What are senior and subordinated debt?

Senior debt is often secured by a first lien on the borrower's assets. If the collateral does not cover the whole claim, the shortfall ranks alongside the borrower's other unsecured debts. Subordinated, or junior, debt includes mezzanine, while second-lien loans rank behind first-lien lenders on the collateral; an intercreditor agreement usually sets out how the two groups of lenders rank. In real bankruptcies the order can bend, for example when new lenders are allowed to rank ahead.

Say a company owes $60 million of senior debt and $20 million of subordinated debt, and is sold in a restructuring for $70 million. The senior lenders get their $60 million back; the subordinated lenders get the other $10 million, half of what they are owed. Simple example. Terms vary by fund.

Where a loan ranks decides how much a lender is likely to get back in a default, and so how much interest it asks for.

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