The Seniority Structure of Debt

Senior

Senior debt is a class of corporate debt that has priority with respect to interest and principal over other classes of debt and over all classes of equity by the same issuer. However it may occur that certain holders of particular tranches of debt which may have been designated and sold as senior debt may be below others who have super-senior claims.

Subordinated

Subordinated debt or bond holders have accepted that their clami to the issuers assets ranks below that of senior debt the scenario of liquidation. In most cases the subordinated debt since it is entitled to a higher rate of interest than senior debt because the holder of this debt is subject to greater risk.

Mezzanine and PIK Loans

Mezzanine debt is even more risky than subordinated debt. It will rank below other forms of debt, but above equity in the event of the company going into liquidation. It is the most risky debt,  will offer a higher rate of interest than the subordinated and senior levels of debt. Interest on mezzanine debt is not always paid in in cash. What happens instead is that the repayment that would have been made is instead added to the cost of the loan. This later portion is known as payment in kind or PIK. In some cases where mezzanine debt is used there are no interest repayments at all and all the debt is rolled up to become an increased amount owed. These notes are referred to as PIK notes. PIK notes are very similar to zero coupon bonds in that they free the issuer from the need to service the borrowing with cash until the notes/bonds reach maturity.




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