Unsecured Note

An unsecured note is a corporate debt instrument that is not backed by specific collateral. Issuers promise to repay principal and interest over a fixed term, but if they default there are no pledged assets that noteholders can claim. Because of this higher risk, unsecured notes typically offer higher interest rates than secured debt and are often subordinated or uninsured.

How unsecured notes work

• Issuance: Companies commonly sell unsecured notes in private placements to raise capital for purposes such as share repurchases, acquisitions, or general corporate needs.
• Terms: Notes have a fixed maturity and specified interest payments. They may include covenants, call provisions, or subordinated status that affect investor recovery in default.
• Investor return: To compensate for the lack of collateral and greater default risk, unsecured notes generally pay higher yields than secured debt.

Contrast with secured notes

Secured notes are backed by assets (collateral) that can be seized and sold to repay creditors if the borrower defaults. Common collateral examples include real estate (mortgages), vehicles, securities, jewelry, or other tangible assets. Because collateral reduces lender risk, secured debt usually carries lower interest rates than unsecured debt.

Credit ratings and risk assessment

Credit rating agencies evaluate issuers’ likelihood of default and assign letter-based ratings that affect interest costs and investor demand. Ratings broadly fall into:
* Investment grade (lower default risk): AAA, AA, A, BBB
* Non-investment (higher default risk / speculative): BB, B, CCC, CC, C, D

Unsecured notes issued by lower-rated (non-investment grade) companies will generally offer higher yields to attract investors, reflecting elevated default and recovery risk.

Claim priority in liquidation

In the event of insolvency and liquidation, creditors are paid in a defined order:
1. Secured creditors (paid from collateral proceeds)
2. Unsecured creditors (including unsecured noteholders, certain bondholders, taxing authorities, and employees for unpaid wages)
3. Shareholders (preferred then common)

Unsecured noteholders rank behind secured creditors, so recovery rates after default tend to be lower.

Considerations for investors

• Creditworthiness: Review issuer financials, cash flow stability, and credit ratings.
• Recovery prospects: Understand whether the note is subordinated and where it sits relative to other debt.
• Yield vs. risk: Compare offered yield to comparable secured instruments and to issuer default probabilities.
• Liquidity and covenants: Check market liquidity and any protections (restrictive covenants, events of default, call features).
• Diversification: Limit exposure to any single issuer or high-risk sector.

Key takeaways

• Unsecured notes are corporate loans without collateral, making them riskier than secured debt.
• They typically offer higher interest rates to compensate for increased default and recovery risk.
• Credit ratings and the issuer’s financial health are critical for assessing risk.
• In liquidation, unsecured noteholders are subordinate to secured creditors and may recover less.