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DIP Lending Dries Up

posted by Adam Levitin

The Wall Street Journal is reporting that DIP financing--lending to companies reorganizing in chapter 11 bankruptcies--is hard to come by and the GE has gotten out of the business. This is actually a much more shocking story than it appears because DIP lending is a very safe and profitable type of corporate lending.

At first blush, lending to a bankrupt company looks like a horrible idea--good money chasing bad. But it is actually one of the safest investments possible. A DIP financier typically has a court-approved, first priority, well-overcollateralized loan, and is guarded by a bevy of covenants that a lender could only dream of outside of bankruptcy, often including the right to appoint or approve of various officers of the director, dictation of a line-item budget for the debtor, asset sale timelines and requirements, the right to exercise self-help remedies upon default without court approval (what's that about an automatic stay?), and lots and lots of reporting requirements.

While covenant defaults are common (and profitable for DIP lenders), payment defaults are virtually non-existent. There has only been a payment default in one major case. DIP lending is almost as safe as T-bills. What's more, it is (at least historically) very profitable. DIP loans are low risk, but bear much higher coupons than equivalent investment grade loans, and also include lots and lots of fees.

Historically, GE was the DIP financier of last resort--they generally charged more and had more onerous covenants, and only the most desperate debtors would go to them if they didn't have a preexisting financing relationship.

I'm not sure what spooked GE (syndication risk strikes me as only part of the story), but a retreat from DIP lending is an indicator of a real credit freeze. And without DIP (and exit) lending, a lot of reorgs just can't happen. Without DIP lending, companies that can't survive on cashflow and trade credit will have to liquidate.

Comments

This is because the lenders have to hoard cash to resist the Lehman deleveraging. They are broke!

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