What is Senior Security in the Stock Market?

Key Highlights

• Senior security is a financial instrument that has the highest repayment priority in case of liquidation.

• Senior debt generally offers lower interest rates compared to junior debt.

• Bondholders are considered creditors. They have a higher priority over common shareholders in receiving payments during bankruptcy.

• Examples of senior securities include secured debt, guaranteed bonds, and preference shares.

Senior Security Meaning

Senior security is a financial instrument issued by a company that gets priority payment status if the company liquidates. Most publicly traded firms have a combination of debt and equity instruments in their capital structure. A typical system might consist of preferred stock in addition to common stock. It also comprises multiple bonds with varying maturities or maturity dates. Most securities have a priority status in an ascending order of seniority. This order is as follows: debt securities, preferred stock, and common stock.

Bondholders are a firm’s creditors. However, common shareholders own a stake in the company. The bond's principal must be returned when the bond matures. So, a corporate bond is designated as a senior security. The firm must pay the bondholders yearly interest. In case of bankruptcy, preferred and common shareholders receive payment only after the bondholders.

Numerous companies issue different classes of senior securities. They are arranged in order of the preference granted to them in case of liquidation. A company's physical assets may serve as security for some of the bonds the firm issues. A company's debentures, or bonds, may also be categorised as unsubordinated or subordinated.

Subordinated bonds are regarded as senior securities with respect to the claims of preferred and common stockholders. Still, they are junior or subordinate to the interests of the holders of a company's unsubordinated debt instruments.

Ranking of Senior Security

Now that you understand the senior security meaning, let's look at the ranking. Secured or mortgage-backed bonds rank highest in terms of principal payments. They provide lower yields since collateral assets back the secured bonds. Senior bondholders have the right to get the repayment only after the secured bond.

Senior and secured bonds come first in the ranking of junior bonds. Compared to the top-ranked bonds, they give a slightly better return. Guaranteed or insured bonds come first, followed by junior bonds. These bonds have an agreement with a third party to assume repayment obligations when the issuer defaults.

Convertible bonds are ranked next. They provide the bondholder the option to convert the bond into stock at a later date. On the other hand, this method is ineffective if the issuer defaults. They are paid out prior to the preference and equity holders. However, they are ranked after all the bonds mentioned above.

Preference shareholders are in the highest rank when all debt securities have been paid.
The least senior to receive repayments are equity shares. They have the highest profit potential. Common shareholders receive their payout only after all debts and preferred shareholders have been paid.

Examples of Senior Securities

The following are some common examples of senior securities.

• Secured Debt: Secured debt is more senior compared to unsecured debt. Any security in which the issuer pledges an asset or other valuable object as security for the lender is a secured debt. If the issuer defaults, the title of “collateralised asset” would be given to lenders in order to make up for their losses.

• Guaranteed bond: Guaranteed bonds have a guarantor who assures repayment if the issuer goes bankrupt. A bank, an insurance provider, a subsidiary, etc., can all serve as guarantors. They are backed not just by the issuer but also by a third party. So, they offer a considerable amount of safety to the investors.

• Preference shares: The preference shares are senior to common shares. Preference shareholders are entitled to payment ahead of equity owners. However, they don’t have the right to vote. Preference shares give more returns than debt instruments.

Conclusion

A firm must pay back its obligations when it files for bankruptcy or is shut down. Seniority is the order in which they are repaid. The firm issues all instruments, including bonds and shares. It assigns a certain seniority to each one of them. Senior obligations must be paid off before junior debts. Bonds and debts are often the instruments that must be paid back first in case a company is liquidated. Preference shares come next, and equity shares at the end. As an investor, you must know the seniority of each asset to in