Notes for Level I CFA® Program

R55 Fundamentals of Credit Analysis

3.2. Seniority RankingWatch Video Play


A single borrower may issue debt with different maturity dates and coupons. These various bond issues may also have different seniority rankings. Seniority ranking determines who gets paid first, or who has the first claim on the cash flows of the issuer, in the event of default/bankruptcy/restructuring. Bondholders are broadly classified into: secured and unsecured.

  • Unsecured bonds are known as debentures. They have a general claim on an issuer’s assets and cash flows.
  • Secured bondholders have the first (direct) claim on cash flows in the event of a default.
  • Priority of claims determines who gets paid first.

The exhibit below shows seniority ranking.

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Within each category of debt, there are types and sub-rankings. Let us look at each of the items in detail now (in the order of priority for repayment):

Secured debt: Highest ranked debt in which some asset is pledged as collateral.

  • First mortgage debt: A specific property is pledged.
  • First lien debt: A pledge of certain assets such as buildings, patents, brands, property and equipment etc.
  • Second lien or third lien: Some more assets could be pledged as a second or third lien to rank below the first mortgage/first lien.

Unsecured debt (in the order of ranking): Loss severity can be as high as 100%. Lowest priority of claims. No asset is pledged as collateral. The types are:

  • Senior unsecured
  • Subordinated
  • Junior subordinated

Companies issue debt with different ranking for the following reasons:

  • Cost effective: Secured debt has a lower cost due to reduced credit risk.
  • Less expensive than equity: From a borrower’s perspective, even though the cost of issuing subordinate debt may not be as low as secured debt, it is less restrictive and is relatively less expensive than equity.
  • Investors invest in subordinated debt because the higher yield compensates the high risk assumed.