What is Subordinated Debt?
Subordinated debt is any outstanding loan that, should the borrowing company fail, it will be repaid only after all other debt and loans have been settled. It is the opposite of unsubordinated debt.
How Does Subordinated Debt Work?
Should an individual or company file for bankruptcy, the court will prioritize the outstanding loans which the liquidated assets will repay. Any debt with lesser priority qualifies as subordinated debt.
Suppose a company issues two bonds: Bond A and Bond B. The company fails and is forced to liquidate its assets to pay off debt. The money owed to Bond A holders is considered the priority debt, so Bond B debt holders will be paid off only after all Bond A holders are repaid. Because Bond B was ranked second in priority, it is considered subordinated debt. Bond A debt is considered unsubordinated debt.
Why Does Subordinated Debt Matter?
The risk associated with subordinated debt increases as the priority of the debt becomes lower. For this reason, it is important for lenders to consider a loan applicant's solvency as well as other loan obligations in order to evaluate the risk should the entity be forced to liquidate.