The Distressed Municipal Universe

For most industry professionals, the distressed universe encompasses all credits that are either in various stages of default or heading toward default. Historically, this may also include so-called “fallen angels” that have experienced multiple notch downgrades, and those that are either trading “flat” (i.e., without accrued interest) or are trading on a dollar price basis only, regardless of yield. Generally speaking, unless an issue came to market at an unusually low coupon rate (say, between 0 and 4 percent), the fact that it is trading at a very low dollar price (less than 60 cents on the dollar) would seem to indicate a potential credit problem. This is why many distressed investors have set up database screens or filters to identify credits that are trading at (or at least evaluated at) an unusually low price. It is worth noting that “distressed” is not synonymous with “defaulted.” All defaulted bonds are considered distressed, but not all distressed bonds are necessarily in default.

Many defaulted issues are in fact secured by revenue-producing assets, ranging from hotels to parking facilities to toll roads. Others are secured by real estate or other collateral that can readily be foreclosed on. The potential for gaining control of real revenue-producing assets through the purchase of tax-exempt bonds is a key attraction of any distressed muni strategy. In order to fully realize the potential upside, a longer-term investment horizon is ...

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