Sharp Dip in DIPs

 

Curious about the current accessibility of debtor-in-possession (DIP) financing after Class 9, I set out to explore the background of and current state of restructuring finance instruments, and DIPs specifically.  Historically, DIP financing has been attractive to banks and hedge funds because of the high priority these lenders get when bankrupt companies pay back their loans, the court-permitted supervision investors can execute over the debtor company's inner workings, and the short maturities and high interest rates associated with the loans.  In 2007 it was popular for banks to originate and syndicate these loans, and then hedge funds would buy up the securities. 

 

GE Capital, who is traditionally one of the world’s largest lenders in DIP and exit financing made an undisclosed decision “to largely halt lending to companies in bankruptcy-court protection or near it, said several bankruptcy lawyers and financial advisers.”[1]  The number of lenders providing DIP financing has dropped from over thirty in 2006-07 to maybe five or six now, according to chairman investment-banking boutique Miller Buckfire & Co.  Several factors (some more obvious than others) contribute to institutions’ resistance to do DIP financing:

1)      Banks have more constrained balance streets and hedge funds’ capital has dried up

 

2)      Widespread industry outlooks are negative; associated low recovery ratings (which assess a debt instrument's ultimate prospects for recovery of estimated principal and interest accrued but unpaid at the time of default given a simulated payment default)[2] are key metrics for considering financing a bankrupt firm, and these ratings are suffering across industries.  The following table illustrates what debt-holders can expect to receive today relative to during the 2001-2002 downturn.[3]

 

Debt-holder Class	Today	2001-2002 Downturn
1st lien	$0.68/$1.00	$0.71/$1.00
2nd lien	$0.21/$1.00	$0.61/$1.00
Senior Unsecured	$0.32/$1.00	$0.34/$1.00
Subordinated	$0.18/$1.00	$0.15/$1.00

 

3)      Due to the market’s volatility, there is a general lack of trust in valuations and ratings themselves performed by third-party institutions.

 

The scarcity of DIPs will lead to several disruptive consequences for bankruptcy-facing companies that struck me as particularly distressing (no pun intended).  First, the disappearing use of DIP financing will strictly limit the options that BankruptCo will have in restructuring its firm.  For example, in order to avoid liquidation, firms will be forced to sell off assets much earlier in the process.  Because the # of potential buyers will also be lower, liquidation, loss of value, and loss of jobs will ensue.  Second, there are likely quite a few future-BankruptCo’s currently in a holding pattern as they pursue the highly demanded and limited supply of DIP facilities.  This indicates that the worst is yet to come, but around the corner.  Lastly, strong relationships with the few currently active restructuring lenders and the size of debt obligations will be key to the success of a Chapter 11 reorganization.  This last development will create some obstacles for the most problem and debt-laden future-BankruptCo’s (e.g. GM) in reorganizing successfully.

 

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[1] 'DIP' Loans Are Scarce, Complicating Bankruptcies

[2] S&P Definition of Recovery Ratings

[3] Bankruptcy's New Dance-Hard To Get DIPped, Find Exit

 

Comments

[Randy Picker]

good; nice follow up

[Karl T. Muth]

I think your comment regarding ratings is right on. While ratings agencies have done their best to eliminate the obvious sources of direct bias that may exist in other media (a company advertising in a financial news magazine may receive biased coverage, for instance), they've done little to remove themselves from market "environmental factors" that may make them more or less likely to be enthusiastic about a given issue. Areas like DIP financing where few people are trusted, agnostic onlookers to start with may well have had the number of people in a position to be trusted "raters" or "appraisers" drop to zero. And, unfortunately, that credibility won't be rebuilt overnight... hence, in the meantime, it will be "DIP at your own risk" for the few suppliers of DIP financing out there...