Second-lien loans are being gobbled up in the primary market, but some investors and lawyers are warning that not all second liens are alike. There is a lack of a standard language defining the terms of the tranches--best described as senior unsecured debt structured as bank loans--and investors need to pick apart the small print. "The devil is in the details in a second lien," one buysider said. "They are not all created equal." Some loans give second-lien investors more rights than others. "If you are in the first lien, you want to have as little rights as possible going to the second-lien holder and if you are in the second lien, you want to have as little rights as possible going to the first-lien holder," he added.
It takes a period of time for standards to develop, noted Francis Huck , a partner with law firm Simpson Thacher & Bartlett . "It's not unlike where we were on subordination provisions 20 years ago, but today basic terms on these provisions are generally agreed. It's in everybody's interest for standards to develop. Such standards increase the speed of completion of a transaction and enable investors to have greater certainty about what they're buying."
Huck and J.T. Knight , also a partner with Simpson Thatcher, said there are probably five issues of common discussion in which the outcome depends on the bargaining power of those involved (see box). "Every transaction is different, different people bring different bargaining power to the table," Huck said.
Key Issues With Second Liens
* What collateral is entitled to first-lien status?
* Is the amount of debt secured by the first lien capped?
* Are there some stand-still provisions that apply and go away?
* Are first-lien holders entitled to approve a DIP on their own or do the second-lien holders have a right to approve or to object in bankruptcy?
* Are the second-lien holders entitled to request adequate protection payments or challenge those for first-lien holders?
Knight noted there are not a lot of second-lien deals yet compared to the number of subordinated debt deals, but the deals are definitely becoming more frequent. Second-lien offerings that have hit the market recently or are in syndication include a $100 million tranche in the credit backing Plastech Engineered Products ' acquisition of LDM Technologies , a $75 million second lien backing a dividend recapitalization for Oriental Trading Co. , a $30 million second lien for MedAssets and a $55 million second lien for MetoKote Corp.
To be sure, investors don't seem to be hesitating on second liens. "Our offering was fully subscribed and was a successful transaction," noted Richard Kaplan , cfo of DeCrane Aircraft Holdings , which recently completed an $80 million second-lien loan. "Our deal was structured in a very straightforward manner. I think it was on terms that were reasonably equivalent to the terms of the first lien, in terms of structure at least." Kaplan noted some of the key terms and how the covenants were constructed as examples of the similar terms.