Investors and institutions are constantly seeking innovative ways to unlock value from unconventional sources. One such instrument gaining traction is the recovery note, a marketing term for a type of debt security backed by non-performing loans or defaulted bonds. These notes provide a structured approach to managing and monetizing distressed assets that would otherwise sit idle on a balance sheet.
How Recovery Notes Work
Recovery notes are essentially a form of securitization, whereby illiquid assets are pooled and repackaged into tradable securities. The core of this structure involves a Special Purpose Vehicle (SPV), a separate legal entity created to hold the defaulted assets. The original holder of the distressed debt, often a bank or hedge fund, transfers these loans or bonds to the SPV. In return, the SPV issues the recovery notes, which are then sold to investors. The proceeds from the notes are used to fund a recovery effort. The value of the notes is directly tied to the success of the recovery process, as investors are paid from the cash flows generated by collecting on the defaulted debt.
The utility of these instruments lies in their ability to provide a solution for both the original creditor and the investor. For the original creditor, recovery notes offer a way to remove non-performing assets from their books, freeing up capital and improving financial ratios without the complexities of a traditional debt sale. For investors, they present an opportunity to achieve potentially high returns by acquiring a claim on defaulted debt at a significant discount. The risk, however, is that the recovery effort may be unsuccessful, leading to a loss of principal.
Two Structuring Varieties
Recovery notes can be structured in two primary ways, each with a distinct approach to funding the recovery effort:
- “No Money” Structure: In this model, the defaulted debt is transferred to the SPV in exchange for the issuance of recovery notes. No money is paid in this issue. The original creditor receives the notes and may either hold them or sell them in the secondary market. The recovery effort is funded by an outside source or through a success-based arrangement where the recovery contractor is paid solely from the recovered proceeds. This structure is simpler and avoids the need to raise capital upfront, but it requires a dedicated funding source for the recovery or a contractor willing to work on a contingency basis.
- “Money Raised” Structure: This variety is more complex and involves a simultaneous transfer of defaulted debt and a capital raise. The defaulted debt is transferred to the SPV at a speculative value, and money is raised by issuing the notes to investors. The proceeds from the issue are then used to fund the recovery effort, including legal fees, collection agency costs, and other operational expenses. This structure is particularly useful when the recovery requires significant upfront investment. However, it is trickier to execute as it involves pricing a speculative asset and raising capital simultaneously.
Recovery notes represent a sophisticated financial tool for managing and monetizing distressed assets. By creating a transparent and tradable security backed by defaulted debt, they facilitate the flow of capital to a niche but often lucrative area of finance. As a specialized instrument, they require careful due diligence and a deep understanding of the underlying assets and recovery strategies.
Tiner Wernow (formerly John Tiner & Partners) designs and creates securities and other financial instruments that help our clients raise capital, sell managed trading strategies, and securitize a wide range of assets.
We offer a full-cycle service, guiding you from the initial structuring concept through complete implementation. This includes obtaining an ISIN (International Securities Identification Number), issuance, global clearing, exchange listings, and placement routes. Our goal is to transform any asset or investment idea into a globally cleared, easily tradable security.
Our global services platform, 208Markets (208markets.com), provides issuance, brokerage, and SPV maintenance services across multiple jurisdictions.
Educational materials appearing on the internet under the “Tiner Educational Hub” aim to help professionals become more aware of the securitization tools available to achieve their business goals efficiently.