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At times, Savannah Electric was unable to issue any new first mortgage bonds because of another indenture provision: its interest coverage ratio (pre-interest income divided by interest expense) was below 2.5, the minimum coverage that it must have in order to sell new bonds. Thus, although Savannah Electric passed the property test, it failed the coverage test, so it could not issue any more first mortgage bonds. Savannah
Electric then had to finance with junior bonds. Because first mortgage bonds carried lower interest rates, this restriction was costly.
Savannah Electric’s neighbor, Georgia Power Company, had more flexibility under its indenture—its interest coverage requirement was only 2.0. In hearings before the Georgia Public Service Commission, it was suggested that Savannah Electric should change its indenture coverage to 2.0 so that it could issue more first mortgage bonds. However, this was simply not possible—the holders of the outstanding bonds would have to approve the change, and they would not vote for a change that would seriously weaken their position.
Debentures A debenture is an unsecured bond, and as such it provides no lien against specific property as security for the obligation. Debenture holders are, therefore, general creditors whose claims are protected by property not otherwise pledged. In practice, the use of debentures depends both on the nature of the firm’s assets and on its general credit strength. Extremely strong companies often use debentures; they
simply do not need to put up property as security for their debt. Debentures are also issued by weak companies that have already pledged most of their assets as collateral for mortgage loans. In this latter case, the debentures are quite risky, and they will bear a high interest rate.
Subordinated Debentures The term subordinate means “below,” or “inferior to,” and, in the event of bankruptcy, subordinated debt has claims on assets only after senior debt has been paid off. Subordinated debentures may be subordinated either to designated notes payable (usually bank loans) or to all other debt. In the event of liquidation or reorganization, holders of subordinated debentures cannot be paid until
all senior debt, as named in the debentures’ indenture, has been paid.

Taken From : Five-Minute MBA – Corporate Finance

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