Subordinated Debt
Debt that ranks below senior creditors in bankruptcy proceedings, compensating investors with higher yields for the greater loss risk.
What is Subordinated Debt?
Subordinated debt (also called junior debt or sub-debt) is a class of debt that ranks below senior secured and senior unsecured creditors in the priority of claims during bankruptcy or liquidation. If an issuer defaults, subordinated debtholders receive repayment only after all senior creditors have been paid in full—meaning subordinated holders bear a higher probability of receiving less than par or nothing in a distressed scenario. To compensate for this additional risk, subordinated bonds carry higher coupon rates than senior debt from the same issuer. Subordinated debt is common in bank capital structures (as Tier 2 regulatory capital), in leveraged buyout financing stacks, and in corporate high-yield issuance.
Example
In a leveraged buyout, a private equity firm finances the acquisition with: $500 million senior secured loans (first lien), $200 million senior unsecured notes (second priority), and $100 million subordinated notes (third priority). If the company subsequently defaults with only $650 million of asset recovery, senior secured holders receive $500 million in full, senior unsecured holders receive $150 million (75 cents on the dollar), and subordinated holders receive nothing—illustrating why subordinated debt demands a higher yield.