What is a non-performing asset
A non-performing asset (APN) is a debt instrument in which the borrower has not made any interest and principal repayment previously agreed to the designated lender for an extended period. The non-performing asset therefore does not generate any income for the lender in the form of interest payments.
BREAKDOWN of non-performing assets
For example, a mortgage in default would be considered non-performing. After a long period of non-payment, the lender will force the borrower to liquidate all of the assets that were pledged under the debt agreement. If no asset is pledged, the lender can write off the asset as a bad debt and then sell it at a discount to a collection agency.
Banks generally classify loans as non-performing after 90 days of non-payment of interest or principal, which can occur during the term of the loan or in the event of non-payment of principal due on maturity. For example, if a business with a $ 10 million loan with interest payments of only $ 50,000 per month fails to make a payment for three consecutive months, the lender may be required to classify the loan as non-performing. to meet regulatory requirements. A loan can also be classified as non-performing if a company makes all the interest payments but cannot repay the principal when due.
The effects of NPAs
Putting non-performing assets on the balance sheet, also called non-performing loans, imposes three separate charges on lenders. Failure to pay interest or principal reduces the lender’s cash flow, which can disrupt budgets and decrease income. Provisions for loan losses, which are set aside to cover potential losses, reduce the capital available to provide future loans. Once the actual losses on delinquent loans are determined, they are written off from the results.
Recovery of losses
Lenders generally have four options to recover some or all of the losses from nonperforming assets.
When businesses are struggling to pay down debt, lenders can take proactive steps to restructure loans to maintain cash flow and avoid classifying loans as non-performing. When the defaulted loans are secured by the assets of the borrowers, the lenders can take possession of the collateral and sell it to cover losses up to its market value.
Lenders can also convert bad debts into equity, which can appreciate to the point of fully recovering the capital lost in the defaulted loan. When the bonds are converted into new shares, the value of the original shares is generally wiped out. As a last resort, banks can sell bad debts with large discounts to companies specializing in loan recovery. Lenders generally sell defaulted loans that are not secured by collateral or when other means of recovering losses are unprofitable.