Subordinated Liabilities

Definition

The concept of subordinated liabilities originates infinancial statement accounting. Subordinated liabilities refer to all of a company’s obligations to third parties that, in the event of bankruptcy or liquidation, will be repaid only after the claims of senior creditors have been satisfied from the available insolvency estate.

Since subordinated liabilities are the last to be repaid in the event of insolvency or liquidation—and thus pose a higher risk of default for the creditor—they are valued at a lower loan-to-value ratio. It is therefore important for lenders to conduct an appropriate risk assessment and select the appropriate interest rate and term.

To compensate for the higher risk associated with subordinated debt, a risk premium may be added to the interest rate. Long-term subordinated debt generally has a maturity of at least five years, while short-term subordinated debt has a maturity of at least two years.

Unlike other liabilities, subordinated liabilities have the characteristics of equity and appear as liability items on the balance sheet. They can either be repaid as debt with corresponding interest or function as part of equity and be used to cover liabilities or losses in the event of a loss or after the primary safety reserves (e.g., share capital or retained earnings) have been fully exhausted.