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Distressed securities (also known as distressed-debt) are securities or bonds of companies or government entities that are either already in default, under bankruptcy protection, or in distress and heading toward such a condition. Purchasing or holding such distressed-debt represent significant risk since bankruptcy may render such securities worthless (zero recovery). They therefore tend to trade at significant discount to their intrinsic value.
Some investors have deliberately used distressed-debt as an alternative investment where they buy the debt at deep discount and aim to realise a high return if the company or country does not go bankrupt or defaults. The major buyers of distressed securities are typically large institutional investors, who have access to sophisticated risk management resources, such as hedge funds and private equity firms and units of investment banks. Firms that specialise in investing in distressed debt are often referred to as vulture funds.
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. In 2006 distressed debt investments earned well above average returns. and there were more than 170 institutional distressed debt investors. These institutions used "very strong and varied strategies included traditional passive buy-and-hold and arbitrage plays, direct lending to distressed companies, active-control elements, foreign investing, emerging equity purchases and even equity plays while the firms are going through reorganization in bankruptcy." 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 points over the risk-free rate of return (e.g. Treasuries) are commonly thought of as being distressed. Distressed securities often carry ratings of CCC or below from agencies such as Standard & Poor's, Moody's and Fitch.
By 2006, the increased popularity in distressed debt hedge funds, led to an increase in the "number of benchmark performance indexes. Highly specialized risk analysts, experts in credit, are key to the success of alternative investments such as, distressed debt investment. They depend on accurate market data from institutions such as CDX High Yield Index and India-based Gravitas. Gravitas for example, combines risk management software with sophisticated risk analysis using advanced analytics and modelling. They produce customized scenarios that assess risk impact of market events. Gravitas uses IBM Risk Analytics technology, (formerly Algorithmics), also used by major banks, to help hedge funds meet regulatory requirements and optimize investment decisions.
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. Private investment partnerships such as hedge funds have been the largest buyers of distressed securities. By 2006, hedge funds has purchased more than 25% of the high-yield market’s supply to supplement their more traditional defaulted debt purchases. By 2006, new issues rated CCC to CCC reached an all time high of $20.1 billion. Other buyers include brokerage firms, mutual funds, 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 United States has the most developed market for distressed securities. The international market (especially in Europe) has become more active in recent years[when?] 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. See Business valuation: Option pricing approaches.
In June 2013, Goldman Sachs’s Special Situations Group, the proprietary investment unit of the investment bank, purchased US$863 million Brisbane-based Suncorp Group Limited's loan portfolio. The finance, insurance, and banking corporation is one of Australia's largest banks (by combined lending and deposits) and its largest general insurance group, In the summer of 2013 as European lenders were divesting their loans portfolios, in Australia, hedge funds and investment banks were buying them. In 2013, distressed-debt investors, seeking investment opportunities in Asia, particularly in Australia, acquired discounted bonds or bank loans of companies' facing distressed debt, with the potential of profitable returns if the companies' performance or their debt-linked assets improves. In 2013 Australia was one of the biggest markets for distressed-debt investors in Asia.
- "Understanding Distressed Securities". Barclay Hedge. 2013.
- "Distressed-Debt Investors Eye Asia". Wall Street Journal. 7 August 2013. Retrieved 8 August 2013.
- Edward I. Altman; Jeffrey Swanson (February 2007) (PDF). The Investment Performance and Market Size of Defaulted Bonds and Bank Loans: 2006 Review and 2007 Outlook (Report). Special Report. New York University Salomon Center, Leonard N. Stern School of Business. http://pages.stern.nyu.edu/~ealtman/2006%20InvestPerf.pdf.
- Groenfeldt, Tom (24 June 2013). "Distressed Debt Fund Monitors And Hedges Its Risks For Low Volatility". Retrieved 8 August 2013.
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- Henry F. Owsley and Peter S. Kaufman (2005). Distressed Investment Banking: To the Abyss and Back. Beard Books. ISBN 1-587-98267-6.
- Stephen G. Moyer (2004). Distressed Debt Analysis: Strategies for Speculative Investors. J. Ross Publishing. ISBN 1-932-15918-5.
- Martin J. Whitman and Fernando Diz (2009). Distress Investing: Principles and Technique. John Wiley & Sons. ISBN 978-0-470-48865-2.
- 2006 Distressed & defaulted debt market review by Edward Altman
- Understanding Distressed Securities
- Distressed Debt Articles from VCExperts.com