Everything you need to know about distressed Securities?

What are 'Distressed Securities’?

When a company is going through or close to bankruptcy it issues financial instruments that are called Distressed securities. Since the concerned company has failed in meeting its financial obligations, the distressed securities are low in value, but they offer investors high potential returns because of how risky they are. Growth capital in India or any other developing country is an alternate option to improve the situation of your firm. But that must be sought for at a suitable period. Distressed securities may consist of common and preferred shares, bank debt, trade claims and corporate bonds. 

BREAKING DOWN 'Distressed Securities'

Distressed securities generate interest of investors who are on the lookout for a bargain and thus are open to risks. In a few cases these investors anticipate their investments to increase in value since they believe that the company's situation is not as bad as it look.During other scenarios, investors may predict the company going into bankruptcy, but they feel confident that there might be enough money upon liquidation to cover the securities they have purchased.

What happens to Distressed Securities in bankruptcy cases?

Unfortunately, in many cases, the companies that issue distressed securities end up filing for Chapter 11 or 7 bankruptcy, and as a result, individuals interested in investing in these securities need to consider what happens in the case of bankruptcy. In most bankruptcies, equity, such as common shares, is rendered worthless, making investing in distressed stocks extremely risky. However, senior debt instruments, such as bank debt, trade claims and bonds, may yield some payout.

When chapter 7 bankruptcy is filed by a company, it halts its operations and goes into liquidation, at which point its funds are dispensed to its creditors, including bondholders.Real estate in India went through such a phase during the global markets meltdown a few years ago.

Whereas, under chapter 11 bankruptcy, a business restructures and continues operations. If reorganisation is successful, its distressed securities, including both stocks and bonds, may yield surprising amounts of profits.

When are Securities considered Distressed?

When the company in question fails to meet multiple financial obligations it declares its securities as distressed. In most cases, these securities carry a CCC or below credit rating from debt-rating agencies, such as Standard and Poor's or Moody's Investor Services. Distressed securities contrast with junk bonds, which traditionally have a credit rating of BBB or lower.