The vast majority of all second lien loans are
senior
Senior (shortened as Sr.) means "the elder" in Latin and is often used as a suffix for the elder of two or more people in the same family with the same given name, usually a parent or grandparent. It may also refer to:
* Senior (name), a surname ...
secured obligations
An obligation is a course of action that someone is required to take, whether legal or moral. Obligations are constraints; they limit freedom. People who are under obligations may choose to freely act under obligations. Obligation exists when ther ...
of the borrower. Second lien loans differ from both
unsecured debt
In finance, unsecured debt refers to any type of debt or general obligation that is not protected by a guarantor, or collateralized by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation or failure to meet the ...
and
subordinated debt
In finance, subordinated debt (also known as subordinated loan, subordinated bond, subordinated debenture or junior debt) is debt which ranks after other debts if a company falls into liquidation or bankruptcy.
Such debt is referred to as 'subordi ...
.
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 lenders 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
A secured loan is a loan in which the borrower pledges some asset (e.g. a car or property) as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan. The debt is thus secured against the collateral, an ...
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. 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.
Unsecured debt
Unlike
unsecured debt
In finance, unsecured debt refers to any type of debt or general obligation that is not protected by a guarantor, or collateralized by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation or failure to meet the ...
, second lien loans receive a pledge of specific assets of the borrower (e.g., buildings, land, equipment, intellectual property, receivables and other financial assets).
Subordinated debt
Subordinated debt
In finance, subordinated debt (also known as subordinated loan, subordinated bond, subordinated debenture or junior debt) is debt which ranks after other debts if a company falls into liquidation or bankruptcy.
Such debt is referred to as 'subordi ...
refers to a class of obligations that are contractually subordinated in ranking to all of the
senior
Senior (shortened as Sr.) means "the elder" in Latin and is often used as a suffix for the elder of two or more people in the same family with the same given name, usually a parent or grandparent. It may also refer to:
* Senior (name), a surname ...
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. 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 buyout
A leveraged buyout (LBO) is one company's acquisition of another company using a significant amount of borrowed money ( leverage) to meet the cost of acquisition. The assets of the company being acquired are often used as collateral for the loa ...
s to fill small gaps between the financing needs of the borrower and maximum thresholds (measured by various
leverage metrics) of
senior
Senior (shortened as Sr.) means "the elder" in Latin and is often used as a suffix for the elder of two or more people in the same family with the same given name, usually a parent or grandparent. It may also refer to:
* Senior (name), a surname ...
secured lenders. The arrangement fee and
interest (finance)
In finance and economics, interest is payment from a borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is distinct ...
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
Senior (shortened as Sr.) means "the elder" in Latin and is often used as a suffix for the elder of two or more people in the same family with the same given name, usually a parent or grandparent. It may also refer to:
* Senior (name), a surname ...
unsecured debt
In finance, unsecured debt refers to any type of debt or general obligation that is not protected by a guarantor, or collateralized by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation or failure to meet the ...
).
See also
*
Negative pledge
Negative 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.
Negative pledges often appear in security documents, where they operate to ...
*
Pari passu
''Pari 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 pa ...
*
Preferential creditor
*
Seniority (finance)
In finance, seniority refers to the order of repayment in the event of a sale or bankruptcy of the issuer. Seniority can refer to either debt or preferred stock. Senior debt must be repaid before subordinated (or junior) debt is repaid.The America ...
*
Senior debt In finance, senior debt, frequently issued in the form of senior notes or referred to as senior loans, is debt that takes priority over other unsecured or otherwise more "junior" debt owed by the issuer. Senior debt has greater seniority in the is ...
*
Security interest
In finance, a security interest is a legal right granted by a debtor to a creditor over the debtor's property (usually referred to as the ''collateral'') which enables the creditor to have recourse to the property if the debtor defaults in makin ...
*
Secured creditor
A 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 av ...
*
Subordinated debt
In finance, subordinated debt (also known as subordinated loan, subordinated bond, subordinated debenture or junior debt) is debt which ranks after other debts if a company falls into liquidation or bankruptcy.
Such debt is referred to as 'subordi ...
*
Unsecured creditor
External links
Second Liens: Borrower BewareSecond Lien Financing ForumLinklaters. Banking Update. Second lien financings and the European loan markets.SECOND LIEN DEBT: A Guide to Key Terms and Inter-Creditor Issues
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