What is a Nonaccrual Loan?
A nonaccrual loan, or non-performing loan – sometimes referred to colloquially as a doubtful, sour, or troubled loan – is a loan that is overdue on payments. The reason for the more colloquial “doubtful” and “troubled” terminology is that the lending institution is doubtful about whether the loan will be collected in full or if it will slip further into default.
Most lending institutions typically send a loan – without interest payment for 90 days – into a nonaccrual status, putting it on a cash basis. It means that the lender can’t add the interest payment on the loan to its revenue until the payment is made.
Almost every type of loan is subjected to such treatment. The only loans exempted from the nonaccrual status or adjustment are loans backed by solid collateral. They include certain types of consumer loans and mortgages or home loans. (They are known as “secured loans” because they are backed by collateral; the lending institution can collect the collateral and liquidate it to recover any unpaid balances in the event of loan default.)
- A nonaccrual loan is a loan that has not received payment in at least 90 days.
- A nonaccrual loan is structured differently, meaning that the lender can’t mark interest payment as income until payment has been received.
- Nonaccrual loans can be shifted back to accrual status through collaboration between the lender and the borrower, a joint effort that typically results in a troubled debt restructuring (TDR).
How Nonaccrual Loans Work
Again, the first step in the process of a traditional loan shifting to a nonaccrual loan is the loan recipient neglecting to make payments for 90 days. Typically, when an individual with a standard loan makes a payment, interest is accrued because the loan recipient has proven his or her ability to make regular payments. Thus, the lender assumes the regular payments will continue.
The Federal Deposit Insurance Corporation (FDIC) states that assets must be listed and maintained under the nonaccrual status if they meet any ONE of the following three criteria:
- No payment is expected.
- Payment has not been made in 90+ days.
- Cash maintenance is necessary because of borrower riskiness.
Some lenders place loans on a cash basis ahead of marking the loan as nonaccrual as a sort of marker that the borrower’s dependability may be questionable, or if the borrower’s level of risk becomes greater.
Additionally, the lender will usually adjust how much is allowed in terms of loan loss on nonaccrual loans and set aside a sort of reserve fund to help protect the lender if the loan ends up in total default.
Depending on the size of the loan, the specific terms of the loan, and any risk factors deemed relevant, the lender may take some form of legal action to recover the loan payment. The information is then passed along to credit agencies and affects the loan amounts the borrower may be able to receive in the future.
Changing the Nonaccrual Loan Status
While it’s never good for a loan to move into the nonaccrual phase, it is possible to come back from such a situation. Many lenders recognize a borrower’s financial status may change over the course of a loan. Often, a lender will review the borrower’s financial situation and work with the borrower to develop a troubled debt restructuring (TDR).
It is often the TDR that helps borrowers move their loans back to accrual status. Sometimes, part of the loan debt (principal and/or interest payments) can be reduced or lowered, or the terms for repaying the loan can be renegotiated. They are done in an effort to help the borrower continue to make payments while respecting his or her ability to pay.
There are a few traditional options for fully returning a loan to accrual status. They are:
- The borrower simply makes full restitution of all overdue principal and interest payments, compensates for fees attached to late payments, and then returns to the original payment plan.
- In most cases, the first option isn’t feasible, and a TDR is established. Within the TDR – provided both the lender and borrower agree to the terms – principal and interest payments resume for a set period of time (usually a term of three to six months). It is done with some reasonable certainty that the borrower can repay any past due loan payments.
- Additionally, the lender may require the borrower to provide some form of collateral and fully repay the loan’s outstanding balance over one to three months. The option also usually mandates that the borrower return to the original payment schedule outlined in the loan agreement.
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