Distressed securities
Encyclopedia
Distressed securities are securities
of companies or government entities that are either already in default
, under bankruptcy
protection, or in distress and heading toward such a condition. The most common distressed securities are bonds
and bank debt
. While there is no precise definition, fixed income instruments with a yield to maturity
in excess of 1000 basis point
s over the risk-free rate of return (e.g. Treasuries
) are commonly thought of as being distressed. A related category is stressed debt yielding between 600-800 basis points over Treasuries. Distressed securities often carry ratings of CCC or below from agencies such as Standard & Poors, Moodys, and Fitch.
When companies enter a period of financial distress
, the original holders often sell the debt or equity securities of the issuer to a new set of buyers. In recent years, private investment partnerships such as hedge fund
s have been the largest buyers of distressed securities. Other buyers include brokerage firms, mutual fund
s, private equity
firms, and specialized debt funds (such as collateralized loan obligations
) are also active buyers.
Investors in distressed securities often try to influence the process by which the issuer restructures its debt, narrows its focus, or implements a plan to turn around its operations. Investors may also invest new capital into a distressed company in the form of debt or equity.
The US has the most developed market for distressed securities. The international market (especially in Europe
) has become more active in recent years as the amount of leveraged lending increased, capital standards for banks have become more stringent, the accounting treatment of non-performing loans has been standardized, and insolvency laws have been modernized.
Investors in distressed securities typically must make an assessment not only of the issuer's ability to improve its operations but also whether the restructuring process (which frequently requires court supervision) might benefit one class of securities more than another.
Security (finance)
A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...
of companies or government entities that are either already in default
Default (finance)
In finance, default occurs when a debtor has not met his or her legal obligations according to the debt contract, e.g. has not made a scheduled payment, or has violated a loan covenant of the debt contract. A default is the failure to pay back a loan. Default may occur if the debtor is either...
, under bankruptcy
Bankruptcy
Bankruptcy is a legal status of an insolvent person or an organisation, that is, one that cannot repay the debts owed to creditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor....
protection, or in distress and heading toward such a condition. The most common distressed securities are bonds
Bond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...
and bank debt
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
. While there is no precise definition, fixed income instruments with a yield to maturity
Yield to maturity
The Yield to maturity or redemption yield of a bond or other fixed-interest security, such as gilts, is the internal rate of return earned by an investor who buys the bond today at the market price, assuming that the bond will be held until maturity, and that all coupon and principal payments...
in excess of 1000 basis point
Basis point
A basis point is a unit equal to 1/100 of a percentage point or one part per ten thousand...
s over the risk-free rate of return (e.g. Treasuries
Treasury security
A United States Treasury security is government debt issued by the United States Department of the Treasury through the Bureau of the Public Debt. Treasury securities are the debt financing instruments of the United States federal government, and they are often referred to simply as Treasuries...
) are commonly thought of as being distressed. A related category is stressed debt yielding between 600-800 basis points over Treasuries. Distressed securities often carry ratings of CCC or below from agencies such as Standard & Poors, Moodys, and Fitch.
When companies enter a period of financial distress
Financial distress
Financial distress is a term in Corporate Finance used to indicate a condition when promises to creditors of a company are broken or honored with difficulty. Sometimes financial distress can lead to bankruptcy...
, the original holders often sell the debt or equity securities of the issuer to a new set of buyers. In recent years, private investment partnerships such as hedge fund
Hedge fund
A hedge fund is a private pool of capital actively managed by an investment adviser. Hedge funds are only open for investment to a limited number of accredited or qualified investors who meet criteria set by regulators. These investors can be institutions, such as pension funds, university...
s have been the largest buyers of distressed securities. Other buyers include brokerage firms, mutual fund
Mutual fund
A mutual fund is a professionally managed type of collective investment scheme that pools money from many investors to buy stocks, bonds, short-term money market instruments, and/or other securities.- Overview :...
s, private equity
Private equity
Private equity, in finance, is an asset class consisting of equity securities in operating companies that are not publicly traded on a stock exchange....
firms, and specialized debt funds (such as collateralized loan obligations
Collateralized debt obligation
Collateralized debt obligations are a type of structured asset-backed security with multiple "tranches" that are issued by special purpose entities and collateralized by debt obligations including bonds and loans. Each tranche offers a varying degree of risk and return so as to meet investor demand...
) are also active buyers.
Investors in distressed securities often try to influence the process by which the issuer restructures its debt, narrows its focus, or implements a plan to turn around its operations. Investors may also invest new capital into a distressed company in the form of debt or equity.
The US has the most developed market for distressed securities. The international market (especially in Europe
Europe
Europe is, by convention, one of the world's seven continents. Comprising the westernmost peninsula of Eurasia, Europe is generally 'divided' from Asia to its east by the watershed divides of the Ural and Caucasus Mountains, the Ural River, the Caspian and Black Seas, and the waterways connecting...
) has become more active in recent years as the amount of leveraged lending increased, capital standards for banks have become more stringent, the accounting treatment of non-performing loans has been standardized, and insolvency laws have been modernized.
Investors in distressed securities typically must make an assessment not only of the issuer's ability to improve its operations but also whether the restructuring process (which frequently requires court supervision) might benefit one class of securities more than another.
External links
- 2006 Distressed & defaulted debt market review by Edward AltmanEdward AltmanEdward I. Altman is a Professor of Finance at New York University`s Stern School of Business. He is best known for the development of the Z-Score for predicting bankruptcy which he published in 1968...
- Understanding Distressed Securities
- Distressed Debt Articles from VCExperts.com