What Is Junior Debt?
Let me explain junior debt directly to you: it's bonds or other debt forms issued with lower priority for repayment compared to senior debt in default situations. This makes it riskier for you as an investor, so it usually comes with higher interest rates than senior debt from the same issuer.
You can think of junior debt as synonymous with subordinated debt; it generally means any second-tier debt repaid right after senior debt. In a default, junior debt has a lower chance of full repayment because higher-ranking debts get priority first.
Key Takeaways
- Junior debt refers to bonds or debts with lower priority than senior debt.
- Also called subordinated debt, it's repaid in default or bankruptcy only after senior debts are fully settled.
- Unlike senior debt, junior debt isn't usually backed by collateral.
- Due to these factors, junior debt is riskier and offers higher interest rates than senior debt.
Understanding Junior Debt
I want you to grasp that the corporate debt market is less regulated than equities, giving companies more flexibility to raise capital through debt. They might secure a loan from a bank, team up with an underwriter for a syndicated loan, or issue bonds with different repayment terms.
As a fixed income investor, you need to understand 'junior debt' when looking at a firm's bond issuances. Repayment priorities are part of the company's capital structure, and they become crucial during credit events like defaults. Companies issue various securities to raise funds, structured by underwriters, with repayment order typically starting with senior debtholders, then junior debtholders, preferred shareholders, and finally common stockholders.
Unlike equity, institutional debt is issued in the primary market directly between corporations and investors. After that, loans and bonds trade in secondary markets through various groups. Even there, senior debt remains less risky than subordinated debt.
Debt Repayment Terms
One key term for all credit types is repayment seniority, which you should always check. Loans and bonds can be senior or subordinated. Senior debt gets repaid first in default or liquidation, often secured by collateral but sometimes unsecured with seniority provisions. Subordinated debt comes next, with its own terms.
Senior debt generally requires lower interest or coupons due to lower risk. With subordinated debt, you're taking on higher risk of lower priority in default, so you get compensated with higher interest rates. Typically, junior and subordinated debt is unsecured, without collateral backing.
Subordinated Debt in Tranches
Sometimes, corporations issue junior debt as bonds. It's also common in structured products where you can invest in different bond tranches. Repayment terms heavily influence bond coupon rates. The underwriter spells out junior debt repayment in default clearly in the investment terms, so you know the bond's priority.
For example, in many structured products, the z-tranche is the part repaid only after all other tranches are fully paid.
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