What Is the Net Charge-Off Rate?

The net charge-off rate is the annualized ratio of net charge-offs (NCOs) to average loans outstanding. NCOs are a lender's gross charge-offs less recoveries of its delinquent debt.

The net charge-off rate measures the proportion of debt owed to a company that is unlikely to be paid back to that company. This "bad debt" will then be written off on its financial statements. NCO rates shed important information to investors and analysts about credit standards of lenders and the quality of their loan portfolio, and may also provide signals about general economic conditions.

Key Takeaways

  • The net charge-off rate is the percentage of a lender's debt outstanding that is delinquent or bad debt.
  • The net charge-off rate is used to evaluate the quality of a loan portfolio.
  • A high net charge-off rate indicates that a company believes it will never collect much of its debt, and lead investors or analysts to believe it has a very risky portfolio.

Understanding Net Charge-Off Rate

A net charge-off (NCO) is the dollar amount that measures the difference between gross charge-offs and any subsequent recoveries of delinquent debt. Debt that is unlikely to be recovered is often written off and classified as gross charge-offs. If, at a later date, some money is recovered on the debt, the amount is subtracted from the gross charge-offs to compute the new net charge-off rate.

The net charge-off rate is the percentage representing that amount of debt that a company believes it will never collect and is an indicator of a financial institution's loan portfolio performance. A high net charge-off rate, especially when compared to the previous period or to other banks, would suggest that the loan portfolio may be too risky.

Net Charge-off Rate = (Net Charge-off / Average Outstanding Loans) x 100

Non-performing loans may be charged off as bad debt and purged from the books, often on a monthly or quarterly basis. If and when part of the debt is repaid, the net charge-off can be calculated by finding the difference between the gross charge-offs and the repaid debt. A negative value for net charge-offs indicates that recoveries are greater than charge-offs during a particular period.

The charge-off rate of a credit card company is based on statistics identifying what debt is likely to default. A credit card company, for example, may post a 10.31% net charge-off rate, meaning that, for the specified period, the company expects that 10.31% of its debt will never be recovered.

Example

For instance, if a bank's average loans outstanding is $1 million and the net charge-off is $75,000, then the net charge-off rate would be

($75,000 ÷ $1,000,000) x 100 = 7.5%

Let's look also at a real-world example: Capital One Financial Corp (COF). reported that its total net charge-off rate in 2017, as a percent of average loans outstanding, was 2.67%. This was an increase in the net charge-off rate compared to the 2.17% figure it posted in 2016, or an increase of 50 basis points (bps). Per accounting rules, the bank applied the net charge-off amount to the loan loss provision.