Subordinated Debt

Intermediate

Subordinated debt is borrowing that ranks below other debts for repayment if a company goes bankrupt or is liquidated, so it is repaid only after senior debt has been paid in full.

Subordinated debt, also called junior debt, carries more risk than senior debt because, in a default, there may be little or nothing left to repay it once senior lenders have been paid. To compensate for this risk, it pays higher interest rates.

Subordinated debt still ranks ahead of preferred shares and common shares, so its holders are repaid before shareholders receive anything.

For example, a company that fails with assets worth 80 million, senior debt of 70 million and subordinated debt of 30 million would repay the senior lenders in full, leaving only 10 million for the subordinated lenders, who would lose two-thirds of what they are owed. Shareholders would receive nothing.

Companies use subordinated debt to raise additional money beyond what senior lenders will provide, without issuing new shares and diluting existing shareholders. Banks often issue certain types of subordinated debt that count towards their regulatory capital, since it can absorb losses in a crisis. Subordinated debt is common in leveraged buyouts and is a key part of mezzanine financing.

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