Early last year, when corporate defaults were headed for the stratosphere and capital was hard to come by, lenders willing to provide debtor-in-possession loans to Chapter 11 companies looked to make a killing. Some deals were churning out yields of 13 to 14 percent, up-front fees of 3 to 5 percent and exit fees of 1 to 3.5 percent — double what was common for DIP financings in 2002, the last big default cycle.
Indeed, to cash in, several firms launched hedge funds dedicated to DIP financing — the first of their kind in the market — to provide primary loans to bankrupt companies. High yields and fees weren’t the only lure. Highly collateralized DIP financing is relatively risk-free, because the loans receive priority over other claims, including bank credits and ....