A quick thread about DIP (Debtor in Possession) financing because I find "buy the dip" in distressed names very funny.

In short, a DIP lending facility allows a going concern (company operating under Chapter 11) to continue while not impairing any underlying capital claims. 1/x

When a company files for Chapter 11 bankruptcy protection it is usually because one or more of the secured creditors has attempted to (or expressed willingness to) foreclose on collateral (can be cash or other non-physical assets) because of technical default or probable default.

Of course, assets are the skeleton and muscle of an enterprise so if American Airlines $AAL had its entire fleet foreclosed on and scrapped, they might have a tough time with other obligations such as payroll, trade accounts (lets say fuel and food), and unsecured credit claims.

While capital structures give the most senior creditors the most power over a distressed enterprise, they are usually secured by assets that have carrying value well in excess of the money they loaned to the business so C11/RX proceedings then shift to relative equitable division

Another consideration for the most senior, secured creditors is that if the going concern was shifted to Chapter 7 liquidation proceedings, the value of the collateralized assets will almost certainly be impaired, threatening the creditors recovery.

Think $AAL or $HTZ fleet

Its a lot easier to liquidate a few billion of retail inventory at 75 cents on the dollar than it is thousands of used 767s.

Also remember that when people discuss the aggregate market cap of the airlines... that doesnt include the planes

Thats why we use Enterprise Value (TEV)

Anyway, because most companies that enter Chapter 11 bankruptcy proceedings have operations that produce cash, or assets that could produce cash with better management, the purpose of RX is generally not to kill the enterprise, employees, unsecured claims, and equity.

Enter DIP

The terms of the Debtor in Posession facility are often contentious, especially if the senior debt is close to having collateral value fall below their exposure

This is because post-C11 filing borrowings, including trade accounts payable and payroll, are senior to all pre-filing

Furthermore, seeing as the enterprise has already filed for bankruptcy protection, it seems highly unlikely that the firms financial position and operations would allow it to take on more debt.

Which is why DIP is seen as funding of last resort and can be controversial.

Generally though, first lien secured creditors are covered well in excess of the money lent to the borrower, for this exact reason.

Lets say if AAL owed the banks $20b but had planes worth $30b book value, net depreciation, the court could approve a $10b secured DIP facility.

In this scenario, all levels of the capital structure might be better off because while the fleet may have $30b book value, it is extremely unlikely that the assets fetch that in a fire sale.

The first lien could claim that they arent adequately protected.

But so would payroll.

I had been thinking about this for a while in the context of Hertz, and while this isn't the thinking behind the Robinhood traders activity...

A situation with badly impaired assets ($20b in used cars in a bad market) could create favorable post-petition environment for the co

Hertz $HTZ creditors could move to force the company to liquidate its fleet but that would obviously kill operations, subordinate the first lien to trade claims (not a big number here, but could be in other cases), and threaten the recovery of the largest class of creditors.

All of this creates an environment where the equity turns into a no expiration, free binary call (at least until it was bid up) on the entire operations of the enterprise.

And a bet that the creditors don't want to sell thousands of cars or planes or whatever... they want cash

Could you imagine some RX bankers in 10k suits going around trying to sell used cars like Jonah Hill in The Wolf of Wall Street?

Well maybe you can lol but they sure as hell arent going to.

The debtor will have funding approved and first lien will whine but it will all be ok.