What is an NPL (non-performing loan) and how to invest in one

What NPL actually means

NPL stands for Non-Performing Loan: a loan where the borrower has stopped paying instalments, typically for more than 90 days, or that the bank no longer expects to collect under normal terms.

Many NPLs are backed by collateral, for example a mortgage over a property. That collateral is what gives the loan value even if the borrower does not pay: whoever buys the debt can enforce the collateral to recover their money.

NPL, NPA and distressed debt: terms worth distinguishing

The NPL is the unpaid loan. When the bank enforces the collateral and takes over the property, that asset becomes a REO (Real Estate Owned) or, in accounting terms, an NPA (Non-Performing Asset): no longer debt, but a property on the balance sheet. Distressed debt covers both: loans and assets bought at a discount due to default or difficulty.

The NPL market in Spain

After the financial crisis, Spanish banks transferred hundreds of billions of euros in doubtful assets to specialised funds. The credit default rate, published monthly by the Bank of Spain, marks the pulse of how much bad debt is generated. European regulation (the European Banking Authority (EBA) guidelines on managing non-performing exposures and Directive 2021/2167 on credit servicers and purchasers) has organised and opened this market, which was historically the domain of large funds and is now starting to be accessible to the private investor.

Why banks sell their NPLs at a discount

An unpaid loan costs the bank money: it ties up regulatory capital, forces provisions and worsens its ratios. So banks prefer to sell NPL portfolios to funds and investors, even below face value, and clean up their balance sheet.

• They free up capital and reduce reported bad debt.
• They avoid the cost and time of collection or enforcement.
• They turn a problem asset into immediate liquidity.

How you make money with an NPL

The investor buys the debt at a discount and then tries to recover more than they paid. There are several routes, depending on the case.

1. An agreement with the borrower to settle for part of the debt.
2. Refinancing or restructuring the loan.
3. Enforcing the collateral, for example taking over the mortgaged property.

What are the risks of investing in NPLs

Investing in debt carries a risk of loss. Recovery can take time, court timelines are long, collateral can be worth less than expected and the borrower may have other charges. That is why analysing each deal before committing is essential.