Financial metric · Banks
Nonperforming Loans and Allowance Coverage (Banks)
The nonperforming loan ratio is the share of a bank's loans that are not being repaid as agreed. The allowance for credit losses is the reserve the bank has set aside for losses it expects.
How to calculate it
Nonperforming loans = nonaccrual loans + loans 90 or more days past due and still accruing (definitions vary slightly by bank)NPL ratio = nonperforming loans ÷ total loansAllowance coverage = allowance for credit losses ÷ nonperforming loansNet charge-off rate = loans written off, net of recoveries ÷ average loansHow to read it
- Low nonperformers and a solid allowance mean good asset quality. Net charge-offs show losses actually realized; the trend in charge-offs often matters more than the level of nonperformers.
- Break it down by loan type. Commercial real estate, credit cards and consumer loans behave very differently in a downturn.
- Criticized and classified loans (special mention, substandard), disclosed by many banks, are the pipeline for future nonperformers.
Common pitfalls
- Since the CECL standard (ASC 326) took effect for large U.S. banks in 2020, allowances reflect expected lifetime losses on all loans, not just losses already incurred. Allowance coverage of nonperformers is therefore less comparable with older years and with banks reporting under other standards.
- Banks can reduce nonperformers by selling or charging off bad loans; a falling ratio is not always improving quality.
- Loan modifications for borrowers in difficulty can keep loans out of nonperforming status for a time.
Where to find it in a 10-K
The credit quality section of MD&A and the loans and allowance notes in the 10-K; quarterly earnings supplements. FDIC call report data for individual banks is free on the FDIC website.
U.S. vs. China reporting
Chinese banks classify loans into five regulatory categories (normal, special mention, substandard, doubtful, loss) and report an NPL ratio and provision coverage ratio against regulatory minimums. U.S. banks have no regulatory minimum for allowance coverage; CECL ties the allowance to expected lifetime losses instead.