NPLs and Distressed Assets

We are dealing with The Binomial of Loan + Collateral.

We will hear about NPL contingencies in the following weeks and months, so staying tuned on this asset is advisable. In times of economic uncertainty or market volatility, in times of weak currencies dependent on Public Debt and printing money, or under blurred expectations of interest rate performing, the issue of non-performing loans (NPLs) and development in the distressed debt market becomes, if not crucial, almost challenging, given the potential for increased NPL contingencies.

This is a set of notes on the theme of NPLs I drafted these past days about both elements in the binomial: the intangible loans/credits and the very tangible collaterals. Regarding NPLs, not merely a few of them well qualify as a matter for investment as a non-financial singular asset (nFSA); on the contrary. So these lines and the connected post have their point nowadays. They are my views on the situation and do not necessarily match my preferences or opinions.

So, in this series of posts, I’ll write ideas for not an argument but a fair discussion among readers concerned with the theme. I hope you enjoy the reading, or the little, think a bit about it. Thus, by staying tuned to NPL contingencies and proactively monitoring market trends, investors can position themselves to capitalise on opportunities and mitigate risks in the dynamic landscape of distressed debt investments.

Preliminary Digression: Distressed Credits and Stressed Assets, Do they qualify differently?’

In October 2023, Tom Briney published an article as part of his promotional performance (he is President and Chief Operational Officer of Origin Credit Advisers). The title is an effort for an academic digression: "The line between Stress and Distress" (take access here).

His statements to grab the difference address to:

(i) “A stressed asset is one in which the cause of the stress is relatively obvious, and the risks are contained and quantifiable”, while

(ii) “In a distress scenario, the cause may be less obvious and the potential repercussions much more challenging—or impossible—to identify and quantify."

So the binary set approach of two levers is: (a) realising vs non-realising the causal inference of facts, and (b) measuring vs non-measuring the consequences performed in the scene. Moreover, you have to pay attention to the two elements in the aetiology of the relationship: the credit and its linked asset. Finally, the different weights of the two pairs for leverage, together with sharing the part of each element in the relationship and combining and balancing the set at sight.

There may be a perfect credit setting, joint to a plain devaluated asset, whose room for damages has very little to worry about, while a poorly performed credit joint to a precious asset is impossible to asses to a connexion to request compensation. Weakness and Threads collaborate to get to a menace with fewer chances to perform, and the scene resolves in a ‘nothing to do here’ for the better of the credit: either for not needing or not conveying.

Reasons for staying tuned on NPLs and Distressed Assets

Given the potential for increased NPL contingencies in the coming weeks and months, here are some reasons why it's advisable to stay tuned to this asset class:

1. Market Opportunities: Economic downturns or financial crises often result in a surge in non-performing loans as borrowers struggle to meet their debt obligations. During these periods, investors may be able to acquire distressed assets at discounted prices and generate attractive returns through effective resolution or recovery strategies.

2. Risk Management: Non-performing loans carry inherent risks, including credit risk, legal risk, and market risk. Staying informed about NPL contingencies allows investors to assess risk factors, monitor market trends, and implement proactive risk management measures to protect their investments and mitigate potential losses.

3. Regulatory Changes: Regulatory initiatives and policy interventions addressing NPLs can impact market dynamics and create opportunities or challenges for investors. By staying updated on regulatory developments, investors can adapt their strategies and navigate regulatory requirements.

4. Industry Trends: Monitoring industry trends, market dynamics, and investor sentiment in the distressed debt market can provide valuable insights into emerging opportunities, competitive dynamics, and best practices for managing NPL assets. Staying tuned to industry news and market analyses enables investors to make informed decisions and optimise investment outcomes.

5. Networking and Collaboration: Engaging with industry peers, professionals, and experts in the distressed debt space facilitates knowledge sharing, idea generation, and collaboration on investment opportunities and risk management strategies. Participating in industry events, conferences, and forums allows investors to stay connected with key stakeholders and gain valuable perspectives on NPL contingencies.

6. Adaptability and Agility: Economic conditions and market dynamics can change rapidly, necessitating adaptability and agility in investment strategies. Staying tuned to NPL contingencies enables investors to assess evolving risks and opportunities, adjust their investment approach, and capitalise on market inefficiencies or dislocations as they arise.

Symptoms for being concerned either looking at the loan or the collateral asset

I collected some common symptoms or indicators that may suggest loans are underperforming or assets are becoming distressed; let me know if there are others:

Symptoms of Underperforming Loans:

1. Late Payments: Borrowers consistently miss or delay loan payments beyond the agreed-upon due dates, indicating financial strain or cash flow difficulties.

2. Increased Delinquencies: A rise in delinquent loans or accounts exceeding the standard grace period suggests deteriorating borrower creditworthiness and heightened default risk.

3. Reduced Cash Flow: Lenders experience a decline in loan repayments or interest income, which impacts cash flow and profitability metrics and potentially signals underlying credit quality issues.

4. Weakened Financial Metrics: Borrowers exhibit deteriorating financial performance indicators, such as declining revenue, profitability, liquidity, or solvency ratios, indicating financial distress or insolvency.

5. Credit Rating Downgrades: Credit rating agencies downgrade the creditworthiness of borrowers or loan portfolios based on deteriorating financial health, increased default risk, or adverse market conditions.

6. Loan Covenant Breaches: Borrowers fail to comply with loan covenants, triggering default events or loan accelerations and indicating financial distress or liquidity constraints.

Symptoms of Distressed Assets:

1. Decreased Market Value: Collateral assets experience a decline in market value or appraised value, reflecting adverse market conditions, reduced demand, or depreciating asset quality.

2. Physical Deterioration: Collateral assets exhibit signs of physical deterioration, neglect, or damage, which impacts their condition, usability, and marketability and potentially reduces recovery prospects.

3. Legal Encumbrances: Collateral assets are subject to legal encumbrances, such as liens, mortgages, or claims, which affect their title, ownership rights, or transferability and complicate asset recovery efforts.

4. Environmental Risks: Collateral assets are exposed to environmental risks, contamination, or regulatory violations, which can pose liabilities, cleanup costs, or legal challenges to creditors and reduce asset value.

5. Liquidity Constraints: Collateral assets face liquidity constraints or illiquidity in the market, limiting their saleability, exit options, or recovery potential for creditors during distressed situations.

6. Market Disruptions: Market disruptions, supply chain disruptions, oric challenges can affect collateral assets and reduce industry-specif demand, pricing, or investment attractiveness in the market.

Note about this post's topic. Monitoring these symptoms and conducting regular assessments of loan portfolios and collateral assets enables lenders, investors, and financial institutions to identify early warning signs of underperformance or distress, implement timely remedial actions, and mitigate potential losses. Proactive risk management and effective resolution strategies are essential for preserving asset quality, protecting investor interests, and optimising recovery outcomes in the dynamic landscape of non-performing loans and distressed assets.

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In the next post, the question is whether the NPLs themselves are assets that can be welcomed under the concept of singular assets eligible for a non-financial investment (nFSA).

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