What is unsubordinated debt?
Unsubordinated debt is a senior, secured or unsecured bond that has preferences over other Bonds based on the payment of principal and interest. This means that if there are bonds, other than unsubordinated debt bonds, with higher priority like preferred stock or debentures, the issuer will pay the unsubordinated debt obligations first before paying the subordinated debt.
Subordinated debt is an unsecured obligation that ranks below standard debt in a company's capital structure. This type of debt is typically issued by banks and financial institutions, and it is considered a higher risk than unsubordinated debt because it carries with it the lowest priority for repayment among all forms of loans or bonds issued by the same company. Subordinated debt can be issued in the form of bonds by corporations or financial institutions.
Unsubordinated debts have no strings attached; they don't come with any special terms and conditions that you need to fulfil. The unsubordinated debt meaning states that it is simply a financial obligation of your business, but not tied to any other debts or obligations. If you declare bankruptcy, for example, an unsubordinated debt won't be affected by the filing. You can still pay off this type of loan at your own pace without worrying about whether it will affect other creditors' claims against the company or its assets in any way.
How Unsubordinated Debt works
Unlike subordinated debt holders, unsubordinated debt holders are more likely to receive payments in the event of bankruptcy. Unsubordinated debt holders are also less likely to suffer losses from their investments because they are guaranteed to receive some amount of payment in the event of a bankruptcy filing.
Subordinated debt holders, on the other hand, are at a much higher risk of not getting paid during a bankruptcy proceeding. Although these investors will still be eligible for the payment they may not receive all of the money owed them and could even be wiped out completely if those payments fall short of covering all outstanding debts held by that creditor.
Unsubordinated debt vs Subordinated debt
Senior unsubordinated bonds are ranked above junior, or subordinated, bonds in the order of payments of principal and interest. Unsubordinated bonds are those that have a higher priority than subordinated debt. In other words, they have a higher ranking than junior or subordinated debt.
To comprehend the difference between senior and junior (or subordinated) debt, you need to know how payments are made on a bond issue. Senior bonds have the first claim on all of the cash flow from the company before any other creditors get paid. In contrast, junior bondholders only receive payment after senior creditors are paid in full and/or receive their interest payments as agreed upon in their indentures (the agreements outlining how much money each class of security receives).
The order of these payments is called "priority" and it follows the hierarchy as below:
- senior credit holders
- second-lien holders
- third lien holders (if applicable)
- common stockholders (if applicable)
Subordinated bonds are at higher risk than unsubordinated bonds and thus offer higher yields to compensate for this risk. In general, subordinated debt is second in line to be paid back once the issuer can pay off its other debts. As a result, subordinated bonds have a lower credit rating than unsubordinated bonds and are more likely to default.
While some investors purchase subordinated debt to take advantage of their potentially higher returns, others prefer unsubordinated debt because it is safer. Subordinated debt can indeed be repaid after bankruptcy or liquidation, but only after all other claims against the company have been satisfied. As a result, in most cases, unsubordinated debt has a better chance of being paid back than subordinated debt.
Types of Unsubordinated debt
The different types of unsubordinated debt bonds consist of collateralized securities, exchange-traded notes (ETNs) and certificates of deposit (CDs). Mortgage-backed securities (MBS) are a type of collateralized security and, just like other collateralized securities, they are structured with several tranches that bear different risks, interest rates, and maturities. A tranch with a higher claim on the underlying assets of a company is relatively more secure as compared to junior tranches with a second lien Tranches are segments that are created from a pool of securities, such as bonds or mortgages, that are split up according to their risk or other categorization. These senior tranches are paid first and also have a higher credit rating compared to the junior ones.
Simply put, unsubordinated debt is a senior, secured or unsecured bond that holds preferences over other bonds when it comes to the payment of principal and interest even in the condition of bankruptcy. If you've found the concept of unsubordinated bonds interesting and would like to explore more bond and stock-based investment opportunities, open your Demat account with IIFL Securities today! Excel your trading journey with expert advice, algo-trading research and more such helpful techniques for trading.
Frequently Asked Questions Expand All
Unsubordinated debts have a range of benefits adding to their importance:
- Unsubordinated debt holders are more likely to receive payments in the event of bankruptcy.
- Unsubordinated debt holders are less likely to suffer losses from their investments
- Unsubordinated bonds have a higher priority than subordinated debt and stocks.
- Unsubordinated debts have no strings attached; they don't come with any special terms and conditions that you need to fulfil.