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. Investors may also invest new capital into a distressed company in the form of debt or equity.
The US has the most developed market for distressed securities. The international market (especially in Europe) has 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.
SFAS No. 115: new accounting rules for investments in debt and equity securities. (Statement of Financial Accounting Standards)
Feb 01, 1994; Financial instruments are risky investments.(1) Examples of financial instruments include securitized and unsecuritized loans,...