How it works (Example):
Let's assume Bank XYZ lent $1,000,000 to Company ABC, which much repay the loan in monthly installments of $25,000. Company ABC makes payments on the loan for two years, then encounters cash flow problems and stops making the payments.
Three months go by without a payment from Company ABC. At this point, Bank XYZ has a nonperforming loan. The longer Company ABC goes without making a payment, the less likely it is that Bank XYZ will ever get its money back.
Why it Matters:
Nonperforming loans are the bane of the lending world's existence. The represent debts that are probably not going to be repaid, thus posing cash problems to their lenders. Additionally, banks that have too many nonperforming loans may come under heavy scrutiny from the FDIC, which provides significant incentive to restructure or renegotiate nonperforming loans before they're too far gone to recover any money at all.