SENIOR & SUBORDINATED CORPORATE DEBT EXPLAINED

Yesterday’s post was about corporate debt of which there are two types secured & unsecured debt and senior & subordinated debt. We will look at the latter in this post

Senior debt is a secured debt in that it is the primary debt that is paid off in the unfortunate event of an issuer’s bankruptcy. Most high grade debt securities are senior debt and also loans from financial institutions. Since they are secured, this means that secured investors receive lower yield that their unsecured counterparts.

In the words of Wikipedia, senior debt is a class of corporate debt that has priority with respect to interest and principal over all the other classes and equity that an issuer has.

In most cases the law states that taxes and certain payments to employees be paid before creditors have their share of a dying company.

The opposite of senior debt is junior debt also called subordinated debt.   It is a corporate debt that is serviced after senior debt(secured debt) in the event of liquidation. It goes without saying that a subordinated debt holder is exposed to more risk that in the senior debt holder because he will be paid by the portions left over in the loan repayments. This could be a portion of his initial capital.

A little about subordinated debt is that a company issues it as a last resort in that it has already used its assets to back up senior debt but the money obtained is not enough and so they issue this corporate debt. It is more expensive to them in that they have to pay higher interest rates to the investor because he bears most of the risk in case the company goes bankrupt.

Also not all companies can issue subordinated debt. Only those with good reputations and high credit worthiness find this debt somewhat success as no investor want to loan out cash to a company with a reputation of defaulting.

But for the risk tolerant investor, even though there is a large possibility in losing invested capital in the case of bankruptcy, there is also the chance of a higher pay off if all goes well. But this is pure speculation as there is no way of knowing a company’s future. But still an investor will insist on details of a company’s financial records and past performance.

Finally this linked Wikipedia article has quite a lot to say about subordinated debt

That is senior and subordinated debt for you. If you have any questions or additions, the comment box is all yours.