While taking the decision to lend
to corporates, most banks do
an ‘entity evaluation’ instead of
an ‘asset evaluation’. In other words,
though banks look at security for their
loans, the primary source of credit comfort
is the balance sheet of the corporates.
Second lien or junior secured loans
make sense for both the borrowers and
lenders. In second lien or second secured
loans, the bank takes second charge over
the assets. The first charge either already
exists or the corporate has the option
of tapping another senior secured
charge over the same asset at any time at
a cheaper cost. The bank is able to create
a credit asset on a healthy corporate, at
higher spreads, though with only a second
claim on the asset.
India has recently passed through a
period of low rates of interest when credit
offtake was not increasing. At such a
time, originating second tier loans and
thereby enhancing credit portfolio yields
was a good choice for the banks. It was
also an opportunity for the corporates to
increase the credit pool by keeping senior
secured lending intact.The debt-to-equity levels of corporate
India are lower than those in many developed
countries. In such a scenario, second
tier borrowing can help increase the leverage
and improve the returns on equity.
There is no specific regulatory or legal
barrier to borrow money by second
lien loans. The Companies Act understands
stratification of lenders by a subordination
agreement. In fact, every
floating charge is, by definition, a second
lien loan, though over unspecific property.
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