What Is Unsubordinated Debt?
Let me explain what unsubordinated debt is. It's also known as senior security or senior debt, and it refers to an obligation that gets repaid before any other form of debt. If a company goes bankrupt or becomes insolvent, holders of this debt have the first claim on the company's assets or earnings. Since it comes with a guarantee of repayment, you can see why it's considered less risky than other types of debt.
Key Takeaways
- Unsubordinated debt is an obligation that must be repaid before any other form of debt if the debtor goes bankrupt or insolvent.
- The majority of unsubordinated debt is usually secured by collateral.
- This kind of debt is also known as a senior security or senior debt.
- Types of unsubordinated debt include exchange-traded notes, collateralized securities, and certificates of deposit.
How Unsubordinated Debt Works
When a company faces bankruptcy or insolvency, there's a specific order for paying creditors. Lenders with unsubordinated debt get paid in full first. Most of this debt is secured by collateral. You'll find that loans from financial institutions and high-grade debt securities like mortgage bonds are typically senior debt. Loans can also be unsubordinated based on their balance and how long they've been outstanding compared to others.
Since senior debt has a secure claim, it's less risky. That's why it offers lower interest rates than other debts. Lenders accept these lower rates because they get priority over the borrower's assets in a liquidation. Remember, because of this security, unsubordinated debt lenders charge lower interest rates to debtors.
After paying unsubordinated debt holders, any remaining funds go to preferred stock holders, then subordinated debt, and finally common shareholders.
Types of Unsubordinated Debt
You should know some examples of unsubordinated debt: exchange-traded notes (ETNs), collateralized securities, and certificates of deposit (CDs). Take collateralized securities like mortgage-backed securities (MBS); they're structured with tranches that have different risks, interest rates, and maturities. Tranches with a higher claim on assets are safer than junior ones with a second lien. Senior tranches get higher credit ratings and are paid first.
Unsubordinated vs. Subordinated Debt
Unsubordinated debt is the opposite of subordinated debt. Subordinated debt ranks below all senior debts and is also called junior debt. It's subject to subordination in default or bankruptcy. When assets are liquidated, subordinated debt holders get paid only after unsubordinated lenders and preferred stockholders. Sometimes, there's nothing left after paying the seniors, leaving other creditors unpaid.
Due to the higher risk, subordinated debt lenders charge higher interest rates than those for unsubordinated debt.
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