Bill Chepell | Chicago, Illinois

Corporate Bonds – Understanding Distressed Debt

Per the “Corporate Bond Market – Understanding How It Works” post, the bond market can be confusing given the large number of debt issues and the market’s limited transparency.  However, for monitoring struggling companies financed with debt securities, the distressed bond market offers insight onto the capital market’s current view of a company’s credit-worthiness.  Note the following:

  • Distressed debt refers to companies in distress due to over-leveraged financials, inadequate cash flow and deteriorating credit ratings. These companies will eventually need an asset restructuring (e.g. selling assets) or financial restructuring (e.g. private workout with the firm’s creditors and equity investors or a bankruptcy filing).
  • The typical distressed company has considerably less bond issues than GE (from the “Corporate Bond Market – Understanding How It Works” post, GE had nearly 900 bond issues at one point). The number of debt issues varies greatly dependent on the size of a company.  Most distressed companies are not a large conglomerate such as GE, therefore the number of debt issues is limited to say roughly 3 – 12 debt issues.
  • The liquidity of many issues could be thin. While some issues are traded fairly frequently, others trade once per each week or even months.  Similar to a real estate property which needs just the right buyer, the issue can be fairly illiquid.  Of course, the price of these issues needs to be scrutinized.
  • Distressed market participants are often asset managers specialized in this area.  They take advantage of a difficult situation as distressed securities have a history of being highly inefficient in which securities are sold at very steep discount. Some investors go as far as buying up a reorganizing company’s debt or trade claim in order to attain seats on creditor committees.  This allows for input in bankruptcy proceedings.

Companies that hire advisors, defer an interest payment, and begin negotiating rarely survive in their current form.