Subordinated debt

Subordinated debt is debt that ranks below other, senior debt in priority of repayment if an issuer becomes insolvent. If a company is liquidated or goes through bankruptcy, senior debt holders must be paid in full before subordinated debt holders receive anything, and subordinated debt holders are in turn generally paid before common or preferred stockholders.

Because of this lower priority, subordinated debt carries meaningfully more credit risk than senior debt from the same issuer, even though both may share the same maturity date and the same overall business risk. To compensate investors for standing further back in line, subordinated debt pays a higher coupon than senior debt issued by the same company, the wider yield compensates for the possibility that subordinated holders recover less, or nothing at all, if the issuer fails.

Banks and other financial institutions are frequent issuers of subordinated debt, partly because regulators treat certain types of subordinated debt as counting toward regulatory capital requirements in a way that senior debt does not. For an investor, evaluating subordinated debt means paying close attention not just to an issuer's overall creditworthiness but specifically to how much senior debt sits ahead of it in the capital structure, since that gap determines how much cushion exists before subordinated holders start absorbing losses.