Sponsor-backed companies have a standard playbook of liability management exercises when faced with liquidity concerns or upcoming debt maturities. Typical moves include an uptier, in which the sponsor creates a new tranche of secured debt that’s senior to existing lenders, or a drop down, wherein assets are transferred out of the collateral package entirely.
In recent months, a new tool has picked up steam as a viable alternative: the double dip financing.
Creative Structuring
In a double dip, a creditor provides additional debt financing to the borrower that is secured by two dollars in claims for every dollar lent—doubling up the creditor’s protection against a downside scenario.
With this structure, the borrowing company forms a new subsidiary that borrows the money, guaranteeing the loan with the company’s other operating subsidiaries, while simultaneously lending the loan proceeds from the newly formed subsidiary to the operating subsidiaries—pledging this loan as collateral to the original lender. This maneuver provides the lender with two separate secured claims against the borrower’s assets: the initial loan it made (the 1st dip), and the inter-company loan (the 2nd dip).
If all goes well, the borrower pays back the original principal as it normally would. But, if the situation takes a turn for the worse, the double dip lender will be better positioned in a restructuring than it otherwise would be. While the lender would never recover more than the amount owed on the loan, its outlook in a below-par recovery is more favorable (relative to other lenders who have only a single claim).
What’s the Point?
On the surface, it can seem like added complexity for little upside—you’re still borrowing and repaying the same amount. In practice, however, the double dip structure provides a level of added security for lenders that allows a company to take out new financing when it otherwise couldn’t have (due to its risk profile). A double dip financing can also lower the cost of capital for borrowers.
The other advantage of the double dip’s emergence is that it provides an option for companies that can’t execute either an uptier or a drop down. With both moves now more common, many credit agreements have incorporated protections that prevent such strategies.
That said, there are risks involved with a double dip. The end result is still unfavorable for existing creditors, which opens up a greater possibility of litigation. They also bring added complexity to the capital structure, and could reduce the likelihood of a successful out-of-court restructuring, should things get to that point.
Double dips could also invite scrutiny in a bankruptcy process, though, for lenders, it’s probably still better to have both a strong claim (1st dip) and a questionable claim (2nd dip) than only the one.