Subordinated loans: what they are and how they work

Helpful Personal Finance Advice

Subordinated loans belong to the category of bonds with certain specific characteristics that differentiate them, such as the level of return and the degree of risk. The bond is the loan requested by an institution that then issues bonds in favor of the investors, who will be entitled to a coupon with a fixed maturity until the total repayment of the loan. The repayment of the bond takes place at a specific date fixed in block or in deduction through installments to be paid together with the interest coupons. Subordinated loans, on the other hand, are often given to savers through life insurance policies, so unwitting savers find themselves with this financial instrument for the hands. In other words, they are assisted loans, which imply a clause of subordination to repayment if the debtor goes bankrupt. In this way, the lender accepts that the repayment of his credit depends on the full repayment of the other creditors and is subordinated to it. We know the financing instrument more closely.

What are the benefits?

As we have anticipated, subordinated loans from the point of view of economic performance are subordinated to the payment of interest, which moreover are more profitable than bonds. This higher profitability depends, however, on a much higher investment risk than the bond loan cousin. This is because in the event that the investment behind these loans should be ruinous, the subordinated loans will be paid only after all the other creditors have been satisfied. We can therefore say that a greater risk of loss is always linked to greater profitability. In other words, they are low-level bonds, but for this very profitable as well as risky. The nature of this type of financial instrument is controversial, since there is a tendency to recognize that the clause conditions the obligation to repay the sum, thus removing the scheme from that of the loan and attributing it the character of risk provision.

Who issues them?

It is generally the banks that manage this type of financing, for which they issue subordinated loans. Moreover those issued by Italian credit institutions are not particularly risky thanks to their stability; more risky, without a shadow of a doubt, those issued by foreign banks. It is the art. 12 paragraph 7 of the TUBC to establish that the banks can issue subordinated loans, also in the form of bonds or deposit securities. All this is regulated by the Banktaly, which has established that such loans can be part of the assets in the supervision of the issuing bank. It is not certain, however, that listed companies can issue these instruments, given that there are very delicate aspects concerning the protection of capital.

The Banktaly regulates the issuance by banks of subordinated, irredeemable or repayable loans subject to the authorization of the Banktaly itself. These issues may also take the form of bonds or securities.

Difference with bonds. Considering that often, as anticipated at the beginning, savers are trimmed in the form of a life insurance policy, it is good to check that there are no such loans in their investments. This is because, being profitable but risky, in the event of bankruptcy events the last subject to be liquidated is the saver who owns them. As long as the capital is not lost, of course.

The substantial difference between an obligation and the subordinated loans lies in the repayment method at the time of the issuer’s liquidation. The interests of the subordinated creditor can only be paid after all the interests of the bondholders have been satisfied.