What is an unearned loan?

Definition and Examples of Non-Performing Loans

A loan becomes non-performing when payments have not been made for at least 90 days. After 90 days, the loan is considered non-performing and enters a state of default. As a result, the loan stops accruing interest, and it does not generate any revenue for the lender.

A non-performing loan is one that becomes so when the principal or interest payment is delayed for 90 days or more, or when full payment of the principal or interest is not expected.

Alternative names: doubtful loans, distressed loans, bad loans

Lenders typically place the loan on a cash basis and are unable to add interest to the loan, leading to a loss of revenue. At this point, the loan is classified as non-performing and reported to credit reporting agencies.

Note: Non-performing loans include mortgage, bank, commercial, and industrial loans. Additionally, lease contracts, securities receivables, and other assets can enter a state of default.

Here is an example of a non-performing loan. Suppose you have defaulted on a mortgage loan for more than 90 days and have no collateral securing it. The bank will classify the loan as non-performing and report it. Since the payment history is part of your credit score, this is likely to have a negative impact on your credit rating.

How Non-Performing Loans Work

Lenders use the guidelines established by the Federal Deposit Insurance Corporation (FDIC) and the Federal Financial Institutions Examination Council (FFIEC) to determine when assets should be reported as non-performing.

A lender will classify a loan as non-performing if any of the following criteria are met:

1. The bank decides to hold the loan on a cash basis due to the borrower’s deteriorating financial condition.
2. It is not expected that the principal or interest payment will be made in full.
3. The principal or interest payment has been delayed for 90 days or more unless the assets are well-secured and in the process of collection.

The FDIC defines well-secured assets as collateral backed by a lien on real or personal property that sufficiently covers the debt or is guaranteed by a financially responsible party.

Note: Placing the loan in a non-performing status allows lenders to identify losses and assess the borrower’s financial situation to determine the likelihood of repayment.

Although reaching a non-performing status is undesirable for both banks and borrowers, it is possible to reverse it.

For example, suppose your mortgage loan enters a non-performing status. In this case, the bank may review your financial history and agree to restructure the troubled debt (TDR) as a means for you to repay the debt.

Restructuring troubled debt can adjust and renegotiate the loan terms so that you can make payments and return the loan to performing status. Troubled debt restructuring may reduce the principal balance, lower interest rates, or extend the loan’s maturity date.

Requirements to Restore a Non-Performing Loan

Banks are willing to work with borrowers to restore a loan or asset to performing status. Whether through troubled debt restructuring, another payment arrangement, or restructuring, a non-performing loan must meet one of the following requirements to restore performing status:

1. The bank must have received all due assets and interest, and anticipates receiving the remaining principal and interest.
2. The loan becomes well-secured by collateral or a personal guarantee and is in the collection process. The loan is still non-performing at this stage, but the borrower has resumed full payments of principal and interest for at least six months. As a result, the bank has a reasonable assurance of repayment.

Each

Borrowers and loans differ. The likelihood of repayment and recovery of the entitlement depends on a variety of factors, including the lender’s policies, the borrower’s financial assessment, the borrower’s ongoing repayment performance, and the restructuring agreement.

Key Points

• Loans become non-accrual when the installment payment is delayed for 90 days or more.
• Non-accrual loans do not earn interest or generate revenue for lenders.
• You can recover non-accrual loans through restructuring distressed debts or other repayment plans.
• Non-accrual loans can negatively impact your credit score and may affect you in the future if you need another loan.

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Sources:

• Federal Financial Institution Examination Council. “FFIEC 051 Call Report Instruction Book Update March 2021.” Accessed Oct. 6, 2021.
• Federal Deposit Insurance Corporation. “Schedule RC-N — Past Due and Nonaccrual Loans, Leases, and Other Assets,” Page RC-N-2. Accessed Oct. 6, 2021.
• Federal Deposit Insurance Corporation. “2012 Bankers Outreach Accounting,” Page 33. Accessed Oct. 6, 2021.
• Federal Financial Institutions Examination Councils. “FFIEC 051 Call Report Instruction Book Update March 2021,” Page A-76. Accessed Oct. 6, 2021.
• Federal Financial Institutions Examination Councils. “FFIEC 051 Call Report Instruction Book Update March 2021,” Page RC-N-4. Accessed Oct. 6, 2021.
• Federal Deposit Insurance Corporation. “2012 Bankers Outreach Accounting,” Page 39. Accessed Oct. 6, 2021.

Source: https://www.thebalancemoney.com/nonaccrual-loan-5204862