Subordinated Bonds are the bonds which are ranked after other loans or debts for payment in case of dissolution or closing down of the company. Subordinated Bonds are also called as Subordinated debt, junior debt and Subordinated loans.
In Subordinated Bonds, those who lend the money will be paid only before stock holders i.e. they have Subordinated status in case a company is liquidated. In comparison to the other bonds issued by the issuer, Subordinated Bonds are given a lesser priority for re-payment of debt or loan during bankruptcy. In the list of creditors, Subordinated Bonds come only after liquidator, tax departments and major debt holders or major bond holders.
Since these bonds are repaid after the payment of other bonds, Subordinated Bonds are considered very risky. As a result, Subordinated Bonds provide higher rate of interest to compensate the risk factor involving its repayment. Subordinated loans are generally provided by major shareholders or even promoters of the company since a third party would demand more compensation to balance the risk factor. The credit rating of the Subordinated Bonds is generally very low when compared to the other bonds due to the risk factor involved in repayment of the loans.
Examples of Subordinated Bonds:
Bonds issued by the bank and asset-backed securities are the two examples of Subordinated Bonds. In United States, many big banking institutions regularly come out with Subordinated Bonds. Bond holders of Subordinated Bonds can claim repayment. Asset backed securities are released n tranches out of which Subordinated tranches are repaid after senior tranches.
Subordinated Bonds are generally not issued by corporate groups since they will have to pay higher interest rate to compensate the risks involving non-repayment of debts and loans. Corporate groups issue Subordinated Bonds only
in cases where they need funds quickly and don’t have to pay any compensation at the outset. Subordinated Bonds help the corporate groups to finish the project in one go and at less cost as compared to an unsecured loan. The higherrate of interest paid to bond holders will still be less than the interest on other types of loans.
Advantages of Subordinated Bonds:
The high interest rate paid by the issuer to the Subordinated Bond holder is the biggest advantage which attracts the investors despite the risk factor involved in non-repaymentof the loans. The higher interest rate paid mostly half-yearly offsets the non-repayment risk.
Subordinated Bonds are still considered as the safest instruments in comparison to the other stock options. Subordinated Bonds will be risky only if the issuer of these Subordinated Bonds faces liquidation goes bankrupt or closes down. Otherwise it is safe as the bond holder will get interest regularly and the principal amount at the endof the maturity.
Disadvantages of Subordinated Bonds:
Subordinated Bonds are risky since the bond holder of Subordinated Bonds will be repaid only after liquidator, tax department and bond holdersof the senior bonds are paid. In case of bankruptcy of the issuer, the bondholder may lose his money.
Due to the risk factor involved, Subordinated bonds are given lower credit rating by the credit rating agencies.
Subordinated Debenture bonds:
Like Subordinated bonds, Subordinated Debenture bonds also pay higher rate of interest to the bond holders but the Subordinated Debenture bonds are given even lesser priority than the Subordinated bonds in case of repayment of loans or debts.
Bond holders of junior Subordinated bonds too, get repayment only after bond holders of senior bonds and Subordinate bonds are paid.