Cost of Subordinated Debt
Subordinated debt is more expensive than senior debt because:
- it is subordinate to senior debt (meaning in a liquidation the senior debt lender will be paid in full before the secondary lenders get any capital returned) and
- it typically does not require any principal payment until the end of the term loan.
This structure obviously creates more risk for the sub debt lenders and as a result they charge higher interest rates.
Subordinated debt is less expensive than equity as ...
... Sub debt has priority in a liquidation to any common stock, and is therefore less risky than equity, and therefore requires a lower return.
Pricing
Subordinated debt loans are typically priced anywhere between 10% and 20%, which is a wide gap, but there are endless combinations of factors that affect pricing, such as:
- Leverage ratios,
- Debt service coverage ratios
- Sector/industry
- Recurring nature of revenues (contracts, subscriptions, etc.)
- Who the Customer is (B2B, B2C, B2G), and their size/stability
- Existence of Long Term contracts
- Asset coverage
- Perception of where we are in the Economic cycle
- Interest rates (2, 10, 30-year rates, etc.)
- Growth rates
- Competition
- Margins
- and other risk factors
Generally, unitranche could be priced in the 9%-14% range, and subordinated debt behind senior debt could be in the 12%-20%+ arena, including a coupon, warrant and other fees and costs.