distressed securities

 

  • Adding private debt with public registration rights allows private bank debt and trade claims of defaulted and distressed companies to bring the total book value of defaulted
    and distressed securities to $284 billion, a market value of $177 billion.

  • [Notes 1][19][20][21] According to the African Development Bank Group, at least twenty heavily indebted poor countries in Africa have been threatened with or subjected to
    legal actions by commercial creditors and hedge funds since 1999.

  • [10] The business plan involved buying the sovereign debt instruments at a deep discount based on a very high risk, and then attempting to enforce the full claim.

  • Typically, the investors in distressed securities must make an assessment not only of the issuer’s ability to improve its operations, but also whether or not the restructuring
    process (which frequently requires court supervision) will benefit one class of securities more than another.

  • Investors may also invest new capital into a distressed company in the form of debt or equity.

  • [1] Some investors have deliberately used distressed debt as an alternative investment, where they buy the debt at a deep discount and aim to realize a high return if the
    company or country does not go bankrupt or experience defaults.

  • [15] 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.

  • Sovereign debt In 2003, Seveq observed that the emergence of the secondary debt market led to a “modern sovereign debt litigation” and the creation of an industry of “professional
    suers of foreign states”.

  • The Jubilee Debt Coalition’s Tim Jones traveled to Jersey in November 2011 to ask the government to ban hedge funds involved in sovereign debt.

  • [4] History The market developed for distressed securities as the number of large public companies in financial distress increased in the 1980s and early 1990s.

  • The international market, especially in Europe, has become more active in recent years as the amount of leveraged lending has 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.[when?]

  • [14] These institutions used “very strong and varied strategies including the traditional passive buy-and-hold and arbitrage plays, direct lending to distressed companies,
    active-control elements, foreign investing, emerging equity purchases and equity plays during the reorganization of a firm in bankruptcy”.

  • [10][11][12][13] 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.

  • “[8][7] Investment strategy The distressed securities investment strategy exploits the fact many investors are unable to hold securities that are below investment grade.

  • NML Capital’s main argument is that the “pari passu”—Latin for “on equal footing”—clause in the original contract requires Argentina to pay back all of its creditors, including
    those who did not agree to restructure, if it paid back one creditor.

  • He claimed that while these distressed debt investment funds can choose to “play the game” and “put their head in the mouth of the Leviathan”, the U.S. courts should not choose
    to.

  • [14] Highly specialized risk analysts and experts in credit are key to the success of alternative investments such as distressed debt investment.

  • [5] In 1992, professor Edward Altman, who developed the Altman Z-score formula for predicting bankruptcy in 1968, estimated “the market value of the debt securities” of distressed
    firms as “is approximately $20.5 billion, a $42.6 billion in face value”.

  • Purchasing or holding such distressed-debt creates significant risk due to the possibility that bankruptcy may render such securities worthless (zero recovery).

  • [2] According to a 2006 report by Edward Altman, a professor of finance at the NYU Stern School of Business, distressed debt investments earned well above average returns
    in 2006 and there were more than 170 institutional distressed debt investors.

  • Before the hedge funds could collect their money, the Debt Relief (Developing Countries) Act 2010[23] was passed in the UK parliament in 2010 after Liberian president and
    2011 Nobel Peace Prize winner Ellen Johnson Sirleaf appeared on the BBC Newsnight program for the hedge funds to “have a conscience and give this country a break”.

  • [6][7] By 1993 the investment community had become increasingly interested in the potential market for distressed firms’ debt.

  • FG sued in Hong Kong, Australia, and Jersey, which was not covered by the UK law against hedge funds involved in sovereign debt.

  • [29] NML Capital rejected the proposal and sued Argentina for the full amount in New York State courts.

  • Gravitas uses IBM Risk Analytics technology (formerly Algorithmics), which is also used by major banks, to help hedge funds meet regulatory requirements and optimize investment
    decisions.

  • Nick Dearden of the Jubilee Debt Campaign said of the change, “It will mean the poorest countries in the world can no longer be attacked by these reprehensible investment
    funds who grow fat from the misery of others”.

  • [2] The deliberate investment in distressed securities as a strategy while potentially lucrative has a significant level of risk as the securities may become worthless.

  • The major buyers of distressed securities are typically large institutional investors, who have access to sophisticated risk management resources such as hedge funds, private
    equity firms and units of investment banks.

  • [1] As far as debt securities, this is called distressed debt.

  • [18] There have been “sporadic calls for a bankruptcy analogue for sovereign states” similar to the bankruptcy process for private debtors, however these calls have lacked
    momentum.

  • [2] In 2012, Edward Altman, a professor emeritus at the NYU Stern School of Business, and an expert on bankruptcy theory, estimated that there were “more than 200 financial
    institutions investing between $350–400 billion in the distressed debt market in the United States”.

 

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Photo credit: https://www.flickr.com/photos/thebosque/6606749757/’]