sub bond
Sub Bond means a subordinated bond, one that gets paid back after other debts if the company runs into trouble, which is why it usually pays a higher rate.
In plain English
If two people lend the same company money, why would one of them agree to be paid last?
That is the whole story of a sub bond. Sub is short for subordinated, meaning lower in rank. When a company borrows money by issuing bonds, it often issues different classes of debt. Senior bondholders stand at the front of the queue if the company ever struggles to pay everyone back. Subordinated bondholders stand further back. If there is trouble, senior lenders get their money first, and only what remains, if anything, goes to the sub bondholders.
Naturally, nobody wants to stand at the back of a queue for free. So companies and banks that issue sub bonds offer a higher interest rate to make up for the extra risk. A Nigerian bank raising capital through a Tier 2 subordinated bond, for instance, might offer a rate a percentage point or two above what it pays on its senior debt, because investors are taking on more risk by holding it.
Consider a Nigerian professional in London who has some savings and wants better returns than a regular fixed deposit gives. Their broker mentions a subordinated bond from a bank paying 9 percent, compared to 6 percent on the same bank's senior bond. The extra 3 percent is not a gift. It is compensation for being paid later than everyone else if things go wrong.
Sub bonds are common with banks because regulators actually encourage banks to hold this kind of capital, since it can absorb losses before depositors are ever touched. That is useful for the banking system, but it means the investor holding the bond is calmly taking on more of the shock.
So a sub bond is not bad, and it is not a trick. It is simply a trade. Higher pay for lower priority, and every investor should know exactly which queue they are standing in before they hand over their money.
An investor buys a ₦5,000,000 subordinated bond from a Nigerian bank paying 14 percent yearly, while the bank's senior bond pays 11 percent. In normal times the investor earns the extra 3 percent happily. But if the bank ever faces serious financial trouble, senior bondholders get repaid first, and the subordinated bondholder only gets whatever is left afterward.
Questions people ask
Is a sub bond riskier than a normal bond?
Yes. It ranks below senior debt, so if the issuer runs into serious trouble, subordinated bondholders are repaid after senior bondholders, and sometimes there is less left for them.
Why would anyone buy a sub bond then?
Because it usually pays a higher interest rate than senior bonds from the same issuer, and for many investors that extra return is worth the extra risk, as long as they understand the trade.
Do individual Nigerian investors ever buy sub bonds?
Yes, particularly when banks issue subordinated bonds to the public to raise Tier 2 capital, and investors who want higher yields often participate through their stockbrokers.
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