What it is:
How it works (Example):
Debt in the form of loans or debt securities (e.g. bonds and CDs) are classified as unsubordinated debt if claims on revenues and capital assets by lenders and/or investors take priority over the repayment of other related debt. Related debt with a lower payment priority is called subordinated debt and is, consequently, considered riskier than unsubordinated debt. In most cases, loans are determined to be subordinated or unsubordinated based on the amount and length of time outstanding in comparison with other loans.
In the bond markets, unsubordinated and subordinated debt can best be exemplified by the tranches into which collateralized securities are classified based on value and time to maturity. A security's Class A tranche is considered unsubordinated debt because it takes payment priority over Classes B and C, both of which are subordinated debt. This means that obligations on Class A issues of a security will always be fulfilled before those of Class B and C issues.
Why it Matters:
The distinction between unsubordinated debt and subordinated debt is crucial for creditors and investors in assessing the risk associated with loans and collateralized debt securities. Unsubordinated debt is considered less risky than subordinated debt because it is first in line to be repaid once means for repayment have become available.