Junior debt, also known as subordinated debt, is debt that is unsecured and is lower on the debt hierarchy than other debt claims. Junior debt is provided without any collateral to back it and is often subject to an inter creditor agreement with the senior lender.
When a company goes bankrupt, junior debt is low on the repayment food chain. Since it is subordinate, it means that the loan will most likely not be paid back if the company goes bankrupt, and other debts that are of higher importance will be paid back first.
Junior loans are very high-risk debt, and generally have higher interest rates than senior debt to compensate for this high risk. It has a risk profile close to an equity security, due to the fact that it is uncollateralized and that its principal is only repaid upon the long term growth of the business.
If a company is liquidated, it is repaid after senior debt and government tax agencies are repaid. Shareholders and parent companies are generally the ones who purchase junior debt.
The reason the shareholders and parent companies are looking to purchase junior debt is because they have close relationships with the companies and they are willing to provide it at lower interest rates due to their knowledge and familiarity with the company.
Another name for junior debt is mezzanine debt. While it is a risky loan for a lender, it is a growing and increasingly popular form of borrowing for mid-market companies. With junior debt and mezzanine debt, the lender’s incentives are very much aligned with the long term interests of the shareholders and management.
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