Financial institutions, credit unions, CMBS, and other lenders are all too familiar with non-performing debt and currently find themselves in a unique situation with enforcement mechanisms limited due to the shutdown of many courts and offices, the curb on enforcement by certain authorities, or the perceived cost of enforcement.   

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Each borrower who defaults on a loan negatively impacts that lender, resulting in additional paperwork and internal protocols and, if legal action is required, legal fees and costs which are always unpredictable and uncertain.

In 2019, 0.89% of U.S. loans were non-performing. That number will increase exponentially for 2020 and 2021 thanks to the global pandemic and economic crisis.

Managing Non-Performing Debt, and Why Does it Matter?

Non-performing debt is complicated because it requires a lot of attention by the impacted lender (or lenders), mandates the spending of new money to manage that defaulted loan, may require legal counsel, and enforcement is highly regulated by both State and Federal agencies.   

In the banking world, commercial loans are considered non-performing if the borrower is 90 days late in paying. The International Monetary Fund considers loans that are less than 90 days past due as non-performing if there’s a high likelihood that there will not be future payments.   Further, regulators require that non-performing loans be reported and that, for each non-performing or defaulted loan, certain cash reserves are set aside by the institution to cover a percentage of the losses that loan may generate.    

So why does non-performing debt matter?

When a bank has too many non-performing loans on its books, it doesn’t just lose money, but it also has less money available for new loans, which can put prospective borrowers in a bind trying to find financing. We’re seeing that currently with fewer types of loans available for borrowers during the COVID-19 pandemic. Many banks tapped their resources (both financial and human) with the PPP and EIDL loans and closed off other lending options temporarily.

Banks must report their non-performing loans to total loans ratio as a measure of credit risk, and that can put a negative cast on a company that is otherwise performing well. Banks with a large amount of non-performing loans may be a less attractive stock investment. If a bank’s percentage of non-performing loans increases, it could cause its stock price to go down. 

Non-Performing Debt Thanks to COVID-19

The mortgage delinquency rate increased by nearly four percentage points to 8.22% during the second quarter of 2020, the highest since 2011.

Businesses across industries are shuttering as defaults rise: as an example, 30 owners of shopping malls and storefronts in the Greater Chicago area were delinquent on loans backed by more than $630 million in bonds.  Both urban and suburban areas are suffering, with hospitality (hotels and restaurants) and retail bearing the brunt of the COVID-19 shutdowns. Many small businesses are not equipped to weather months of closure without a significant outlay of capital or additional loans.  Loans for which they are no longer qualified.    

As such, lenders can expect even more non-performing debt in the near future.

Options for Dealing with Non-Performing Debt

So what options do lenders have to at least try to recoup some of the lost cost of non-performing debt? 

For secured loans, banks can seize assets, foreclose on a property, or repossess a car. For unsecured loans, it gets more complicated.

They can sell their outstanding debt to a collection agency or outside investors at a discount, but this is costly, as these entities will take 25-50% of the amount collected and the lender will receive pennies on the dollar. It’s also time-consuming.

Lenders can wait and hope the borrower pays, but warehousing debt on the balance sheet can reflect poorly on the company’s financials and must be written off eventually, depending on their regulatory requirements.

Then there’s litigation, traditionally an expensive endeavor. It’s hard to predict costs, and the cost of litigation might outweigh the amount you’re trying to recover in the dispute.  

A Better Way to Recoup Non-Performing Debt

A better option to resolve debt is online dispute resolution or arbitration. It offers predictable pricing, typically at a fraction of the cost of litigation. Arbitration offers the same efficacy as traditional means, and technology creates efficiencies of time and cost.  Online arbitration is simple to use, done at a flat fee, and is resolved quickly and efficiently.  Companies like Ejudicate create an easy to use online portal for the submission and service of arbitration claims. 

Having an arbitration clause in your loan documents is fairly standard and, with these new online services, it is an easy and cost-effective process to obtain an award and judgment against the defunct borrower.   

Simply reducing your non-performing debt into a judgment will facilitate clearing it off of a lender’s books and will lead to a projected increase in the ability to collect on that judgment (or, sell it a higher value as it is now reduced to an enforceable judgment).  

And, with a post-arbitration award and pre-judgment, there is a significant opportunity for settlement, resolution, and collection.

If you are facing non-performing debt, consider online arbitration with a company like Ejudicate as online arbitration and its efficiencies allow for recovery potential on debts that would otherwise be written off.