Double-dipping is Never a Compliment

If you don't understand this diagram, don't do double dips.

Some leveraged companies whose low-rate loans are coming due are resorting to "double-dip" loans:

Here’s how a double-dip loan generally works: A company creates a subsidiary that issues new loans and it lends loan proceeds to its parent on a secured basis, meaning the proceeds are backed by collateral. The parent also guarantees the new loans, creating a second claim on the assets. New lenders often get collateral not pledged to existing lenders. Such a transaction is called double-dip because the loan to the parent company, along with the loan guarantee, creates separate claims on company assets.

A double-dip provides additional claims against existing collateral via an intercompany note and guarantee. Double-dips must be allowed by a company’s credit agreements, and they usually are because contractual provisions have weakened over the last several years, [AllianceBernstein director Scott] Macklin said.

Companies drawn to these transactions generally have a significant amount of leverage and few options for refinancing short-term debt. Potential new lenders often are concerned a heightened bankruptcy risk for many of these companies would prevent recovering the par value of debt they provide, so they require additional protections, Macklin said.

If you're still with me, dear reader, here are my comments.

To vet the transaction a lender needs to diagram the cash flows and understand thoroughly what happens when a deal goes south.

On a macro level when money gets tight, structures get more complex. Securitizations and collateralized debt obligations were all the rage because buyers convinced themselves that the collateral was good in case the cash flows did not materialize. We know how that turned out.

Double-dips are simpler to analyze because they only involve one company and look like a way to borrow against assets that are unpledged. Prospective lenders should ask themselves: why doesn't the parent just issue the debt without all this complexity? Instead, they've got to lend to a subsidiary that's got the collateral and a parent guarantee that's worth little when things go south.

They've got to ring-fence the sub with enough protections so they can sleep at night. Frankly, I'd try to get some upside over and above the nominal spread as compensation for the risk.

From the borrower's point of view, these loans may carry a lower coupon than other alternatives, but legal, investment banking, sales-commissions, and compliance costs make them expensive.

Yes, I used to look at complex financial arrangements and didn't particularly enjoy it. But it was a living.