Understanding Senior Debt: A Comprehensive Guide

A senior debt refers to a type of outstanding financial obligation that takes priority over other current debts owed by an entity, usually a company or a corporation. In the perspective of a lender or creditor, a senior liability is the least risky type of secured lending. In case the debtor files for bankruptcy protection, the lender of the senior liability will be given priority in the payment schedule. Aside from having greater importance when it comes to the payment of the loan principal, a senior liability also takes precedence when it comes to the interest payments.

Often, a senior debt is secured or backed by collateral. More often than not, the lender of this type of debt will put a first lien on the borrower’s asset, the value of which is enough to cover the full payment of the obligation. Some companies use all of their assets as collateral when securing a senior revolving credit line. Although there are some lenders that offer unsecured senior loans, such debts are not common.

Limitations to Seniority

There are instances where the seniority status of a loan is not a guarantee that it takes first priority in the payment schedule. For instance, all debts that have securities are more likely to be settled ahead of an unsecured senior debt in case the borrower becomes insolvent. Still, senior loans that are not secured by any collateral can have the first claim on the non-collateral assets of the borrower.

Certain oversight and regulatory powers can also limit the seniority status of a loan, particularly the unsecured ones.  This usually happens during mergers, acquisitions, or other unexpected events such as seizures.

In case of a Chapter 11 filing of the borrower, any senior loans (secured or otherwise) may become subordinate to new loans whose lenders were given a super seniority status. This usually happens when the new lenders obtain a status of debtors in possession, which means that the new lenders will finance the continuing business operations of the borrower.

Senior Debt Requirements

Senior debt financing is often available to corporations and other business entities. However, the requisites in obtaining this loan can be very strict. For one, a company must have an asset that can be used as collateral. Moreover, lenders will usually look at the company’s cash flow to make sure that it is capable of repaying its financial obligations.

Lenders will also consider the company’s performance as well as the quality of its collateral to determine the interest rate that will be applied to the senior debt. A borrower can get a high interest rate, which can go as much as five points over prime, if the lender perceives a high risk of not being paid on time. However, interest rates can also be as low as one point below prime if the borrower can show a strong cash flow history. The terms and conditions of the loan are also dependent on the company’s balance sheet figures.