Subordinated debt

In finance, subordinated debt (also known as subordinated loan, subordinated bond, subordinated debenture or junior debt) is debt which ranks after other debts should a company fall into receivership or be closed.

Such debt is referred to as subordinate, because the debt providers (the lenders) have subordinate status in relationship to the normal debt. A typical example for this would be when a promoter of a company invests money in the form of debt, rather than in the form of stock. In the case of liquidation (e.g. the company winds up its affairs and dissolves) the promoter would be paid just before stockholders -- assuming there are assets to distribute after all other liabilities and debt has been paid.

Subordinated debt has a lower priority than other bonds of the issuer in case of liquidation during bankruptcy, below the liquidator, government tax authorities and senior debt holders in the hierarchy of creditors. Because subordinated debt is repayable after other debts have been paid, they are more risky for the lender of the money. It is unsecured and has lesser priority than that of an additional debt claim on the same asset.

Subordinated loans typically have a higher rate of return than senior debt due to the increased inherent risk. Accordingly, major shareholders and parent companies are most likely to provide subordinated loans, as an outside party providing such a loan would normally want compensation for the extra risk.

Subordinated bonds usually have a lower credit rating than senior bonds. Here are a couple examples for subordinated bonds. First of all, the main example of subordinated bonds can be found in bonds issued by banks. Subordinated debt is issued by most large banking corporations in the U.S. periodically. It is believed that subordinated notes are risk-sensitive. That is, subordinated debt holders have claims on bank assets after senior debtholders and they lack the upside gain enjoyed by shareholders. This status of subordinated debt makes it perfect for experimenting on the significance of market discipline. This can be accomplished in two separate ways. First, a simple look at secondary market prices of subordinated debt would suffice. Second, one can have a look at issue price of these bonds initially in the primary markets.

For a second example for subordinated bond, consider asset-backed securities. These are often issued in tranches. The senior tranches get paid back first, the subordinated tranches later. Finally, Mezzanine debt is another example of subordinated debt.

Subordinated bonds are regularly issued (as mentioned earlier) as part of the securitization of debt, such as asset-backed securities, collateralized mortgage obligations or collateralized debt obligations. Corporate issuers tend to prefer not to issue subordinated bonds because of the higher interest rate required to compensate for the higher risk, but may be forced to do so if indentures on earlier issues mandate their status as senior bonds. Also, subordinated debt may be combined with preferred stock to create so called monthly income preferred stock, a hybrid security paying dividends for the lender and funded as interest expense by the issuer.

ee also

* tier 2 capital
* Basel II
* Bank condition
* Banking regulation
* CAMELS rating

External links

*http://www.anz.com/edna/dictionary.asp?action=content&content=subordinated_loan