Key Takeaways
- Loan interest accrual stops after 90+ days overdue.
- Signals high credit risk; interest recorded on cash basis.
- FDIC requires nonaccrual for serious payment doubts.
- Exemptions exist for well-secured or restructured loans.
What is Nonaccrual Loan?
A nonaccrual loan is a loan on which interest accrual has been suspended because the obligor has failed to make payments, typically when principal or interest is overdue for 90 days or more. Instead of recognizing interest income as it accrues, lenders use cash-basis accounting, recording interest only when received in cash.
This status indicates elevated credit risk and helps prevent overstating a lender's earnings. Nonaccrual loans are a key consideration in managing loan portfolios and assessing asset quality.
Key Characteristics
Nonaccrual loans possess distinct features that differentiate them from performing loans:
- Interest Suspension: Interest stops accruing once a loan becomes nonaccrual, and any previously accrued interest may be reversed.
- Past Due Threshold: Typically triggered when payments are 90 days or more past due, per regulatory guidelines.
- Cash Basis Accounting: Interest income is recognized only upon receipt of cash, rather than on an accrual basis.
- Exemptions: Well-secured consumer loans or mortgages may remain on accrual if collateral provides adequate recovery options.
- Regulatory Reporting: Banks report nonaccrual loans in regulatory filings, impacting their financial statements and capital requirements.
How It Works
When a loan becomes nonaccrual, the lender stops recognizing interest income as it accrues and instead records interest only when cash payments occur. This prevents inflating earnings with interest unlikely to be collected.
Lenders assess the borrower's financial condition and payment history to determine the loan's status. If the borrower’s ability to repay improves or the loan is restructured with reasonable assurance of repayment, the loan may return to accrual status after sustained performance.
Examples and Use Cases
Nonaccrual loans arise in various lending scenarios, illustrating how financial institutions manage credit risk:
- Commercial Loans: A business loan with missed payments for over 90 days is placed on nonaccrual, halting interest accrual until cash payments resume.
- Airlines: Companies such as Delta and American Airlines may experience loans moving to nonaccrual during industry downturns impacting cash flow.
- Loan Restructuring: Troubled Debt Restructuring (TDR) may allow a loan to exit nonaccrual if modified terms are met and payments are sustained.
- Investment Strategy: Investors evaluating financial institutions should consider exposure to nonaccrual loans when analyzing bank stocks or bond ETFs, such as those discussed in our best bank stocks and best bond ETFs guides.
Important Considerations
Understanding nonaccrual loans is vital for managing credit risk and evaluating lender financial health. Nonaccrual status impacts reported income and can signal deteriorating credit quality requiring close monitoring.
If you hold or manage loans, consider the loan’s collateral value and borrower status before classifying it as nonaccrual. Effective accounting and regulatory compliance rely on accurate loan status assessments, including the use of tools like the T-account for tracking loan balances and payments.
Final Words
Nonaccrual loans indicate increased credit risk and signal that interest revenue recognition has been paused due to payment issues. Monitor your loan status closely and consult your lender to understand implications for your financial reporting or investment decisions.
Frequently Asked Questions
A nonaccrual loan is a loan on which interest accrual has been suspended because the borrower has failed to make payments, typically after being past due for 90 days or more. Instead of recognizing interest income as it accrues, lenders only record interest when cash payments are actually received.
A loan is classified as nonaccrual if principal or interest payments are overdue for 90 days or more, if there are serious doubts about the collectibility of payments, or if the borrower's financial condition has deteriorated enough to require cash-basis accounting.
Not necessarily. Some loans, like well-secured consumer loans or mortgages backed by collateral with ongoing collection efforts, may be exempt from nonaccrual status to avoid overstating income, even if they are past due for 90 days or more.
When a loan is on nonaccrual status, lenders stop recognizing interest income as it accrues and only record interest income when payments are actually received in cash. Any previously accrued but unpaid interest may also be reversed to prevent overstating income.
The FDIC requires banks to place loans on nonaccrual status if they meet criteria like being overdue by 90 days or having serious doubts about collectibility. Banks must keep loans on nonaccrual until the borrower returns to current status and shows sustained payment performance.
Yes, restructured loans, known as troubled debt restructurings (TDRs), can be restored to accrual status if the borrower demonstrates reasonable assurance of repayment and sustained performance under the modified terms for a period, often six months.
Banks report nonaccrual loans and other assets in Schedule RC-N of their Call Reports on a fully consolidated basis. This includes loans, leases, and debt securities, though some restructured loans with zero percent interest rates may be excluded.
