Nonperforming AssetsWhat they are and how to handle them

Written By:
Adiste Mae

What is a Non Performing Asset (NPA)?

Non-Performing Assets are assets that don’t provide any future benefit to the company.

Perfect examples of NPAs are loans in default (loan agreement that has been broken and the debtor is unable to make payments) or loans in arrears (loan obligations that the debtor fails to settle on their due date).

How Non Performing Assets (NPA) Work

Non-Performing Assets is a Financial Statement item, specifically in the bank’s or financial institution’s Balance Sheet.

A way for the creditors to be paid is the execution of the accessory contract in the loan agreement which is the contract of pledge.

Pledged items will be auctioned and the proceeds will be used to cover the debtor’s obligation to the creditor should the debtor fail to make a payment on the interest and principal.

If there is no pledged item, the uncollected loans are recognized as bad debts. 

If the non-payment exceeds the 90 standard days, the loan is considered a Non-Performing Asset.

However, it is still the discretion of the company how they will treat the uncollected loan amounts – it could either be shorter or longer than the standard 90 days. 

For example, a borrower applied for a $500,000 loan with computed $75,000 monthly interest.

The monthly amortization hasn’t been paid for over three months now.

Following the accounting standard bad debts recognition, the uncollected loan amount will be recognized as such.

Another form of  Non-Performing Asset recognition is when only interests are paid while the principal amount is not paid by the debtor at its maturity date.

The negative effects of NPA on lenders are a decrease in the profitability rate, negative cash flow performance, an increase in loan loss provision, and a decrease in revolving capital used in lending transactions.

Once the final amount of losses is determined, such an amount is written off. 

Types of Non Performing Assets (NPA)

Aside from loans in default and loans in arrears, other forms of Non-Performing Assets are the following:

• Bank Overdraft and Cash Credit left out of order for over 90 days 
• Overdue payment on interest and principal for Agricultural Loans/Advances:
  • Short-duration advances – two crop/harvest seasons
  • Long-duration –  one crop season
• Overdue payment for other account types whose standard payment term is 90 days

Recording Non performing Assets (NPA)

There are three classifications of NPA. Banks must classify NPA on their level of nonperformance. 

• Sub-standard Assets – NPA classified for less than twelve months
• Doubtful Assets –  NPA classified for more than twelve months
• Loss Assets – the final identification of write-offs is made by the bank, auditor, or relative inspector.  A company already assumed default in payment, even though they provide an extension for non-payment.

Special Considerations

There are four ways for financial institutions to recover the losses brought about by nonperforming assets.

One of the ways is through debt restructuring, wherein a revision of the loan agreement is made by changing its loan terms so that borrowers can settle their obligation.

Another way is to sell the pledged items when the loan agreement is a secured type of borrowing to recoup the losses. 

Creditors may also put the bad loans into bond conversion which works by converting bonds into equity shares.

The original share price may change, but the strategy here is to make the shares appreciate until the defaulted loan amount is recovered.

The option would be to sell bad debts to a collection agency at a discounted price.

The type of loans that are typically offered for sale are loans that do not constitute collateral.