Wednesday, January 28, 2009

What is a non-performing loan?

Once upon a time I saw loan restructurings as code for faking the accounts.  That was with good justification.

Conseco – before it blew up – had a habit of restructuring any loan that was delinquent.  After restructure it was no longer delinquent – and lo – the credit metrics seemed OK.

After Conseco finally went bankrupt the truth came out.  Loan performance went from sort-of-OK-if-you-ignored-the-fact-that-cash-actually-coming-back-in-payments-was-low to utterly desperate.  The AAA strips of Conseco securitisations failed widely.

These days restructuring loans is the stated objective of many powers that be – most notably Sheila Bair.  I never quite got that.  If you show too many non performing assets (NPAs) Sheila Bair will just confiscate your bank.  So the incentive is to restructure and restructure early.  If the borrower can perform to restructured spec then presumably they are no longer an NPA.  What Sheila Bair appeared to be advocating was government sanctioned account faking.

Then of course some banks tell it straight – and count the restructured loans amongst their NPAs.  Here is an extract from the recent Fifth Third conference call.  Fifth Third is a problematic bank and in WaMu fashion I own the subordinated debt – not the common – and in WaMu fashion I probably have reason to be nervous.  Anyway to quote:

Turning to the consumer portfolio, we also continued to be very aggressive in restructuring consumer loans, modifying over $200 million in the quarter. We believe restructuring loans where appropriate will result in significantly greater likelihood of payment and more value ultimately received by Fifth Third. These activities are beneficial not only to our shareholders, but are also consistent with the needs of our customers.  [Sheila Bair’s line precisely – are they pandering?]

As of year end, we had $574 million in troubled debt restructurings and NPAs, classified that way because they hadn't met the six-month consecutive performance threshold.  [Hey wow – they count restructured loans as non-performing – so they are not producing the Conseco fake numbers…  My cynicism is misplaced in this instance.]

Fifth Third has been among the most active of banks in the US in restructuring loans for consumer borrowers, a process we began over a year ago. We've been among the most active among our peers in these restructurings only one of the 15 largest US banks reports a higher dollar amount of restructured loans among its nonaccrual loans, according to regulatory filings.

Now this is very odd.  $574 million of restructured loans in the NPAs is about the highest in America!  But we know lots of banks are restructuring many loans – many billions worth.  Sheila Bair is telling them to do it.  But if you take Fifth Third at its word (and I think you should here) all the other banks are classifying most those restructured loans as performing.

In other words they are – Conseco like – faking their accounting.  And Sheila Bair is not only complicit – she is actively encouraging.

Welcome to modern banking.  


Kevin Kleen said...

Perhaps insurance companies had different rules or Conseco wasn't following them, but the accounting for modified loans has been pretty well settled since the last S&L crisis. A material modification is a Troubled Debt Restructure, which is a Non-Performing Asset until the payments have been made at least six months. As you suggest, I think Fifth Third may be doing some posturing by breaking their TDRs out of their NPAs. As far as I know there is no requirement to do so. Citigroup reported $12.7B in consumer NPAs for the 4Q 2008, it wouldn't be at all surprising if there were a bunch of TDRs in this category.

I wrote some more about this at

John Hempton said...


I wish your comment were true. Unfortunately Conseco did the lending OUTSIDE the insurance company - and they also deferred payment of loans (and counted as current) loans made within their regulated bank. (Yes they had a regulated bank that did store credit cards for Menards and others.)

The restructure thing is also done in banks. This is a self-assessed exam and the penalty for failure is death.

If you believe what Fifth Third said in their conference call the stock is a no brainer. But the company has an incentive to lie - as do all banks with severe problems...

Too trusting - that is what you are...


Anonymous said...


Are you concerned that the restructed loans inlcuded in the NPAs are only consumer loans? Could this suggest that either (i) no commercial loans have been restructured; (ii) commercial loans have been restructured but have not been included in the NPAs?

John Hempton said...

I haven't checked whether your assertion is true... but I am very concerned about the mix of the NPAs.

Think about it this way. An individual has a mortgage that they hope to pay but are a little stretched. Their income is viable. They miss a payment.

Its better than 50% chance that they won't default. Actual payment is best correlated with wanting to pay. Moreover if you do default you will get at least 50% back. The right provision is BELOW NPAs.

Now if you have a large (say 10 million dollar) commercial loan which is unsecured. That will be paid come-what-may. And if it can't be paid there is generally NOTHING left.

So when it goes deliquent it probably defaults - and the severity is high.

Fifth Third's provisions have moved from the first camp to the second. That worries me.


Anonymous said...

Many loans become non-performing after being in default for 3 months, but this can depend on the contract terms you apply for.

Anonymous said...

Thank you sharing this interesting information.Non Performing Asset means an asset or account of borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss asset, in agreement with the directions or procedure relating to asset classification issued by Reserve Bank.

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