Distressed Securities - Explained
What is Distressed Securities?
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Table of ContentsWhat is Distressed Securities?What is a Distressed Security?What Happens to Distressed Securities in Bankruptcy Cases?When Are Securities Considered Distressed?
What is Distressed Securities?
Distressed securities are securities or financial instruments of a company that is under intense price or financial pressure because the company is undergoing bankruptcy. Distressed securities are also securities under operational distress or default and are unable to meet the purpose for which they were issued. These securities are peculiar to companies undergoing financial hardships or distress. When an issuing company is unable to meet its obligations and is at the risk of bankruptcy, it has distressed securities.
What is a Distressed Security?
Distressed securities experience a reduction in their intrinsic value and are traded at substantial discounts. These securities are often regarded as those below the investment grade and have a significant amount of risks. Examples of securities that can be distressed include common and preferred shares, corporate bonds, bank debt, trade claims, and others. Despite the dark sides of distressed securities, they are sometimes juicy and attractive to investors because have the potential for high returns. Investors who are willing to accept the risks of distressed securities purchase them. Issuing companies make distressed securities not look as bad as people think. Investors who purchase these securities expect a significant return.
What Happens to Distressed Securities in Bankruptcy Cases?
Usually, distressed securities are issued by companies going into bankruptcy or under intense financial pressure. In most cases, such companies eventually file for Chapter 7 or Chapter 11 of the bankruptcy code. Investors are generally advised to consider investing in such securities given that they become worthless due to bankruptcy. Investing in distressed securities entails a high level of risk and investors are warned against such. In some, cases, investors purchase distressed securities despite knowing that a company is going into bankruptcy. This is when the foresee that once the company is liquidated, there will be enough money to settle all the securities held by investors.
When Are Securities Considered Distressed?
Generally, securities such as corporate bonds, common and preferred shares, bank debt, and trade claims are Distressed when the company issuing them is under intense financial pressure and is unable to meet its obligations. Distressed securities are common with companies that are going into bankruptcy or insolvent. A typical distressed security has a below credit rating or CCC assigned to it by rating agencies. This is due to the fact that these securities have high risks and have suffered a significant reduction in their intrinsic value.