Level 1 CFA® Exam:
Seniority Rankings & Priority of Claims

The capital structure of a company consists of:

• common equity,
• preferred stock,
• bank debt,
• bonds with different seniority rankings.

Please note that the capital and corporate structure can be less or more complex, e.g. a company might not have or might have subsidiaries that issue debt, might operate in the international market, offers shares to different tiers of investors, etc.

If we take the priority of payment (aka. seniority ranking) into account, we can distinguish among different classes of debt (starting with the highest priority of claims):

• secured debt which offers a direct claim to the issuer’s assets in case of default or restructuring. It includes first lien loan (senior secured), second lien loan (secured), etc.
• unsecured debt (debenture), which includes senior unsecured, senior subordinated, subordinated, and junior subordinated.

Of course, the lower the priority of claims of a given creditor class, the lower the recovery in case of default.

In your exam, you should know what pari passu is. It’s a provision according to which all bonds in a given creditor class are treated the same.

1. The capital structure of a company consists of common equity, preferred stock, bank debt, and bonds with different seniority rankings.
2. If we take seniority ranking into account, we will be able to distinguish between: secured debt [first lien loan (senior secured), second lien loan (secured), etc.] and unsecured debt [senior unsecured, senior subordinated, subordinated, junior subordinated].
3. According to the absolute priority of claims, in case of bankruptcy, holders of secured debt get paid out first, then, holders of unsecured debt, then, preferred stockholders, and, finally, common equity holders.