By MITCH DEACON Staff Reporter
Distress comes with a high price these days.
Although capital remains relatively accessible for quality borrowers, credit options have severely diminished for struggling firms, with large public corporations on the ropes facing particular challenges.
"Banks are still willing to lend to distressed companies, but they have become much more stringent in their credit requirements," said Scott Kolbrenner, a director at investment bank Houlihan Lokey Howard & Zukin in Los Angeles. "The pricing of loans has gotten significantly more expensive."
And the shortage of credit for cash-strapped companies couldn't come at a worse time when more firms are facing liquidity shortfalls. Lenders report rising numbers of troubled companies seeking financing.
"We are definitely seeing an increase in the number of distressed borrowers," said Tim Turner, managing director of Wachovia Capital Finance, an asset-based lender in Pasadena specializing in lines of credit from $10 million to $1 billion. "Before July, even a marginally performing midmarket company could raise capital."
Large corporations with liquidity problems face particularly high obstacles in the credit markets due to the unwillingness of investors to buy packages of debt securities.
With banks tightening their belts, alternative financiers like hedge funds, mezzanine lenders and private equity investors are finding a profitable niche by offering capital at premium prices. That will especially be the case if a bank determines that a distressed company has poor fundamentals, rather than just a rough patch on the road to profitability.
Among the popular forms of credit offered by hedge funds are second lien loans and "stretch" loans, according to George Blanco, a partner in business restructuring services at BDO Consulting in Los Angeles.
Second lien loans are subordinate to initial lien loans and are typically made at 50 cents on the dollar for inventory and 80 cents for receivables. In a stretch loan, the debt capital is collateralized on the remainder of inventory, accounts receivables or other assets such as real estate, equipment or patents.
In some cases, a hedge fund will even allow borrowers to submit pro forma financial statements, which exclude some expenses and generally enhance the appearance of earnings. It's a high-risk game that pays high interest rates, but the funds are often hoping to get more than a premium on their loans.
"Hedge funds are more predatory than commercial lenders," Blanco said. "Banks don't want to want to force liquidation or Chapter 11, but a hedge fund is willing to take the downside risk to end up owning the company."
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