Bankruptcy Loans: The Retail Debt Everyone Wants Their Hands On

(Bloomberg) -- Lenders that wouldn’t spare a dime for retailers as they struggled to avoid bankruptcy are now falling over themselves to supply new debt after they do file.

Debtor-in-possession loans, which fund a company through court-supervised reorganizations, have become one of the hottest pieces of paper for yield-chasing investors to get their hands on. The rising number of retailer bankruptcies has helped fuel $15.5 billion of DIP loans this year, data compiled by Bloomberg show. It’s making 2017 one of the busiest years for DIP loans since the Great Recession.

Lenders are clamoring for the debt for a few reasons. There’s no safer place for a creditor to be during a bankruptcy process. DIP lenders get paid before anyone else, making them appealing to existing lenders who can use them to jump ahead of others in the repayment line. DIPs also lure new investors because they often pay more than debt issued before the bankruptcy, have short maturities, and can give lenders a key seat at the negotiating table when deals are made.

“It’s a place to put your dollars short-term with a nice yield,” said Shap Smith, head of restructuring finance at Citigroup Inc. “It’s a great alternative to the more traditional market, which can be expensive.”

Consider the case of Toys “R” Us, which filed for Chapter 11 in September after a squeeze by its vendors left it unable to manage its $5 billion debt load.

Lenders including Franklin Resources Inc. and Marathon Asset Management vied to provide $3.1 billion of DIP loans that are helping to keep the retailer’s shelves stocked through the holidays while refinancing some of its existing debt.

Rate Shaved

In one $450 million piece of the debt, demand from investors allowed the retailer to cut its proposed borrowing rate by 0.75 percentage point to 6.75 percentage points more than the London interbank offered rate (for a total of about 8.1 percent currently), people with knowledge of the debt sale said. That will potentially save America’s biggest toy seller about $4.4 million in interest over the life of the borrowing, data compiled by Bloomberg show.

A spokeswoman for Franklin declined to comment, while a representative for Marathon didn’t respond to requests for comment.

“With a lowly rated retailer like Toys, there’s lots of risk and it’s a coin flip whether the company’s going to survive or not and stay out of bankruptcy,” said Moody’s analyst Charlie O’Shea. “A lender there will be skittish. But if that same company files Chapter 11 that same lender may become very comfortable because of the structural protection.”

Then there’s Sears Canada, the piece of Eddie Lampert’s sprawling retail empire that is liquidating after seeking creditor protection in June. Getting a piece of its DIP loan proved a lucrative bet for middle-market lender Great American Capital Partners, which is being paid a rate of more than 12 percent on a C$150 million loan ($117 million). That’s roughly 1.5 percentage points more than what it had earned as a lender to the retailer prior to bankruptcy.

Some Risks

Wells Fargo agreed to extend as much as C$300 million in DIP funding to Sears Canada through an asset-based facility at roughly 6 percent, also about 1.5 percentage points more than what it earned on similar debt prior to bankruptcy.

Joel Shaffer, an external spokesman for Sears Canada, declined to comment, and a representative for GACP didn’t respond to requests for comment.

DIPs don’t come without risks. If a restructuring plan fails or takes longer to get court approval, lenders can find themselves waiting as the company’s valuation deteriorates, said Sharon Bonelli, an analyst at Fitch Ratings. But the lenders “rank before anyone else for repayment so they nearly always get 100 percent recovery on bankruptcy. And DIPs don’t default.”

As shoppers increasingly ditch malls and buy online, retailers have been turning to bankruptcy courts to cut their massive debt loads. They took on that debt during a period of relatively cheap credit that fueled leveraged buyouts by private equity firms. Retail defaults are now running at a 7.1 percent rate -- more than double the rate of borrowers overall.

One compelling angle for DIP lenders is that some retailers are opting to file for bankruptcy before they run out of cash, bolstering their value for the most senior creditors, said Lynn Whitmore, managing director of retail finance at Wells Fargo & Co.

“For existing bank lenders, there’s a profitability consideration that can be attractive to us,” she said.

Outside Retail

DIP lenders are finding opportunities outside of retail as well. And the market has been attracting less traditional players. Private equity firms including Apollo Global Management LLC have increasingly made their mark.

Apollo out-muscled a group of lenders led by Goldman Sachs Group Inc. in April to provide an $800 million DIP to Westinghouse Electric Co. The loan gave Apollo a foot in the door as the nuclear-reactor builder’s future was being determined. Apollo was later said to be among firms bidding on the Toshiba Corp. unit.

A spokesman for Apollo declined to comment.

--With assistance from Ryan Kaplan

To contact the reporters on this story: Nabila Ahmed in New York at nahmed54@bloomberg.net, Allison McNeely in Toronto at amcneely@bloomberg.net.

To contact the editors responsible for this story: Rick Green at rgreen18@bloomberg.net, Shannon D. Harrington, Tiffany Kary

©2017 Bloomberg L.P.