Second Lien Financing -

Introduction

Second lien financing refers to a type of debt financing that ranks subordinate to first lien debt but is senior to other forms of debt, such as unsecured debt or subordinated debt. Generally speaking, second-lien debt has a higher interest rate than first-lien debt because it is considered to be more risky. Second-lien finance are generally used in leveraged buyouts and restructurings (especially nowadays) to fill small gaps between the financing needs of the borrower and maximum thresholds of senior secured lenders.

Who are the players

Second lien finance is usually provided by funds specifically set up to invest in products such as second lien debt, mutual funds, and collateralised loan obligation vehicles.

Features

The salient features of a typical second lien finance would include:

Priority – rank equally with senior debt before acceleration. However, second lien finance would rank behind senior debt after acceleration.

Security – it would share the same security package as to the senior debt. Senior debt, however, would usually be secured by specific assets or collateral, and in case of default, the lender has the right to seize and sell these assets to recover their loan principal. Nowadays, it is commonly seen that second lien finance is secured by a different set of collateral.

Ranking – it would rank behind senior debt in respect of unsecured claims against the borrower and guarantors, if senior debts aren’t able to be paid in full.

Maturity – generally mature 6 to 12 months after the final repayment of the senior debt is made.

Others –

second lien facility is usually documented in a separate agreement, whereby the second lien lenders would be able to vote as a separate class of creditors, and able to enjoy covenants that are distinct from those of the senior lenders.
senior lender(s) will determine the manner of any enforcement process. But second lien lender(s) would be entitled to accelerate the debt, commence or join in insolvency proceedings.
second lien finance has the right to buy-out the senior lenders in certain circumstances.

Things to watch out for

When structuring or negotiating a deal involving second lien finance, one may wish to consider the following:

Vote – second lien lender(s) should insist on being entitled to vote in a separate class and for certain events. Otherwise, they would only be able to vote as a group in respect of their own tranche and accordingly, would have limited influence in any restructuring matters.
Security – the type of security package. Whether second lien lender(s) would be able to obtain security over separate asset class, share the same security package with senior lender(s), or be required to waive any rights to interfere with the senior lender(s)’ rights to security.
Risks – it carries higher default risk compared to senior debt instruments, and lenders may conduct stringent due diligence on the borrower’s financial health and asset valuation before extending such financing.

If you would like to find out more about the this note or other issues pertaining to second lien finance, please contact us.