Business Glossary

1. loan written off as uncollectible bad debt. When full repayment is considered unlikely, loans are removed from the lender's balance sheet and charged against the loan loss reserves account for bad debt. Loans removed from the lender's books may be partially or fully recovered by the lender's collection department or an outside debt collection agency if the loan is secured by collateral or the borrower has additional assets that are not secured by the debt. Closed bank accounts are also removed from bank records by charging them off. Also called write-off. See also bad debt; problem loan; workout agreement.
2. process of removing uncollected loans or closed accounts from a bank's balance sheet.

loans and other assets that are at risk to some degree, in the opinion of bank examiners. Such assets fail to meet acceptable credit standards, and totals of classified loans are reported separately in bank call reports. State and national banking examiners have adopted uniform guidelines (the National Bank Examiners risk classification system) listing poorly performing loans as follows, from worst to least serious: loss, or complete write-off; doubtful loan, where repayment in full is questionable; substandard, where some loss is probable unless corrective actions are taken; and special mention, indicating such potential problems as missing documentation or insufficient collateral.

Supervisory agencies require that lenders write down loans classified as doubtful to 50% of the original book value and loans classified as loss by 100% in calculating their net capital (adjusted capital plus reserves for possible loan losses) available for making new loans.

valuation reserve against a bank's total loans on the balance sheet, representing the amount thought to be adequate to cover estimated losses in the loan portfolio. When a loan is charged off, it is removed from the loan portfolio as an earning asset, and its book value is deducted from the reserve account for loan losses. Lenders also set aside reserves for a nonaccrual loan, in which interest and principal payments are no longer being collected. Recoveries from the liquidation of collateral repossessed from the borrower are credited to the reserve account. The tax reform act of 1986 disallowed the tax deduction of loan loss reserves held by banks with assets over $500 million.