What Is the Difference Betwee🌺n Subordinated ♛Debt and Senior Debt?

The difference between subordinated debt and senior debt is the priority in which a firm in bankruptcy pays the debt claims. If a company has both 澳洲幸运5官方开奖结果体彩网:subordinated debt and senior debt and has to file for bankruptcy or 🧸face liquidation, the senior debt is paid back before the subordinated debt. Once the senior debt i﷽s completely paid back, the company then repays the subordinated debt.

Understanding the Two Types of Debt

The fundamental implic▨ations of the two types of debt are the risk to the creditor.

Subordinated Debt

With subordinated debt, there is a risk that a company cannot pay back its subordinated or junior debt if it uses what money it does have during 澳洲幸运5官方开奖结果体彩网:liquidation to pay senior debt holders. Therefore, it is often mor🎀e advantꦅageous for a lender to own a claim on a company's senior debt than on subordinated debt.

Senior Debt

Senior debt is often secured. 澳洲幸运5官方开奖结果体彩网:Secured debt is debt secured by the assets or other 澳洲幸运5官方开奖结果体彩网:collateral of a company and can include liens and claims on certain assets.

When a company files for bankruptcy, the issuers of senior debt, typically bondholders or banks that have issued revolving 澳洲幸运5官方开奖结果体彩网:lines of credit, have the best chance of being repaid. Next in line are junior debt holders, 澳洲幸运5官方开奖结果体彩网:preferred stockholders, and 澳洲幸运5官方开奖结果体彩网:common stockholders. In some cases, these parties are paid by selling collatꦉeral that has been held for debt repayment.

Example of Subordinated Debt vs. Senior Debt

If a company files for bankruptcy, the 澳洲幸运5官方开奖结果体彩网:bankruptcy courts prioritize the outstanding♌ loans that must be paid using the company's liquidated assets.

For example, a company has debt A that totals $1 million and debt B that totals $500,000. Debt A is senior debt, and debt B is subordinated debt. If the company files for bankruptcy, it must liquidate all of its assets to repay the debt. If the company's assets are liquidated for $1.25 million, it must first pay off the $1 million amount of its senior debt A. Only half of the remaining subordinated debt B is repaid due to the lack of funds.

Key Differences

Senior debt has the highest priority and, therefore, the lowest risk. Thus, this type of debt typically carries or offers lower interest rates. Meanwhile, subordinated debt carries higher interest ra🍸tes given its lower priority dꦗuring payback.

Banks typically fund senior debt. Banks assume lower-risk senior status in the repayment order because they can afford to accept a lower rate given their low-cost sources of funding from deposit and savings accounts. In addition, regulators advocate for banks to maintain a lower-risk loan 澳洲幸运5官方开奖结果体彩网:portfolio.

Subordinated debt is any debt that 澳洲幸运5官方开奖结果体彩网:falls under, or behind, senior 🔴debt. However, subordinated debt does have priority over preferred and common equity. Examples of subordinated debt include 澳洲幸运5官方开奖结果体彩网:mezzanine debt, which is debt that also includes an investment. Additionally, asset-backed securities generally have a subordinated feature, where some tranches are considered subordinate to senior tranches. 澳洲幸运5官方开奖结果体彩网:Asset-backed securities are financial securities collateralized by a pool of assets, including loans, leases, credit card debt, royalties, or receivable✨s. Tranches are portions of debt or securities that have been designed to divide risk or group characteristics so that they can be marketable to different investors.

Special Considerations

One of the benefactors of subordinated debt is banks. Banks raise subordinated debt when rates on these loans are lower than other forms of raising capital. This comes as many banks are considered low risk given the increased regulatory scrutiny since the 澳洲幸运5官方开奖结果体彩网:financial crisis of 2007 to 2008. Subordinated debt has become a relatively easy way for banks to meet capital requirements without having to dilute their shareholder base by raising capital.