An NPL with an LTV
by Fairview Partners on Sep 13, 2022 6:24:00 AM
For years, people have heard Fairview talk about the benefits of buying non-performing loans (“NPLs”)—primarily the favorable risk/reward dynamics that can be achieved. We have never been bashful about sharing exactly how we accomplish our goals as investors, because while the process may be straightforward in theory, we have found that it takes great skill and determination to execute well. Our skills enable us to find value across various collateral types, geographies, borrowers, and legal situations that many other investors refuse to pursue. In doing so, we afford ourselves, and our capital, the opportunity to select and price investments with a clear path to profitable resolution.
Over the course of making more than 425 investments, we have experienced many types of distress and special situations, and we have learned valuable lessons from each one. Navigating through so many investments has helped us to learn what we are good at, and what we must avoid. With this experience, we’ve become experts at selecting into situations where the fundamentals favor resolution, and where we believe our skills and experience can create exceptional results.
We like to refer to investments that fit our profile as “Fairview Deals.” One of our very favorite types of investment is a non-performing loan with a low loan-to-value ratio—what we like to call an "NPL with an LTV.”
What is an "NPL with an LTV"? Why does Fairview pursue them?
The Benefits of a Non-Performing Loan
When loan documents are executed by borrowers and lenders, the terms are set and must be adhered to so long as each party meets their obligations; parties have obligations to each other, and by performing on those, they retain rights versus the other party. Loans become non-performing when a borrower defaults on the provisions of the loan agreement.
Once a loan is in default, the borrower loses many of the terms originally agreed upon in the loan documents; the contractual rights of the borrower tend to shrink, and the contractual rights of the lender expand tremendously. This enforcement position is attractive to Fairview as it puts us in a position to get a loan paid off quickly while realizing the discount at which we purchased the loan.
Ironically, this NPL status, which increases our rights, is also what brings a discount to the loan in the first place. The speed with which we have resolved our NPL investments shows that the discounted purchase of a non-performing loan can often be superior to a performing loan—but obviously only if the loan is fully collectable.
The Collectability of a Low Loan-to-Value (LTV) Loan
Most people think of a distressed loan purchase only resulting from a property being “underwater”—for example, the loan is for $10 million, but the property itself is only worth $7 million. We prefer to locate just the opposite—NPLs where the loan is for $7 million but the property is worth $10 million. This latter situation represents a loan-to-value ratio of 70%; a significant number of performing real estate loans are originated at this figure, or even higher. The “underwater” situation represents a loan-to value of 130% and is something we actively avoid because of the lack of leverage we can assert on the outcome of the underwater loan.
In the case of a 130% LTV, if we hire an attorney, for example, it is most likely we will have to pay that expense from our eventual profits. The same is the case with taxes, insurance, and so forth. With a 70% LTV loan, however, these expenses are added to the loan and will eventually be paid through the equity in the property. Also, with a solid LTV, the borrower is motivated to work with us; without one, they can extort us for a “nuisance fee.” In the case of an underwater loan, time is our enemy, constantly degrading our profits; in the case of a low LTV loan, time can be our friend--allowing us to accrue interest at attractive default rates.
So, why would a lender sell a loan that has a low LTV? Perhaps because the cash flow has stopped, as conventional lenders are often primarily cash flow lenders. By contrast, we are collateral lenders. Furthermore, non-performing borrowers are often not helping their regulated lenders “check the boxes” they need to check by providing timely financial statements and other required information. And often they are simply difficult to deal with or incompetent. It is our job to deal with difficult people and to be a “consultant at risk” for them, ultimately helping them to sort out a tangled situation so we can get paid off.
These dynamics are something we understand deeply and use to our advantage to remain in control of default situations. We do so from a position of strength, having both a discount to the collateral value and to the loan balance. Our ability to create these discounts through sourcing and structuring, and to realize on them through active management, is a primary driver of our success.
In today’s full-priced investment environment, there aren’t many better places to have one’s capital than an NPL with a low LTV. These investments offer excellent downside protection with return expectations ranging from reasonable to superior. To achieve these returns, we work diligently and intelligently to drive each borrower toward a resolution, as is illustrated in the two case studies we invite you to review, below.
To view case studies, please click corresponding button below.
The work we do to source promising investments only pays off because our team is willing and able to be persistent in extracting value from day one through our ultimate exit. The dynamics of an NPL with a favorable LTV are such that we, as owners of a loan, are in control and in a position to collect if we have the skills and the resolve to do so. Certainly, there are situations where borrowers or markets can undermine returns in unpredictable ways—but our servicing and asset teams are well-versed in dealing with borrowers using myriad methods and strategies proven to drive our investments toward profitable, timely resolutions to benefit our limited partners.