What it is:
Nonperforming assets are a bank's nonperforming loans plus the owned by the bank due to foreclosures.
How it works (Example):
On a bank's balance sheet, loans made to customers are listed as assets. The biggest risk to a bank is when customers who take out loans stop making their payments, causing the value of the loan assets to decline.
After a certain amount of time, a bank will try to recoup its money by foreclosing on the property that secures the loan. Once the bank legally owns the property, it is classified as real estate owned (REO) on the bank's balance sheet.
Nonperforming assets are footnoted on the balance sheet.
Why it Matters:
The higher the amount of nonperforming assets, the weaker the bank's revenue stream. In the short term, many banks have the ability to ride out an increase in nonperforming assets -- they might have strong reserves or other capital that can be used to offset the losses. But after a while, if that capital is used up, nonperforming loans will imperil a bank's health. Think of nonperforming assets as dead weight on the balance sheet.