Investing In Non-Performing Notes, Part I: Overview

Posted by Bob Bright, Esq.


Market conditions have placed a huge burden upon lenders as they find themselves saddled with a massive inventory of non-performing loans. Under normal circumstances, the lender will try to work the problem out directly with the borrower. If that proves unsuccessful, the lender then begins the foreclosure process in order to recover the collateral.


In today’s market, there are simply too many non-performing loans for the lenders to effectively resolve them relying on the same old processes. And, unlike the Oil Companies, lenders are not as adept at quickly adapting to market forces. As a result, there is a huge backlog of non-performing notes waiting for resolution and it is swelling much faster than the lenders can handle.


The growing trend for resolution is the direct sale of the non-performing note where the lender simply decides to let someone else deal with the problem. The lender sells the note at a discount to a buyer that is either interested in the note, or interested in acquiring the underlying collateral. This process allows the lender to quickly recover its capital without the time and expense of foreclosure and subsequent marketing and sale of the property.


Upon purchase, the borrower “steps into the shoes” of the lender and assumes all rights and remedies that the lender had under the loan documents. This is accomplished primarily by the assignment to the borrower of the loan documents; including the note, the mortgage and security agreement and, if applicable, the guaranty.


However, while the buyer obtains all of the benefits held by the lender, it is equally important to remember that he also obtains all of the burdens. This includes the risk that the loan documentation history may be flawed, that the borrower may refuse to cooperate in either a modification or a foreclosure alternative and the risk that pursuing foreclosure may take much longer than expected. In other words, just like the lender, the borrower now holds a note that is not performing and which will require resolution. I will address these risks further in subsequent parts of this series.


After the purchase, if the note turns out to be a continuing burden rather than a shortcut to acquiring the property, the buyer will have very limited, if any recourse against the lender. This is because the lender will typically sell the note “as-is” without any further warranty or representation and with all faults. What this means is the buyer must be very careful in how it conducts due diligence.


In a typical due diligence scenario, a buyer simply investigates the property. What is the property’s location? What is its condition? What is its capacity to generate income? What are the market forces that may impact its ability to generate income in the future? What is the status of the title? And, are there any environmental concerns?


When buying a non-performing note, the buyer must also conduct due diligence on the borrower. What is the borrower’s financial condition? Is the borrower motivated to seek a modification of the loan? Will the borrower be motivated to fight foreclosure? Does the borrower have the means to fight foreclosure? Is there a risk the borrower will file bankruptcy?


In addition, the buyer should conduct due diligence on the loan documents. Have all the documents been made available for review? Is the seller the original lender? If not, is there a clear chain of assignments from the originator to the seller? Have all documents been properly recorded against the property? Are there any other liens recorded against the property? Are the loan documents sufficient to support a foreclosure? What other remedies are supported by the loan documents


For many buyers, non-performing notes are attractive investments because they typically trade at a large discount off of the secured property’s perceived value. In fact, it is not uncommon to see non-performing notes trade at a discount of up to 60% or more off of the unpaid balance. It should be remembered, however, that this discount is a reflection of the note’s distressed condition.


Non-performing notes do have great investment potential. However, a buyer should not assume that a non-performing note is a guaranteed shortcut to acquiring the underlying asset. As with any investment, there are risks. The prudent buyer will conduct thorough due diligence, not just on the underlying property, but upon the borrower, the lender and the status of the loan documents. It is important for the buyer to understand why the property is distressed and what additional expenditures in time and capital will be necessary to either bring the loan back to a performing condition, or to recover the underlying asset. When a buyer understands these issues, he will be more able to assess whether the discount being offered is sufficient enough to justify the risk.


Bob Bright is General Counsel for COMAC, a leading provider of premiere off market assets and notes. ( Bob is also a principal of Bridgewaters ( and represents clients in the US and Internationally in the acquisition, disposition and management of commercial assets and investment properties. This includes the buying and selling of distressed debt. Bob is dual qualified as a California attorney and a solicitor of England and Wales. He can be reached at

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