Interest rates in the US have been hovering at low levels for the past few years. Conventional wisdom says that this is an ideal situation for any company to raise cheap funds to fuel the growth or to refinance the existing highcost debt. But the recent experiences of the US corporates seem to defy this perspective. The reasons are many. In the wake of a series of corporate scandals and bankruptcies, banks are avoiding risky borrowers and adopting stringent norms for credit approval. As a result, highly leveraged companies are finding it tough to raise funds. However, thanks to second lien term loans, such companies have found a new avenue to meet their capital requirements.

Second lien term loans provide the much-needed funds for a company when other sources of capital are inaccessible. A major characteristic of this instrument is that except for being second in lien in terms of repayment priority, it has the same covenants as a bank loan. These covenants may require the borrower to maintain specific levels of financial ratios, a cap on the salaries of executives, etc. Although second lien term loans have been in existence for several years, the last three years have witnessed a strong growth in demand for this instrument. According to Standard & Poor’s, in the first four months of 2004 alone, the second lien loans raised were more than $5.3 bn, as against approximately $3.2 bn raised in 2003. What is fueling the demand for this instrument at this juncture? What are the risks involved from the borrowers’ standpoint?