What Is a Subordinated Debenture?
A subordinated debenture is some type of bond that is ranked lower compared with other bonds issued by a particular organization. Typically, the subordinated debenture will have no collateral assets backing it and thus will carry high risk, although it offers a potential for high return. Many organizations issue stocks and bonds to raise capital that is necessary to conduct business. Most often, the debt portion of the capital will consist of different debt instruments ranked from safe to risky. The safest debt instrument in the ranks will be classed as senior debt, and the one ranked lower might be called junior debt, subordinated debt, subordinated bond, subordinated debenture, junk bond or high-yield bond.
Essentially, debentures are some kind of bonds normally issued by corporations. When a corporation issues debentures, it might separate them into a senior debenture class and a subordinated debenture class. The latter will be ranked the lowest and thus is the riskier instrument compared with the former. If the case the issuing organization was to go bankrupt and its assets were to be liquidated, then the subordinated debenture holder will get paid only after all senior classes of debt have been paid in full.
One of the reasons for different levels of risk and returns in debt instruments is to cater to a diverse group of investors who have different risk appetites and goals. Also, there might be variations in the ways that corporations structure their debentures. This may be a result of the financial practice particular to a given country. For example, debentures in the United States are normally unsecured U.S. bonds that are backed only by the reputation of the issuer — that is, investors usually have faith in the corporation to give them their money back as promised. In the United Kingdom, however, debentures might be collateralized or backed by the issuer's specific assets.
Investors who purchase all kinds of bonds are referred to as creditors, and the principal investment they make is promised to be returned at a certain date. In most cases, investors also collect regular interest payments on the debt in the interim until the maturity date, when they get a lump sum payment and possibly a final interest payment. The lump sum they receive at maturity is called the face value. For example, a subordinated debenture with $1,000 US Dollar (USD) face value will entitle the investor to receive $1,000 USD at maturity.
Subordinated debentures are a high risk fixed income security, although the return on it is higher when compared with secured debentures.
It is advisable for the investors to invest little amount of their fund in subordinated debenture and larger amount in secured debentures because of the risk of liquidation.
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