Second lien loan
Encyclopedia
Second lien loan is a form of loan
with a security
interest in the assets of a company that are second in ranking
behind a traditional senior credit facility
. A lien
is a form of security interest
granted over an item of property
to secure the payment of a debt
.
The second lien lender will typically be required to agree contractually (through an intercreditor agreement or other contract) to subordinate its claims on the assets to the first lien secured lenders
.
The vast majority of all second lien loans are senior
secured
obligations
of the borrower. Second lien loans differ from both unsecured debt
and subordinated debt
.
as repayment of their borrowings. To the extent that the value of the assets is sufficient to satisfy the company's obligations to the first lien secured lenders
, any additional proceeds from the sale of the pledged assets would then be made available to the second lien lenders as repayment of the second lien loan.
With almost no exceptions, a borrower will take a second lien loan either at the same time or after taking a traditional first lien secured loan
and the secured lenders
will place limitations on the borrower's ability to pledge its assets or borrow additional secured debt
.
The specific rights of the first lien and second lien lenders are established in the credit agreements between the borrower and each class of lender as well as in an intercreditor agreement. As the name implies, an intercreditor agreement is a contract between multiple classes of lenders where each class of lender agrees to specific procedures and preferences in the event of a bankruptcy or liquidation. Secured lenders
will routinely require an intercreditor agreement to protect their interests before allowing a borrower to obtain a second lien loan.
, second lien loans receive a pledge of specific assets of the borrower (e.g., buildings, land, equipment, intellectual property, receivables and other financial assets).
refers to a class of obligations that are contractually subordinated in ranking to all of the senior
obligations (i.e., general non-subordinated obligations) of the company, whether they are secured or unsecured. Although the second lien loan's security interest is subordinated to the first lien loan's interest in the pledged assets of the company, the ranking of first lien and second lien loans are the same in the event the pledged assets are not sufficient to satisfy the outstanding borrowings. By way of illustration, in the event of a liquidation of a company, both the first lien and second lien loans would likely be repaid in full (along with trade and other general creditors) before the subordinated lenders receive any repayment of their obligations.
s to fill small gaps between financing needs of the borrower and maximum thresholds (measured by various leverage
metrics) of senior
secured lenders. The arrangement fee
and interest (finance) of a second lien loan are higher than those of the first lien secured loan of the same borrower because of increased risk for the lender that comes from a subordinated security interest. However, second lien debt can often reduce the overall cost of capital in a leveraged buyout transaction, replacing other more expensive forms of financing (e.g., senior
unsecured debt
).
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
with a security
Security (finance)
A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...
interest in the assets of a company that are second in ranking
Capital structure
In finance, capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities. For example, a firm that sells $20 billion in equity and $80...
behind a traditional senior credit facility
Secured loan
A secured loan is a loan in which the borrower pledges some asset as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan...
. A lien
Lien
In law, a lien is a form of security interest granted over an item of property to secure the payment of a debt or performance of some other obligation...
is a form of security interest
Security interest
A security interest is a property interest created by agreement or by operation of law over assets to secure the performance of an obligation, usually the payment of a debt. It gives the beneficiary of the security interest certain preferential rights in the disposition of secured assets...
granted over an item of property
Property
Property is any physical or intangible entity that is owned by a person or jointly by a group of people or a legal entity like a corporation...
to secure the payment of a debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
.
The second lien lender will typically be required to agree contractually (through an intercreditor agreement or other contract) to subordinate its claims on the assets to the first lien secured lenders
Secured loan
A secured loan is a loan in which the borrower pledges some asset as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan...
.
The vast majority of all second lien loans are senior
Capital structure
In finance, capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities. For example, a firm that sells $20 billion in equity and $80...
secured
Security (finance)
A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...
obligations
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
of the borrower. Second lien loans differ from both unsecured debt
Unsecured debt
In finance, unsecured debt refers to any type of debt or general obligation that is not collateralised by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation or failure to meet the terms for repayment....
and subordinated debt
Subordinated debt
In finance, subordinated debt is debt which ranks after other debts should a company fall into receivership or bankruptcy....
.
Second lien and first lien secured loans
In the event of a bankruptcy or liquidation, the assets used by the company as security would first be provided to the first lien secured lendersSecured loan
A secured loan is a loan in which the borrower pledges some asset as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan...
as repayment of their borrowings. To the extent that the value of the assets is sufficient to satisfy the company's obligations to the first lien secured lenders
Secured loan
A secured loan is a loan in which the borrower pledges some asset as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan...
, any additional proceeds from the sale of the pledged assets would then be made available to the second lien lenders as repayment of the second lien loan.
With almost no exceptions, a borrower will take a second lien loan either at the same time or after taking a traditional first lien secured loan
Secured loan
A secured loan is a loan in which the borrower pledges some asset as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan...
and the secured lenders
Secured loan
A secured loan is a loan in which the borrower pledges some asset as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan...
will place limitations on the borrower's ability to pledge its assets or borrow additional secured debt
Secured loan
A secured loan is a loan in which the borrower pledges some asset as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan...
.
The specific rights of the first lien and second lien lenders are established in the credit agreements between the borrower and each class of lender as well as in an intercreditor agreement. As the name implies, an intercreditor agreement is a contract between multiple classes of lenders where each class of lender agrees to specific procedures and preferences in the event of a bankruptcy or liquidation. Secured lenders
Secured loan
A secured loan is a loan in which the borrower pledges some asset as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan...
will routinely require an intercreditor agreement to protect their interests before allowing a borrower to obtain a second lien loan.
Second lien and unsecured debt
Unlike unsecured debtUnsecured debt
In finance, unsecured debt refers to any type of debt or general obligation that is not collateralised by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation or failure to meet the terms for repayment....
, second lien loans receive a pledge of specific assets of the borrower (e.g., buildings, land, equipment, intellectual property, receivables and other financial assets).
Second lien and subordinated debt
Subordinated debtSubordinated debt
In finance, subordinated debt is debt which ranks after other debts should a company fall into receivership or bankruptcy....
refers to a class of obligations that are contractually subordinated in ranking to all of the senior
Capital structure
In finance, capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities. For example, a firm that sells $20 billion in equity and $80...
obligations (i.e., general non-subordinated obligations) of the company, whether they are secured or unsecured. Although the second lien loan's security interest is subordinated to the first lien loan's interest in the pledged assets of the company, the ranking of first lien and second lien loans are the same in the event the pledged assets are not sufficient to satisfy the outstanding borrowings. By way of illustration, in the event of a liquidation of a company, both the first lien and second lien loans would likely be repaid in full (along with trade and other general creditors) before the subordinated lenders receive any repayment of their obligations.
Application in leveraged buyouts
Second lien loans are used in leveraged buyoutLeveraged buyout
A leveraged buyout occurs when an investor, typically financial sponsor, acquires a controlling interest in a company's equity and where a significant percentage of the purchase price is financed through leverage...
s to fill small gaps between financing needs of the borrower and maximum thresholds (measured by various leverage
Leverage (finance)
In finance, leverage is a general term for any technique to multiply gains and losses. Common ways to attain leverage are borrowing money, buying fixed assets and using derivatives. Important examples are:* A public corporation may leverage its equity by borrowing money...
metrics) of senior
Capital structure
In finance, capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities. For example, a firm that sells $20 billion in equity and $80...
secured lenders. The arrangement fee
Fee
A fee is the price one pays as remuneration for services. Fees usually allow for overhead, wages, costs, and markup.Traditionally, professionals in Great Britain received a fee in contradistinction to a payment, salary, or wage, and would often use guineas rather than pounds as units of account...
and interest (finance) of a second lien loan are higher than those of the first lien secured loan of the same borrower because of increased risk for the lender that comes from a subordinated security interest. However, second lien debt can often reduce the overall cost of capital in a leveraged buyout transaction, replacing other more expensive forms of financing (e.g., senior
Capital structure
In finance, capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities. For example, a firm that sells $20 billion in equity and $80...
unsecured debt
Unsecured debt
In finance, unsecured debt refers to any type of debt or general obligation that is not collateralised by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation or failure to meet the terms for repayment....
).
See also
- Negative pledgeNegative pledgeNegative pledge is a provision in a contract which prohibits a party to the contract from creating any security interests over certain property specified in the provision....
- Pari passuPari passuPari passu is a Latin phrase that literally means "with an equal step" or "on equal footing." It is sometimes translated as "ranking equally", "hand-in-hand," "with equal force," or "moving together," and by extension, "fairly," "without partiality."...
- Preferential creditorPreferential creditorA preferential creditor is a creditor receiving a preferential right to payment upon the debtor's bankruptcy under applicable insolvency laws....
- Seniority (finance)
- Senior debt
- Security interestSecurity interestA security interest is a property interest created by agreement or by operation of law over assets to secure the performance of an obligation, usually the payment of a debt. It gives the beneficiary of the security interest certain preferential rights in the disposition of secured assets...
- Secured creditorSecured creditorA secured creditor is a creditor with the benefit of a security interest over some or all of the assets of the debtor.In the event of the bankruptcy of the debtor, the secured creditor can enforce security against the assets of the debtor and avoid competing for a distribution on liquidation with...
- Subordinated debtSubordinated debtIn finance, subordinated debt is debt which ranks after other debts should a company fall into receivership or bankruptcy....
- Unsecured creditorUnsecured creditorAn unsecured creditor is a creditor other than a preferential creditor that does not have the benefit of any security interests in the assets of the debtor....