Corporate Financial Distress, Restructuring, and Bankruptcy, 4th Edition

CHAPTER 15Investing in Distressed Firm Securities

In the prior chapter, we began our discussion of distressed debt securities by observing its anatomy from its inception; its genesis, growth, investment strategies and some initial exploration of its valuation attributes. We now proceed to examining the detailed aspects of investing in distressed and defaulted debt securities of firms, which are either close to or already in bankruptcy, and in some cases, the equity of the firms that succeed in emerging from the bankruptcy‐reorganization process. In order to rigorously assess whether a class of securities can legitimately be labeled as an “asset class,” we need a relatively long history of returns to investors. In this case, we now have a 30‐year history, from the late 1980s through 2017, to assess the return/risk tradeoff and compare it to other asset classes.

Our concentration will primarily be on the bonds and loans of firms either in “distressed” state, namely where the option‐adjusted‐spread over comparable duration in U.S. government bonds is at least 1,000 basis points (bp), or the securities are traded during the bankruptcy‐reorganization Chapter 11 process. And, in some cases, we assess the returns to debt investors after their securities are exchanged to the equity of the emerged firm. Of particular interest will be performance data of bonds by their seniority. In most cases, we will compare these returns with time‐dependent returns of two other asset classes – the ...