Second Thoughts (First of a Series)

We noted with amusement a tidbit in Friday’s WSJ on professional cuddling. Apparently a growing number of fully clothed people are paying snuggle experts for services that include squeezing, tickling, and bear-hugging. “I felt transformed,” one client reported.

Besides trying to wrap our brain around the fine distinction between this activity and…well, others, we were reminded of similar unintended consequences between unlikely bedfellows; namely, first and second-lien loans in the leveraged loan market.

For those needing a quick refresher, second-lien term loans are secured, but take a subordinate position to first-lien loans in the assets of the borrower. These tranches grew in popularity during the Great Bull Loan Market that peaked in the first half of 2007, often replacing high-yield bonds in larger deals, and mezzanine debt in smaller ones.

Providers included hedge funds, credit opportunity funds, and select asset managers looking for higher yield product. Second-lien appealed to issuers who liked the benefit of debt priced cheaper than traditional mezz, required no equity give-up, and was pre-payable (albeit with make-whole fees).