Telewest is in the market with a £250m second lien loan. The deal represents the largest second lien deal yet to be launched in Europe, outstripping United Biscuits’ £200m facility.
Second lien loans are highly attractive for financial buyers. They reduce financing costs at a time when competition between firms is pushing valuations on the best assets ever higher.
For investors, they price wide of typical term loans, have lighter covenants and allow junior creditors to share collateral, which was previously the exclusive territory of senior banks. Banks, though they would prefer debt subordination not lien subordination, may be won over if second lien proceeds pay down their exposure or if the deal is silent, with restrictions on voting rights.
CLOs buy second lien loans as a higher-yielding alternative to first lien bank debt to lift overall portfolios. The driving force behind the expansion of the structure has been hedge funds, however.
Hedge funds have been growing at an annual rate of 20% since 1990 and manage US$865bn in assets. Industry sources estimate they will grow to US$4trn by 2010 and they have already milked return potential in many parts of the financial markets
They like second lien loans because floating-rate debt is attractive in the current interest rate environment and because many of them are restricted from investing in subordinated paper. They also get the protection of a senior, secured asset, which gives them leverage in workouts.
Hedge funds fuelled a dramatic expansion of second lien loans in the US and are the major story in European leveraged finance this year. According to S&P/LCD, US second lien issuance had reached €7.156bn this year by the end of August, up from 2003 second lien volume of about €2.52bn. European volumes were worth €706m by the end of August.
How these investors would behave in a default or bankruptcy scenario is untested, however. The lack of a unified Chapter 11 protocol means that European creditors work harder to achieve out-of-court restructurings. European inter-creditor agreements rely on payment blocks and remedy standstills to buy time in order to reach a consensus.
But the debt markets are globalising and, in the event that a company does go down, hedge funds are likely to pursue their equity more aggressively than other creditors.
Telewest’s 9-1/2-year second lien deal is part of a £1.8bn bank refinancing. It will be syndicated in Europe and the US, with European investors expected to fill about two-thirds of the facility. A high-yield bond structure had been mooted.
Comparables are Cablecom, NTL and KDG, all of which performed badly initially. KDG was remedied with a 50% cut after regulators blocked the acquisition, while loans for NTL and Cablecom both broke outside fees in the secondary. Cable names have risen since, with KDG’s B/C tranches trading as high as 101.25.