What Is Subordinated Debt?

What Is Subordinated Debt?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

Subordinated debt, also known as subordinated loan, subordinated bond, subordinated debenture, or junior debt, is an unsecured loan or bond that ranks below other loans or securities with regard to claims on assets or earnings. Essentially, subordinated debt is repayable after other debts in the case of a company undergoing liquidation or bankruptcy. This debt falls at the bottom of the repayment hierarchy and is riskier. This means companies often pay a higher interest rate to obtain subordinated debt due to its lower priority during payback.

Related Questions

1. What makes subordinated debt different from other debts?

Subordinated debt is different from other debts because it is repayable after other debts when a company undergoes bankruptcy or liquidation. It’s considered riskier and typically attracts higher interest rates.

2. Why do companies choose to incorporate subordinated debt?

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Companies often choose to incorporate subordinated debt as part of their financial mix as it allows them to obtain more loan funds, albeit at a higher cost. The fact that it’s cheaper for companies compared to equity financing also makes it an attractive option.

3. Can individual investors buy subordinated debt?

Yes, individual investors can buy subordinated debt. However, due to the higher risks involved, only sophisticated and institutional investors are typically involved in these types of investments.

4. How is the interest rate for subordinated debt determined?

The interest rate for subordinated debt is generally determined by the perceived level of risk and the creditworthiness of the company seeking the loan. It’s typically higher than the rate for other types of debt due to its lower payback priority.

5. How is subordinated debt labelled on balance sheets?

On balance sheets, subordinated debt is typically listed separately from senior debt to indicate its lower priority in repayment. It’s often found under long-term liabilities, indicating that it’s due after a year or more.