It is a type of debt that is risky and is secondary in position with respect to repayment of loan, in case of default by the borrower. In other words a subordinated debt that ranks below other securities or loans when the phase of loan repayment occurs.
If the company is under heavy loan and it faces bankruptcy, the borrowers will pay the other loans first and keep the subordinate debt at the last number in the queue. It is very risky as compared to unsubordinated debts. The priority of the subordinated debt is low and it gets repaid after the senior debts get repaid.
Getting a subordinated debt for a company with low credit rating is very difficult. For the acceptance of a subordinated debt it is essential that the borrower company must have goof future cash flows and ratings. Usually companies take a subordinate debt when the chance of getting a normal debt narrows because of the risk factor. These debts have a higher rate of return due to the risk that the lender has to face. Even the subordinated bonds have lower credit rating than senior bonds as they are risk sensitive.
An example of subordinated debt can be seen in the banking sector these days where the lenders easily give away the credit. This is only because of the reason that the lenders have a claim on the bank’s assets after the settlement with the senior debts. Due to the banks financial position regularly monitored in the market the lenders have access to early warning process that makes them realize if their debt is going to repaid or not. Another example is the asset-backed securities often issued in tranches however, in that case to the senior tranches get repaid first.
Subordinated debts are very risky because of the priority aspects and corporate lenders tend to avoid subordinated bonds. However when there is no option left they issue it with a strict monitoring policy. Subordinated bonds have some negative aspects but the lender has the chance of greater returns if the borrower is stable enough to repay it.
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