What Is 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.

Key Takeaways

  • Unsubordinated debt is an obligation that must be repaid before any other form of debt if the debtor goes bankrupt or insolvent.
  • The majority of unsubordinated debt is usually secured by collateral.
  • This kind of debt is also known as a senior security or senior debt.
  • Types of unsubordinated debt include exchange-traded notes, collateralized securities, and certificates of deposit.

How Unsubordinated Debt Works

When a company goes bankrupt or insolvent, there is normally a chain or ranking of creditors who get paid in a specific order. Lenders of unsubordinated debt get paid out in full first by the company. The majority of this type of debt is usually secured by collateral.

Most loans from financial institutions and certain high-grade debt securities such as mortgage bonds are deemed senior debt. Loans are also considered unsubordinated based on the balance and the length of time outstanding in comparison with other loans.

Because senior debt has a relatively secure claim, it is considered to be less risky. As such, it pays a lower rate of interest compared to other types of debt. This means lenders are willing to compensate for lower borrowing rates by claiming a higher priority over a borrower’s assets since they will be repaid first during a liquidation event.

Because they come with some security, unsubordinated debt lenders normally charge lower interest rates to their debtors.

After unsubordinated debt lenders are paid, any remaining money goes to preferred stock holders, subordinated debt, followed by common shareholders.

Types of Unsubordinated Debt

Examples of unsubordinated debt include exchange-traded notes (ETNs), collateralized securities, and certificates of deposit (CDs). Collateralized securities such as mortgage-backed securities (MBS) are structured with a number of tranches that bear different risks, interest rates, and maturities. Tranches with a higher claim on underlying assets are safer than junior tranches with a second lien. Senior tranches also have a higher credit rating than junior tranches and are paid first.

Unsubordinated vs. Subordinated Debt

Unsubordinated debt is the opposite of subordinated debt. This type of debt vehicle is ranked below all senior debts of a company. Subordinated debt is also called junior debt, and is subject to subordination in the event of default or bankruptcy.

When a company’s assets are liquidated to pay off its debt obligations, subordinated debt holders receive payment after all unsubordinated debt lenders and preferred stock holders are paid. In some cases, there is no cash left after paying the unsubordinated lenders, which means every other creditor remains unpaid.

Because there is more risk associated with subordinated debt, these lenders normally charge higher interest rates compared to unsubordinated debt.