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Subordinated debentures are unsecured bonds that are indentured with a "subordination agreement" that renders them subordinate to all present and future debt in the event of default, liquidation, reorganization or bankruptcy. Present and future debt, such as straight debentures and money loaned by banks and insurance companies, thereby becomes "senior debt," while subordinated debentures are "junior debt."
The biggest advantage for corporations issuing subordinated debentures is that the subordination agreement makes junior debt unratable along with debentures and other unsecured debt of general status, which puts them in the company's equity base on the balance sheets. This effectively limits the company's book-value debt, which makes it easier to obtain further loans from banks and financial institutions, who can be sure at least that they will not have to wait in line with junior debtors in the event of default or liquidation.
Subordinated debentures are much riskier investments than straight debentures, and holders of these instruments are rewarded with very high interest rates. In addition, many subordinated debentures are issued with conversion features, making them even more attractive to investors.
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Subordinated Debentures (Junior Debt)