NPL Return Strategy NPL= nonperforming loan There are 3 general ways to get paid back when buying an NPL. 1. Forbearance / Loan Restructure 2. Borrower Payoff 3. Foreclose/Deed in Lieu - Take Title - Sell Property The prevailing market interest rate and the maximum default interest rate according to the loan documents/jurisdiction will impact your strategy. [Note: there are other factors that impact the strategy. For example, the market environment (i.e., how is our deal flow?) and investment incentives of the note buyer (e.g., GP/LP vs. UHNW). These are topics for another day. Option 1: Forbearance / Loan Restructure Offer the borrower a forbearance agreement. Your terms should be in line with bridge/hard money lenders. That is the borrower's only option. A bank is likely not going to touch your borrower. If you like the collateral, another lender probably does, too. If you press too hard, you will likely get paid off quickly. For example, if the hard money market is charging a 2% origination fee and a 10% interest rate you can likely do the same. In fact, you can likely charge a little more as the borrower won’t incur closing costs with you (outside of minor attorney fees). You can also put lender-favorable terms in the agreement. For example, if the borrower defaults on the forbearance agreement, the default interest goes back to the original default date. You could also guarantee yourself minimum interest (ex: the borrower can payoff at anytime but is required to pay X months of interest to the lender). You could also restructure the note to make the payment more affordable and then attempt to sell it as a reperforming loan, but that is not my area of expertise. This probably requires you to buy the note at a discount to make the returns feasible. Option 2: Borrower payoff Sometimes, the borrower just doesn’t want to deal with you. Not speaking and/or cooperating is against their best interest, but it happens all the time. You are forced to run the default interest rate until they find a new lender or sell the property. There are also times when you just want the default interest to run. For example, the property has equity (from your position), but it will be difficult to refinance or sell. For a refinance, it could be an LTV issue for a future lender (too high). For a sale, it could be clearing inferior liens. Eventually, they will pay off. Your strategy depends on the projected payoff timeline and the loan’s default rate vs. the prevailing market interest. If we can yield ~12%, offering a forbearance (assuming a full year of interest), then our max default rate needs to be significantly higher. Every loan document and/or jurisdiction can be different so it is hard to comment on the default rate. Running the numbers is easy. Estimating the likely payoff timeline is difficult. Experience helps. Option 3: Foreclose/Deed in Lieu An exhausted and/or financially strapped borrower may just hand you the keys via a deed in lieu. Other times, you may get paid off at the foreclosure auction. If you do not, you are taking title to the property. This is always a scenario you prepare for, as there will be significant expenses just to get to this point (i.e., legal fees, lender advances, etc.). You will also incur additional expenses until the property is stabilized (e.g., OPEX, lease-up, etc.). You could also attempt to fire sale the property, but you won’t be maximizing value. The best NPL investors can operate the property and create value. Going into every deal, at a very minimum, you should have a basic business plan for the property if you are forced to take title. Often, your biggest winners (and losers) come from taking over. I’ll expand on this in the future. Any questions?
@investingcre If we are taking the forbearance route, we often will include lender favorable terms or credit enhancements, such as a pocket DIL and consents to FCL if there is a default under the provisions of the forbearance.
@investingcre Exactly. Followed you. Thanks. Can't wait to get your insights.