(d) New bonds not to be issued above a certain maximum amount, or a certain amount each year, or a certain percentage of the actual value of the plant.
(e) No property to be sold without turning in to the trustee the full proceeds, or a certain portion there of, to offset the reduced security, or to retire a portion of the bonds.
(f) Maintenance of adequate reserves against de preciation, usually upon some stated basis.
Open mortgages are rare. A bond reserve serves all the purposes of a limited open-end mortgage, and stands in better favor at the present time. Both re quire rigid restrictions of similar nature. The after acquired property clause is now the general rule, especially in the large refunding mortgage issues of American railways, which are showing a strong tendency to clear away the numerous small under lying mortgages and to provide ample bond reserves. It is clear that the bond reserve plan, especially if property is not adequate to secure the entire author ized issue in the beginning, must carefully restrict floating indebtedness and the investment of new funds in non-producing assets and provide against deprecia tion.
8. Junior lien bonds.—It frequently happens that property covered by mortgage increases in value enough to justify an increased loan against it. The first mortgage holder, however, has a lien upon the property which cannot be superseded. If any fur ther loan is to be secured by a mortgage on this prop erty, the new mortgage can cover only the equity above the lien of the first; in other words, it becomes a second mortgage. In form and protection, it is ex actly like the first, with the same remedies at law, and a lien ahead of any general creditors or later mortgage claimants. It may be deposited with a trustee to secure an issue of second mortgage bonds under a deed of trust having substantially the same provisions as the first trust deed.
Second mortgage bonds, third mortgage bonds, or other bonds secured by liens which do not have a first claim against the property are known as junior lien bonds. The only difference between them and prior lien bonds, which lie next to the property, is that they cannot enforce their claim against the property until the prior liens are satisfied in full. Junior lien bonds,
in turn, come ahead of all general creditors, while the property lasts. Yet back of the general creditors are the stockholders.
Sometimes the issue of prior lien bonds is very small, as compared with the value of the property, and second mortgage bonds then become practically as safe as firsts. Junior liens, however, are most fre quently used in refunding operations and to effect consolidations. General mortgage bonds are becom ing the prevalent type in American railway finance. containing provisions for refunding the old under lying first, second and third mortgages outstanding on certain portions of the property. This pyramiding of mortgages arises thru the natural growth and consoli dation of properties already subject to prior liens. For copious illustration, let the reader look up, in Moody's Manual, the capitalization of the Erie Rail road, the Southern, the Rock Island and others.
When consolidations are formed, new working capital is always required, and very frequently new permanent capital as well. The properties being con solidated may all be subject to outstanding mort gages. The equity may be sufficient, however, to justify additional bonds. In this case, it is usual to authorize a large issue of first and consolidating or first and refunding mortgage bonds, large enough not only to pay off the existing prior liens as they mature, but also to supply the additional capital needed. The issue will be secured by a first mortgage perhaps on some minor portion of the property, and will be sub ject to all other existing liens as to the rest. As rapidly as prior mortgages are retired the refunding mortgage becomes a first lien, until finally there re mains but the one big general first mortgage secured by all the property.
The prior lien obligations may be retired by selling the new issue and, with the proceeds, purchasing the prior lien bonds in the open market. Or a bond version plan may be resorted to under which the holders of prior lien bonds may surrender them in ex change for new bonds. Or sufficient reserve of the new bonds may be held to retire the old bonds as they mature.