Distressed DebtBy Charles M. Fernandez

Distressed Debt

Buying distressed debt involves purchase of an asset that is priced much below its fair value due to enormous debt holdings or that is on the verge of bankruptcy. Examples of such assets include companies that have filed for bankruptcy, government debt, or risky bonds. As an investment vehicle for mutual funds, distressed debt is risky. Funds that are more conservatively inclined, such as Fairholme fund, typically eschew such debt. 

Distressed Debt

Purchase of distressed debt involves a mix of research and business acumen. For starters, the buyer must perform extensive research. This consists of identifying candidates for distressed debt investment and dissecting their financials and portfolio to discover profitable assets. For example, the company may own prime real estate in a well-known neighborhood that, if sold, could reap money to invest in company operations. Similarly, the company may hold several patents that might be useful in leveraging a strategic advantage in its industry. During the research phase, the investor’s job is to uncover such non-monetary assets and assign a tangible monetary value to them, in consultation with lawyers and other experts. 

Distressed Debt

Purchase negotiations follow the research phase. During this stage, the buyer needs to come up with a hard dollar value for price-bargaining. Assigning a value figure to a company's assets helps creditors get a sense of the company's worth. In addition, having an assigned value also helps drive further gains when you sell the debt for a profit. 

About the author

Charles M. Fernandez is a finance professional with several years of experience in distressed debt purchase and negotiations. He was previously employed with Miami-based Fairholme Fund.