In distressed dept markers, “recovery notes” have emerged as a specialized tool for monetizing and managing non-performing loans and bonds. While not a formal legal term, this marketing moniker refers to a type of debt security whose value is intrinsically tied to the successful recovery of an underlying, defaulted asset. Essentially, recovery notes are financial instruments created to unlock value from what would otherwise be considered bad debt, offering a way for original creditors to offload risk and for specialized investors to capitalize on potential future recoveries.
The utility of these notes lies in their ability to streamline the recovery process. For a bank or a lender holding a portfolio of defaulted loans, recovery notes provide a mechanism to clean up their balance sheet without the often lengthy and resource-intensive process of pursuing individual recoveries. By transferring these assets to a separate legal entity, known as a Special Purpose Vehicle (SPV), the originating institution can remove the non-performing assets from its books.
For investors, these notes represent a high-risk, high-reward opportunity. They are speculative by nature, as their return is dependent on the ability to successfully collect on the underlying debt, but they can offer significant upside if the recovery effort is successful. The structuring of these notes is crucial and typically falls into two distinct varieties, each with its own purpose and risk profile.
Two Structuring Varieties
The first and more straightforward type involves a direct asset transfer with no new capital being raised. In this model, the defaulted debt or bonds are transferred to an SPV in exchange for the issuance of the recovery notes. No cash is paid in the initial issue—the notes are distributed to the original debt holders in a non-cash transaction.
To initiate the recovery process, an outside contractor is engaged. This contractor’s compensation model is critical: they are either paid from a separate, external funding source or, more commonly, receive their compensation solely upon successful recovery out of the recovered proceeds. This structure aligns the interests of the contractor with the noteholders, as the contractor is only paid if they successfully recover the debt.
The second variety is more complex and involves an element of fundraising. In this scenario, the defaulted debt is transferred to the SPV at a pre-determined, speculative value in exchange for the recovery notes. Crucially, as part of the same issuance, money is raised from investors to fund the recovery effort. This capital is used to pay for legal fees, asset tracing, or the contractor’s upfront costs, providing the resources needed to pursue what might be a difficult or expensive recovery process.
These issues are considered trickier because they require a delicate balance. The speculative value of the underlying debt must be attractive enough to entice investors to buy the notes, while the funds raised must be sufficient to cover the recovery costs without eroding the potential returns. This structure introduces a higher degree of risk, as investors are not only betting on the ultimate recovery of the debt but also on the effectiveness of the funded recovery effort itself.
Recovery notes represent a clever financial engineering solution to a persistent problem in finance: how to deal with bad debt. By packaging non-performing assets into a tradeable security, they create a market for distressed claims, providing a mechanism for creditors to clean up their balance sheets and for specialized investors to take on calculated risks for potentially high rewards.
Tiner Wernow (formerly John Tiner & Partners) designs and creates securities and other financial instruments that help clients raise capital, sell managed trading strategies, and securitize various assets.
We offer a complete, full-cycle service, from developing the initial structuring concept to its full implementation, which includes acquiring an International Securities Identification Number (ISIN), handling issuance, global clearing, exchange listings, and placement routes. We can transform any asset or investment idea into an easily tradable and globally cleared security.
Our global services platform, 208Markets, provides issuance, brokerage, and SPV maintenance services across multiple jurisdictions.
Additionally, we’ve created educational materials under the “Tiner Educational Hub” to help professionals understand the securitization tools available to achieve their business objectives more efficiently.
