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It seems that every industry has its own esoteric language and if you are going to participate you need to understand that language. In the defaulted note industry, the first term you need to understand is exactly what is an NPL or nonperforming loan (also commonly referred to as a nonperforming note or NPN).
In most cases, in bank jargon, these loans are reported as “non-accrual status.” In simple terms, non-accrual loans are loans on which interest is overdue and full collection of principal is uncertain. According to typical banking regulations, if interest has not been paid for 90 days the loan is put on a cash basis. Thus, its interest cannot be credited to the bank's revenue account until it has actually been received. Loans which have adequate collateral (such as home mortgages), and some types of consumer loans, are generally exempt from this requirement. Therefore, a loan can be nonperforming but not yet listed as non-accrual status. When the bank finally does place a home mortgage in the non-accrual status the appearance on that list according to Ernst & Young will be caused by one of the following reasons.
The current market value of the collateral is less than what the borrower paid for the property.
The collateral’s cash flow (rent and other sources of income) is insufficient to for the borrower to service (pay) the mortgage and cover operating expenses.
The borrower is experiencing cash flow challenges due to other poor-performing investments.
At some point the lender decides it must get this nonperforming asset off the books and sells the nonperforming asset, most times at a discount.
Very important to note, this asset in distress is not necessarily a poor quality asset. It very well could be a very nice property but the borrower has lost a renter and therefore cannot make the mortgage payment. The same is true of commercial property. The property may be a very desirable office building but the owner (borrower) lost a large tenant and the property no longer cash flows. Or it could be a very nice home in a good neighborhood and the homeowner lost his or her job and cannot keep up the payment. They all fit under the banner NPL or non-accrual status.
This is one reason defaulted loan investment is such an attractive investment vehicle for the average investor. Since the investor is buying the loan at a discount there are a great many things that can be done to keep the homeowner in the home and still maintain a healthy yield. Many things a bank cannot or simply will not do.