Senior Security

What Is a Senior Security?

In the event of a company's bankruptcy or liquidation, a senior security is one that ranks highest in the order of repayment before other security holders receive a payout. Senior securities are ordinarily viewed as the safest offering by a company in light of the fact that in the event of default the senior security holders will be paid any funds owed before investors in lower ranking securities.

Grasping Senior Security

With respect to a company's capital structure, seniority alludes to the order of repayment to security holders on account of a default by the responsible corporation. Due to its greater degree of safety, a senior security will generally offer lower returns than securities below it in the seniority hierarchy.

Each type of security issued by a company has a specific seniority or repayment ranking, with holders of senior secured bond debt having the privilege of getting compensated first, before other security holders. Inside this seniority hierarchy, secured bonds, which the issuer has backed with collateral, must be repaid before subordinated or junior bond debt is repaid. After bondholders are repaid, preferred stockholders have repayment seniority over common stockholders.

Common stock, which is the least senior security in a company's capital structure, generally offers investors the highest expected returns to make up for this extra degree of risk. Common shareholders likewise have voting rights, while senior security holders don't.

Seniority Bond Ranking

While seeing security ranking, there are several basic rules.

• Debt ranks higher than equity in the payout order.
• Secured debt ranks higher than unsecured debt.
• Senior debt ranks higher than junior or subordinate debt.

There are several types of bonds. This is the way each would rank in terms of seniority.

• Secured Bonds: These rank the highest in terms of safety and seniority, since they are backed or secured by collateral.
• Senior Bonds: Anything with the title senior connected to it means it ranks higher than junior or subordinate debt.
• Junior or Subordinate Bonds: These are bonds that have a payout ranking that is lower than secured or senior bonds. Junior bonds commonly have somewhat higher interest payments relative to secured or senior bonds, which have a higher margin of safety.
• Ensured or Insured Bonds: These are bonds that are insured or backed by an outsider. While they can be very safe, it depends on the outsider to step up and assume control over the repayment of the bonds in the event the responsible company defaults.
• Convertible Bonds: These securities furnish the owner with the option to change over the bond into common stock. This regularly is certainly not a valuable feature in the event that the company is in financial distress, and the bonds will be paid out solely after every one of the more senior securities have been paid first.

Investing in Senior Securities

Assume an investor is interested in investing in a company. Buying stock is one method for investing. With this method, the investor can sell out of their position whenever for a profit or loss. They ordinarily have voting rights, yet assuming the company goes into default and the stock price tanks overnight, common stockholders are the last on the rundown to receive any funds that the company has left.

Another option is to buy preferred shares. Preferred shares don't have voting rights and are substantially more stable in price since the price of the shares depends on the ability of the company to pay the preferred share dividend. The investor's return is the dividend. Sums owed to preferred shareholders are paid out before those of common shareholders.

Commonly, the more senior and safer the investment, the lower the return. On the other hand, the more junior and riskier the investment, the higher the potential return.

The investor could likewise buy debt. This incorporates bonds or commercial paper. In exchange for buying these products, the investor receives interest payments or potentially a lump sum back when the paper or bond matures. Interest and principal sums are paid to investors before preferred shareholders are paid.

Secured or senior debt is another option. With these securities, the investor actually receives interest payments and a lump sum back at maturity, yet commonly the interest is somewhat lower than with junior debt since senior debt is viewed as safer. Assuming the company runs into financial difficulty, secured bondholders approach the collateral that is being held against their position. Senior debt holders get compensated first before junior debt holders, preferred shareholders, and common shareholders.

By taking a gander at every one of the options, an investor can better survey what risk/reward mix they are generally OK with.

Features

• Secured and senior debt is paid first, in the event a company runs into financial difficulty.
• Junior debt, then, at that point, preferred shareholders, lastly common shareholders are paid out last.
• A senior security is one that ranks higher in terms of payout ranking, ahead of more junior or subordinate debt.