Thursday, January 29, 2009
Creditors DIP into pockets again to save companies
--DIP dries up alongside with other credit --DIPS become tougher because more companies have pledged all or nearly all of their assets --More debtors tapp existing creditors so creditors can preserve the original investments. As a result, some existing creditors will have higher seniority than the rest in the same class --DIPS also come in strict terms: shorter term from 12-18ms to 2-6ms; high premium, 900bps insteado 400bps By Nicole Bullock and Anousha Sakoui Published: January 29 2009 02:00 Last updated: January 29 2009 02:00 In the US, companies often need money to go bankrupt. In the early hours of January 8, creditors to one of the world's largest petrochemicals groups scrambled through the halls of the bankruptcy court of the Southern District of New York, fighting to scrape together the cash just to keep the lights on at the plants. The lenders were rushing to raise a special loan vital to the chances of Lyondell Chemical, a subsidiary of LyondellBasell, reorganising in bankruptcy, while jockeying to preserve their investments. Without the loan, Lyondell risked becoming one of the world's biggest liquidations. These special loans, called debtor-in-possession financing, or DIPs, fund operations while bankrupt companies restructure. To attract interest, lenders providing DIP finance typically receive a priority claim over other existing debt. At one time, DIPs were easy to raise. In the last financial downturn at the start of the decade, specialised DIP providers, existing creditors and other investors all lined up to finance the restructurings of bankrupt retailer Kmart and even WorldCom. But this time around, DIP finance lenders has dried up alongside all types of credit, so forcing existing creditors to provide rescue financing in the hope of minimising any eventual losses. "The only way to get DIP financing is what we call the defensive DIP, which is where existing lenders fund it to help preserve their recovery on their original investment. That is effectively what happened in [Lyondell]," says Steven Smith, global head of leveraged finance and restructuring at UBS in New York, which participated in the Lyondell DIP. The scarcity of DIP financing comes as defaults and bankruptcies are set to skyrocket this year. The stakes for lenders are high: banks and hedge funds, some of the creditors to troubled companies, are nursing massive losses from last year's market collapse. Investors also know liquidations tend to result in bigger losses than reorganisations. But funding is scarce on all sides and advisers are having to dream up alternative sources and structures in order to draw in fresh lending. Typically, in a defensive DIP new money and prioritisation is spread equally among existing lenders. The controversial aspects of the Lyondell loan is that some existing lenders were given the chance to put in even more new funds for the DIP and to prioritise more existing debt. This made more of their debt senior to other lenders of the same class - and they received a huge interest rate. The company needed $8bn, one of the largest DIP loans ever and a challenging amount to raise in any market. Some lenders have objected to the Lyondell situation, questioning the criteria used to participate in the attractive "additional money" part of the loan. On Monday, UBS held a conference call with investors to explain the criteria for participation in the DIP. Late last week, a group of Lyondell bondholders also balked, arguing "disparate" treatment in a letter to federal bankruptcy judge, Robert Gerber. "You may see more structures like [Lyondell] to get existing lenders to participate," says Bram Smith, interim executive director of the Loan Syndications and Trading Association (LSTA). Mr Smith says the structure was rare, but not unprecedented. DIPs are also tougher these days because many companies have already pledged all or nearly all of their collateral to existing loans, as the financing market has moved away from unsecured debt in recent years. With so many corporate assets already pledged, restructuring specialists expect to see an increased percentage of DIP loans in which lenders get a lien that supersedes everything else in the capital structure. DIPs also are coming with stricter terms, which give companies less time to reorganise. Diane Vazza of Standard & Poor's says the maturities of DIPs have shortened to 2-6 months from 12-18 months. Also, risk premiums have more than doubled to 900 basis points this year from 429bp in 2001, according to Dealogic. But some situations have still run in a more traditional fashion. Smurfit-Stone, the paperboard company, this week raised $750m in bankruptcy loans at rates below current market averages and with the participation of outside lenders. "It may be too early to say that [the Smurfit DIP] is a signal of a thawing in the market, but the willingness of third-party lenders to participate alongside existing creditors is a positive sign," says Mark Cohen, head of restructuring at Deutsche Bank, which was a coarranger on the loan. However, tight credit is severely limiting DIP volumes in general, while deep-pocketed specialist DIP lenders like General Electric Capital, which has said it is being "more selective" in this area, are retrenching. It is in the interests of investors to come up with financing because losses in liquidation are likely to be greater. Even senior lenders to retail companies, which are at the epicentre of the financial downturn, recover less than 50 per cent of what they would if the company reorganised under Chapter 11, according to S&P. "There is a lot less confidence that issuers are going to make it through," says Steven Miller, managing director at S&P Leveraged Commentary & Data. "Everyone wants to move up in the capital structure."