NPLs (2): Were they an Asset Class that fits non-Financial Investments?

Introduction

Let's step back before discussing the main issue: NPLs' correlation between credits and asset collateralisation. Investing in non-financial singular assets (nF-SA) involves putting your money into tangible items that typically appreciate over time. This is clear. Naturally, these assets can range from real estate and precious metals to collectables like art, antiques, or rare coins. However, NPLs are not precisely tangible (here is the keyword), although their collaterals could fit the requested conditions.

Dealing with nF-SA investments requires managing some drivers and then confronting NPLs assets to check. Let's remind them and try to see how to match with NPLs assets:

Three issues about oneself as a part of the game:

1. Research and Education: Before investing in any non-financial singular asset, it's crucial to thoroughly research and educate yourself about the asset class you're interested in: the recovery right in litigation or the pre-litigation stage. Understand the market trends, historical performance, factors influencing value, and any associated risks.

2. Set Investment Goals: Clearly define your investment goals, whether long-term wealth preservation, capital appreciation, diversification, or a combination. Your goals will help shape your investment strategy and guide your decision-making process.

3. Assess Risk Tolerance: Evaluate your risk tolerance level (avoiding self-confirming biases) and determine how much volatility you can comfortably handle. Non-financial singular assets can vary significantly regarding risk, liquidity, and market dynamics, so aligning your investments with your risk profile is essential.

Three issues about the Asset presence

4. Diversification: Like financial assets, diversification is critical to managing risk in non-financial singular asset investments. Spread your investments across different asset classes, geographic locations, and types of assets to reduce concentration risk and protect your portfolio against adverse events.

5. Quality and Authenticity: When investing in collectables like art or antiques, prioritise quality and authenticity over any other (unless you were caught with a single item in particular, but always at your own risk: getting caught in not labelled as investment, precisely, but another form). Work with reputable dealers, auction houses, or appraisers to verify the authenticity and condition of the assets before making a purchase. And here emerges the nature of the Due Diligence as a must to perform. So do it with NPLs because due diligence expression means more than simply a pair of words jointly written according to a particular jargon.

6. Storage and Maintenance: Consider the logistics of storing and maintaining your non-financial singular assets. Some assets may require specialised storage facilities or ongoing maintenance to preserve their value. Factor these costs into your investment plan. The case: collaterals should be used to be maintained up-to-date unless caring about the value was not on the agenda while assessing the maturity period.

Two more issues about the maturity period for non-performing:

7. Market Timing: While it's challenging to time the market perfectly, pay attention to market trends and cycles when making investment decisions. Be patient and disciplined, and avoid making impulsive decisions based on short-term fluctuations in the market.

8. Exit Strategy: Have a clear exit strategy for each investment, whether selling, leasing, or passing down the assets to future generations. Regularly review your investment portfolio and adjust your plan based on changes in your financial situation or market conditions.

And,

Two final issues regarding not walking alone in the regulatory landscape beyond the horizon line:

9. Professional Advice: Consider seeking advice from financial advisors, wealth managers, or experts in the asset class you're interested in. They can provide valuable insights, help you navigate complex investment decisions, and optimise your portfolio for maximum returns.

10. Legal and Tax Considerations: Understand the legal and tax implications of investing in non-financial singular assets, especially when dealing with cross-border transactions or highly regulated markets. Consult with legal and tax professionals to ensure compliance with relevant laws and regulations and minimise tax liabilities.

Non-Performing Loans as a Class for Becoming (non-Financial?) Investment Asset

Nonperforming loans (NPLs) may seem contradictory at first, given that NPLs typically represent loans that borrowers have failed to repay. To be more precise, the issue with NPLs takes a broader scope: the Credits always go with a Collateral Asset, and the value issue is always about the collateral, not the credit. So then, and in a more pragmatic sense, non-performing Loans are always a theme not on Distressed Credits but on Stressed Assets and the mutual correlation between the credit and the collateral. Here, you can balance by playing with two binary levers: identifying the causal connection between the distress and the credit and measuring the damages involved in the credit loan and the collaterals. However, a chance to trigger the process sometimes doesn't correlate with grabbing hidden benefits at the end of this venture.

But well, there are scenarios where NPLs can be well-considered when setting a portfolio to diversify risks. Here's how this can be understood for fitting:

1. Investment Strategy: Some investors specialise in distressed debt or troubled assets, including NPLs. They purchase these loans at a discount from financial institutions or other lenders, expecting to either recover the debt through restructuring or asset seizure or sell it to other investors at a profit. For these investors, NPLs are viewed as opportunities to generate returns through effective management and resolution strategies.

2. Asset Diversification: Including NPLs in a diversified investment portfolio can provide a hedge against market volatility and economic downturns. NPLs may exhibit a low correlation with other asset classes, such as stocks or real estate, offering diversification benefits. Investors who allocate a portion of their portfolio to distressed debt or NPLs may seek to balance risk and potentially enhance overall portfolio performance.

3. Specialized Expertise: Investing in NPLs requires specialised knowledge, expertise, and resources to assess credit risk, conduct due diligence, and implement effective recovery or resolution strategies. Institutional investors or distressed debt funds often have dedicated teams with experience in credit analysis, legal proceedings, and loan workout negotiations. For these investors, NPLs represent an opportunity to leverage their specialised skills to unlock value in distressed assets.

4. High Potential Returns: Despite the inherent risks associated with NPLs, successful resolution or recovery efforts can yield significant returns for investors. Distressed debt investors may target NPLs with favourable risk-reward profiles, where the potential for recovery outweighs the initial investment risk. Investors aim to maximise recovery rates and achieve attractive risk-adjusted returns through active management and strategic interventions.

5. Market Dynamics: Economic and market conditions can influence the availability and pricing of NPLs. During periods of economic stress or financial crises, lenders may experience a surge in non-performing assets, creating opportunities for investors to acquire distressed debt at discounted prices. Conversely, in periods of economic stability or recovery, the supply of NPLs may decrease, leading to increased competition among investors and potentially higher acquisition costs.

So, while non-performing loans may seem out of place within a non-financial singular assets portfolio at first glance, their inclusion can be -could be, better- rationalised based on (i) investment strategy, (ii) diversification benefits, (iii) specialised expertise, (iv) potential returns, and (v) market dynamics as there is drafting here.

What are the main characteristics of the non-performing Loans that make them suitable as a Singular Asset Investment Class?

Non-performing loans (NPLs) possess several characteristics that can make them suitable as a singular asset investment class for confident investors:

1. Discounted Pricing: Financial institutions or lenders looking to offload distressed assets from their balance sheets typically sell NPLs at a discount to their face value. This discounted pricing allows investors to acquire loans at below-market rates, potentially allowing for attractive returns upon successful resolution or recovery. But there is a singular risk here: from which line level is the 'discount'? This is not an easy answer.

2. Potential for High Returns: While investing in NPLs carries inherent risks, successful resolution or recovery efforts can lead to significant returns for investors. Through various strategies such as loan restructuring, debt renegotiation, asset seizure, or foreclosure, investors can aim to maximise the recovery value of the distressed loans, potentially generating substantial profits. And there is another warning here: 'Potential' has an intrinsic weakness: it is not a fact but an expectation.

3. Diversification Benefits: Including NPLs in an investment portfolio can provide diversification benefits by adding an asset class with low correlation to traditional financial instruments such as stocks and bonds. NPLs may exhibit different risk-return characteristics compared to other asset classes, helping to mitigate overall portfolio risk and enhance risk-adjusted returns. Diversifying would be a value as it is, but not for any chance.

4. Customisable Risk Exposure: Investors can tailor their exposure to NPLs based on their risk appetite and investment objectives. Distressed debt markets offer various NPLs with varying credit risk, maturity, collateralisation, and geographic exposure. Investors can customise their portfolio allocations by selecting NPLs and aligning return preferences with risk. Overall, the point is that aligning self-preferences with honesty is not doing monkey business.

5. Opportunity for Active Management: Investing in NPLs requires active management and specialised expertise to assess credit risk, conduct due diligence, and implement effective recovery or resolution strategies. This hands-on approach allows investors to engage with the underlying assets actively, potentially enhancing value through strategic interventions and efficient asset management practices. Active management is not an end in itself but a means for an end always.

6. Counter-Cyclical Investment: NPLs often become more prevalent during economic downturns or periods of financial distress when borrowers struggle to meet their debt obligations. As a result, investing in NPLs can be counter-cyclical, with opportunities emerging during market stress or recession when traditional asset classes may underperform. Not everyone is ready to be contrarian all the time.

7. Regulatory Environment: Regulatory changes and initiatives addressing non-performing loans can create opportunities for investors. For example, government-led efforts to facilitate loan restructuring, establish asset management companies, or promote secondary markets for distressed debt can influence market dynamics and create favourable conditions for investors seeking to acquire NPLs.

Note about this post's topic. However, it's essential for investors to carefully evaluate the specific characteristics of NPLs, conduct thorough due diligence, and assess the feasibility of recovery or resolution strategies before investing in this asset class. Without leaving aside some of the characteristics included in a list of tactical levers, more than shaping the essence for an asset class. In my view, the more accurate lever for such a class was being opportunistic in a narrow open window; say, in two words, it may be a feasible venture, but mainly not for the commons.

---

And what else comes next?

In the third part of this, shorten written notes on Distressed Credits and Stressed Collateral Assets. with these two issues:

1. The critical momentum -if any- for benefiting from NPLs and

2. Bargains at the early stages.

---