What Is a Face-Amount Certificate Company?
A face-amount certificate company is a type of corporation that raises money by issuing investors debt securities of a specified value. These instruments, called face-amount certificates (FACs), are backed by a security interest. In other words, the company offers up its assets such as the real property it owns or other securities as collateral against these debts.
This method is similar in nature to mortgage bond debt financing.
- Face-amount certificate companies are issuers of face-amount certificates (FACs), which are debt securities of a specified value collateralized by the firm's assets.
- Holders of these certificates are usually paid a fixed amount of annual interest and then refunded the principal of their securities at a specified termination date.
- Companies use FACs to obtain financing at relatively low-interest rates.
- Fewer face-amount certificate companies operate today because they offer fewer tax advantages than before.
Understanding a Face-Amount Certificate Company
A face-amount certificate is effectively a contract between an investor and an issuer. Under this arrangement, the investor agrees to pay the issuer a set amount of money either in periodic installments or as a lump sum—if the investor pays for the certificate in a lump sum, the investment is known as a "fully paid" face-amount certificate.
In return for giving the company this capital, owners of FACs are usually paid a fixed amount of annual interest. Then later, at a specified, preset termination date, they are refunded the principal, or face amount, of their securities.
Entities that issue FAC investments are referred to as face-amount certificate companies. This technique is advantageous to them as backing debt with specific tangible assets under the company's control enables them to obtain financing at relatively low-interest rates.
FACs are secured by enforceable legal claims or lien on collateral, enabling the lender to charge lower interest and, subsequently, reduce the costs to borrow money.
Example of a Face-Amount Certificate Company
Company ABC is in need of a steady injection of capital to build its cash reserve and pleads with investors to help out by loaning it $20 million over five years. As a sweetener, company ABC offers some of the property it owns as collateral. That means that if the company should somehow default on its repayment, lenders can seize control of this real estate and sell it on to recoup some or all of their losses.
Offering this collateral makes the prospect of lending company ABC money less risky. Suddenly investors begin lining up to partake in the fundraising, enabling company ABC to drive down the interest rate it pays on the loan to 4 percent. Certificates are then issued to those who agree to these terms, functioning as a sort of IOU document.
Company ABC is obligated to pay its lenders $800,000 in interest each year until it repays them in full the $20 million it borrowed from them. In other words, it incurs a total cost of $4 million for the loan, excluding the impact of inflation. It's worth bearing in mind, though, that investors can choose to redeem their certificates before they mature for a predetermined surrender value.
Very few face-amount certificate companies operate today because tax law changes have eliminated much of their advantages. One of the most notable financial services companies still in the face-amount certificate business is Ameriprise Financial.