how nonperforming assets npas work
nonperforming assets are listed on the balance sheet of a bank or other financial institution the lender will force the borrower to liquidate any assets that were pledged as part of the debt agreement after a prolonged period of non payment the lender might write off the asset as a bad debt and sell it at a discount to a collection agency if no assets were pledged debt is typically classified as nonperforming when loan payments haven t been made for 90 days this is the standard but the amount of elapsed time can be shorter or longer depending on the terms and conditions of each loan a loan can be classified as a nonperforming asset at any point during the term of the loan or at its maturity assume a company has a 10 million loan with interest only payments of 50 000 per month it fails to make a payment for 90 days or 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 can t repay the principal at maturity nonperforming assets are also referred to as nonperforming loans carrying them on the balance sheet places a significant burden on the lender the nonpayment of interest or principal reduces the lender s cash flow and this can disrupt budgets and decrease earnings loan loss provisions are set aside to cover potential losses they reduce the capital available to provide subsequent loans to other borrowers the actual losses from defaulted loans are determined and then written off against earnings carrying a significant amount of npas on the balance sheet over time is an indicator to regulators that the financial fitness of the bank is at risk types of nonperforming assets npas the most common nonperforming assets are term loans but there are other forms as well recording nonperforming assets npas 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 one that s 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 reasonably be assumed that they won t be repaid recovering losseslenders generally have four options to recoup some or all of their losses that result from nonperforming assets lenders might take proactive steps to restructure loans when companies struggle to service their debts these steps might help them maintain cash flow and avoid classifying the loan as nonperforming altogether lenders can take possession of the collateral and sell it to cover losses when loans in default are collateralized by the borrower s assets lenders can also convert bad loans into equity that may appreciate to the point of full recovery of principal lost in the defaulted loan the value of the original shares is usually eliminated when bonds are converted to new equity shares banks can sell bad debts at steep discounts to companies that specialize in loan collections as a last resort lenders typically sell defaulted loans that are unsecured or when other methods of recovery are deemed to be not cost effective 