What Is a Nonperforming Loan (NPL)?
A nonperforming loan (NPL) is a loan that is in default due to the fact that the borrower has not made the scheduled payments for a specified period. Although the exact elements of nonperforming status can vary depending on the specific loan's terms, "no payment" is usually defined as zero payments of either principal or interest.
The specified period also varies, depending on the industry and the type of loan. Generally, however, the period is 90 days or 180 days.
- A nonperforming loan (NPL) is a loan in which the borrower is in default and hasn't made any scheduled payments of principal or interest for a certain period of time.
- In banking, commercial loans are considered nonperforming if the borrower is 90 days past due.
- The International Monetary Fund considers loans that are less than 90 days past due as nonperforming if there's high uncertainty surrounding future payments.
- However, there is no standard or definition of NPLs.
- Some banks opt to sell NPLs to other banks or investors to free up capital and/or focus on performing loans that bring in income.
How a Nonperforming Loan (NPL) Works
A nonperforming loan (NPL) is considered in default or close to default. Once a loan is nonperforming, the odds the debtor will repay it in full are substantially lower. If the debtor resumes payments again on an NPL, it becomes a reperforming loan (RPL), even if the debtor has not caught up on all the missed payments.
In banking, commercial loans are considered nonperforming if the debtor has made zero payments of interest or principal within 90 days, or is 90 days past due. For a consumer loan, 180 days past due classifies it as an NPL.
A loan is in arrears when principal or interest payments are late or missed. A loan is in default when the lender considers the loan agreement to be broken and the debtor is unable to meet the obligations.
Types of Nonperforming Loans (NPLs)
A debt can achieve nonperforming loan status in several ways. Examples of NPLs include:
- A loan in which 90 days' worth of interest has been capitalized, refinanced, or delayed due to an agreement or an amendment to the original agreement.
- A loan in which payments are less than 90 days late, but the lender no longer believes the debtor will make future payments.
- A loan in which the maturity date of principal repayment has occurred, but some fraction of the loan remains outstanding.
The Fair Debt Collection Practices Act prohibits certain abusive or deceptive practices in order to collect on nonperforming personal loans. However, this law only applies to third-party debt collectors or debt investors, not the original lender.
Official Definitions of Nonperforming Loans (NPLs)
Several international financial authorities offer specific guidelines for determining nonperforming loans.
The European Central Bank Definition
The European Central Bank (ECB) requires asset and definition comparability to evaluate risk exposures across euro area central banks. The ECB specifies multiple criteria that can cause an NPL classification when it performs stress tests on participating banks. The ECB has performed a comprehensive assessment and developed criteria to define loans as nonperforming if they are:
- 90 days past due, even if they are not defaulted or impaired
- Impaired with respect to the accounting specifics for U.S. GAAP and International Financial Reporting Standards (IFRS) banks
- In default according to the Capital Requirements Regulation
An addendum, issued in 2018, specified the time frame for lenders to set aside funds to cover nonperforming loans: two to seven years, depending on whether the loan was secured or not. As of 2020, eurozone lenders still have approximately $1 trillion worth of nonperforming loans on their books.
The International Monetary Fund Definition
The International Monetary Fund (IMF) also sets out multiple criteria for nonperforming government loans.
The IMF has defined nonperforming loans as those whose:
- Debtors have not paid interest or principal payments in at least 90 days or more
- Interest payments equal to 90 days or more have been capitalized, refinanced, or delayed by agreement
- Payments have been delayed by less than 90 days, but come with high uncertainty or no certainty the debtor will make payments in the future
Nonperforming loans may damage the credit rating of the borrower, making it harder and more expensive to borrow money in the future.
Nonperforming Loan (NPL) vs. Reperforming Loan (RPL)
Nonperforming loans are those in default. Reperforming loans are those that were once nonperforming and are now performing again. The reperforming loans were once delinquent for at least 90 days and are now performing again.
Reperforming loans are often loans where the borrower has filed for bankruptcy and has continued to make payments as a result of the bankruptcy agreement. Such an agreement generally allows the borrower to become current on their debt via a loan modification program.
Example of a Nonperforming Loan (NPL)
Imagine a hypothetical borrower who cannot make loan payments due to job loss. After 90 days without payment, the bank or lender will consider the loan nonperforming. The bank would shift the loan to their nonperforming list and continue seeking payment for the debt.
There are multiple avenues available to the creditor. One of the most common ways to collect the debt is to send it to a collections agency, which will be paid a percentage of any money they recover. The lender can also sell the debt to a debt buyer at a fraction of the face value. Although the creditor will lose money, this is often a better financial choice than trying to collect on a nonperforming loan.
Borrowers with nonperforming loans may be able to negotiate with creditors to forgive part of their debt. However, this may damage their credit rating, making it harder and more expensive to borrow in the future.
What Happens to Nonperforming Loans?
Nonperforming loans can be sold by banks to other banks or investors. The loan may also become reperforming if the borrower starts making payments again. In other cases, the lender may repossess the borrower's collateral the satisfy the loan balance.
What Are the Causes of Nonperforming Loans?
Nonperforming loans tend to occur during economic hardships when delinquencies are high. They happen when the borrower fails to make a payment for a long period of time (such as 90 to 180 days).
Why Do Banks Sell Nonperforming Loans?
Banks may sell nonperforming loans to focus on the loans that bring in money each month. Selling the loans at a discount may be more profitable than trying to collect money from a delinquent borrower.
Who Buys Nonperforming Loans?
Other banks or distressed debt investors may consider investing in nonperforming loans, as well as real estate investors.
How Do You Solve a Nonperforming Loan?
Solving a nonperforming loan involves getting back on track with payments. This is may be done with a loan modification agreement through the lender.
The Bottom Line
The number of nonperforming loans tends to rise during economic uncertainty. These loans are the ones where borrowers do not (or cannot) make payments. The loan goes to NPL status if no payment is received for a set period of time (usually 90 or 180 days—depending on the lender).