What is a 'Nonaccrual Loan'
A nonaccrual loan is a nonperforming loan that is not generating its stated interest rate because of nonpayment from the borrower. Nonaccrual loans are more likely to default, meaning that the lender will not receive its principal and interest unless the lender has adequate collateral to cover the loan. Because these loans can have interest credited only when the borrower makes a payment, the interest on a nonaccrual loan is recorded as earned income.
BREAKING DOWN 'Nonaccrual Loan'After 90 days of nonpayment, a loan is placed on nonaccrual status, and interest stops accumulating. The bank classifies the loan as substandard and reports the change to the credit reporting agencies, which lowers the borrower's credit score. The lender changes its allowance for the potential loan loss, sets aside a reserve to protect the bank's financial interests and may take legal action against the borrower.
Restructuring a Loan
After entering nonaccrual status, the borrower typically works with the lender in determining a plan for paying off the debt. After reviewing the borrower's income and expense status, the lender may create a troubled debt restructure (TDR). The TDR may erase part of the loan's principal or interest payments, lower the interest rate, allow interest-only payments or modify repayment terms in other ways. Lower debt payments may be made until the borrower's monetary circumstances improve. The lender may recoup at least its principal rather than losing its entire investment.
Returning a Loan to Accrual Status
One option for returning a loan to accrual status involves the borrower paying all overdue principal, interest and fees and resuming monthly payments as outlined in the contract. Another involves keeping current with scheduled principal and interest payments for six months and providing the lender reasonable reassurance that the outstanding principal, interest and fees will be paid within a set amount of time. A third option requires the borrower providing the lender collateral for securing the loan, repaying the outstanding balance within 30 to 90 days, and resuming monthly payments as detailed in the contract.
Example of a Nonaccrual Loan
In the fourth quarter of 2015, a $91.5 million loan from Ares Capital to Instituto de Banca y Comercio, a private school operator in Puerto Rico, was on nonaccrual status. When Ares assumed the loan, the company's main balance sheet already had $60 million at cost and $49 million at fair market value (FMV) in loans to the school operator. After taking on the additional debt, the loan was converted to preferred and non-income producing, giving Ares investments costing $127 million with a FMV of $101 million. None of the investments appeared to be paying current income. Ares believes the school operator will turn around and the debt will be repaid.