What Is a Charge-Off Rate (Credit Card)?
The credit card charge-off rate is a measure that shows the percentage of defaulted credit card balances in comparison to the total amount of credit outstanding. Credit card companies track credit card charge off rates to monitor the performance of their credit card loans. Across the industry, a credit charge off rate can also be calculated comprehensibly to show the total percentage of credit card balances in default.
How to Calculate Credit Card Charge-Off Rates
The charge-off rate is equal to the value of credit card fund balances in default divided by the total outstanding balance on cardholder accounts. The process is typically done as follows:
- The charge-offs that are written off by a credit card company are totaled for the year.
- The credit card company subtracts any payments they received from defaulted buyers to arrive at the net charge-off total.
- The net charge-off total is divided by the average loans outstanding.
What Does a Charge-Off Rate (Credit Card) Tell You?
A credit card charge-off rate is a measure used when analyzing credit card loan performance. Companies typically calculate charge-off rates for all categories of loans on their balance sheet. A credit card is typically charged off when an account is in default, which usually results when the credit card company hasn't received at least the minimum payment in over 180 days.
In other words, borrowers can typically accumulate loan delinquencies for up to 180 days before a loan is charged off and considered in default. However, some lenders calculate their charge-off rates using loans that are in default beyond 120 days.
Lenders usually integrate loss reserves into their expense management programs to counteract the effects of charge-offs. In some cases, lenders may still be able to receive repayment on defaulted debt due to ongoing debt collection activities.
- The credit card charge-off rate shows the percentage of credit card balances in default as compared to the total amount of credit outstanding.
- Both charge-offs and loan-loss reserves can influence a credit card company’s profitability.
- Investors who own stock in credit card companies should monitor whether charge-off rates have been stable, or whether they have been decreasing or increasing.
If a credit card company has tight lending standards, meaning it only lends to the most creditworthy consumers, it's likely to have a lower charge-off rate than companies with looser lending standards.
Charge-off rate data can be an important metric for investors considering investing in credit card companies. Investors who own stock in credit card companies can follow whether charge-off rates have been stable, or whether they have been decreasing or increasing. Loan-loss reserve levels are also another important measure for credit card company investors since companies typically allocate loan loss reserves based on credit card charge-off trends. Both charge-offs and loan-loss reserves can influence a credit card company’s profitability.
Across the credit market, statistics are also gathered to show charge-offs by loan categories. Industry participants typically follow charge-off rates to understand and integrate charge-off trends into the risk management program. Overall, economic conditions can have a significant impact on charge-off rates with higher unemployment being a lead catalyst for increases in charge-offs.
Example of Credit Card Charge-Off Rates
The Federal Reserve reports industrywide charge off rates quarterly by loan category. As of the third quarter of 2018, credit cards had a charge-off rate of 3.64%. The credit card charge-off rate was higher when compared to the 0.87% charge off rate for other consumer credit products.
As we stated earlier, economic conditions impact credit card charge-offs. For example, in the fourth quarter of 2009, at the height of the Great Recession, the credit card charge-off rate for the industry was 10.54%. As a result, we can see that the improved economy in 2018 has led to lower charge-offs when compared to the recession in 2009.
Example of How to Use Charge-Off Rates (Credit Cards)
Below is a portion of the investor presentation from the credit card issuer, Capital One Financial Corporation (COF). At the bottom of the table, highlighted in red, we can see that Capital One recorded a net charge-off rate of 4.15% in Q3 of 2018 for their Credit Card division. Here are a few takeaways from their report:
- The charge-off rate of 4.15% was higher than the average rate of 3.64% reported by the Federal Reserve Bank for the same period (shown above).
- However, we can see from the table below that the net charge-off rate in Q3 of 2018 improved or decreased when compared to the same period in 2017. In Q3 2017, the net charge-off rate was 4.51%.
- Investors looking to invest in Capital One should monitor the charge-off rate trend to see if it continues to improve in the upcoming quarters. If it does, Capital One might see an increase in profitability or earnings. However, if the rate increases significantly, that might be a sign that the economy is weakening, or the bank is having financial difficulty or both.
Limitations of Credit Card Charge-Off Rates
The charge-off rates reported by companies show the percentage of accounts already in default. In other words, it's not a predictor of defaults, but instead, it's a backward-looking indicator.
Also, credit card charge-off rates can vary among financial companies. For example, a bank that has a small portion of its outstanding loans in credit cards may have a lower charge-off rate than a company that primarily issues credit cards. However, the bank with a lower charge-off rate might not necessarily be a better investment. It's important to look at the charge-off rates for all of the credit products that a bank offers to arrive at a complete picture of a bank's credit quality.