First Mortgage Debenture

Definition of First Mortgage Debenture

A first mortgage debenture is a type of debenture that provides the holder with the first charge over the property or assets owned by the issuing company. This means that in the event of a default by the company, the holders of these debentures have the first right to be repaid from the proceeds of the liquidation of the secured assets. First mortgage debentures are typically issued by property companies as a means of securing long-term funding. The primary advantage of these instruments for creditors is the added security provided by the first lien position on designated properties.

Examples

Real Estate Developers: A real estate development company issues first mortgage debentures to raise capital for building new residential properties. These debentures are secured by the constructed properties. In case of default, the debenture holders have a first claim on the proceeds from the sale of these properties.
Commercial Property Companies: A commercial property management firm issues first mortgage debentures to finance the acquisition of new office buildings. The debentures are backed by these office buildings, ensuring that in case the company fails to repay its debts, debenture holders can sell the buildings to recover their funds.

Frequently Asked Questions

1. What distinguishes a first mortgage debenture from a regular debenture?

A first mortgage debenture is secured by the company’s property or assets, offering a first charge on these in case of default, whereas a regular debenture may not be secured by specific assets.

2. Are first mortgage debentures risk-free for investors?

No investment is entirely risk-free. While first mortgage debentures are secured and offer higher protection in case of liquidation, there are still risks such as market volatility affecting property values or the overall financial health of the issuing company.

3. Can a company issue multiple first mortgage debentures?

Yes, a company can issue multiple first mortgage debentures, but usually not on the same asset. Each debenture would typically be secured against different assets to maintain the first lien status.

4. How do first mortgage debentures affect a company’s balance sheet?

First mortgage debentures are recorded as a liability on the company’s balance sheet. The secured property will appear on the asset side, reflecting its role in securing the debt.

5. What happens to first mortgage debenture holders if the issuing company goes bankrupt?

First mortgage debenture holders have the first claim on the proceeds from the liquidation of the secured assets. They are typically repaid before unsecured creditors and other lienholders.

Debenture: A type of debt instrument that is not secured by physical assets or collateral. Debenture holders are creditors of the issuer but only have a general claim on the issuer’s assets.
Lien: A legal claim or right against a property. Liens ensure obligation fulfillment, such as repayment of debts. The property acts as collateral for the debt.
Secured Debt: Debt that is backed by assets (collateral) to reduce the risk for lenders. If the borrower defaults, the lender can seize the collateral to recover the loan amount.
Unsecured Debt: Debt that is not protected by collateral. If the borrower defaults, the lender has a claim against the borrower’s general assets but no specific property to seize.
Liquidation: The process of converting assets into cash. In the context of bankruptcy, liquidation involves selling company assets to repay creditors.

Online Resources

Suggested Books for Further Studies

“Principles of Corporate Finance” by Richard A. Brealey, Stewart C. Myers, and Franklin Allen: This book covers a broad range of financial topics, including debt securities like debentures.
“Financial Markets and Institutions” by Frederic S. Mishkin and Stanley G. Eakins: Insight into financial instruments and markets, including detailed discussions on different types of debentures.
“Corporate Finance: Core Principles & Applications” by Stephen A. Ross, Randolph W. Westerfield, and Jeffrey Jaffe: An essential read covering the core principles of corporate finance, with discussions on secured and unsecured borrowing.

Accounting Basics: “First Mortgage Debenture” Fundamentals Quiz

### What type of charge does a first mortgage debenture provide over a company's property? - [x] First charge - [ ] Second charge - [ ] General charge - [ ] No charge > **Explanation:** A first mortgage debenture provides the holder with the first charge over the company's property. This priority ensures the debenture holders are first in line to be repaid in case of a default or liquidation. ### Are first mortgage debentures considered secured or unsecured debt? - [x] Secured debt - [ ] Unsecured debt - [ ] Convertible debt - [ ] Equity debt > **Explanation:** First mortgage debentures are considered secured debt because they are backed by specific assets of the issuing company. ### In the event of liquidation, who gets repaid first? - [x] First mortgage debenture holders - [ ] Unsecured creditors - [ ] Preferred shareholders - [ ] Common shareholders > **Explanation:** In the event of liquidation, first mortgage debenture holders are given priority and repaid first from the proceeds of the sale of the secured assets. ### Who typically issues first mortgage debentures? - [x] Property companies - [ ] Technology companies - [ ] Retail companies - [ ] Start-ups > **Explanation:** First mortgage debentures are typically issued by property companies, as they often leverage real estate assets to secure long-term funding. ### Does the value of the secured property affect the risk associated with first mortgage debentures? - [x] Yes, it does. - [ ] No, it does not. - [ ] Only if the market fluctuates. - [ ] Only if the company is afloat. > **Explanation:** The value of the secured property is crucial in assessing the risk associated with first mortgage debentures. If the property's value declines, the security provided to debenture holders weakens, increasing risk. ### Can first mortgage debenture holders sell the secured property in case of a default? - [x] Yes, they can sell the property to recover their funds. - [ ] No, they can't. - [ ] Only with special permission. - [ ] Only if the company agrees. > **Explanation:** First mortgage debenture holders have the right to sell the secured property in case of a default, allowing them to recover their funds. ### What makes first mortgage debentures appealing to investors? - [ ] They offer the highest returns. - [x] They provide added security through collateral. - [ ] They are free from any risk. - [ ] They are subject to no market fluctuations. > **Explanation:** First mortgage debentures are appealing to investors because they provide added security through collateral, ensuring prioritized repayment in case of default. ### What type of debt does a first mortgage debenture fall under? - [x] Lon-term secured debt - [ ] Short-term unsecured debt - [ ] Convertible debt - [ ] Revolving debt > **Explanation:** A first mortgage debenture is a form of long-term secured debt, typically utilized for significant, long-term financial needs of companies. ### What precaution should investors take when obtaining a first mortgage debenture? - [ ] Ensure constant communication with the issuing company. - [x] Assess the value and liquidity of the secured asset. - [ ] Ask for personal guarantees from company directors. - [ ] Review annual financial results only. > **Explanation:** Investors should carefully assess the value and liquidity of the secured asset to ensure that it provides adequate collateral in the event of default. ### Which sector most commonly issues first mortgage debentures? - [x] Property sector - [ ] Technology sector - [ ] Healthcare sector - [ ] Agribusiness sector > **Explanation:** The property sector is most commonly associated with issuing first mortgage debentures due to the nature of their assets being ideal for securing debt.