Debtor-in-possession (DIP) financings are frequently being left out of the equation for the current crop of bankrupt energy firms as many opt for pre-negotiated bankruptcy plans to speed up the restructuring process and rely on cash, according to Fitch Ratings. This makes energy somewhat of an outlier as DIP financing generally remains common among recently bankrupt companies in other industries.

"DIPs are sometimes costly and restrictive but are available, often provided by junior creditors that will become majority owners in debt-to-equity swaps," says Sharon Bonelli, Senior Director, Leveraged Finance.

Many DIP loans have wide interest margins or fixed-rate interest costs. In Fitch's study of 39 DIP facility tranches, the median LIBOR margin was 9%, nearly double the 4.8% average on 'B' rated new issue institutional term-loans.

When DIPs are sought in bankruptcy, existing unsecured bondholders or junior-lien creditors often make up the lender base. For junior creditors, greater control in the bankruptcy and restructuring process in advance of assuming majority ownership of the new stock post-bankruptcy can be appealing. Fitch believes non-bank lenders are more likely to provide DIPs than traditional banks given their flexibility in negotiating and closing facilities.

"Distressed debt funds and private equity firms are poised to play a greater role in bankruptcy and distressed funding and have built up significant dry powder, however, they remain highly selective," says Meghan Neenan, Senior Director, Financial Institutions. "Most of the recent default volume is in energy names where commodity price volatility and wide bid-ask spreads makes it challenging to determine valuations and invest with certainty."

The significant dry powder is likely to be put to work when commodity prices stabilize. At that point, energy sector asset sales and company mergers may pick up.

In the meantime, energy defaults and bankruptcies are expected to continue. Many highly leveraged shale producers cannot generate sufficient cash flow to sustain debt service and fund operations, especially as hedges roll off, despite the recent bump in oil prices. Distressed energy firms face a dearth of traditional funding options and have limited choices: production-asset-level financing, out of court debt exchanges, asset sales, and bankruptcy are potential outcomes.

The full report, 'Funding Trends for Bankruptcy and Distressed Debt; DIP Financing Available, Fundraising Robust,' is available at www.fitchratings.com.