What is a Subordinated Debenture?

A subordinated debenture is a bond classified lower than more senior debt in the event of a default. This means that the holders of more senior securities are paid first, before any residual funds are made available to the holder of the subordinated debenture. Given the higher risk of nonpayment, this security pays out a relatively high interest rate, either because it has a high coupon rate or because investors are buying it at a discount from its face amount.

A subordinated debenture can be relatively low risk, as long as the borrower has a proven stream of cash flows that can be used to pay down its obligations, and especially if it also has a large asset base that can be used to pay off both senior debt and the subordinated debenture.