Subordinated debenture has a lower priority than other bonds of the issuer in case of liquidation during bankruptcy, below the liquidator, government tax authorities and senior debt holders in the hierarchy of creditors. Because subordinated debenture is repayable after other debts have been paid, they are more risky for the lender of the money.
It is unsecured and has lesser priority than that of an additional debt claim on the same assets.A typical example for this would be when a promoter of a company invests money in the form of debt, rather than in the form of stock.
In the case of liquidation (e.g. the company winds up its affairs and dissolves) the promoter would be paid just before stockholders assuming there are assets to distribute after all other liabilities and debts have been paid.
Subordinated debentures typically have a higher rate of return than senior debt due to the increased inherent risk. Accordingly, major shareholders and parent companies are most likely to provide subordinated loans, as an outside party providing such a loan would normally want compensation for the extra risk
Subordinated debentures usually have a lower credit rating than senior bonds. Here are a couple examples for subordinated debentures. First of all, the main example of subordinated debenture can be found in bonds issued by banks . Subordinated debenture is issued by most large banking corporations in the U.S. periodically. It is believed that subordinated notes are risk-sensitive. That is, subordinated debenture holders have claims on bank assets after senior debt holders and they lack the upside gain enjoyed by shareholders. This status of subordinated debenture makes it perfect for experimenting on the significance of market discipline . This can be accomplished in two separate ways. First, a simple look at secondary market prices of subordinated debenture would suffice. Second, one can have a look at issue price of these bonds initially in the primary markets.
Subordinated debentures also enjoy a higher discount in the secondary market because of the higher interest they provide to the debenture holder. However, it is important to keep in mind that you should not expect payment from a subordinated debenture before other corporate debts have been satisfied.
Subordinated debenture and stocks
When somebody decides to invest in stocks, he or she becomes one of the owners and thus, becomes a shareholder of the good and bad times of the company. The investor faces uncertain fortunes related to the company's financia graph. So this explains the amount of risk related to stock investments But debentures are more secured investment, as payments with high interest rates are guaranteed. The company is bound to pay interest on the borrowed money, and once the debenture matures, all the borrowed money is returned. In other words, the investors gain interest as income from the debentures.
Subordinated debenture and bonds Subordinated debenture and bonds are similar, but bonds carry more security than debentures. In both of these investment forms, interest and value is guaranteed, but in case of liquidation, bond holders receive the payment first, followed by the senior bonds, and only after that comes the subordinated debenture holders, who have no collateral which they can claim from the company in case bankruptcy takes place. To compensate for the possibility of such losses, high interest rates are paid to the subordinated debenture holders.
More Information on Debenture
|Debenture Agreements||Definition of Debenture|
|Bank Debenture||Discount Rate|
|Convertible Debenture||Debenture Exchangeable|
|Corporate Debenture||Government Debenture|
|Corporation Debenture||Debenture Holder|
|Debenture Rate||Subordinated Debenture|
Last Updated on : 9th July 2013