Module IV· Debt TranchesAdvanced
Question
What is 'Second Lien' debt and why does it hold a specific position in the capital stack?
Answer
Mechanics
Second Lien = a debt tranche with a second lien (security interest) on the assets. It sits between First-Lien Senior and Mezzanine — subordinated only in the enforcement/recovery order, not in cash-flow rights.
Deep diveShow more details
Comparison
| Aspect | First Lien Senior | Second Lien | Mezzanine |
|---|---|---|---|
| Security | first lien | second lien | usually unsecured |
| In insolvency | first to enforce | second (often 50-70% recovery) | last (often 10-30% recovery) |
| Coupon | SOFR + 400 | SOFR + 700-900 | 12-15% total yield |
| Maturity | 6-7 years | 7-8 years | 7-9 years |
| Standard in the middle market | yes | rare (more US-typical) | yes |
Consequence
Second Lien fills a gap — it offers lenders an asset-backed investment with higher yield than senior but lower risk than mezzanine. Typical use case: a 1.0-1.5x EBITDA slot between senior at 4x and mezz at 0x.
Common pitfalls
- Second Lien is NOT the same as mezzanine — it has security, which makes the recovery profile materially better
- The inter-creditor agreement between 1L and 2L is complex — standstill periods, acceleration rights
Pitch tip
Question: "When do you use 2L instead of mezz?"
Answer: "When cash flow is stable enough to carry the 2L cash coupon (no PIK). Mezz with PIK is more cash-flow-friendly but more expensive on a YTM basis"