A non-performing asset (NPA) is a debt instrument 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 non-performing asset is, therefore, not yielding any income to the lender in the form of interest payments.
Breaking Down Non- Performing 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 collection agency. Top MBA college in Bangalore
Banks usually categorize loans as non-performing after 90 days of non-payment 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 non-payment 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. Best B-school in Bangalore
Types of Non-Performing Assets (NPA)
Although the most common nonperforming assets are term loans, there are other forms of nonperforming assets as well.
- Overdraft and cash credit (OD/CC) accounts left out-of-order for more than 90 days
- Agricultural advances whose interest or principal installment payments remain overdue for two crop/harvest seasons for short duration crops or overdue one crop season for long duration crops
- Expected payment on any other type of account is overdue for more than 90 days
Recording Nonperforming Assets (NPA)
Banks are required to classify nonperforming assets into one of three categories according to how long the asset has been nonperforming: sub-standard assets, doubtful assets, and loss assets.
A substandard asset is an asset classified as an NPA for less than 12 months. A doubtful asset is an asset that has been nonperforming for more than 12 months. Loss assets are loans with losses identified by the bank, auditor, or inspector that need to be fully written off. They typically have an extended period of non-payment, and it can be reasonably assumed that it will not be repaid.
Lenders generally have four options to recoup some or all losses resulting from nonperforming assets. When companies struggle to service their debt, lenders may take proactive steps to restructure loans to maintain cash flow and avoid classifying the loan as non-performing altogether. When loans in default are collateralized by the borrower's assets, lenders can take possession of the collateral and sell it to cover losses.
Lenders can also convert bad loans into equity, which may appreciate 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 eliminated. 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 unsecured or when other methods of recovery are deemed to not be cost-effective.
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