What is Senior Debt
Senior debt is borrowed money that a company must repay first if it goes out of business. Each type of financing has a different priority level in being repaid if the company goes out of business. If a company goes bankrupt, the issuers of senior debt, which are often bondholders or banks that have issued revolving credit lines, are most likely to be repaid, followed by junior debt holders, preferred stock holders and common stock holders, possibly by selling collateral held for debt repayment.
What Is Senior Debt?
BREAKING DOWN Senior Debt
Senior debt is a company’s first tier of liabilities, typically secured by a lien against some type of collateral. Senior debt is secured by a business for a set interest rate and time period. The company provides regular principal and interest payments to lenders based on a preset schedule. This makes the debt less risky, but also commands a lower return for lenders.
Senior debt holders may be able to voice their opinions on how much subordinated debt a company assumes. If the company becomes insolvent, carrying too much debt may mean the business cannot pay all of its creditors. For this reason, senior debt holders typically want to keep other debt at a minimum.
Secured and Unsecured Senior Debt
Secured senior debt is backed by an asset that was pledged as collateral. For example, lenders may place liens against equipment, vehicles or homes when issuing loans. If the loan goes into default, the asset may be sold to cover the debt. Conversely, unsecured debt is not backed by an asset pledged as collateral. If a business becomes insolvent, unsecured debt holders file claims against the company’s general assets.
Senior and Subordinated Debt
If a company files for bankruptcy, senior debt claims are paid first. All other debt is subordinated. Collateral from asset-backed debts may be sold to pay off senior secured debt. Senior unsecured debt is then paid using other company assets. If any assets remain, subordinated debt is paid. For this reason, subordinated creditors may lose some or all of the principal and interest payments that they are owed.
Example of Senior Debt
In July 2016, Alejandro Garcia Padilla, governor of Puerto Rico, announced that Puerto Rico would default on $779 million in constitutionally-backed general obligation debt, its most senior debt. The Commonwealth had been focusing on covering services required for its citizens rather than paying its debt obligations. The previous month, President Barack Obama signed into law a bill providing a debt restructuring process, which stopped any litigation that would have resulted from the default. A federal oversight board was also implemented to manage Puerto Rico's finances. The general obligation (GO) debt is a category of debt that the United States had not defaulted on in decades. Unlike municipalities, Puerto Rico is not covered by Chapter 9 bankruptcy laws.