Senior Unsecured Bond

What is a senior unsecured bond?

A senior unsecured bond is a direct debt obligation of the issuing company. This type of bond gives its holders a top priority claim on the company’s assets and income if the company goes bankrupt, surpassing superseding the claims of subordinated bondholders. It’s important to note that this bond is not backed by any specific assets.

During bankruptcy proceedings or if the company defaults on its obligations, the court prioritizes the debt payments based on the company’s existing assets. Holders of senior (non-subordinated) bonds are given priority over subordinated bondholders, preferred shareholders, and ordinary shareholders when it comes to receiving their dues.

Secured bonds vs. unsecured bonds

When considering investment options, understanding the key differences between secured and unsecured bonds becomes crucial for assessing risks and potential returns.

Secured bonds are backed by specific assets of the issuing firm. Throughout the bond’s circulation period, the issuer retains ownership of these assets. However, if the issuer fails to meet its obligations, the creditors have the right to claim these assets. The issuer will then sell the assets and use the proceeds to redeem the bonds.

In contrast, unsecured bonds are not backed by specific assets of the enterprise but rather rely on the overall creditworthiness of the issuer. To protect the interests of holders of unsecured bonds, certain covenants may be included in the terms of the bond issue. One common covenant is the "Negative pledge" (also known as "Limitation on Liens"), which prohibits the issuer from using existing assets to secure debts owed to other creditors. This ensures that the assets remain available to back the unsecured bonds and protect the bondholders’ interests

Senior bonds vs. subordinated bonds

In the event of a default, senior debt takes precedence over other debts, while subordinated debt does not enjoy the same priority. In simple terms, if a company faces bankruptcy, senior debt holders are given top priority in receiving payments from the company’s assets, whereas subordinated debt holders occupy the last position in line .

Other types of corporate bonds

• Secured Corporate Bonds. Secured corporate bonds follow a ranking structure to prioritize debt payout. At the top are the senior "secured" debts, backed by collateral provided by the issuer, such as industrial equipment, a warehouse, or a factory. This collateral makes these bonds more secure, offering a higher recovery rate in the event of default.

• Senior Secured Bonds. In this structure, any security labeled as "senior" takes precedence over other sources of capital. The most-senior security holders receive the first payout in case of default, followed by those with second-highest seniority, and so on, until the available assets are exhausted.

• Junior, Subordinated Bonds. After senior securities are paid out, junior, unsecured debt holders are next in line for repayment. These bonds, also known as debentures, lack collateral and are paid out only after senior bonds in the event of default.

• Guaranteed and Insured Bonds. These bonds are not backed by collateral but are guaranteed by a third party. In case the issuer is not able to make payments, the third party steps in to fulfill the bond’s terms. Examples include municipal bonds backed by a government entity or corporate bonds backed by a group entity. Insured bonds offer an additional layer of security by relying on the credit ratings of two entities, resulting in reduced risk and lower interest rates.

• Convertible Bonds. Convertible bonds provide investors with the option to convert their bonds into common stock shares at a predetermined price, even if the stock’s market price has increased since the bond issuance. The price of convertible bonds is influenced by the company’s stock price and prospects at the time of issuance, and they typically offer a lower yield than standard bonds due to their expanded options for investors.