What is an uncredited loan?
An uncredited loan is a nonperforming loan that does not generate its declared interest rate due to non-payment by the borrower. Uncredited loans are more likely to default, which means that the lender will not receive capital and interest unless the borrower has adequate collateral to cover the loan. Since these loans can only be credited when the borrower makes a payment, the interest on an uncredited loan is recorded as earned income. Uncredited loans are also sometimes called or described as a “bad loan”, a “distressed” loan or an “acid” loan.
How an uncredited loan works
An uncredited loan comes after 90 days of non-payment and interest stops accumulating. The bank classifies the loan as non-compliant and reports the change to the credit reporting agencies, which lowers the borrower’s credit score. The lender changes its provision for potential credit loss, sets aside a reserve to protect the bank’s financial interests, and can take legal action against the borrower. The loan is cashed, which means that interest is only recorded when it is received when the payment is collected, and not as a deemed payment. Usually, interest income is accrued on loans because regular payment of principal and interest is assumed.
According to the Federal Deposit Insurance Corp. (FDIC), an asset must be declared as non-credible if one of the three criteria is met:
- It is maintained in cash due to the deterioration of the borrower’s financial situation;
- No payment in principal or interest is expected, or;
- The principal or interest has been in default for 90 days or more, unless the asset is both well secured and in the process of being recovered.
A secured property is a property secured by collateral (liens, pledges of real estate or personal property or securities of sufficient value to cover the debt, or is guaranteed by a financially responsible party.
Unless a loan has adequate collateral (such as a mortgage), if interest is not paid for 90 days, the loan is put into cash, which means that no interest can be credited to the account income from the lender until it has been received.
Restructuring of an uncredited loan
After entering non-credible status, the borrower usually works with the lender to determine a debt repayment plan. After examining the state of the borrower’s income and expenses, the lender can create a Distressed Debt Restructuring (TOR).
The TDR can erase part of the principal or interest from the loan, lower the interest rate, authorize interest only payments or modify the repayment terms by other means. Lower debt payments can be made until the borrower’s monetary situation improves. The lender can recover at least his capital, rather than losing the entire investment.
Reinstate a regularization status loan
One option to bring a loan back to stacking status is for the borrower to pay all principal, interest and overdue fees and resume monthly payments as specified in the contract. Another option is to keep abreast of scheduled principal and interest payments for six months and to provide the lender with reasonable assurance that principal, interest and unpaid fees will be paid within a specified time. A third option requires the borrower to provide collateral to secure the loan to the lender, repay the outstanding balance within 30 to 90 days, and resume monthly payments as indicated in the contract.
Example of an uncredited loan
In the fourth quarter of 2020, a loan of $ 91.5 million from Bank A to Company B was in non-credible condition. When Bank A contracted the loan, the bank already had $ 60 million at cost and $ 49 million at fair market value (FMV) of loans to Company B. By contracting the additional debt, the loan was converted in privileged and non-income producing loans. None of the investments appeared to pay current income. Bank A thinks that Company B will recover and the debt will be paid off.