Loading the player...

What is a 'Nonperforming Asset'

A nonperforming asset (NPA) is a debt obligation where the borrower has not made any previously agreed upon interest and principal repayments to the designated lender for an extended period of time. The nonperforming asset is, therefore, not yielding any income to the lender in the form of interest payments.

BREAKING DOWN 'Nonperforming Asset'

For example, a mortgage in default would be considered nonperforming. After a prolonged period of non-payment, the lender will force the borrower to liquidate any assets that were pledged as part of the debt agreement. If no assets were pledged, the lender might write-off the asset as a bad debt and then sell it at a discount to a collections agency.

Banks usually categorize loans as nonperforming after 90 days of nonpayment of interest or principal, which can occur during the term of the loan or for failure to pay principal due at maturity. For example, if a company with a $10 million loan with interest-only payments of $50,000 per month fails to make a payment for three consecutive months, the lender may be required to categorize the loan as nonperforming to meet regulatory requirements. A loan can also be categorized as nonperforming if a company makes all interest payments but cannot repay the principal at maturity.

The Effects of NPAs

Carrying nonperforming assets, also referred to as nonperforming loans, on the balance sheet places three distinct burdens on lenders. The nonpayment of interest or principal reduces cash flow for the lender, which can disrupt budgets and decrease earnings. Loan loss provisions, which are set aside to cover potential losses, reduce the capital available to provide subsequent loans. Once the actual losses from defaulted loans are determined, they are written off against earnings.

Recovering Losses

Lenders generally have four options to recoup some or all of the losses resulting from nonperforming assets.

When companies are struggling to service debt, lenders can take proactive steps to restructure loans to maintain cash flow and avoid classifying loans as nonperforming. When defaulted loans are collateralized by assets of borrowers, lenders can take possession of the collateral and sell it to cover losses to the extent of its market value.

Lenders can also convert bad loans into equity, which may appreciate to the point of full recovery of principal lost in the defaulted loan. When bonds are converted to new equity shares, the value of the original shares is usually wiped out. As a last resort, banks can sell bad debts at steep discounts to companies that specialize in loan collections. Lenders typically sell defaulted loans that are not secured with collateral or when the other means of recovering losses are not cost-effective.

RELATED TERMS
  1. Non-Performing Asset (NPA)

    A non-performing asset refers to loans or advances that are in ...
  2. Lender

    A lender makes funds available with the expectation that the ...
  3. Problem Loan

    A problem loan is a loan in which the borrowers cannot or are ...
  4. Collateral Value

    A collateral value is the estimated fair market value of an asset ...
  5. Term Loan

    A term loan is a loan from a bank for a specific amount that ...
  6. Loan Stock

    Loan stock refers to common or preferred stock shares that are ...
Related Articles
  1. IPF - Mortgage

    What Are the Main Types of Mortgage Lenders?

    Shopping for a mortgage lender can feel confusing and a little intimidating. Understanding the differences among the main types of lenders can help you narrow down the field.
  2. Personal Finance

    What Is Collateral?

    Collateral is property or other assets that a borrower offers a lender to secure a loan. If the borrower stops making the promised loan payments, the lender can seize the collateral to recoup ...
  3. Personal Finance

    Interest-Only Mortgages: Home Free or Homeless?

    These loans can be beneficial, but for many borrowers, they present a financial trap.
  4. Financial Advisor

    Tips To Improve Chances Of A Small Business Loan

    Enhance your small business loan eligibility by keeping these important tips in mind.
  5. Personal Finance

    Getting a loan without your parents

    Do you want to receive a loan without the help of your parents? Use these five tips to finance your dreams without banking on a second signature.
  6. IPF - Mortgage

    How to Get the Best Mortgage Rate

    A crucial consideration as you shop mortgages is getting the best possible interest rate.
  7. Insights

    An Introduction to Government Loans

    Government loans further policymakers' efforts to create positive social outcomes by offering timely access to capital for qualified candidates.
  8. Investing

    Financing Basics For First-time Homebuyers

    If you're buying your first home and getting a mortgage, you have many financing options to sort through.
  9. Retirement

    10 Ways to Borrow in Retirement

    Before you take money from your nest egg, consider these 10 other ways to borrow in retirement.
  10. Investing

    Bank of America's 3 Key Financial Ratios (BAC)

    Discover some of the key financial ratios that show the quality of Bank of America's loan portfolio and how profitable the bank has been.
RELATED FAQS
  1. What is the difference between secured and unsecured debts?

    Learn about the differences between secured and unsecured debt — and how banks buffer risks associated with each type of ... Read Answer >>
Trading Center