The collateral trust bond is commonly employed to finance construction by subsidiary companies. The credit of both the subsidiary and the controlling com pany are thrown together for the purpose of borrow ing to the best advantage. In the same manner, the credit of the subsidiary and of the holding company may be merged to secure capital for an extension of the direct property of the latter.
Collateral trust bonds are also employed by cor porations to acquire the stock of other companies. This purchased stock, when pledged as collateral under the bonds, furnishes the means for its own pur chase, without drawing extensively upon the credit of the purchasing company. Of course, if the income from the securities purchased is not ample to meet the interest upon the collateral trust bonds which they secure, then the general credit of the purchasing cor poration may become the chief reliance of the bond holder. Usually, however, the income from the stock purchased is greater than the interest upon the bonds, thus actually increasing the surplus and the credit of the debtor controlling corporation by enhancing its annual profits. This is a case in which the credit of a corporation becomes better by borrowing, and illus trates the manner in which many of our largest com binations, by means of holding companies, have been able to acquire property, income and power out of all proportion to their original capital investment.
8. Security of collateral trust bonds.—To what
extent does the security of the collateral trust bond depend upon the collateral, and to what extent upon the direct promise of the borrowing company? Clearly, when a corporation is strictly a holding company, the value of the collateral is practically the sole security of the bond, unless the borrowing com pany, having pledged only a part of its holdings with the trustee, has other unencumbered securities.
When the value depends upon collateral consisting of the stocks of other companies, collateral trust bonds are naturally highly speculative and will fluctuate widely in value with the earnings of the subsidiary companies, since the collateral trust bondholders de pend upon the dividends of these subsidiaries for their interest. The fluctuation, of course, is not as wide as that of the stocks pledged as collateral, for the reason that bonds mature on a definite date for a certain amount, and therefore cannot rise very far above par. But they may sink to any depth below par, or may become entirely valueless if the subsidiary companies become bankrupt. This explains why collateral trust bonds are usually secured by stocks and bonds of sev eral companies and are not confined to the hazard of only one or two subsidiaries.
Collateral trust bonds are best issued when the credit of the borrowing corporation itself is ample to meet the interest charges irrespective of any income from the collateral deposited.