To DIP, Or Not To DIP?

I’m confused. I hear all kinds of doom and gloom about how bankrupt companies can’t find debtor-in-possession (DIP) financing. They’ll be forced into Chapter 7 liquidation! Everybody panic!

But then I see stories like this, where lenders insist, “By no means is the DIP market really dead.” For example, Kevin Phillips of Bank of America says that putting new money into the DIP market is “exciting” at the moment, Dealscape reports.

So what is it? DIP or no DIP? I asked a mid-market lender to clear things up. For starters, there are different approaches to DIP lending. There’s defensive lending, which is when you’re already exposed to the mess as a lender. You convert your existing exposure into a piece of the DIP loan, thus giving you a little more upside than just waiting to see what trickles down in the restructuring. One example of this situation is Apollo’s move on Lyondell. The company filed for Chapter 11 earlier this month. Apollo, which owned $2 billion of Lyondell’s debt, joined the company’s DIP financing group, which provided $8 billion to the company, to protect the downside on its loans. Another example is GE, BofA and Wells Fargo’s $1.1 billion DIP loan to Circuit City. Only $350 million of it is new money.

Then there’s new DIP, issued from scratch. GE and Citigroup have done some of that.

Regardless of the lender (defensive or new), each DIP lending opportunity requires a “yes” to the following three questions before it passes muster with picky lenders:

1. Is exit financing a possibility? If there’s no exit from Chapter 11, though a new loan and possibly a 363 sale to a buyout firm, how will the DIP lender get its money back? GE Capital has been providing a bit of that as well, recently to companies like Gottschalk’s.

2. Is it a good, sound business that has survived past downturns? If not, the odds it’ll slip into Chapter 7 are too risky for DIP lenders to care. It’s especially true given the general belief that this recession won’t end anytime soon.

3. “Where’s the Ebitda?” In December, consumption fell off a cliff. The Ebitda of many companies dropped by 50% or more. If that’s the case, lenders aren’t excited about the company’s post-holiday prospects. “How can you leverage something that’s close to zero?” our lender said.

Lenders are truly playing the role of Peter at the pearly gates, deciding which companies get put on life support and which get their plugs pulled. (Yes, I just mixed two bad metaphors there…)

The companies most worthy of life support are those with tangible assets. “You can get a double digit yield providing DIP lending to an asset-heavy company,” our lending source said. “There is a guaranteed exit.”