A Non Performing Asset is also known by its acronym NPA. This pertains to a certain way of categorizing loans on a banks’ balance sheet. Such NPA loans are those which are in arrears on their regular payments or are otherwise in outright default. In the majority of instances, loans become categorized as nonperforming as the payments on the loans are not received consecutively over 90 days. It is possible for the time lapse to be less or more than the typical 90 days in order for NPA classification to occur. It all comes down to the individual conditions and terms which each loan spells out in the documents and the policies of the bank in question.
Following 90 days of non-payment, most banks will commonly reclassify the loans as Non Performing Assets or loans. This might happen during the term for the loan or as a failure ultimately to pay off the balance principal of the loan which becomes due upon maturity. It always helps to consider a real world example in order to better understand a somewhat complicated topic.
Consider a firm that takes out a $20 million loan with associated payments that are interest-only in nature for a $100,000 payment amount each month. If the borrower misses payments for three months in a row, the bank which originally made the loan could be forced to classify the loan as a Non Performing Asset in order to comply with its government-mandated regulatory requirements. It is also possible for loans to finally become nonperforming if the borrower pays out all of its interest payments but is unable or alternatively fails to pay back the final principal that becomes due at maturity date.
Banks which carry such Non Performing Assets on their books and balance sheets create three separate drags for themselves. The cash flow of the bank lender in question becomes reduced as principal and/or interest payments do not become made. This can reduce earnings or even upset budgets. Provisions for loan losses must be set aside in order to compensate for possible defaults. These provisions actually lower the amount of total capital with which the bank can issue additional loans. After the realized losses are booked, the bank or financial institution will have to write them off versus their earnings.
There are as many as four different means for lenders to recover all or part of their losses that arise because of Non Performing Assets. Smart lending institutions will be willing to restructure loans in order to keep cash flow incoming. It also permits them to keep the loan from becoming categorized as a nonperforming asset. Banks might also seize the underlying collateral of the loans. They can then sell this off in order to reduce their losses as much as the market value of the assets will allow.
Thirdly, financial institutions might also choose to convert their NPA loans into equity. This could grow back all the way to full value over time. As bonds become converted to new equity shares, the original stakes’ value typically disappears. Finally, banks might sell off their bad debts for substantial discounts to such firms as specialize in collections on loans. Lenders will tend to sell off their NPA loans which do not come collateral-secured. This is particularly the case when the other methods of recouping their losses do not prove to be especially cost effective for the bank or other lending institution.