Distressed securities are securities of companies or government entities that are either already in default, under bankruptcy protection, or in distress and heading toward such a condition. 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. In recent years, private investment partnerships such as hedge funds have been the largest buyers of distressed securities. Other buyers include brokerage firms, mutual funds, private equity firms, and specialized debt funds (such as collateralized loan obligations) are also active buyers. 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. The US has the most developed market for distressed securities. Other international markets (especially in Europe) have become more active in recent years as the amount of leveraged lending 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. Investors in distressed securities typically must make an assessment not only of the issuer’s ability to improve its operations but also whether the restructuring process (which frequently requires court supervision) might benefit one class of securities more than another.

During the recent crisis, we saw many Indian real estate companies trading at historic lows on account of being highly leveraged and having lack of cash flows to support such leverage. These companies then saw many rounds of equity infusion through QIP route and restructured/ refinanced or repaid their debt. This, however, presented an opportunity for investors to invest in such companies at fairly low levels and see the prices appreciate as these companies improved their cash flows and mended their debt levels. Investing in distressed companies involves a fair amount of judgement about the future path of the company, availability of sustained financing, improved business conditions and residual value of assets, etc.