Subordinated debt ranks behind senior secured debt but ahead of equity. Common forms: second mortgages, mezzanine finance, junior tranches of structured warehouse facilities, and contractually subordinated unsecured debt.
On default, subordinated debt only sees recovery after the senior debt is paid out in full. The recovery rate on subordinated debt is therefore materially lower than on senior debt, historical data on Australian property-secured private credit suggests senior debt recovery rates above 95%, subordinated debt recovery rates closer to 60-75% depending on the cycle.
Yield reflects the risk. Subordinated property-secured debt in Australia typically prices 400-800bp above the equivalent senior position. For investors, the question is whether the yield premium adequately compensates for the higher loss-given-default. Most institutional private credit allocators size subordinated debt as a smaller portion of the book than senior debt because of the recovery profile.
Borrowers use subordinated debt when senior alone doesn't get them to their target capital structure, typically on development sites or commercial acquisitions where the LVR cap on senior debt would otherwise require too much equity.