What Is a Subordinated Debenture
A debt that is ranked after other debts incase the debtor falls in to receivership is known as subordinate debenture, at times this may also be referred to as junior debt. The debt is referred to as subordinate because the debt providers who are the lenders possess a lower status unlike other normal debt . An example of subordinate debt is when someone promoting a company puts money as a debt not as stock. Should the company be liquidated and its affairs put under insolvency then the promoter before the stockholders are paid, this is after all the assets and any other liabilities have been met. This places subordinate debt at a lower cadre than other debentures of the issuer should liquidation be declared on bankruptcy.
Due to being a less priority debt which is repayable to other debts has been paid the risks associated with such ventures is great. This is because the debt is unsecured and has less priority than that of additional debt claim on the assets. Shareholders who have major stakes in a company are likely to provide subordinated loans, the reason for this is that should an outside person provide the money for the loan they are likely to require compensation due to the risk they will run by such practices. The subordinate debentures always have lower rates compared to other bonds.
Banks are some of the facilities that provide for subordinate debentures, this is especially common in the US where they are offered by large banks. The debentures are always considered to be risk sensitive as the holders’ claims on the bank assets will come after shareholders have staked their claims. Subordinate debts are often seen as ideal in experimenting with market discipline, this is done through the effect of secondary market prices of the junior debts. Policy makers argue that there’s potential benefits of banks offering subordinate debts as the information generating abilities are includes in the supervision of the financial condition that the issuing bank is in. The debentures are perceived as providing early signs to warn incase the bank management needs to put measures in place to curb any financial crisis that may be lurking round the corner. Thus the junior debentures act as canary in the mine giving the people concerned time to respond appropriately enabling them to offset any moral hazard that may be in existence where the financial facility may have limited deposits and equity. Junior debentures have attracted attention especially from people who makes policies as they seek to understand their role in the financial world.
Usually the junior debentures are issued as a part of the security of the assets, collateralized mortgages and debts which have collaterals. Oftentimes corporate avoid issuing the bonds due to the rates at which they are required to compensate the risk associated with the loans, however at times they are forced to offer them should indenture issues done earlier make them necessary. In certain circumstances the bonds are put together with preferred stock and they come up with preferred monthly income stock which is actually a mix of securities for the lenders.