Sums set aside at stated intervals to provide for the payment of all or part of the principal of a debt. A method of sinking or extinguishing it; a provision for an obligation not yet matured, and as binding upon the issuer as any other provision of the mortgage.
This money is sometimes used to buy in, or pay off, some of the debt itself, from time to time, under conditions provided; or may be held until the maturity of the debt and then applied to its payment, and, in the meantime, invested in other securities, so that it may increase in amount.
The conditions attached to sinking funds differ, but the best form is that which applies the money directly to the extinguishment of the debt for which it was created, thus avoiding any loss by temporarily investing it otherwise.
In many bond issues a condition is imposed that the sinking fund shall be applied to the principal by the calling by lot of a certain number of bonds annually. This is very objectionable; it frequently works hardship upon the holders, and it often prevents bonds advancing to a premium, owing to the fact that every bond of an issue subject to call by lot must be looked upon as subject to payment at the next call, making it unsafe to base the interest return on but a comparatively short time. A better plan is explained under "Serial Bonds."
Generally speaking, " sinking funds" are desirable in issues against properties which have not demonstrated a tendency to liberal expenditures out of earnings for the maintenance at a high standard of efficiency; and, also, in the case of properties which are exhausting themselves, such as mines, oil wells, and the like. Or, in other words, "sinking funds" are advisable in those issues the security of which is likely to become less before maturity. Industrial concerns dependent upon a business of an unstable character should create " sinking funds" for the retirement of indebtedness. In large corporations, like our well-established railroads, many financiers argue against the establishment of a "sinking fund' altogether.
The question of a sinking fund, even in small corporations, is becoming a debatable one; although, in lack of such a safeguard, some other provision should be made. The commonly accepted one is a "depreciation" fund. (See that subject.)
The trust deed provided for yearly redemptions of a certain percentage of the issue. This took so much of the surplus earnings that the road was unable to maintain a modern standard. At the end of ten years, although the sinking fund had been met, the road was in a deplorable condition. It would have been better, for the safety of the bonds, if the same amount had been expended in modernizing the equipment. To illustrate: an indebtedness of $100,000 against an appreciating and growing property is better than a gradually reducing amount against a property that is going behind faster in value and earning capacity than is offset by the reduction in the indebtedness. Accidents are more likely to occur, and business to be handicapped. Depreciation must be guarded against, whatever the conditions for reducing the debt. But if a depreciation account is stipulated in the Trust Deed, the clause should be drawn with care so that the money shall not be used merely to replace wear and tear, but for the avowed purpose of keeping the property up to date, or for additions likely to increase the earnings.