The definition of distressed securities is very broad, encompassing all kinds of instruments below investment grade debt, with CCC ratings or lower, yields to maturity (YTMs) greater than 1,000 basis points over U.S. Treasuries or prices below 80 cents to the dollar. Examples of distressed securities include:
- Trade claims and receivables
- Common stock, preferred stock, PIPEs, rights and warrants
- High yield bonds, corporate and municipal bonds
- Below par bank loans, debtor-in-possession loans, bridge and mezzanine loans
Nevertheless, the distressed universe is highly concentrated in debt securities of companies in the midst of, or on the road toward, restructuring, liquidation, bankruptcy (Chapter 7 or Chapter 11) or other extraordinary situations.
Distressed Market Participants
Money managers specializing in distressed and defaulted company securities focus primarily on bank debt, trade claims and bonds. Their portfolios tend to perform best during bull markets, realizing profits on investments made during previous economic downturns. The target annual returns of these investors rests in the 20-25 percent range, though, on average, overall annual returns lie in the 12 percent range.
Experienced distressed investors typically use bottom-up strategies in their portfolio assessments. Therefore, their returns not only depend on the status of the overall credit market cycle, but on company-specific factors, sector-specific factors or both. Effective investment strategies are grounded in scrupulous research of all critical variables specific to the distressed company.
The skill set of experienced distressed investors is highly specialized. Often from a legal background, they have prior exposure to the bankruptcy processes and are equipped with:
- Restructuring expertise
- Strong negotiating skills
- Extensive networks in the field
- Asset valuation skills
These attributes enable these investors to closely examine the creditors involved in reorganization, and to assess claim complexities and case duration. In addition, they are able to analyze asset distributions and determine if expected returns are worth the wait. In fact, some investors go as far as buying up the reorganizing company’s debt or trade claims in order to attain seats on creditors’ committees, so they can actively control distribution processes and maximize the profitability of their investments. To do so, some vulture investors seek bargain basement prices for such distressed securities and capitalize on uninformed creditors who may react emotionally in anticipation of, or in light of, bankruptcy, overlooking a company’s true worth.
Distressed securities markets are highly inefficient and such securities often sell at deep discounts (or premiums, e.g., if committee seats are sought).
How Pluris Can Help
Fair value estimation of distressed securities requires a highly specialized skill set, in addition to time and resources that ordinary investors and creditors do not have. Pluris can help. Pluris’ experienced team provides a wide range of valuation services for securities, claims and interests in distressed and defaulted companies. Click here for more information about our services or email your questions to email@example.com.