What is Subordinated Debt?
How Does Subordinated Debt Work?
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 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.