Distressed securities

From Wikipedia, the free encyclopedia
Jump to: navigation, search

Distressed securities (also known as distressed-debt) are securities or bonds of companies or government entities that are experiencing financial or operational distress or already in default or under bankruptcy.[1] Purchasing or holding such distressed-debt represents significant risk since bankruptcy may render such securities worthless (zero recovery).[2] Distressed securities tend to trade at substantial discounts to their intrinsic or par value[1] and are therefore considered to be below investment grade.[1] This usually limits the number of potential investors to "large institutional investors—such as hedge funds, private equity firms and investment banks."[2]

Distressed securities in the 1990s[edit]

In 1992 Edward Altman, a leading authority on bankruptcy theory, who had developed the Altman Z-score, Z-score formula for predicting bankruptcy in 1968,[3] estimated "the market value of the debt securities" of distressed firms as "approximately $20.5 billion ($42.6 billion in face value)."[4] By 1993 the investment community had become increasingly interested in the potential market for distressed firms' debt.[4] At that time distressed securities "yielded a minimum ten percent over comparable maturity U.S. Treasury bonds, i.e., 16.6% or above, are estimated to amount to $71 billion in par value (with several issuers and 600 issues) and about $37 billion in market value. Adding private debt with public registration rights, private bank debt and trade claims of defaulted and distressed companies brings the total book value of defaulted and distressed securities to $284 billion (market value, $177 billion)."[5][4]

Distressed securities investment strategy[edit]

Distressed securities investment strategy exploits the fact that only a few investors are able to enter into the "long low investment grade credit" by holding securities that are below investment grade."[1]

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.[2][6] Firms that specialize 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.[2] According to a 2006 report by Edward Altman, Professor of Finance at the Leonard N. Stern School of Business, in 2006 distressed debt investments earned well above average returns.[7] 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."[7] 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.[2] Distressed securities often carry ratings of CCC or below from agencies such as Standard & Poor's, Moody's and Fitch.[2]

Risk management[edit]

By 2006, the increased popularity in distressed debt hedge funds, led to an increase in the number of benchmark performance indexes.[7] 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.[8]

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.[2] By 2006, hedge funds has purchased more than 25% of the high-yield market’s supply to supplement their more traditional defaulted debt purchases.[7] By 2006, "new issues rated CCC to CCC- were at an all time high ($20.1 billion)."[9] 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.

Key players[edit]

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.[6] The finance, insurance, and banking corporation is one of Australia's largest banks (by combined lending and deposits) and its largest general insurance group.[10] In the summer of 2013 as European lenders were divesting their loans portfolios, in Australia, hedge funds and investment banks were buying them.[6] 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.[6]

According to The Guardian, the principal investment strategy used by Paul Singer (businessman)'s hedge fund Elliott Management Corporation, "is buying distressed debt cheaply and selling it at a profit or suing for full payment."[11] Singer founded his Elliott Associates L.P., in 1977,[12]. Elliott Management Corporation oversees Elliott Associates and Elliott International Limited, which together have more than $21 billion in assets under management.[13] Singer has been active in Debt Advisory International (DAI), DC Capital Management, Select Capital Limited and Emerging Market Select Asset Fund Limited, e-Century Capital Partners as founder and/or manager and is described by DAI as a "specialist in structuring debt related transactions in emerging market countries and in supervising debt recovery and work out operations on behalf of corporate and sovereign creditors."[14]

Distressed sovereign debt[edit]


One of the most well-known distressed debt deals was first brokered in 1999, when Romania sold $3.2 million of Zambian sovereign debt-which dated back to 1979- to U.S. financier Michael Sheehan. After pursuing Zambia through the courts for years for a payment of $55 million, the face value of the debt, Sheehan was awarded a settlement of $15 million dollars by Justice Smith in 2007. Sheehan became the best-known of a small group of distressed-debt investors.[Notes 1]


In July 2014 a U.S. federal judge has ruled in favor of NML Capital Ltd., a unit of Elliott Management, against Argentina. The country now owes its creditors more than $1.3-billion.[15] According to Mark Weidemaier, a law professor at the University of North Carolina argued this will be "the most significant litigation victory that a holdout creditor has ever achieved" in the realm of sovereign debt.[15]

See also[edit]


  1. ^ According to articles by journalists Moore and Seager and an article published in The Guardian, a shell company called Donegal International, incorporated and registered in the British Virgin Islands was specially-purposed by U.S. financier Michael Sheehan, to hold the Zambian debt. The deal between Romania and Sheehan was executed by Fisho Mwale, former mayor of Lusaka, Zambia, from 1993 to 1998. Simultaneously Romania was involved in the negotiations with Donegal and a Zambian finance ministry team. Zambia’s economist at that time, David Ndopu, described his optimism that the Zambian team's formalized proposal of a debt-relief deal with Romania whereby Zambia would only pay "12 cents on the dollar, or $3.5 million" would be a success.



Further reading[edit]

  • Altman, Edward I. (1991), Distressed Securities, Chicago: Probus Publishing 
  • Owsley, Henry F.; Kaufman, Peter S. (2005). Distressed Investment Banking: To the Abyss and Back. Beard Books. ISBN 1-587-98267-6. 
  • Moyer, Stephen G. (2004). Distressed Debt Analysis: Strategies for Speculative Investors. J. Ross Publishing. ISBN 1-932-15918-5. 
  • Whitman, =Martin J.; Diz, Fernando (2009). Distress Investing: Principles and Technique. John Wiley & Sons. ISBN 978-0-470-48865-2. 
  • Rosenberg, H. (1992), The Vulture Investor, New York: Wiley and Sons Inc. 

External links[edit]


WikiProject Finance  
WikiProject icon This article is within the scope of WikiProject Finance, a collaborative effort to improve the coverage of articles related to Finance on Wikipedia. If you would like to participate, please visit the project page, where you can join the discussion and see a list of open tasks.
 ???  This article has not yet received a rating on the project's quality scale.
 ???  This article has not yet received a rating on the project's importance scale.