VERY IMPORTANT! Read this and let's discuss NPNs!

11 Replies

I just read this article about NPNs:

Some of you may already be familiar with this article, but it's something that has always bothered me. 

One school of thought is, as the article states, the hedge funds, private equity firms, etc. buy these notes in bulk, skim the cream off the top, and sell them to the firms "downstream". This process repeats until it reaches the private investor who gets the garbage that's left.

The other school of thought is the large firms don't bother working the notes. They split the notes into smaller groups, take a "small" percentage, and sell them.

As far as I'm concerned, this is a HUGE issue as to the viability of investing in NPNs. I would love to hear opinions on this. I think an open discussion would benefit every investor.

Hi Peter,

This is a good article, Papersource is a wonderful resource and event, and the author of the article is a well heeled investor.

That being said, the process of buying non-performing loans downstream is a non-issue. There is profit to be made every step of the way. Now it may not be every investors cup of tea, but there is substantial profit at each step. This applies to both 1st and 2nd liens.

- Josh

Don is active on this forum and can comment further, but it's a 10000 foot view of note investing that doesn't take into account the low level variables that affect whether notes are going to be profitable or not.

For example out of those 1,000 notes, they will probably get rid of most notes under 125k, which is what most people here focus on. So the fact that they "discarded" them has zero impact whatsoever on each note's individual potential.

Second and very important, when they analyze those big pools the notes are only numbers in a spread sheet. They do very little deep dive into the circumstances surrounding individual notes. You also can't discount human error. 

For example I've bought a HELOC before for $2,700ish that was in first position, on a $36,500 house. On paper, the loan was deeply underwater (like 300% underwater) so the Harvard-grad MBA with deep analytical tools just discarded it as worthless. The homeowners had actually paid off the first and that wouldn't have shown up on a spreadsheet. Ended up doing a DIL and selling the house, getting a 800%ish profit.

We can write examples all day but another notable case is a woman who went through BK and the loan was sold 5 times. Each time she'd just fax them the BK papers and the hedge fund preferred selling it for a 15% profit rather than fight for it. We did and she's been paying religiously for 3 years.

Your concerns are unjustified. You do need to be extra vigilant (and I made mistakes when I wasn't and sometimes even when I am) but there is money to be made even at the bottom end of the food chain.

There are other major issues with note investing, stories for another day, but this isn't one of them.

From what I've seen of the business, I believe that the article does a great job of describing the general flow of most NPN's from beginning to end. I've also seen that every hedge fund is different in motivation, goals, abilities, inventory, and competency. They consist of human beings that make mistakes and not all the gems get picked up. The larger the hedgefund or bank, in general, the less attention they give to individual assets. It seems like they use cruder strokes to get to their profits because they can. Smaller investors, IMO, have an advantage in that they give individual assets a lot more attention and have a better chance at maximizing the profit of each one. The challenge for the small investor is to get access to notes "higher up the stream" or to find the diamond in the rough that everybody else passed over. Either approach requires work. The next challenge is to balance the amount of notes you can effectively work with your resources. Small investors can become like big banks on a different level if you don't have the right teams and tools in place to work your notes effectively.

As long as there's some quality notes available for the individual investor (even if you have to do a little digging) then that's great. 

The author paints the picture that if you invest in NPNs, you're a sucker because they're trash, which is concerning.  

I contacted Don Konipol (the author) and asked him to jump into the thread.

Okay, I'll jump in.

There is always the possibility of finding "the diamond in the rough". However, the PROBABILITY of that is very small, and over time the investor rummaging through the bottom of the barrel of NPN will find (1) the number of decent opportunities is VERY small in relation to the notes he looks at (2) the time consumed in finding, tracking, doing due diligence, etc. is huge for the very few good candidates found. Typically, the investor becomes discouraged by the low per hour return and begins making offers to buy any note that seems to be less than a bad deal.

Here is why many of the stories of "success" in this arena are less than what they seem. An investor I know told me about the note in which he tripled his investment. Sounded pretty good, so I bit and asked him for the details. After weeks of looking through NPN opportunities, he found a note which had a $35,000 original principal, and UPB of $26,000, our years in default. He paid $2700 for the note, another $4000 in legal fees, and long story short after two years of owning the note, he was able to obtain ownership of the property. Lo and behold, the property was in terrible condition. However, he was able to sell it for $22,500 with 2500 down.

BTW, he paid $7800 in back taxes to clear title at closing.  So, he's out the original $2700 note purchase price, $4000 legal and $7800 taxes, a total of $14,500.  On the credit side he received $2500 down, reduced by closing costs of $1200.  So for his $14,500 investment, after 2 years he got back $1300 plus a $20,000 note probably worth less than $15000 in the secondary market.  And NPNs are not a passive investment; he doesn't know or give any value consideration to his time spent.  

More than anything else my concern with the whole program is not that experienced, knowledgeable investors may not be able to find a way to make a profit, they will, although stories about isolated instances of making a killing may be just that - isolated and not the norm.  Any investment program needs to be judged after a period of time with ALL the investments made accounted for, not just the winners.  And investing in NPNs have a bias that make it seem much more profitable early, with the reality o lower returns or losses not showing up until the end.  The reason is that prices of the portfolio of NPNs an investor creates are not "market to market", so that the early successes are fully accounted for as they occur, but the failures and total losses, which take much longer to become visible, remain hidden and unaccounted for until the investor finally gives up and accepts his loss.  

My article was limited to investments in NPNs that were bought as a package by private investment funds, and separated and sold of too individual investors after being picked through first.  This seems to be the only avenue of sourcing open to small, inexperienced investors.  NPNs purchased directly from the lending institutions can be greatly profitable.  In the past 6 months we purchased 4 NPNs on commercial properties, restructured the notes, and we feel we have very secure positions with excellent returns.  However, in each instance we were able to pay the institution holding the non performing paper in excess of $1,000,000 cash in 14 days for the notes. 

To Don's point there are many mentoring programs hyping up those big wins to sell education and of course they don't show the losers, so buyer beware when framed from that perspective. 

As far as "minimal investment returns", that is relative to the exit strategy on a NPL so what does not work from the "intensive analysis by highly trained MBAs", may work for the individual small balance investor who knows how to repurpose an asset for profit. Yes, there is portion of inventory offered which are "bottom of the barrel" assets and the savvy investor needs to know how to differentiate them from assets which have potential when performing due diligence prior to purchase. 

For most of us on this discussion board being at the bottom of the asset waterfall, and selecting from a pool of leftovers, learning how to sort the good from junk is key when buying NPLs. A broad statement that one may be a sucker if buying NPLs is hyperbole as you can be a sucker when buying in any assets class. Getting educated and working with more experienced note investors would be a good way to avoid this syndrome. 

My company and myself individually have found success when buying assets leftover from the large pools, and thorough research and correct pricing is what has kept us from losing money. I would say that 90% of the time our offers are rejected as "too low" since we are making them based on our internal standards and yield expectations. 


I think all the comments above are applicable to your question. NPN's take a lot of work and due diligence. The guru's in most cases tell of the successes and forget the about the challenges that caused heart aches. @Bob Malecki pointed out "thorough research and correct pricing is what has kept us from losing money" is very true. Most note investors do not have or unaware of all the tools you need to have in order to perform due diligence. Buying NPN's is not the same as investing in SFD's, it is a different vehicle altogether.

@Peter Lipschutz Some hedgefunds reach out to try to get them re-performing. One of our regular trading partners does loan mods all the time and the last few that we bought from them were loans in which the borrowers defaulted on the loan mod. They have lots of verticals and make a lot of profits from servicing the notes. They also have trustee services, realty services, asset management, and other "arms." The whole loan business is just one part of a conglomeration really. One of our other regular trading partners, however, has a different strategy. They don't want to hold onto any paper longer than a few months if they can help it. They'll tack on a small profit and sell it to the next guy. 

"There is an inherent conflict of interest with any education program that offers investment assets as well.  Note investors beware: someone can't be an impartial and expert educator and also offer assets for sale. The educator's fiduciary obligation is to teach discerning and quality due diligence (and to help one master the art of the negotiation) to maximize the student's profit from the acquisition of an asset. The note seller's function is to maximize the asset's sale price. The two are, by definition, in conflict. If you expect a two-for-one deal you're merely asking to get screwed." -- Dean Engle, Park Tree Investments, in the Sept. 2017 Paper Source Journal

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