Nonaccrual Loan: Definition, FDIC Criteria, Ways To Fix

What Is a Nonaccrual Loan?

Nonaccrual loan is an accounting term in the lending industry for an unsecured loan that is no longer generating its stated interest rate because no payment has been made by the borrower for 90 days or more. For a lender in business to earn interest, it has become a nonperforming loan (NPL).

Loans generate interest only when the borrower makes a payment, a portion of which is applied to interest and the rest to the principal. The interest on loans is recorded as income by the lender. If no interest has been paid by the customer, the expected interest has not accrued, so the loan has become nonaccrual.

Nonaccrual loans are sometimes referred to as doubtful loans, troubled loans, or sour loans.

Key Takeaways

  • A lending institution categorizes an unsecured debt as a nonaccrual loan if no payment has been made for 90 days or more.
  • In accounting terms, the expected interest has not accrued to the lender because no interest has been paid by the customer.
  • A borrower can work out a repayment plan to restore the loan to its previous status.

How a Nonaccrual Loan Works

When no payment has been received for 90 days, a loan becomes nonaccrual. 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 also 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.

Since regular payment of both principal and interest is expected by the lender, interest income from loans is usually assumed. When a loan becomes nonaccrual, the interest is no longer an assumed payment, so the loan is put on a cash basis. Interest will be recorded as income again only if payment is eventually collected.

According to the Federal Deposit Insurance Corporation (FDIC), an asset should be reported as being in nonaccrual status if one of three criteria is met:

  • It is maintained on a cash basis because of a deterioration in the financial condition of the borrower,
  • Payment in full of principal or interest is not expected, or,
  • Principal or interest has been in default for 90 days or more—unless the asset is both well-secured and in the process of collection. (A well-secured asset is one that is either backed by collateral—such as a lien, a pledge of real or personal property, securities valuable enough to cover the debt—or guaranteed by a financially responsible third party.)

An unaccrued loan is classified as substandard and the borrower is reported to credit agencies.

Returning a Loan to Accrual Status

After entering nonaccrual status, the borrower can usually work with the lender to determine a plan for paying off the debt.

For example, a loan can be returned to accrual status if the borrower pays all the overdue principal, interest, and fees and resumes the regular monthly payments defined in the contract.

If both parties agree, another option involves resuming the 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 period of time.

A third option requires the borrower to provide collateral for securing the loan to the lender, repaying the outstanding balance within 30 to 90 days, and resuming monthly payments.

Troubled Debt Restructuring

After reviewing the borrower's income and expense status, another option is for the lender to create a troubled debt restructuring (TDR). The TDR may erase part of the loan's principal or interest payments, lower the interest rate, allow interest-only payments, or modify the repayment terms in some other way. Lower debt payments may be accepted until the borrower's financial situation improves.

Can Any Loan Become Nonaccrual?

Lenders can put almost any loan into nonaccrual status if payments are 90 days behind, with the exception of secured loans backed by solid collateral (e.g., a mortgage backed by a house). If a secured loan goes into default, the lending institution can seize the collateral and liquidate it to recover the unpaid balance.

What Are the Requirements for Troubled Debt Restructurings (TDRs)?

The Office of the Comptroller of the Currency (OCC) lists accounting and reporting requirements for lenders seeking to establish troubled debt restructurings (TDRs) for nonaccrual loans. A borrower in financial difficulties can work with the lender to determine whether a TDR is appropriate in their situation.

What Does Cash-Basis Loan Mean?

Cash basis means that the lending institution has sent the loan into nonaccrual status. Because the lender hasn’t received interest for 90 days or more, they can’t record it as accrued income—they have to record it on a cash basis.