A non-performing loan (NPL) is a loan that is in default ( loan default is the failure to meet the legal obligations (or conditions) of a loan) or close to being in default. In Nigeria Non Performing Loans are defined as loans that have their interest or principal that is due and unpaid for 90 days or more, as well as interest payments equal to 90 days interest or more that have been capitalised, rescheduled or rolled over into a new loan. In simple terms, a loan is tagged as non-performing when it ceases to generate income for the bank/lender.
A Case Study of how a Non – performing Loan can happen
In February 2019 Mr. John, an industrial shoe-maker in the city of Aba got a major distributor for his products in the neighboring Benin Republic and decided to expand his production and supply his new distributor by exporting through the land borders.
To achieve this he needed more machines and working capital for increased production which would cost N20, 000, 000 but the cash was not readily available. Having kept accurate business records for the past 2 years, he decided to take a loan from a financial institution.
Due to his hurry, he did not approach a development bank or commercial bank for the loan and instead he applied to a Microfinance bank. After 3 weeks, he got the loan at 10% flat per month ( which translates to 120% per year) with a repayment tenor of 6 months, and the fund was channeled into procuring machines and raw materials needed for production.
He started production in June and rounded up with packaging in late July of 2019. When it was time to deliver the goods to his distributor in Benin Republic, the Federal Government announced the ban on exporting goods through the land borders. John could not sell the huge volume of goods in the Nigerian market due to the sluggish local economy and with the land borders closed the other alternative was to ship by air which was expensive and would wipe all his profits from the transaction.
It was already 3 months into the loan and he could not continue paying the principal and interest on the loan from his regular local sales and he became frustrated after the bank started writing warning letters to him. After 6 months of regular loan default by John the bank is about to seize the business assets and real estate property used to secure the loan which will ruin him financially. John discussed his problems with other business associates who had faced similar challenges in the past. They recommended a business consultant who had helped them restructure their business to enhance their loan repayment capacity and also negotiated with the banks on modifying the terms and conditions of the loans through a loan workout for easier repayment. John booked an appointment with the Consultant who analyzed the issues and worked with him towards resolving the loan repayment problem.
What you should know about Loans
A secured loan is a loan in which the borrower pledges some asset (e.g. a moveable assets or real estate property) as collateral for the loan, which then becomes a secured debt owed to the creditor/Lender who gives the loan. When you take out a secured loan, you give the lender a legal interest in some of your assets, making them “collateral.” If you don’t repay the loan, the lender can take the collateral to recover the unpaid funds.
There are two purposes for a loan secured by debt. In the first purpose, by extending the loan through securing the debt, the creditor is relieved of most of the financial risks involved because it allows the creditor to take ownership of the property in the event that the debt is not properly repaid. In exchange, this permits the second purpose where the debtors may receive loans on more favorable terms than that available for unsecured debt, or to be extended credit under circumstances when credit under terms of unsecured debt would not be extended at all.
The creditor/Lender may offer a loan with attractive interest rates and repayment periods for the secured debt. Since there’s less risk to lenders, secured loans are easier to qualify for, even if you don’t have good credit — but some of these loans may end up being costly for borrowers who are not careful.
Loan approval is usually communicated through a formal offer letter from the Lender to the Loan applicant. The offer letter contains the amount of the loan approved and terms and conditions attached to the loan including tenor, interest rate, monthly repayments and loan covenants which is a list of dos and don’ts for the borrower.
Why Borrowers default on Loans
A default can occur when a borrower is unable to make timely payments, misses payments, or avoids or stops making payments. There are many reasons why a borrower might default on a loan and these reasons include:
- Sudden and unexpected Government policies: The business environment is constantly influenced by government policies. Who would imagine that just months after Nigeria signed the free trade agreement that she would close her land borders. Government policies can also influence interest rates which in turn increases the cost of borrowing in the business community.
- High-Interest Rates: High interest charged by some financial institutions have been discovered to be the reason behind the alarming default. Some charge as much as 10% per month. A 10% interest on N500,000 translates to N50,000 per month and for a whole year, the borrower would pay N600,000 as interest on the N500,000.
- Borrowing beyond your capacity: You look at your peers and buy as much as possible with borrowed funds without thinking about whether your income is sufficient to repay these loans after meeting your day to day requirements.
- Loss of employment/income generation: You borrow based on the salary you get monthly from the employment/income from the business. If you lose the job or have to close down the business, the loan repayment will be affected.
- Lack of financial planning: Proper financial planning enables one to estimate the repayment obligations and allocate resources accordingly. When there is no financial planning or where the financial planning inefficient, the surplus may not be sufficient to repay loans.
- Extravagant living style: Your living style can eat away a major part of your income leaving little or no surplus for repaying the loan obligations.
- Contingencies: Sometimes, some unexpected events may disrupt all your financial plans. For example, you may not be able to repay the loans if you have to spend a substantially large amount for medical expenses of yourselves or our parents, spouse or children. However, planning by taking a healthcare insurance policy can avert such occurrences.
What Is a Loan Workout Agreement?
A loan workout agreement is a mutual agreement between a lender and borrower to renegotiate terms on a loan that is in default. A workout agreement is only possible if it serves the interests of both the borrower and the lender.
Generally, the workout includes waiving any existing defaults and restructuring the loan’s terms and agreements. A loan workout can involve a variety of adjustments to the original loan agreement, such as spreading the payments over a longer period of time, writing off part of the loan balance, reducing the interest rate, and so forth.
The renegotiated terms will generally provide some measure of relief to the borrower, in terms of reducing the debt-servicing burden through reasonable measures provided by the lender. A workout agreement intends to help a borrower avoid foreclosure, the process by which the lender assumes control of a property from the borrower due to a lack of payment as stipulated in the loan agreement.
While the benefits to the borrower of a workout agreement are obvious, the lender also has an interest in allowing these adjustments, since the alternative may be the bankruptcy of the borrower or its complete nonpayment, which will require the lender to engage in expensive foreclosure activities.
Workout agreements apply to liquidation scenarios as well. A business that becomes insolvent and cannot meet its debt obligations may seek an arrangement to appease creditors and shareholders. Workout agreement terms will vary. A lender is not under any obligation to restructure the terms of a loan, so it is incumbent on the borrower to find out the best way to negotiate with its Lenders.
Have you defaulted or about to default on a business or personal loan and worried about the Bank foreclosing on your property or ruining your credit reputation? We can help you resolve the challenges by analyzing and restructuring your business to increase your repayment capacity and negotiating with your lenders for a loan workout.
To learn more contact us on +234 (0) 817 908 4185, 0815 8300437 or visit our website: www.highnetresources.com