What Is an Indenture?

What Is an Indenture?

Let me explain what an indenture is directly to you. It's a legal and binding agreement, contract, or document between two or more parties. Traditionally, these had indented sides or perforated edges, which is where the name comes from.

Historically, indenture also meant a contract where one person was bound to work for another for a set time, like with European immigrants as indentured servants. In today's finance world, you'll see the term most often in bond agreements, real estate deals, and some bankruptcy situations.

Key Takeaways on Indentures

You should know that an indenture is a legal contract usually tied to bond agreements, real estate, or bankruptcy. It lays out detailed information on terms, clauses, and covenants. There are different types of indentures and various clauses that can be part of them.

Indenture Explained

The term indenture started in England, and in the U.S., you'll find several types, all generally linked to debt agreements, real estate, or bankruptcy.

Types of Indentures

Let me break down the common types for you. In real estate, an indenture is a deed where two parties agree to ongoing obligations, such as one maintaining a property while the other makes payments on it.

In bankruptcy, an indenture can serve as proof of a claim on property. It details collateralized property, showing the claim a lender has against a debtor, often secured by a lien.

For credit indentures, this is the core contract that outlines all provisions and clauses for a credit offering. In unsecured bond offerings, they're sometimes called debentures. These are mainly for bond issuers and holders, specifying maturity date, interest payment timing, calculation methods, callability, and convertible features if any.

A bond indenture includes all terms and conditions for the issue, plus financial covenants governing the issuer and formulas to check compliance, like ratios from corporate financials. If there's a conflict between issuer and bondholder, the indenture is the document you turn to for resolution.

In the fixed-income market, you rarely refer to the indenture during normal times, but it becomes crucial if the issuer risks violating a covenant. Then, you scrutinize it to avoid ambiguity in calculating ratios that confirm covenant adherence.

Other Common Credit Indenture Terms

In credit offerings, a closed-end indenture clause might detail collateral backing the offering, with provisions ensuring it's assigned only to that specific offering.

You might also encounter terms like open-end indenture, subordinated, callable, convertible, and non-convertible in these clauses.

Sometimes, a bond issuer hires a trustee, and in those cases, you need a trust indenture too. This is like a bond indenture but also covers the trustee's responsibilities in overseeing the bond issue's terms.

An indenture trustee manages fiduciary duties for the credit issuance, monitoring interest payments, redemptions, and investor communications. They might lead trust departments at institutions. Their main role is to oversee and administer all terms, clauses, and covenants of an indenture from a company or government agency.