Nonaccrual Loans
Definition
A nonaccrual loan is a loan on which the lender has stopped accruing interest income because it no longer expects to collect the contractual interest, the principal or both in full. Under US bank regulatory guidance a loan is placed on nonaccrual when principal or interest is 90 days or more past due, unless it is both well secured and in the process of collection, or earlier when the lender concludes that full collection is doubtful regardless of days past due. On placement the lender reverses interest that was accrued but not received, stops adding new interest to income, and applies any cash the borrower does pay to principal or recognizes it as interest only when received, depending on policy. The loan remains an asset, is not yet charged off, and can return to accrual after a sustained period of payment, commonly six months, and reasonable assurance of full collection. For a bank, a BDC or a private credit fund, the nonaccrual rate, nonaccrual balances as a share of the portfolio at cost and at fair value, is the standard measure of how much of the book has stopped earning, and it moves before charge-offs and after delinquency.
Why it matters
A private credit fund's income is mostly interest that has been accrued, not received: payment-in-kind coupons, quarterly payers, borrowers a month behind. Nonaccrual is the accounting line where that income stops being assumed, and its rate is the cleanest public signal of how much of a lender's yield is real. It moves after delinquency (the loan was late before it went on nonaccrual) and before charge-off (the loan is still carried, at a written-down value, while the lender works it out), which makes it the right middle-stage measure for a book of corporate loans that are too few for roll-rate statistics. A BDC reporting a 9 percent portfolio yield with 4 percent of its book on nonaccrual is earning materially less than 9 percent, and the gap between its nonaccruals at cost and at fair value is how much of the loss it has already admitted.
Common misconceptions
- •Nonaccrual is not default. Many nonaccrual loans are not in contractual default, and many defaulted loans (a covenant breach, for example) are still accruing; nonaccrual is an accounting judgment about collectibility.
- •Nonaccrual is not charge-off. The loan stays on the balance sheet at cost less any specific allowance or, for a fund, at fair value; charge-off comes later if the workout fails.
- •A nonaccrual loan is not necessarily paying nothing. Many pay partial interest, which the lender applies to principal or recognizes as received; the coupon is not lost, it is no longer assumed.
- •The nonaccrual rate at fair value is not the loss rate. It is the share of the marked-down portfolio that has stopped earning; the loss is in the mark, and the mark can move further.
Technical details
Worked example: a $20 million loan goes on nonaccrual
A private credit fund holds a $20 million first-lien term loan at 11 percent (SOFR plus 6.5). The borrower misses its June 30 quarterly interest payment of $550,000; the fund had accrued it as income through the quarter.
September 30: 92 days past due. The fund places the loan on nonaccrual, reverses the $550,000 of accrued but unpaid interest against third-quarter income, stops accruing, and marks the loan to 75 cents, $15 million, reflecting its recovery estimate. Effect on the quarter: interest income down $1.1 million (the reversal plus the foregone third-quarter accrual), unrealized loss $5 million.
The fund reports nonaccruals of 2.0 percent of the portfolio at cost ($20 million of $1 billion) and 1.5 percent at fair value ($15 million of $980 million after marks).
December: the borrower pays $300,000. Under cost recovery the fund reduces its recorded investment to $19.7 million and recognizes no income; under the cash basis, with principal judged collectible, it recognizes $300,000 of interest income.
Following June: after a restructuring to a lower coupon with a sponsor equity injection and four consecutive monthly payments on the new terms, the fund returns the loan to accrual at its restructured rate. If instead the sponsor walks away, the loan is sold or the collateral liquidated and the difference between $19.7 million and proceeds is charged off.
Placement, recognition and restoration rules
Placement: 90 days past due (banks, per call report instructions and interagency policy) unless well secured and in process of collection; or earlier on a determination that collection is doubtful; or on bankruptcy filing for most lenders.
Reversal: accrued but uncollected interest is reversed against current-year income or charged to the allowance for prior-year accruals; interest capitalized into principal on PIK loans is treated the same way.
Cash application: cash basis (income when received, if principal is collectible) or cost recovery (all cash to principal until recovered); the loan agreement's own application clause can differ from the accounting.
Restoration: sustained performance (typically six months of contractual payments), the loan brought current, and reasonable assurance of full collection; for restructured loans, performance on the new terms.
Disclosure: banks report nonaccruals in call reports and 10-K credit quality tables by loan class; BDCs report nonaccrual balances and rates at cost and fair value in every 10-Q and shareholder letter.
Nonaccrual in the sequence of credit stress
Watch list or criticized: the lender's internal grade falls; nothing changes in accounting; disclosed by some BDCs as internal ratings.
Delinquency: a payment is missed; buckets begin; interest is still accrued.
Nonaccrual: 90 days or doubtful; accrual stops; interest reversed; the loan is usually marked down or specifically reserved.
Restructuring or modification: terms changed to avoid default; may stay on nonaccrual until performance is shown; disclosed as modifications to borrowers experiencing financial difficulty.
Charge-off, sale or foreclosure: the loan is written off, sold at a discount, or the collateral is taken (OREO for real estate); recoveries follow.
Reading a lender's nonaccrual disclosure
Rate at cost and at fair value: the gap is the write-down already taken on troubled loans; a small gap means the lender is carrying nonaccruals near par, which is either well-secured collateral or optimism.
Trend and inflows: new nonaccruals in the period versus cures, payoffs and charge-offs; a flat rate with heavy inflows and heavy charge-offs is a book in motion.
Concentration: how many loans make up the nonaccrual balance; three loans at 2 percent is idiosyncratic, thirty is systemic.
PIK and amendments: a rising share of PIK interest and a rising count of amendments precede nonaccruals; both are disclosed by BDCs.
Effect on yield: the reported yield on the portfolio usually excludes nonaccrual loans; the yield on the whole book including them is lower by roughly the nonaccrual rate times the coupon.
Nonaccrual across lender types
Banks: 90-day rule, regulatory reporting, allowance under CECL; nonaccruals feed the nonperforming loan ratio that regulators and rating agencies watch.
BDCs and private credit funds: investment-company accounting at fair value; nonaccrual is a policy decision by the adviser and the board's valuation process; disclosed quarterly.
Marketplace and consumer lenders: nonaccrual is often implicit in the charge-off timeline (120 or 180 days) rather than separately reported; delinquency buckets do the work.
Real estate debt funds: nonaccrual on maturity defaults is common and can last through a long workout; interest reserves and forbearance agreements complicate the accounting.
Frequently asked questions
- What does nonaccrual mean?
- That the lender has stopped counting the loan's interest as income. Normally a lender records interest as it comes due whether or not the borrower has paid yet. When the borrower is far enough behind, or collection looks doubtful, continuing to book that interest would overstate earnings, so the loan is moved to nonaccrual: no new interest is recorded, previously recorded but unpaid interest is reversed, and cash is recognized only when it arrives.
- When is a loan placed on nonaccrual?
- At 90 days past due on principal or interest for most bank and regulated lenders, under the federal call report instructions, unless the loan is well secured by collateral and in the process of collection. Earlier if the lender judges full collection unlikely: a borrower in bankruptcy, a covenant default with no cure, a collateral shortfall. Private credit funds and BDCs follow their own valuation policies, which generally mirror the 90-day rule with judgment for earlier placement.
- What happens to interest already accrued when a loan goes on nonaccrual?
- It is reversed against interest income in the current period if it was accrued in the current year, or charged against the allowance if it was accrued in a prior year, so that the lender's books no longer show income it has not collected. This reversal is why a large loan going on nonaccrual can cut a quarter's reported interest income by more than the loan's coupon for that quarter.
- Is interest paid on a nonaccrual loan counted as income?
- It depends on policy and on the loan's prospects. Under the cash basis, payments are recorded as interest income when received if the remaining principal is judged fully collectible. Under the cost-recovery method, all payments reduce principal until the lender's recorded investment is recovered, and only then is anything recognized as income. Lenders disclose which they use; cost recovery is the more conservative and is required when collection of principal is doubtful.
- When does a nonaccrual loan return to accrual?
- When the borrower has brought the loan current, has made contractual payments for a sustained period (six months is the usual benchmark) and the lender has reasonable assurance that the remaining principal and interest will be collected. A single catch-up payment, a maturity extension or a restructuring that lowers the payments does not by itself qualify; a restructured loan may return to accrual on its new terms after demonstrated performance.
- What is a good nonaccrual rate for a BDC or private credit fund?
- Below 1 percent of the portfolio at fair value in benign conditions for a diversified direct-lending book, with 2 to 3 percent common in stress; the rate at amortized cost runs higher because nonaccrual loans have been written down. A rising rate at cost with a stable rate at fair value means the fund is marking the troubled loans down as it puts them on nonaccrual. Compare the fund's rate with its peers, with its own history, and with the share of the portfolio on its internal watch list, which precedes nonaccrual.