U.S. second-lien loans expected to remain important source of funding, Fitch says

By Sara Rosenberg

New York, Feb. 8 - The U.S. second-lien loan market is expected to remain a critical ongoing source of funding for speculative-grade issuers, according to a special report put out by Fitch Ratings on Wednesday.

"The newfound popularity of second-lien loans appears to be more than a passing phenomenon," said Lisa Matalon, senior director of Fitch High Yield Corporates Team, in the release.

"The second-lien loan market provides a critical and enduring alternative for highly leveraged companies in search of additional available sources of funding."

Volumes in the U.S. second-lien loan market have grown from just over $2 billion in 2002 to over $20 billion in both 2004 and 2005.

However, predicting future second-lien loan volumes and demand volatility is somewhat difficult being that the product is still undergoing an evolution process, Fitch explained.

The second-lien loan developed during a period of unusually lower default rates, meaning that it has not been subject to real world testing of intercreditor agreements through loan workouts and bankruptcy proceedings.

With the expectation that default rates will rise over the next year, bankruptcy cases involving companies with second-lien loans will likely pop up, which will help bring some clarification to the recovery issue.

"These cases will likely produce some landmark decisions and provide clarity and consistency for the market," said Matalon, in the release.

"It remains to be seen whether actual results will support the presumption by investors that second-lien lenders stand to recover more in bankruptcy than unsecured creditors, as well as whether these second-lien transactions prove to have greater-than-expected potential to undermine the recovery rights of first-lien lenders."

Despite this uncertainty, it has become apparent that the U.S. second-lien loan has established itself as a critical and enduring financing alternative for highly leveraged companies in search of additional sources of available funding, Fitch concluded.

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