COLLATERAL TRUST BONDS 1. Use of collateral trust bonds.—Technically speaking, all bonds which are secured by personal property deposited with a trustee for the benefit of bondholders are collateral trust bonds. In practice, however, mortgage bonds occupy a separate classifi cation, and bonds secured by lease are variously de scribed as equipment trust bonds, car-trust bonds, or car-trust certificates. In ordinary usage, therefore, the term "collateral trust bond" applies only to bonds secured by the deposit with a trustee of the stocks and bonds of other companies.
As a rule, none but holding companies, or large companies owning subsidiaries, are in possession of enough stocks and bonds of other companies to enable them to put out collateral trust bonds. The securi ties of small companies are not popular, because their market is restricted, and they are not well enough known to possess the public confidence. This is par ticularly true when the new issue is second to an exist ing first mortgage. Under these circumstances, when the financing of new construction becomes necessary, the credit of the parent or holding company will be utilized to secure capital upon better terms than the subsidiary could obtain acting alone.
If it is impossible or inexpedient for the parent or holding company itself to issue mortgage bonds, and its guarantee of subsidiary company bonds is not strong enough to carry conviction, collateral trust bonds will be resorted to. The bond in such case will be the general debenture obligation of the large com pany, with the additional security of stocks and bonds of its subsidiaries, which are deposited with a trustee for the protection of the bondholders. The securities are held under the terms of a deed of trust. The deed is not a mortgage, however, as in the case of real estate, but an actual pledge of the securities as col lateral, accompanied by deposit of the securities them selves.
The value of these bonds depends primarily upon the credit of the holding company and only second arily upon the earnings of the subsidiary, since only in event of default will the pledged securities or their earnings be taken over directly by bondholders. The
only advantage of issuing collateral trust bonds, when the assets of the holding company consist entirely of stocks and bonds of subsidiaries, is to average the risk over a number of companies. In such case, the col lateral trust bonds will fluctuate widely in price, ac cording to the earnings of the subsidiaries, but will sell at better prices than would the average junior lien bonds of the subsidiaries individually. When the is suing company has a direct income of its own, ample to meet the interest charges without relying upon interest or dividends from subsidiary companies, the fact that the collateral trust bond does not represent a first lien upon any part of the property may not injure its value greatly. It should be remembered that earnings form the ultimate security of all bonds. When the collateral consists of stock, all the obliga tions of the subsidiary companies of course come be fore the security of the collateral trust bond. In such cases it is necessary for the issuing corporation to have an independent income, or for the subsidiaries to have large surplus incomes above fixed charges, if the bonds are to be marketed to good advantage.
2. Guaranteed bonds as an times it is desired to market the bonds of subsidiary companies, or directly affiliated companies, with the guarantee of the controlling or parent company. This course is not resorted to as a rule unless the sub sidiary company itself has adequate assets and income to protect the issue under ordinary circumstances. Guaranteed bonds are not popular, unless it is felt that the direct obligor will be able to meet the in terest charges, and that the indorser or guarantor is to be relied upon only in the event of emergency. Sometimes individuals may guarantee bonds of cor porations, as in the case of the Virginian Railway the bonds of which were guaranteed by Mr. H. H. Rogers.