Unwilling To Stump Up The Cash

Michael Panzner
updated | Author's Website

Some might describe it as paradoxical, Daliesque, or poetic justice when a company whose liabilities far outweigh its assets can’t get the financing it needs to declare Chapter 11 bankruptcy.

Regardless, it says something about the alleged recovery in credit and other markets that some optimistic analysts claim is on the horizon (as well as the overall state of the economy) when lenders who have top priority in such proceedings are unwilling (or unable) to stump up the cash.

In “Liquidation Risk Grows as Finance Dries Up,” the Financial Times reports on the latest developments.

US companies face a greater risk of liquidation because sources of finance to let them reorganise under the country’s bankruptcy code are drying up in the global financial crisis.

In the US, companies on the verge of insolvency can restructure themselves under a Chapter 11 bankruptcy protection process, sometimes taking years.

But the credit crunch has severely limited the availability of so-called ‘debtor in possession’ financing that is vital to give them this second chance.

With previous big providers of DIP financing, such as GE Capital, shying away from the market, companies may have to rely on their existing lenders, says Standard & Poor’s, the rating agency.

It said on Friday there had been no substantial increase in DIP volumes in 2008, in spite of a jump in the number of bankruptcies, highlighting the reluctance of banks and investors to finance companies in bankruptcy.

Steven Smith, global head of leveraged finance and restructuring at UBS in New York, said this cycle was likely to see more liquidations than in the last three combined.

He said: “The lack of DIP financing available is an issue for the American economy because of the potential job destruction that could result.”

Lenders, even those with priority claims, face big losses, if a company cannot reorganise and liquidates.

Senior lenders to retail companies would recover less than half of what they would if the company reorganised under Chapter 11, according to S&P.

Debtors also face the highest rates yet for DIP financing. The risk premium a debtor has to pay on the loan has more than doubled since 2001-2002, the height of the last downturn, according to Dealogic.

In 2001 the spread over Libor was 429bp versus 900bp now.

Most companies are trying to delay Chapter 11 as long as they can, said Mr Smith. Once in Chapter 11 it was not certain they would get financing.

Other companies have been contemplating pre-emptive bankruptcies while they still have cash, to improve their chances of an organised restructuring. Analysts speculated this was the case with Nortel Networks, the Canadian telecoms equipment maker which filed for Chapter 11 earlier this month.

Companies have also been looking to avoid Chapter 11 by using a debt exchange, where creditors are asked to accept concessions to reorganise debt outside the courts.

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