When a company or a bank fails, it cannot pay everyone. The law sets an order. Some creditors get their money first. Others wait and often get less. The seniority of a bond is its place in that order. It is one of the facts that set the yield of the bond.
This guide lists the ranks a bond can have, from secured debt down to equity. It shows with an example how the money is split after a default. It explains what the Seniority row on a BondSmartly bond page means and how the issuer yield curves use it.
1. What is bond seniority?
Seniority is the rank of a debt among all the debts of one issuer. The rank decides the order of payment if the issuer defaults or is wound up. A creditor with a higher rank is paid in full before a creditor with a lower rank gets anything.
A bond with a high rank has a small risk of loss. Its yield is lower for that reason. A bond with a low rank carries more risk, so the issuer has to pay a higher yield to find buyers for it.
Two bonds of one issuer can have different ranks. The bond with the lower rank has a higher chance of a loss. The rank of each bond is written in its terms.
2. The ranks from top to bottom
Most bonds fall into one of the ranks below. The list starts at the top, with the debt that is paid first.
Secured debt
A secured bond has a claim on specific assets of the issuer, for example a building or a pool of mortgage loans. If the issuer fails, the holders of the secured bond are paid from those assets before anyone else. Covered bonds of banks belong here. A covered bond is backed by a pool of mortgages or public sector loans. The bank must keep that pool in good shape for as long as the bond is alive.
Senior unsecured debt
Most corporate bonds and most bank bonds are senior unsecured. The bond has no specific asset behind it. It ranks with the other ordinary debts of the issuer, such as bank loans and unpaid bills.
EU banks issue two kinds of senior bonds. Senior preferred bonds rank with the other ordinary claims of the bank. Senior non-preferred bonds sit one step lower. They are paid after the senior preferred bonds and before the subordinated bonds. Banks issue them to build a layer of debt that can absorb losses in a resolution.
Subordinated debt
A subordinated bond is paid after all senior debt. For a bank this layer is called Tier 2. Tier 2 bonds count as capital of the bank under the bank rules. Many of them have a call date some years before the maturity date.
Junior subordinated debt
Junior subordinated debt ranks below ordinary subordinated debt. For banks this is Additional Tier 1 capital, AT1 for short. An AT1 bond has no maturity date. The bank can call it on set dates, with the approval of its supervisor. The bank can cancel a coupon. When the capital of the bank falls below a set level, the bond is written down or converted into shares.
Equity
Shares come last. Shareholders get what is left after every creditor is paid in full. In most defaults that is nothing.
Mezzanine debt and hybrid bonds
Mezzanine debt sits between senior debt and junior debt. It is common in leveraged buyouts and in private finance, where a fund lends to a company below the bank loans.
Companies also issue hybrid bonds. A corporate hybrid is deeply subordinated. It has a very long maturity or none at all, and the company can defer the coupons. Rating agencies treat part of a hybrid as equity. That is the reason companies issue them.
3. Bail-in for EU banks
The EU bank resolution rules give the authorities a tool called bail-in. When a bank is failing or likely to fail, the resolution authority can write down its bonds or convert them into shares. This happens before the bank goes through an ordinary insolvency. The authority works up the ranks in reverse order:
- Shares absorb the losses first.
- AT1 bonds follow.
- Then Tier 2 bonds.
- Then senior non-preferred bonds.
- Then senior preferred bonds.
Covered bonds and insured deposits are excluded from bail-in. The rank of a bank bond matters even when the bank never reaches a court.
4. Who gets what after a default
Lower ranks usually recover less after a default. How much a rank gets back depends on the assets that are left and on the size of the debt above it. The example shows the mechanism with simple numbers.
The numbers are made up. The issuer is wound up. The sale of its assets brings in 100 million. The table lists what it owes, by rank. The costs of the procedure are ignored.
| Rank | Owed | Paid | Money left |
|---|---|---|---|
| Secured bond | 60 | 60 | 40 |
| Senior unsecured bonds | 50 | 40 | 0 |
| Subordinated bond | 30 | 0 | 0 |
| Shares | no claim | 0 | 0 |
The secured bondholders are paid in full from the 100 million. That leaves 40 million. The senior bondholders share it. They get 40 of the 50 million they are owed, or 80 cents on the euro. The subordinated bondholders get nothing. The shareholders get nothing.
Change the numbers and the split changes. With 120 million of assets, the senior bonds are paid in full and the subordinated bond gets 10 million of its 30 million. Real cases are less tidy. The procedure takes years, and its costs come out before the creditors see any money.
5. Seniority and yield
Take two bonds of the same issuer with a similar maturity. One is senior. The other is subordinated. The subordinated bond almost always trades at a higher yield. The gap pays you for the lower rank.
The size of the gap changes by issuer and by market. It grows when the market worries about the issuer. It shrinks in calm periods. A wide gap between two bonds of one issuer is a reason to read the terms of the lower bond again.
Compare senior and subordinated bonds
The yield curve builder draws the bonds of one issuer by maturity. Pick the seniority to see one group on its own, or put senior and subordinated bonds on one chart.
6. Government bonds
A bond of a state is usually a senior unsecured obligation of that state. No asset stands behind it. The state pays from its revenue. Treasury bills, such as the Italian BOT described in the article on zero-coupon bonds, have the same rank as the long bonds of the same state. What a holder gets back after a default of a state depends on the deal that the state reaches with its creditors.
7. What to check before you buy
- The seniority. Find the rank in the prospectus or in the final terms. The clause on the status of the notes names it.
- The call date. Subordinated bonds and AT1 bonds often have a call date. The issuer can call the bond on that date. It does not have to. If the issuer leaves the bond outstanding, you hold it longer, and the coupon may reset to a new rate.
- The coupon rules. The bank can cancel an AT1 coupon, and a cancelled coupon is lost for good. A company can defer the coupons of a hybrid bond. Read the coupon clause before you count on the income.
- The write-down or conversion trigger. An AT1 bond names the capital level at which it is written down or converted into shares. Check how far the bank is above that level.
8. Seniority on BondSmartly
The Seniority row
Each bond page has a Seniority row in the key facts. The value comes from the FIRDS reference data of ESMA, the register of financial instruments in the EU. The FIRDS field is called DebtSnrty. It holds one of four codes, and the page shows each code as a word.
| Shown on the page | FIRDS code | What it means |
|---|---|---|
| Senior | SNDB | Senior debt. It is paid before the subordinated debt of the issuer. Most corporate and bank bonds have this rank. |
| Subordinated | SBOD | Subordinated debt. It is paid after the senior debt. For a bank this is usually a Tier 2 bond. |
| Junior | JUND | Junior debt. It is paid after the subordinated debt, just above the shares. |
| Mezzanine | MZZD | Mezzanine debt. It ranks between senior debt and junior debt. |
Many bonds have no seniority in FIRDS. The row then shows N/A.
Nachrang in the name
Some German bank bonds carry the word Nachrang in their name. Nachrang is German for subordinated. For some of these bonds FIRDS says senior, or it gives no seniority at all. BondSmartly shows those bonds as Subordinated.
The issuer yield curves
The bond page and the yield curve builder draw the bonds of an issuer on a curve by maturity. The curves sort the bonds into two groups. A bond counts as subordinated when its FIRDS code is SBOD, JUND or MZZD, or when its name says Nachrang. Every other bond counts as senior. That includes the bonds with no seniority in FIRDS, because these trade like senior bonds. Government bonds and covered bonds are examples.
The curve can show one group (“Same seniority”) or both groups together (“Mixed seniority”). The builder shows the senior bonds by default. When you put both groups on one chart, a subordinated bond usually sits above the senior curve.
The Guarantee or rank row
Some bond pages also show a row called Guarantee or rank. Its value comes from the CFI code of the bond, the ISO 10962 classification. The standard calls this attribute “guarantee or ranking”. The row says who backs the bond besides the issuer, or where it ranks. It can show:
- Government/state guarantee: a government stands behind the payments.
- Joint guarantee: two or more parties guarantee the bond together.
- Supranational: the issuer is a supranational body, such as a development bank owned by states.
- Secured: specific assets back the bond.
- Unsecured/unguaranteed: no asset and no other party stands behind the bond.
- Negative pledge: the bond is unsecured, and the issuer has promised to give no other creditor security ahead of it.
- Senior: the bond ranks with the ordinary debts of the issuer.
- Senior subordinated: the bond ranks below the senior debt and above the junior debt.
- Junior: the bond ranks below the senior subordinated debt.
- Junior subordinated: the bond ranks lowest among the debts, just above the shares.
The page hides the row when the CFI value is “Not applicable”. It also hides the row when the value would only repeat the Seniority row, for example when both say Senior.
Summary
- Seniority is the rank of a bond among the debts of its issuer. It sets the order of payment in a default.
- The ranks from top to bottom are secured debt, senior unsecured debt, subordinated debt, junior subordinated debt and equity. For EU banks, senior debt splits into senior preferred and senior non-preferred.
- A higher rank means a smaller risk of loss and a lower yield. A lower rank means the opposite.
- In a bail-in of an EU bank, the authority writes down the ranks from the bottom up, starting with the shares.
- The subordinated bond of an issuer usually yields more than its senior bond of a similar maturity.
- BondSmartly shows the FIRDS seniority as Senior, Subordinated, Junior or Mezzanine, or N/A when FIRDS has none. The issuer curves split the bonds into a senior group and a subordinated group.
Questions
What does senior mean on a bond?
A senior bond is paid before the subordinated bonds of the same issuer if the issuer defaults or is wound up. It ranks with the other ordinary debts of the issuer. Most corporate and bank bonds are senior unsecured bonds.
Is a subordinated bond a bad investment?
Not by itself. A subordinated bond pays a higher yield than the senior bond of the same issuer, because it is paid later in a default. The question is whether the extra yield pays you enough for the extra risk. Read the terms, the call date and the coupon rules before you decide.
What is a senior non-preferred bond?
It is a senior bond of an EU bank that ranks below the senior preferred bonds and above the subordinated bonds. Banks issue these bonds to build a layer of debt that can absorb losses in a resolution. In a bail-in they are written down after the Tier 2 bonds and before the senior preferred bonds.
What is an AT1 bond?
AT1 stands for Additional Tier 1. It is the lowest rank of bank debt, just above the shares. An AT1 bond has no maturity date. The bank can call it on set dates and can cancel a coupon. When the capital of the bank falls below a set level, the bond is written down or converted into shares.
Why does the Seniority row on a bond page show N/A?
The value comes from the FIRDS reference data of ESMA. Many bonds have no seniority in that data. BondSmartly then shows N/A. On the issuer yield curves these bonds count as senior, because they trade like senior bonds.
Why does BondSmartly show a bond as Subordinated when FIRDS says senior?
Some German bank bonds carry the word Nachrang in their name. Nachrang is German for subordinated. When the name says Nachrang and FIRDS says senior or gives no seniority, BondSmartly shows the bond as Subordinated and puts it in the subordinated group of the issuer curve.