Rent Extraction by Super-Priority Lenders

Abstract

We present strong evidence of supra-competitive pricing of debtor-in-possession (DIP) loans to firms filing for Chapter 11 bankruptcy. Fully collateralized and with super-priority and strong covenants, we show that DIP loans have near-zero default risk. Nonetheless, their spreads and fees exceed those of even junk-rated loans, adding billions to the borrowing costs of Chapter 11 firms. There is also no evidence that the increasing involvement of hedge funds and private equity funds in providing DIP financing has mitigated rent extraction by lenders in this market. Junior claimants often contest DIP-loan terms in court - but apparently to little avail.

Keywords: Debtor-in-possession, Chapter 11, rent extraction, covenants, loan spreads, fees, roll-up, leveraged loans, prepetition lenders

JEL Classification: G14, G34