CFA Level I Exam · Credit Analysis for Corporate Issuers

Seniority, Recovery Rates and Priority of Claims in Bankruptcy

Updated 7 October 2026 · Fact-checked

Priority of claims is the order in which creditors are repaid when an issuer defaults. Secured debt is paid first from its collateral, then senior unsecured, then subordinated, then equity. Claims at the same level are pari passu and share losses pro rata. Higher seniority usually means higher recovery and lower loss severity.

Understand Seniority, Recovery Rates and Priority of Claims

When a company cannot pay its debts, its assets are used to repay claims in a set order. This order is the priority of claims, also called the capital structure ranking. Where your bond sits in that order drives how much you get back.

The usual ranking, from first to last, is: secured debt (first lien, then second lien), senior unsecured debt, subordinated (junior) debt, then preferred equity and common equity. Secured debt is backed by specific collateral. Unsecured debt has a claim on the issuer's general assets only. Subordinated debt ranks below senior debt and is paid only after senior claims are satisfied in full.

Pari passu is Latin for 'on equal footing'. Claims that rank pari passu have the same priority. If assets are not enough to pay them all, they share the available value in proportion to the size of their claims. Two senior unsecured bonds of different maturities usually rank pari passu, because maturity does not change ranking.

Recovery rate is the percentage of the claim's value (principal plus accrued interest) that the creditor gets back after default. Loss severity is the part not recovered: loss severity = 1 − recovery rate. Expected loss = probability of default × loss severity. Historically, average recovery rates rise with seniority, but any single case can differ.

The ranking affects pricing. A subordinated bond has higher expected loss than a senior bond from the same issuer, so it needs a higher yield and a wider credit spread. Rating agencies often notch subordinated debt below the issuer rating and may notch secured debt above it. Note that in practice the absolute priority rule can be departed from in negotiated reorganizations, so equity holders sometimes receive something even when creditors are not paid in full. Exam questions normally assume strict priority unless told otherwise.

Key formulas to remember

Typical priority of claims: First lien secured > second lien secured > senior unsecured > subordinated > preferred equity > common equity; Higher in the list is paid first. Same-level claims are pari passu.
Loss severity: Loss severity = 1 − Recovery rate; Recovery rate is a percentage of the claim, including accrued interest, that is recovered.
Expected loss: Expected loss = Probability of default × Loss severity; Use loss given default in the same units as the claim. Both inputs must cover the same horizon.
Pari passu sharing: Class recovery rate = Value available to the class ÷ Total claims in the class; Every holder in the class gets the same percentage. Multiply this rate by each claim's size to get the amount, so recovery is pro rata to claim size.
Recovery amount: Recovery amount = Claim × Recovery rate; Claim usually means face value plus accrued interest at default.

How to solve Seniority, Recovery Rates and Priority of Claims questions

Use this method for any question on ranking, pari passu or recovery in bankruptcy.

1List every claim in order of priority: secured first (by collateral), then senior unsecured, subordinated, preferred and common equity.
2Identify what value is available. For secured debt, use the collateral value. For the rest, use the remaining assets after higher claims.
3Pay the top-ranked class in full or until the money runs out. Never pay a lower class until the class above is fully paid.
4If a class cannot be paid in full, split the available value pro rata across the claims in that class (pari passu).
5Compute recovery rate = amount received ÷ claim. Then loss severity = 1 − recovery rate.
6If a secured creditor's collateral is worth less than its claim, treat the shortfall as a senior unsecured claim, pari passu with other senior unsecured creditors.
7Check the answer: higher-ranked classes should recover at least as much as lower-ranked ones, and total payouts cannot exceed total value.

Quickest way: Waterfall and pro rata shortcut

When to use it: Use for any numerical recovery question with three answer options and about 90 seconds per question.

Write the claims top to bottom with their sizes.
Subtract value from the pool class by class until it hits zero.
For the class where money runs out, divide remaining value by that class's total claims to get the recovery percentage.
Everything below that class recovers zero; everything above recovers 100%.
For conceptual questions, eliminate any option that puts a longer maturity, a higher coupon or an earlier issue date above ranking. Those do not set priority.

Common mistakes in Seniority, Recovery Rates and Priority of Claims

Assuming a bond with a longer or shorter maturity ranks differently from another bond of the same class.
Students link time to payment order, as in normal coupon schedules.
Fix: In default, ranking depends on the legal class (secured, senior, subordinated), not maturity. Same-class claims are pari passu.
Treating pari passu as meaning equal dollar amounts.
The words 'equal footing' sound like equal payouts.
Fix: Pari passu means equal priority. Each holder gets the same percentage of its claim, so payouts are proportional to claim size.
Ignoring the unsecured deficiency claim of a secured creditor.
Students stop once collateral has been paid out.
Fix: If collateral value is below the secured claim, the shortfall becomes a senior unsecured claim sharing pari passu with other unsecured creditors.
Confusing recovery rate with loss severity.
Both are percentages of the claim and are discussed together.
Fix: Loss severity = 1 − recovery. If a question gives recovery 40%, the loss is 60%.
Using only principal as the claim and leaving out accrued interest.
Problems often show face value prominently.
Fix: Use the claim stated in the question. If it includes accrued interest, include it, since the claim is principal plus accrued interest.
Assuming senior debt always recovers more than subordinated debt in every real case.
Students overread the ranking rule.
Fix: Say that seniority generally leads to higher recovery on average. In calculation questions, apply strict priority unless told otherwise.

Worked examples

Example 1

An issuer defaults. After costs, €300 million is available for creditors. Claims: first-lien secured debt €120 million (collateral worth €120 million), senior unsecured debt €200 million, subordinated debt €100 million. Assuming strict priority, what is the loss severity on the subordinated debt? Options: A) 0%, B) 40%, C) 100%.

Show the solution

Pay secured first: €120 million paid in full, leaving €300 − 120 = €180 million.
Pay senior unsecured next: claims are €200 million, but only €180 million remains.
Senior unsecured takes all €180 million (recovery 180 ÷ 200 = 90%), leaving €0.
Subordinated debt receives nothing: recovery rate is 0%.
Loss severity = 1 − 0 = 100%.

Answer: C) 100%. Subordinated debt recovers nothing, so its loss severity is 100%.

Example 2

A company defaults. €90 million is available for unsecured creditors after secured claims are settled. Senior unsecured claims are two bonds: Bond X €60 million and Bond Y €120 million, ranking pari passu. Subordinated claims total €50 million. What amount does the holder of Bond X recover? Options: A) €20 million, B) €30 million, C) €60 million.

Show the solution

Total senior unsecured claims = 60 + 120 = €180 million.
Available €90 million is less than €180 million, so subordinated holders get nothing.
Recovery rate for the senior class = 90 ÷ 180 = 50%.
Bond X recovery = 60 × 50% = €30 million.

Answer: B) €30 million. Both bonds recover 50% of their claims.

Exam tips

Questions are standalone with three options. For ranking questions, find the legal class first, then eliminate options that rank by maturity, coupon or issue date.
Watch for secured debt whose collateral is worth less than the claim. The shortfall is a senior unsecured claim, and this is a common hidden step in calculations.
Numerical options are listed from smallest to largest. If you get a recovery above 100% of any claim, you made an error in the waterfall.
Remember the link to pricing: lower seniority means higher loss severity, wider credit spread and often a lower rating notch.
Be ready to read stems that give recovery as a percentage and ask for expected loss. Multiply probability of default by (1 − recovery).

Practice questions from Credit Analysis for Corporate Issuers

Seniority, Recovery Rates and Priority of Claims: frequently asked questions

What is the order of priority of claims in bankruptcy for bonds?

Secured debt is paid first from its collateral, then senior unsecured debt, then subordinated debt, then preferred and common equity. A higher class must be paid in full before a lower class receives anything, under strict priority. Claims in the same class are pari passu.

What does pari passu mean in bonds?

It means claims rank equally in priority. If there is not enough value to pay them in full, they share the available value pro rata to their claim sizes. All holders in that class get the same recovery percentage.

How do recovery rates differ by seniority?

On average, more senior and secured debt recovers a larger share of its claim than junior or unsecured debt. Individual outcomes vary with collateral value, the asset mix and the process. In exam calculations, apply the priority order and compute recovery from the numbers given.

What is the difference between recovery rate and loss severity?

Recovery rate is the percentage of the claim you get back. Loss severity is the percentage you lose, which equals 1 minus the recovery rate. Expected loss multiplies loss severity by the probability of default.