What Is Distressed Debt Investing?

Based on the standardized credit rating system, distressed debt is categorized as being below investment grade. The term “vulture funds” is affiliated with distressed investors, which can be attributed to the opportunistic strategy utilized by the majority of distressed funds. In most cases, distressed debt can be purchased at a steep discount in relation to what it’s worth because the owner of the debt is in a dire financial situation and in imminent risk of defaulting on debt payments. It must either quickly find the funds to pay off the debts or unload some of them before defaulting, even if this means taking a significant loss.

To further complicate the process, investors are typically unaware if other distressed debt investors are trying to gain a controlling share of the company’s debt. Because of our record for resolving clients’ problems efficiently and successfully, we have attracted a strong client base of industry leaders, public and private companies, officers and directors, private equity firms and hedge funds, investment… We can assist in determining whether an out-of-court restructuring is viable by thoroughly analyzing the capital structure and existing creditor, intercreditor, and inter-lender relationships. Distressed debt and credit is a rapidly growing sector of the private equity and hedge fund universe, having grown exponentially in the wake of the coronavirus pandemic to a $1 Trillion1 market in the U.S. alone. The sector is focused on investment opportunities that involve any credit instrument that is trading at a significant discount with a greater than average spread for its industry. The field of alternative investments, which comprises any investments besides stocks, bonds, and cash, has grown in both size and accessibility in recent years. Some companies offer mutual funds that invest in distressed debt, or they include distressed debt as part of a portfolio.

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By collaborating across offices and practices, we offer a seamless network of legal professionals, working together to formulate comprehensive responses to client needs. From explanatory memoranda to pinpointed analysis, we provide our clients and friends with practical guidance in a variety of formats to help them to understand complex issues and make informed decisions about their businesses. From commenting on pressing legal and policy issues to explaining the implications of big deals, important court decisions and regulatory changes for leading news outlets and legal publications, our attorneys are sought out for their views and perspectives. If you’re new to debt investing, understanding each type is important, as they require different skills, knowledge, and strategies. The first will be in pricing because advance rates had vaulted quite high in favorite asset classes — leverage shot high while pricing dropped low.

But contrary to a common misconception, distressed debt does not necessarily mean that the underlying company is in financial distress or is post-petition. With interest rates sitting at historic lows, investors of all types have had to go further out on the risk spectrum in search for yield. This is evidenced by the expansion of the total pool of US high-yield corporate bonds, an asset class which has nearly doubled in size between 2007 and 2018. As high-yield corporate bonds are the types of bonds with the highest likelihood of defaulting, the increased size of this market has naturally also resulted in the increased market size of distressed assets. At its simplest, Distressed Debt Trading involves purchasing debt obligations which are trading at a distressed level in anticipation of reselling those securities over a relatively short period of time at a higher valuation, generating a trading profit.

Investment Management

Uncertainties surrounding the financial markets can also cause a “liquidity crunch”, which is when the cash in circulation is in short supply while demand is disproportionately higher. The unexpected tightening of the credit markets, which worsens the corporate liquidity crisis, is often the “event” that sets an economic downturn in motion. Over time, more specialty lenders have emerged, such as subsidiaries of investment banks, business development companies (“BDCs”), and direct lenders. Even if the price paid was at a significant discount, the return will be far below equity returns in a successful turnaround because the upside of equity, in theory, is unlimited. The senior secured debt is unlikely to be underpriced and has less leverage in negotiating the POR because they are most likely going to be repaid in full in either cash, new debt, or a mixture of both. The longer the anticipated investment holding horizon, the more the fund’s returns are contingent upon the actual turnaround of the debtor. The further down the capital structure one goes, the fewer investors there are with the risk appetite to invest and the higher the likelihood of finding mispricing.

Should the company be liquidated, distressed debt firms may recover the entire amount invested because they are entitled to be repaid before equity holders. However, financial distress is also a precursor to corporate restructuring. In the event that the corporate restructuring is successful and the company is saved from bankruptcy and/or liquidation, then the debt security is likely to be repaid in full. Success in distressed situations requires a clear-eyed focus and measured judgment, qualities shared by a collaborative team of Cadwalader attorneys who take a creative yet pragmatic approach to solving issues facing lenders and distressed borrowers.

Causes Of Underperformance By Distressed Funds

The chief of Bosnia’s financial police said, “Of course it was illegal”, referring to Energoinvest’s sale of assets to FG Hemisphere, noting that the man who brokered the sale, former Bosnian Prime Minister Nedzad Brankovic, “should go to jail”. We regularly advise on M&A deals worth more than a billion dollars, and we have experience working with some of the most talented foreign law firms in the world on cross-border deals. Federal courts should “turn to state law to resolve” a “fight over a tax refund,” held a unanimous U.S. Schulte Roth & Zabel, a leading law firm serving the financial services industry, has announced the addition of Douglas S. Mintz as a partner and co-chair of the Business Reorganization Group. The Third Circuit recently held, in a case from the Energy Future Holdings bankruptcy, that a losing stalking horse bidder can provide sufficient value to the debtor’s estate to receive an administrative claim for a break-up fee and expenses….

For now, distressed investors are hopeful government economic support programs will wear off soon, pushing companies to begin scrambling for financing to pay off outstanding debt with near-term maturities. For that reason, it can be in the best interest of the investor to buy the company’s debt piece by piece over an extended period from other investors to avoid alerting the owners that they’re trying to gain a controlling share of debt. Due to this secrecy, research and due diligence is limited to public information only; for instance, the company’s public financial records.

What Is Distressed Debt Investing?

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 and 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, which combines risk management software with sophisticated risk analysis using advanced analytics and modeling. They produce customized scenarios that assess the risk impact of market events. Gravitas uses IBM Risk Analytics technology , which is also used by major banks, to help hedge funds meet regulatory requirements and optimize investment decisions.

Given the magnitude of their controlling stake, active-control investors often receive a seat on the board of directors and are prioritized during negotiations regarding the plan of reorganization . Consistent performance in distressed investing requires not only being able to identify market mispricings, but also being able to recognize when the market price is valid. But note, the potential for a turnaround and value creation is the reason to consider investing, rather than means to justify paying a premium.

Private Funds Market Trends Report

These investors however are constrained by “the sovereign-immunity rules that national legislatures have enacted and national courts have elaborated” to protect the vulnerable nation states from litigation. Investors who engage in distressed debt investing, such as larger hedge funds, perform robust risk analyses using modeling and test scenarios. These funds are often skilled at spreading out risk through diversified investments or partnering with other firms. When investing in a company’s debt, you have choices to make based on the company’s capital structure and your goals.

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• Once the potential of default is announced in the market, mass-selling could ensue shortly, causing prices to decline.
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• For investment firms, distressed debt investment strategies can be appealing by adding elements of counter-cyclicality to their portfolio.
• Cadwalader partner Mark Howe and Phil Balzafiore, Head of Tax for Tetragon Financial Group, discuss the tax aspects of litigation finance.

Schulte Roth & Zabel’s Distressed Investing Group meets the complex needs of investment funds and other creditors in every phase of distressed investing. This interdisciplinary approach allows us to give comprehensive representation and advice to investors in all manner of distressed situations. The combination of our superior knowledge of the investment management industry and our experience developing and implementing the structures and products that a distressed investor analyzes results in substantial synergies and gives us an insider’s edge. 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.

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Chapman’s debt‑trading team possesses extensive experience in representing investors in the purchase and sale of par and distressed loans, portfolios of loans, and other financial instruments, including various forms of claims. We also advise on strategic acquisitions of such loans and claims in connection with attempting to execute a specific outcome in a bankruptcy proceeding.

• Represented the purchaser of senior secured loans and executed strict foreclosure resulting in the client owning a portfolio company.
• This compensation may impact how, where and in what order products appear.
• Instead, the U.S. government and Federal Reserve flooded the market with liquidity, from government assistance programs to buying financial assets.
• Ability to assess and ascertain the reason behind the issuer’s distress and advise about downside risks and upside potential of investments accordingly.
• Second, to get that market-rate return, the loans are overleveraged — the lender turns to a bank, collateralized loan obligations or repurchase agreements, basically borrowing against those assets to bring down the cost of capital.

Someone who is risk averse has the characteristic or trait of preferring avoiding loss over making a gain. This characteristic is usually attached to investors or market participants who prefer investments with lower returns and relatively known risks over investments with potentially higher returns but also with higher uncertainty and more risk. The securities of an entity are classified as distressed when the issuer cannot meet a large number of its financial obligations. Unlike junk bonds, which have a credit rating of BBB , distressed securities have a credit rating of CCC or lower. Investors can walk away with payments even if a company goes bankrupt in many cases.

Many organizations buy distressed debt because they are confident that the company won’t be able to turn around its situation, meaning the buyer eventually will gain control of a company that no longer owes any debt. “Distress investing is an intricate game of strategy where investors try to anticipate and indirectly influence the company’s financial decisions,” she says in the course. By definition, most debt funds toward the end of the previous cycle drifted to the aggressive side of the lending spectrum, doing mezzanine, or lending on hospitality or other riskier product types. “Those debt funds are getting hit really hard,” notes Ryan Krauch, principal at Mesa West Capital. Represented bank in sale of senior secured loans related to farming and other agricultural‑related businesses. Represented the purchaser of senior secured loans and executed strict foreclosure resulting in the client owning a portfolio company. We represent clients seeking to acquire portfolio companies by acquiring a controlling position in the fulcrum security to exercise secured creditor remedies under the Uniform Commercial Code.

For instance, an example in Alternative Investments presents a company with a capital structure made up of term loans and bonds. Term loans are contractually senior to bonds, meaning they’re to be paid out first in the case of bankruptcy. According to United States bankruptcy law, however, two-thirds of bondholders must agree to give loan holders equity. If you’re able to secure two-thirds of the company’s bonds, you can control the restructuring vote and gain equity, but you may not be paid out first.

Diligence For Potential Distressed Debt Investments

In 2009, a British court awarded $20 million to hedge funds suing Liberia. In 1999, the US firm Donegal International purchased $40 million of Zambian debt owed to Romania for the “discounted purchase price” of $3.2 million. In 2007, a British high court granted the company “permission to enforce a claim for tens of millions of dollars against the Government of Zambia”. That counsel is bolstered with knowledge from every practice area of our firm — from tax and M&A to intellectual property, employment law and litigation — so your fund is covered from every angle. Specialty financing alleviates short-term liquidity shortages, preventing fundamentally sound companies from having to file for bankruptcy protection. Loan-to-own and distressed-to-control are frequently used interchangeably. But one minor distinction to be aware of is that loan-to-own can be used to refer to providing new debt to a company near distress and not purchasing the existing debt of a distressed company.

Excel Shortcuts PC Mac List of Excel Shortcuts Excel shortcuts – It may seem slower at first if you’re used to the mouse, but it’s worth the investment to take the time and… Liquidation value is an estimation of the final value which will be received by the holder of financial instruments when an asset is sold or liquidated. Liquidity and flexibility to exploit investment opportunities as they arise.