What is a subordinated loan

What is a subordinated loan

A subordinated loan is a loan concluded for a term of 5 years or more, while the interest rate and lending terms remain unchanged throughout the entire term of the agreement. It is impossible to fully or partially repay the debt ahead of schedule without approval from the Central Bank. It is also forbidden to terminate the agreement without the consent of the regulator. If the company declares bankruptcy, claims for this loan will be satisfied first.

Who can get a subordinated loan

Only legal entities can obtain it. Ordinary individual citizens cannot use this type of service. A subordinated loan can be taken by:

• banks;
• insurance companies;
• limited liability companies.

The following requirements are imposed on borrowers:

1. The debtor is obliged to pay fees and taxes to the budget without arrears. The lender checks the borrower's reporting for the last reporting period.
2. When drawing up the agreement, rating agencies must record the growth of the enterprise's shares. There must be an exclusively positive dynamic in key positions.
3. The borrower must provide a business model in order to analyze the probability of return on investment.
4. Regulatory authorities must not ban the company's activities.
5. The lender analyzes profitability; for this, an assessment of the company's reporting is carried out, and business operations are also taken into account.

After the check, investors make a decision on whether it is advisable to provide a loan. The application is reviewed within 3 to 10 business days. Funds can be issued after the loan agreement is concluded in the presence of a notary. Participants in the transaction must have their constituent documents with them.

A subordinated loan is often used to remedy a financial situation. The Central Bank of Russia, acting as the chief regulator of credit and financial relations, provides funds for refinancing to organizations that are experiencing difficulties in forming and utilizing their credit portfolio. Borrowed funds become part of assets.

Requirements for subordinated loans

A subordinated loan differs from consumer and mortgage loans in the following ways:

1. Only a legal entity can act as the borrower. 
2. The term of the credit agreement, as well as the possibility of its unilateral termination, is subject to strict conditions.
3. The amount of overpayment and the interest rate are regulated by the Central Bank. 
4. There are obligations regarding the targeted use of funds.
5. Certain requirements are established for the loan to secure debt repayment by the borrower.

The main feature of a subordinated loan is the need to repay the debt in a lump sum by the end of the agreement term. Payment of interest is expected along with the principal debt. All nuances of interaction between the creditor and the debtor are specified in the agreement.

Benefits for creditors

The narrow scope of application of a subordinated loan makes it unavailable to all financial market participants. Only certain companies interested in obtaining funds on favorable terms can use such a loan.

There are advantages for investors. When using a subordinated loan, the main benefit is simple and fast transaction processing, as well as the opportunity to make a profitable, long-term investment with guarantees. Upon expiration of the crediting period, the investor can receive a high return.

Who can act as a lender

The circle of investors is not restricted by law. Subordinated loans can be issued by legal entities and individuals. Individuals who are heads of enterprises and organizations, state and commercial banks, and municipal institutions can engage in investing funds.

The founder of an enterprise can take out a subordinated loan to increase working capital or to eliminate existing loans. The director of the institution signs the agreement on behalf of both parties and is considered both borrower and lender simultaneously. Within a year, the company must create a fund with a target asset. One month before the expiration of the agreement, the creditor may propose changing the purpose of using the borrowed funds during capital formation. The loan cannot exceed one-third of the total amount; if the loan is larger, the creditor is obligated to participate in the distribution. Otherwise, the loan is considered attracted funds and is subject to taxation.

Pros and cons of a subordinated loan

Positive aspects for the creditor:

• quick and simple transaction processing;
• opportunity to receive a large return;
• opportunity to receive a share of the enterprise or its shares as payment for the loan.

There are certain disadvantages, namely risks for the creditor:

• in the event of the borrower's bankruptcy, the creditor may not receive their funds;
• there is a ban on demanding early repayment of the loan;
• the interest rate can only be changed after approval by the Central Bank.

Borrowers receive the following benefits:

• low interest rate that is difficult to change;
• no need to make monthly loan payments; the loan is repaid once at the end of the credit term;
• minimum term is 5 years;
• debt can be repaid with shares or shares in the enterprise, subject to the consent of both parties.

Despite the listed advantages, subordinated loans also have disadvantages:

• any changes to the terms must be agreed upon with the Central Bank;
• it is impossible to pay off the loan ahead of schedule;
• the interest rate cannot be lowered without the consent of the Central Bank;
• before the transaction, the creditor thoroughly reviews the borrower's activities.

A subordinated loan is a convenient way to invest funds for a long time with a fixed interest rate. Such a loan has advantages for both investors and borrowers. Funds are most often allocated for the development of the company's financial activities.