Red Ink Rising

Debtor-in-possession financing is keeping increasing numbers of bankrupt companies afloat. But squishy assets are making large deals harder to negotiate.

A growing segment of corporate America is now in bankruptcy. The number of organizations that register a negative value is rising, as is the amount of cash pouring out of big banks to keep these companies running. Why lenders that can't collect old debts from insolvent companies are offering them new loans is an old story. But a new story is emerging from the huge, murky balance sheets of today's prominent Chapter 11 filers. The way these corporations obtain financing may have a substantial impact on the organizations that do business with them.

To give troubled companies the time, cash and credibility they need to recover, the bankruptcy code not only provides respite from current creditors, but also includes safeguards that encourage lenders to advance new money to keep the bankrupt business going during its reorganization, explains bankruptcy attorney Stephen Karotkin, partner with Weil Gotshal & Manges LLP in New York City. That means lenders which advance funds after the bankruptcy petition is filed move to the front of the line for repayment.

The number of bankruptcy filings may not be at an all-time high, but the dollars involved are record-setting, whether you're looking at assets, liabilities or revenues. So is the amount of debtor-in-possession (DIP) financing outstanding, according to investment banker Henry S. Miller, chairman and managing member of Miller Buckfire Lewis & Co. LLC in New York City. Lenders and investors are lining up for a piece of the action because DIP lending has tradition- ally been a low-risk, high-profit business. However, the forced liquidation of telecommunications company Winstar, from which DIP lenders stand to recover only about 24 cents on the dollar, has made them more cautious, Miller notes.

In the United States' last big wave of bankruptcies, in the early 1990s, the problem often was overleverage following leveraged buyouts; operations were essentially healthy. But many of today's bankruptcies are "truly sick companies in sick industries with excess capacity, dangerous cash burn, and real structural and operational problems," reports Mitchell Drucker, senior vice president of CIT Business Credit, a provider of asset-based lending in New York City.

"We used to see mostly metal benders and other mainline companies with A/R and inventory to borrow against," says Joe Lehrer, managing director­head of restructuring at Banc One Capital Markets Inc., Chicago. Now many bankruptcies involve energy, telecom and airline companies that don't have those assets, so the deals are more difficult to do. They get whittled down in size, and they have to be collateralized with fixed assets like real estate, machinery and equipment, Lehrer explains.