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DIP loans to distressed companies mount with bankruptcies

NEW YORK (Reuters) - Distressed U.S. companies including a coal producer, sporting goods retailer and brokerage firm received loans this year to sustain business while reorganizing, and the number will swell as troubled energy companies increasingly file for bankruptcy protection.

Debtor-in-possession (DIP) loans totaling US$2.1bn have been extended to a half dozen companies so far this year, topping the US$930m from four deals in the whole of 2015, according to Thomson Reuters LPC.

DIP loan issuance had been muted during the recovery years, aside from a blip in 2014, when a multi-billion-dollar Texas Competitive Electric Holdings loan accounted for a majority of that year’s US$7bn total.

Leveraged loan defaults are running at a rate last seen in 2009, as energy companies slammed by depressed oil prices fail to make timely debt payments, analysts note. Bankruptcy filings are expected to mount.

Retailer Sports Authority, paper producer Verso Paper Holdings and brokerage RCS Capital were among the companies that received US$1.6bn of DIP loans in the first quarter. It was the most since US$6.5bn in the second quarter of 2014, which was skewed by the Texas Competitive loan.

Entering the second quarter, leading global coal producer Peabody Energy filed for bankruptcy protection on April 15, saying its need for the US$800m DIP financing the company secured was “immediate and urgent.” Solar energy company SunEdison then entered the queue after an April 21 filing.

“It would be reasonable to expect that as bankruptcy filings continue to occur, you will continue to see DIP financings,” said Brian Trust, restructuring, bankruptcy and insolvency partner at Mayer Brown.

The largest annual DIP loan volume dating back 15 years was US$14.6bn in 2009 from 37 deals, according to Thomson Reuters LPC.

Borrowers often seek larger DIP loans than needed, attorneys and analysts said, signaling that they can still gain market access and are on a path toward recovery.

A larger-than-required committed DIP loan is good from “an optics perspective,” Trust said, sending creditors, unions, the government, taxing agencies and others a message that the borrower is well capitalized during its restructuring.

DIP loan investors include banks, lenders, hedge funds and investment funds, while a typical bankruptcy is 18 months to two years, analysts said.

BY DEFAULT

The loans are structured with low risk profiles and are meant to be paid back before existing debt, analysts said.

“In the Great Recession default cycle, no DIPs defaulted,” said David Keisman, senior vice president and a loss given default analyst at Moody’s Investors Service.

“Although a bankrupt company is rated “D”, signifying default, DIPs are a well structured, superpriority asset class that has investment-grade characteristics in terms of loss and default performance,” said Keisman. “This has shown to be the case even with DIPs in the coal industry, which faces both ongoing deep price erosion and political pressures.”

Tepid economic growth and ongoing weakness – albeit less than early this year – in oil and gas, metals and mining markets are boosting leveraged loan defaults.

April marked the sixth straight month that leveraged loan defaults surpassed US$1bn, a milestone last reached between October 2009 and March 2010, Fitch Ratings wrote in an April 27 report.

Still, overall defaults are contained, with the trailing 12-month rate for institutional leveraged loans at 1.8% in April, Fitch said.

Collateralized Loan Obligation (CLO) funds, the biggest buyers of leveraged loans, hold a stake in increasingly problematic loans, although their overall exposure is also limited.

According to LPC Collateral, 108 U.S. CLOs hold a total US$293bn, or 24%, of Peabody’s existing pre-DIP term loan. That exposure for the vast majority of these CLOs, however, is less than 1% of their fund.

Reporting by Lynn Adler; Editing By Michelle Sierra and Chris Mangham

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