Research Note on Distressed Debt
Distressed securities are securities of companies or government that are experiencing distress (either in financial or operational terms), default, or even bankruptcy. In case of debt, this is called distressed debt. Investing in distressed debt can result in big returns, but the downside is that when a company goes completely bankrupt, the value of your securities can go to zero.
Distressed debt sells at a very low percentage of par value, for example 30 cents on the dollar. This percentage indicates that you can buy debt that is worth 1$ at maturity for 30 cents, which seems very attractive but there is of course a reason that it is only worth 30 cents on the dollar. If the distressed company emerges as
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This limits the scope of potential investors to sophisticated individual investors, hedge funds, private equity firms, vulture funds, and certain investment banks. The majority of distressed debt is bought by these institutional investors because they have the resources, expertise, and sophisticated risk management systems to assess the risk of these debt securities.
There are various ways investors can invest in distressed debt. The easiest way is to buy the distressed debt in the bond market. Because most mutual funds are not allowed to invest in distressed debt, there is ample supply of debt available shortly after a firm defaults. The second way is to buy distressed debt directly from a mutual fund, since they have to sell according to their mandate. These transactions are generally limited to institutional investors since large quantities of debt, and therefore large quantities of cash, exchange hands. The third and final options is to buy directly into the distressed firm. This involves working directly with the company to extend its credit, either in the form of bonds or a revolving line of credit. Distressed companies usually need significant amounts of cash for a turnaround, so it is common for a consortium of investment banks and hedge funds to provide this cash to avoid overexposure to one
The company’s leverage ratio is 28% - 72% of its assets are financed by common equity and the company was profitable in the last reporting period. The company should easily raise additional funds from creditors and a convertible debenture will be an appealing venture for creditors who would want to purchase stocks of the company in the future.
Many companies in the United States are struggling to survive. These companies are experiencing significant decreases in revenue, reduced assets, and increases in liabilities. Companies that already filed, or are at-risk for filing bankruptcy are struggling with keeping up with their competitors, causing the companies to lose their value. When a company files for bankruptcy, the company no longer gets to make the business decisions. The bankruptcy courts begin to make the decisions for the companies in efforts to restore the businesses. If the company is unable to revive itself from bankruptcy status, the company goes out of business. If this occurs, the company must sell everything it owns in order to compensate its shareholders and repay
Then, in the 1990s, bonds were created consisting of subprime mortgages, which were higher risk mortgages with high interest rates, made to borrowers with lower credit levels. Essentially, banks were handing out mortgages like candy to consumers who were never going to be able to make the payments, but Wall Street kept buying and packaging the mortgages into bonds. Since these bonds were inherently riskier, one wonders why investors were still willing to buy. Investors, who look at ratings by agencies such as Moodys and Standard & Poors, had no reason to believe these bonds were risky investments. The agencies, whom were being paid by Wall Street, were assigning high ratings to these risky bonds.
The debt in the United States has been growing for decades and has accumulated all the way up to 19.9 trillion dollars. This amounts to 61,036 for each person living in the U.S, 157,735 for each household, 104 % of the U.S gross domestic product, and 546% of annual federal revenues. Tackling debt and deficits is a national security issue that affects our ability to compete in the international system. The proportion of U.S. government debt held by foreign entities has significantly increased.
The net of interest holds them fast, requiring them to sell their time and energies to meet the demands of creditors. They surrender their freedom, becoming slaves to their own extravagance.
There are many forms of bad debt, but I define bad debt as taking out a loan for a product which will not provide any return on investment and, instead will depreciate. Getting back to my above example, if you were to take out debt to buy a car, the investment you just
Thank you for coming to my office yesterday. Since we last met, I have researched your concern regarding whether your neighbors have taken title to your property through adverse possession. I reviewed the facts you gave me as well as the relevant law on the element of open and notorious possession. As we discussed yesterday, the Neros will most likely have title to the disputed property because they have established open and notorious possession of the land through various recreational activities like clearing the land for camping, building a treehouse and bird watching.
Definition: The Savings and Loans Crisis was the greatest bankcollapse since the Great Depression of 1929. By 1989, more than 1,000 of the nation's Savings and Loans (S&Ls) had failed. This effectively ended what had once been a secure source of home mortgages.
Furthermore, those banks who invested in collateral debt obligations, a lot of whom before 2007 (particularly investment banks) sold off senior CDOs but kept junior ones for profit (8). However, the values of these CDOS plummeted and as a result banks with large amount of junior CDOS were in a bad position therefore many investment banks were in
In 2008, one of the worst financial crises since the Great Depression occurred. The severity of this collapse cannot be understated as demonstrated by the bankruptcy of Lehman Brothers, the fourth largest investment bank in the US, and with many other financial institutions such as Merrill Lynch and the Royal Bank of Scotland having to be bailed out. In addition, the Global Banking System was within a whisker of collapsing and if it where not for the trillions of dollars invested in the system by national banks then this banking collapse would have lead to economic catastrophe. Therefore, in order to avoid such a calamity from occurring again, it is important to ask the question why did this financial recession occur and what factors contributed towards this downfall? Although there are many reasons as to why this recession occurred it could be argued that securitized lending and shadow banking played the largest role in this economic crisis. It is therefore important to understand what securitized lending and shadow banking means. Securitized lending is the process by which a financial institution such as a bank pools illiquid assets, such as residential and commercial mortgages and auto loans (by which the bank receives from the public through house mortgages and loans), and loans these newly formed short-term bonds to third party investors in exchange for cash or collateral. Since its creation in the 18th century, securitized lending was increasingly popular and very much
This can be done by selling loans. The sale could be with or without recourse and it may or may not lead to securitization.
However, the bailout plan as of today needs some modifications. Instead of only concentrating on buying bad assets from financial institutions and banks, it should pay more attention to homeowners. The assets that the government plans on buying are mostly impaired mortgages –related assets that have fallen because of the housing sector and knocked holes in firms’ balance sheets. Therefore, if focused on homeowners, this problem can be dealt with from the beginning. It will reinstate up to 80% of the $500 billion already written off by Wall Street as toxic loans. This way, the government will put in $500 billion and instantly get back the $500 billion. It will also refinance 100% of loans, thereby giving banks 100% of value on corresponding securities instead of the 30% to 50% if securities would be sold to the government. Furthermore, refinancing homeowners will stabilize the entire real estate market and create a 30% to 70% greater monetary return since taxpayers now own these mortgages.
Rating agencies also had a strong motivation to compete for market share by catering to their clients. In 2000, Moody’s became an independent, publicly owned firm after being released by its parent company, Dun & Bradstreet. This placed even more pressure on Moody’s managers to increase revenues and improve their shareholder’s returns. (Lawrence, p. 456) From this point on, we begin to see the credit rating agencies drastically underestimate the risks of mortgage-backed securities in a selfish attempt to further their own bottom lines. The birth of structured finance came from new techniques of quantitative analysis used by Wall Street investment banks, and suddenly, Moody’s was not just evaluating corporate, municipal, state and federal government bonds. Structured finance consisted of combining income-producing assets—everything from conventional corporate bonds to credit card debt, home mortgages, franchise payments, and auto loans—into pools and selling shares in the pool to investors. (Lawrence, p. 456)
Quickly these corporations became known as the Fallen Angels and they were looking to rebound in any way possible. Operating managers at the time believed the corporations would rebound fairly easily because corporations would have no choice but to put all their attention on controlling their debt. However, in a situation such as this, close precision and execution is required otherwise the smallest mistake can lead to failure. According to Warren Buffet, “a plan that requires dodging them all is a plan for disaster.” The accumulation of debt continued to rise and not even the healthiest of corporations could obtain the capital to finance it. Even though businesses continued to suffer from accumulating debt, Investment Bankers noted that researchers found over time “higher interest rates received from low grade bonds had more than compensated for their higher rate of default.” From this information, Investment Bankers saw this accumulation of debt as an opportunity for investors. They concluded it was beneficial to have a diversified portfolio of junk bonds because the returns would be higher than a portfolio of high grade bonds. However Warren Buffet disagrees and discovered a hole in this fundamental approach by the Investment Bankers.
Financial distress is defined as a low cash flow state of a firm in which it incurs losses without being insolvent or 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. Financial distress is different from insolvency. Financially distressed companies have lower profitability, higher leverage, lower past excess returns and larger size compared to active companies.