Unsubordinated Debt
Unsubordinated debt, also known as a senior security or senior debt, refers to a type of obligation that must be repaid before any other form of debt. So, holders of unsubordinated debt have the first claim over a company's assets or earnings if the debtor goes bankrupt or insolvent. Because unsubordinated debt comes with a guarantee of repayment, they are considered less risky than other types of debt.
Senior Debt
Definition
Senior debt, also known as senior securities or senior obligations, refers to debt that must be repaid before any other forms of debt. Therefore, holders of senior debt have the first claim on a company's assets or earnings in the event of bankruptcy or insolvency. Due to the repayment guarantee, senior debt is considered to be lower risk compared to other types of debt.
Origin
The concept of senior debt originated from early commercial lending practices, where borrowers needed to offer higher repayment priority to specific creditors in exchange for lower borrowing costs or higher loan amounts. As financial markets evolved, this concept gradually developed and became widely used in corporate financing and bond markets.
Categories and Characteristics
Senior debt can be categorized into the following types:
- Secured Senior Debt: This type of debt is backed by specific assets, such as real estate or equipment. If the borrower defaults, creditors can sell these assets to repay the debt.
- Unsecured Senior Debt: This type of debt is not backed by specific assets but still has repayment priority over subordinated debt.
The main characteristics of senior debt include:
- Low Risk: Due to its repayment priority, holders of senior debt face lower risk.
- Lower Yield: Because of the lower risk, senior debt typically offers lower interest rates.
- Legal Protection: In the event of bankruptcy or liquidation, senior debt holders have legal priority for repayment.
Case Studies
Case 1: A company issues a batch of secured senior bonds, using its office building as collateral. If the company goes bankrupt, bondholders can be repaid by selling the office building.
Case 2: Another company issues unsecured senior bonds. Although there are no specific assets as collateral, these bondholders still have repayment priority over subordinated debt holders in the event of bankruptcy.
Common Questions
Q: What is the difference between senior debt and subordinated debt?
A: Senior debt has repayment priority over subordinated debt, making it lower risk but also lower yield. Subordinated debt is repaid after senior debt, making it higher risk but also higher yield.
Q: Why do senior debts have lower interest rates?
A: Because senior debt has repayment priority, holders face lower risk, which translates to lower interest rates.
