Distressed Debt Deep Dive: A Contrarian Approach

In the unexpected environment of 2025, strong economic growth paradoxically drives corporate distress. This deep dive explores how investors can capitalize on opportunities created by elevated rates, looming maturities, and sophisticated restructuring tools.

A New Paradox in Distressed Debt

For decades, a healthy economy meant fewer defaults. Yet in 2025, positive sentiment around government policy and robust consumer spending have kept interest rates high, pushing many leveraged firms toward restructuring. The result is a curious phenomenon where growth coexists with rising distress—a ripe setting for contrarian investors.

Understanding this paradox begins with recognizing that companies loaded with floating-rate debt face mounting interest expenses. When rates move higher, cash flow strains intensify, setting the stage for balance sheet challenges.

Market Overview & Economic Context

The US economy remains resilient, with unemployment near multi-year lows and GDP growth exceeding expectations. Yet tariffs and trade uncertainty persist, straining sectors reliant on global supply chains. Consumer confidence is strong, but rising costs and tighter financing create stress points.

Internationally, Europe grapples with high energy prices and tepid growth. Over €500 billion in non-performing loans still pressure regional banks, while private credit fills financing gaps. Against this backdrop, distressed opportunities arise across geographies.

Default Rate Projections & Credit Metrics

Analyst forecasts remain modest relative to historical averages, but the uphill climb is real. Projections for 2025-2026 include:

Mid-year data reveals defaults rising quarter-over-quarter, with $27 billion in Q2 2025—a significant uptick. Yet distressed inventories remain below peaks, offering selective entry points.

Interest Rate Environment & Capital Structure Dynamics

Interest rates sit roughly 400 basis points above pandemic lows, creating elevated rate environment testing companies across industries. Firms that issued debt at 0–1% coupon now confront refinancing at significantly higher costs.

Debt structures with shorter maturities or floating coupons bear the brunt first, while fixed-rate bullet maturities prolong pain as they approach their dates with minimal cash cushion.

Maturity Walls & Refinancing Pressures

A massive wave of maturities looms from 2025 through 2028. Nearly 20% of high-yield bonds and 15% of leveraged loans mature by 2027, translating to over $475 billion. In 2028 alone, maturities accelerate to around $674 billion.

This substantial debt maturities due phenomenon forces companies to negotiate with lenders or pursue liability management exercises, often at value-destructive terms.

Distressed Investment Performance & Returns

Despite headwinds, distressed strategies delivered compelling returns. The HFRI Distressed/Restructuring Index gained 11.52% through November 2025, outperforming many traditional credit benchmarks.

Forecasts suggest an average IRR of 13.4% for distressed debt over 2023–2029—up from 8.1% in the prior cycle. Private debt secondaries, trading at discounts to NAV, also offer double-digit yields for patient investors.

• Hedge Fund Research HFRI Distressed Index: +11.52%
• Projected Distressed IRR (2023–2029): 13.4%
• Private Debt Secondaries Yield: Double Digits

Key Market Trends & Structural Changes

Several evolutions shape the distressed landscape. First, advanced liability management exercises can shift the fulcrum security, challenging traditional control strategies.

Second, European co-op agreements are emerging to resolve creditor conflicts in large restructurings. Meanwhile, private credit fundraising gauges investor appetite for senior strategies.

Investors must navigate dramatic shifts in liability management exercises that can dilute recovery and alter claim priority overnight.

• Rise of LMEs: Value-eroding exchanges over cash defaults
• Co-op Agreements in Europe: Collaborative restructuring
• Private Credit Evolution: Record senior debt fundraising

Sector-Specific Opportunities

Software stands out as a key generator of distress. Many firms leveraged floating-rate debt at mid-teens EBITDA multiples in 2020–2021. Now, cash burn and debt costs converge.

software companies acquired at mid-teens multiples require active workouts or covenant amendments—prime targets for creative restructurings.

Other sectors in focus include healthcare, consumer, travel, and real estate. Large-cap broadcasters, retail chains, and hospitality groups also present selective entry points as their issuers navigate sector pressures.

Investment Thesis & Market Psychology

Seasoned investors describe this as one of the richest distressed opportunity sets in years. High demand for credit risk, driven by spillover from equity markets, has tightened spreads despite growing supply.

Paradoxically, a strong economy fuels defaults. Elevated rates, not recessions, are the primary catalyst. Successful contrarian strategies embrace this counterintuitive reality and allocate accordingly.

Market psychology remains mixed: fear of missing out on yield battles caution over credit quality. Investors must balance the two to avoid poor credit decisions in a tightening environment.

Risk Factors & Market Concerns

Tariffs and trade policy remain looming threats, with recent Chapter 11 filings citing import-export uncertainty. Private lenders now hold over $17 billion in distressed positions, raising concentration risks.

Moreover, intense creditor competition can lead to overcrowding in select credits, driving up purchase prices and compressing recovery multiples.

As one veteran manager put it, the market faces demand for credit risk outweighing supply, which can lure investors into marginal credits with thin covenants.

Charting a Path Forward

Contrarian investors who recognize the unique confluence of economic strength and financial distress stand to benefit. Key actions include:

• Identify credits with imbalanced capital structures facing near-term maturities.
• Analyze liability management terms carefully for value erosion.
• Focus on sectors with structural tailwinds or clear turnaround plans.
• Maintain disciplined pricing to avoid crowded trades.

By embracing the paradox of strength-induced distress, deploying patient capital, and leveraging deep research, investors can unearth compelling returns in what is undeniably a transformative moment for the distressed debt market.