In today’s recessionary environment, restructuring finance – especially debtor-in-possession (DIP) financing – is in high demand. As companies seek the funds necessary to file for Chapter 11, many will be successful while others will not. Although lenders are eager to deploy DIP financing where and when it makes good business sense, several factors make doing so more complicated than in past down cycles. Here are some of the market dynamics driving DIP and restructuring finance activity in today’s volatile market.

Overarching Systemic Issues
Recent changes in the economy, capital markets and bankruptcy law have impacted corporate turnarounds and consequently DIP financing. The current global recession is the toughest business environment in decades. It is putting pressure on liquidity for both borrowers and lenders and creating a supply/demand imbalance for capital to finance restructurings. The near shutdown of the capital markets that started this past fall has made the syndication of DIPs larger than $100 million more problematic. Moreover, the 2005 amendment to the Bankruptcy Code has compressed the Chapter 11 timeframe challenging distressed firms to quickly reorganize or liquidate. These systemic issues have resulted in lenders having to make decisions in shorter timeframes and operate in a much less certain environment.

Increased Complexity
Completing DIP financing today is more complex than ever before. Today, a company’s capital structure includes relatively new participants (hedge funds, private equity, distressed debt funds) who often have competing agendas and interests. Also, the rapid growth of second lien debt throughout the past decade means there is typically less unencumbered collateral for the company to use in securing DIP financing. Further, adding to the complexity of DIPs is the abundance of over-levered corporate balance sheets that have resulted from years of plentiful and inexpensive debt. In today’s environment, corporate earnings are plummeting, leverage ratios and risks are increasing, and corporate asset and collateral values are falling. In short, the creditworthiness of these highly levered borrowers is diminishing quickly. With new participants, more complex capital structures and less creditworthy borrowers, offensive DIP lending has become a challenge.

DIP Fundamentals
One dynamic that has not changed within the DIP lending space is the fundamentals that DIP lending was built upon. Good businesses with sound business models, sufficient unencumbered collateral and good management will find DIP financing. The loans, however, will be more expensive, have shorter tenor and include more restrictions to compensate for today’s volatile environment. On the other hand, companies with fundamentally broken business models and ailing balance sheets will ultimately have no other choice but to sell significant assets or even liquidate.

Bottom Line
The dynamics impacting the DIP loan market today make deploying capital more complex than ever before. In addition, the reduced chance of a distressed company executing a successful turnaround in today’s economy adds additional risk to the lending equation. That said, lenders are active and eager to allocate DIP financing when and where it makes good business sense.

Rob McMahon leads GE Capital’s Restructuring Finance Group, a team specializing in working with turnaround advisors to provide corporate lending solutions to distressed companies in or out of bankruptcy.