In the first few months of 2004, $3.3 billion in second lien loans had already been put to work, surpassing the $3.26 billion in second liens issued for all of 2003. It is no surprise that mezzanine debt industry insiders are calling the second lien the biggest challenge to their industry today.
A second lien is senior debt usually secured by company assets and sitting below the most senior bank debt in a company's credit structure. Increasingly, companies are choosing to fill new space on their credit structures with second lien debt, taking advantage of lower interest rates and the option to exit the investment at any time. The popularity of the second lien is the result of a combination of events including bank lenders becoming more active with the recent economic upturn, relatively cheap loans, and companies taking on more debt as the economy improves.
Kirkland transactional partner John Weissenbach commented that the true test of the second lien will come when a company with second lien loans defaults on its debt. Weissenbach argued that the risk profile of the second lien is not very different from mezzanine in that it is still junior to bank debt and would be paid after more senior creditors should the company default on its debt. He pointed out that if a company defaults, investors may regret the relatively low interest they had been collecting on the second lien.
While the rise of the second lien is significant in the mezzanine lending environment, it remains to be seen whether the trend is here to stay. Lenders and investors must patiently wait to see what happens to the second lien in the face of economic downturns or changing interest rates.
The full text of this article can be found in the March 15, 2004 issue of The Deal.