Non-Performing Asset (NPA)

A nonperforming asset (NPA) refers to a classification for loans or advances that are in default or are in arrears on scheduled payments of principal or interest. In most cases, debt is classified as nonperforming when loan payments have not been made for a period of 90 days. While 90 days of nonpayment is the standard, the amount of elapsed time may be shorter or longer depending on the terms and conditions of each loan.

Nonperforming assets are typically listed on the balance sheets of banks.  Banks usually categorize loans as nonperforming after 90 days of nonpayment of interest or principal, which can occur during the term of the loan or at maturity. For example, if a company with a $10 million loan with interest-only payments of $50,000 per month fails to make a payment for three consecutive months, the lender may be required to categorize the loan as nonperforming to meet regulatory requirements. A loan can also be categorized as nonperforming if a company makes all interest payments but cannot repay the principal at maturity.

Although the most common nonperforming assets are term loans, there are six other ways loans and advances are NPAs: 

• Overdraft and cash credit (OD/CC) accounts left out-of-order for more than 90 days 
• Agricultural advances whose interest or principal installment payments remain overdue for two crop/harvest seasons for short duration crops or overdue one crop season for long duration crops 
• Bill overdue for more than 90 days for bills purchased and discounted
• Expected payment is overdue for more than 90 days in respect of other accounts
• Non-submission of stock statements for 3 consecutive quarters in case of cash-credit facility
• No activity in the cash credit, overdraft, EPC, or PCFC account for more than 91 days 

Banks are required to classify nonperforming assets in one of three categories according to how long the asset has been non-performing: sub-standard assets, doubtful assets, and loss assets.  A sub-standard asset is an asset classified as an NPA for less than 12 months.  A doubtful asset is an asset that has been non-performing for more than 12 months.  Loss assets are assets with losses identified by the bank, auditor, or inspector and have not been fully written off.

Carrying nonperforming assets, also referred to as nonperforming loans, on the balance sheet places three distinct burdens on lenders. The nonpayment of interest or principal reduces cash flow for the lender, which can disrupt budgets and decrease earnings. Loan loss provisions, which are set aside to cover potential losses, reduce the capital available to provide subsequent loans. Once the actual losses from defaulted loans are determined, they are written off against earnings.

Lenders generally have four options to recoup some or all losses resulting from nonperforming assets. When companies struggle to service debt, lenders take proactive steps to restructure loans to maintain cash flow and avoid classifying loans as nonperforming. When defaulted loans are collateralized by borrowers' assets, lenders can take possession of the collateral and sell it to cover losses.

Lenders can also convert bad loans into equity, which may appreciate to the point of full recovery of principal lost in the defaulted loan. When bonds are converted to new equity shares, the value of the original shares is usually eliminated. As a last resort, banks can sell bad debts at steep discounts to companies that specialize in loan collections. Lenders typically sell defaulted loans that are unsecured or when methods of recovery are not cost-effective.