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There appears to be a schism within the debtor-in-possession lending community. During a panel discussion at Monday's American Bankruptcy Institute New York City Bankruptcy Conference, some said DIPs are now light on covenants, while others said they are more demanding. Either way, the conclusion seems to be the same: The debtor will lose.
"These days, there are a lot of deals getting done that are Band-Aid deals that will come to roost," said Marc Kieselstein of Kirkland & Ellis LLP. For those debtors who have found more demanding covenants in their DIPs — a number of recent ones include deadlines for auctions and sales — attendees said that they are less positioned for future success. "If [the debtor] can't support the debt and we own the company, I don't care," said Lawrence A. First, who represented a lender. "We look at it as an opportunity." But there seemed more folks who believed that 2006 saw the rise of more covenant-like DIPs, which could be even more insidious. Kenneth Buckfire of Miller Buckfire & Co. LLC said such DIPs were leading to "a very bad, unstable situation," while Thomas M. Canning of J.P. Morgan Chase & Co. noted, "Without the discipline of a lender with a contractual default knocking on the door, it's going to be hard to make changes [in restructurings]." Judge James Peck of the U.S. Bankruptcy Court of the Southern District of New York was more grave. "There are not going to be soft landings," he said. "The speed bumps [that tougher covenants provide] have been eliminated from the system." DIPs represent only 1% of the total loan volume in the market today, according to presenters. But the leverage loan market is now open to triple-C-rated borrowers, showing just how liquid it is. And second-lien loan volume grew 74% in 2006 to $28 billion. In fact, as deals for DIPs get more seasoned, premiums get tighter, Canning said. Consolidation in the DIP lending industry has led to a diminished role of traditional banks in the last few years. In 1995, 70% of the DIP lending market was owned by banks; in 2006, it was 13%. CLOs and hedge funds came to represent 75% of the DIP lending market in 2006. One big reason, according to attendees, was the increased dispersion of lending risk. Syndicates providing DIPs are larger today, leading lenders to lend to riskier borrowers. "When the music stops, it's not entirely clear to everyone who will be holding the bag," said Kieselstein "There are more players in the game, so there's lower risk of one entity holding the bag when the music stops." Calpine Corp.'s DIP got considerable attention. The discussion revolved around how its first- and second-lien structure let banks lend with confidence. Buckfire noted that the agent banks could get the deal properly syndicated so they could hedge their risk. "This adds a layer of complexity," he said. "But if you can't pay off the full DIP anyway, you have bigger problems." —John Blakeley Categories Deal Video
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