2nd Lien Mortgage

2. lien mortgage

Distinction between cash flow, second lien and mezzanine debt - Newsletter Besides gaining an insight into the asset-based credit business, it makes sense to elucidate the fundamental differences between certain other types of credit structured instruments available on the markets - liquid assets, second-line and middle-term. There has been recent evidence of progress towards greater convergence in the SME sector in recent years as financiers (i.e. corporate banking, asset-based creditors, hedge trusts, venture fund companies, venture fund companies, etc.) have attempted to offer a wider variety of credit product offerings.

Because of this divergence, there has been uncertainty about the difference between the different kinds of products on offer. If credit structure is under discussion, certain kinds of credit products are often incorrectly labelled, missunderstood or confused with another kind of creditduct. Cashflow borrowing is the form of borrowing traditionally associated with conventional banking finance: it is priority borrowing provided on the strength of a certain multiples of the borrower's return.

For this purpose, the creditor deals with the total value of the borrower's business as a proportion of its result. In contrast to this type of credit, an asset-based credit is granted by the creditor on the grounds of the estimated value of the working capital of the debtor (i.e. his claims, plant and inventories).

Over the last few years, the emergence of retail mutual fund investments - to include hedge fund investments - has resulted in greater transaction activity and forced donors to take higher risk on their interest advances to the borrower. It is not unusual today for four to five fold your average daily earnings before interest, tax, depreciation and amortization (EBITDA) to be used for your own purposes.

Interest expense discounted lending is similar to an asset-based lending (i.e. between 2% above and 3% below the London Interbank Offered Rate or LIBOR ), but the fees element of the facility is often lower than that of the asset-based lending, which usually includes a surveillance charge, line charges and auditing work.

With regard to securities, the creditors of payment flows place a primary burden on the borrower's total working capital and noncurrent securities. Given that the credit is built on a risk-return approach, there is less worry about periodically providing the creditor with operating results and little or no continuous supervision of the value of collaterals by the underlying creditor (which is not the case with an asset-based creditor).

There is a significant distinction between credit from customers and asset-based credit. Accurate disclosure and supervision by an asset-based creditor allows financially troubled lenders to obtain funding against the realisation value of the securities; the company's accounts may be in poor condition with surplus debts and deficits, but the asset-based creditor will continue to grant credit against adequately rated securities for short-term investments, provided that it receives a first lien on these securities.

There would be no granting of a disbursement facility if the debtor were to suffer a loss or had recently been so. At the other end of the credit spectrum, credit facilities are at the other end of the credit spectrum. Meczanine finance is a combination of external and private capital finance. Such indebtedness is subordinate to all other financed indebtedness of the debtor.

The interest rates are set by the borrowers to the lenders - usually between 15% and 18% - and are often linked to minimum claims to the costs of owning or holding capital in the borrowers in the shape of options to the lenders. Meczanine financings often have the quality of a "contribution in kind".

The interest accrual allows the amount of capital due to the Meczanine Creditor to be raised at the interest rates applicable to the bonds instead of the repayment by the Mortgagor of the interest due and due. Another characteristic of Meczanine finance is that it is often uncollateralised by the borrower's property; if the collateral is taken over by the Meczanine financier, it will be subordinate to the collateral rights of other financiers.

In contrast to secondary market credits, meszanine is a genuine "silent second" indebtedness behind the prime facility. In the first years of this century, second or tranches 1 of BA credits were created. Second liquidity is growing as a result of the sharp increase in the number of privately held investment vehicles and buy-out deals over the last five years.

It is a leverage instrument created in reaction to a price differential in the price structures between prior ranking liabilities (i.e. either CF or asset-based loans) and meszanine financings. A Second Lien is always at the heart of a multi-tranche facility where a First Lien provider provides lower funding costs (typically LIBOR plus 2% or 3%) and also participates in the facility on an assets or cash-flows base.

Charges, prices and coupons of the Second-Liend credit products result from the price differential between cheaper priority bankfinancing and more expensive middle income financings. Price of the Second-Liend is LIBOR plus 6% or 7%, which is less expensive than the interest rates of mortgage lending. Nor are such credits diluting to the extent that the secondary creditor does not make use of option certificates.

Second home loans are confounding because they imply that the loans are not priority loans. Indeed, a Second Lien Lending is a type of a senior Lending as the Second Lien Borrower assumes full collateral for the same asset (s) as the First Lien Borrower and will either participate either para-pazu ( i.e. at the same interest rate) or in accordance with an established proportion when recovering such asset in a winding-up transaction.

Apart from price structure, the main distinction between second lien debts and meszanine financings is that second lien debts are only subordinate liens and not subordinate debts as in the case of meszanine financings. Seniority means that the Mortgagor must transfer any payment the Mortgagor has made to the Priority Mortgagor from any sources; it contains terms in an inter-breditor arrangement which blocks the Mortgagor's payment to the Subordinate Mortgagor until the Priority Mortgagor is fully repaid.

The subordinated lien merely presupposes that the creditor passes on the revenue from divided securities to the prior creditor; it does not contain any blocking clauses. Second credit line borrowings can be either Cashflow line borrowings (determined by a multiple of EBITDA ) or asset line borrowings (based on estimates of working capital). As a rule, the duration is five years or more on a long-term borrowing base and will not normally precede the duration of the initial borrower.

Further characteristics are a final due date or a very restricted amortisation (e.g. 1% per year) and obligatory repayment of surplus liquidity and investment disposals as well as issuance of own funds and outside capital. Of the three types of leveraged loans, there is no question that Second Life has seen the highest rate of increase in the last three to five years.

The value of secondary endowment policy credits in the USA increased from USD 600 million in 2002 to over USD 16 billion at the end of 2005. Canada's secondary endowment policy financing is by far the largest part of secondary endowment policy financing for Canada's commercial operations. Until recently, as a new feature of borrowing capital markets, secondary placements have displaced the distressed mortgage lending as the favoured option for corporate investors and companies looking for a higher leveraging multiplier than older or first-placed companies are willing to offer in a given deal.

Second lien mortgages are a less expensive option of junior mortgages and have certain characteristics in common wiht prior ranking mortgages, as well as certain security administration privileges that have been agreed with the first lien borrower that a mortgage borrower would not have. 1. The two concepts shall be used in an interchangeable manner and shall relate in effect to the same kind of indebtedness instrument.

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