Rent Extraction by Super-Priority Lenders

Abstract

We present strong evidence of supra-competitive pricing of debtor-in-possession (DIP) loans to large firms in Chapter 11 bankruptcy. Over-collateralized and with super-priority, strong covenants, rollups, and debtor-funded monitoring costs, these loans are almost risk-free. Nonetheless, loan spreads average 600 basis points, which is 60% higher than leveraged-loan ("junk"') spreads charged the same firms within three years before bankruptcy filing. While prepetition lenders have a strong bargaining position when supplying DIP loans, spreads are no lower when DIP loans are supplied by new lenders. Junior claimants often contest DIP-loan terms in court - 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