CTP CTP Capital Markets & Financing Alternatives 1 — Questions and Answers
Question 1: What is 'debtor-in-possession' (DIP) financing?
- A loan provided to a Chapter 11 debtor that has super-priority status over most pre-petition claims (Correct answer)
- A government grant available to distressed companies
- A subordinated note issued to existing equity holders
- A revolving credit line extended by the pre-petition lender only
Correct answer: A loan provided to a Chapter 11 debtor that has super-priority status over most pre-petition claims
DIP financing provides critical liquidity during Chapter 11 by granting the new lender first priority on collateral, making it attractive despite the borrower's distressed condition.
Question 2: In capital structure terms, what does 'fulcrum security' mean?
- The security class at which enterprise value is exhausted, giving that class negotiating control in restructuring (Correct answer)
- The highest-priority secured debt in a company's capital stack
- The equity tranche of a leveraged buyout
- A government-backed bond issued during a bailout
Correct answer: The security class at which enterprise value is exhausted, giving that class negotiating control in restructuring
The fulcrum security is pivotal in restructuring because holders at that level stand to receive equity or negotiated recoveries when the reorganized company is valued.
Question 3: A distressed company seeks a 'rights offering' as part of its Plan of Reorganization. What does this involve?
- Existing creditors or shareholders receive the right to purchase new equity at a discount to fund the reorganized company (Correct answer)
- The company auctions its assets to the highest bidder
- The debtor issues new secured debt to replace old unsecured claims
- The company converts preferred stock to common stock
Correct answer: Existing creditors or shareholders receive the right to purchase new equity at a discount to fund the reorganized company
A rights offering gives qualifying stakeholders the opportunity to inject fresh capital into the reorganized entity, often backstopped by a committed group to ensure the raise closes.
Question 4: What is the primary purpose of a 'second lien' loan in a leveraged capital structure?
- It provides additional debt capacity secured by the same collateral as the first lien, but with subordinated repayment priority (Correct answer)
- It replaces the first lien loan upon default
- It is unsecured mezzanine debt used only in investment-grade transactions
- It converts automatically to equity upon bankruptcy filing
Correct answer: It provides additional debt capacity secured by the same collateral as the first lien, but with subordinated repayment priority
Second lien debt allows a company to raise more secured financing than first lien lenders will provide alone, accepting junior collateral position in exchange for higher yield.
Question 5: Which of the following best describes a 'credit bid' in a Section 363 asset sale?
- A secured creditor uses its debt claim as currency to purchase assets rather than paying cash (Correct answer)
- A distressed buyer offers credit terms to the seller post-closing
- The court sets a minimum bid based on appraised asset value
- A stalking horse bidder waives its break-up fee
Correct answer: A secured creditor uses its debt claim as currency to purchase assets rather than paying cash
A credit bid lets a secured lender convert its outstanding claim into ownership of the collateral, effectively acquiring the assets for the value of the debt owed to it.
Question 6: What is 'mezzanine financing' in the context of a capital structure?
- Subordinated debt or preferred equity that sits between senior secured debt and common equity, typically carrying higher yield and equity conversion features (Correct answer)
- Senior secured revolving credit provided by commercial banks
- Government-guaranteed loans for distressed manufacturers
- A bridge loan issued immediately prior to a Chapter 11 filing
Correct answer: Subordinated debt or preferred equity that sits between senior secured debt and common equity, typically carrying higher yield and equity conversion features
Mezzanine sits in the riskier middle of the capital stack and compensates investors with higher interest rates, PIK toggles, or warrants reflecting that elevated risk.
CTP CTP Capital Markets & Financing Alternatives 1
What is 'debtor-in-possession' (DIP) financing?