

Secured vs. Unsecured Bonds

Any asset does not back unsecured bonds and is riskier than secured bonds. Of default, secured bonds ensure you recover your losses, which unsecured bonds do not guarantee. The only source of credibility is the reputation and creditworthiness of the company.

Read More: What Is a Secured Bond with Unsecured Collateral?

Closing Thoughts

Secured bonds are becoming popular in the debt market due to their security and high-interest rates. You can add secured bonds to diversify your portfolio.

However, your risk appetite, financial goals, and interests are the major deciding factors before investing in any security.

Happy Winting!

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