Open-End Indentures

An open-end indenture is a term in a bond contract that permits the issuer to use the collateral guaranteed in one issue as collateral for any number of other bond issues in the future. Subsequent issues have equal liens on the assets that are secured as collateral. These are opposed to closed-end indentures.

Open-end indentures can be a sign of significant financial insecurity in a corporation. For example, if several classes are issued on the same collateral and the bond issuer then defaults of suffers bankruptcy, the bondholder will be in a significantly weakened position. Each issue has equal liens on the collateral, which means that each bondholder has so much less chance of seeing a return of principal. Open-end indentures are often added by companies that anticipate financial difficulties in the not-so-distant future.

On the other hand, an open-end indenture can be a relatively benign addition to a bond contract that anticipates company growth. It is sometimes simpler and more efficient to make a second or third bond issue on the same collateral than to designate new assets to serve this purpose. For example, if a growing corporation issues secured mortgage bonds on all company real estate, but wants to factor in the possibility of acquiring more in the future, then it makes sense to include an open-end indenture in the initial issue. If real estate of equal value is then acquired in the future, another bond issue can be made on the same collateral (i.e., "all company real estate") and the position of the bondholders will not weaken at all.

Open-end indentures can be issued both by successful companies and companies in financial distress. But any way you look at it, these terms make secured bonds a lot less secure. Interest rates will be higher on bonds issued under these terms, but investors should either have a lot of trust in the issuing corporation or a lot of information before purchasing a bond with an open-end indenture.

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