Banks and financial institutions that make loans always expect a proportion of those loans to fail. The borrower will default and the bank will not collect the full amount owed. Those loans are charged off. Institutions usually publish their charge-off rates, as part of their financial reporting. These rates can indicate how good the bank’s underwriting process is -- the lower the charge-off rate, the tighter the lending standards.
Begin with the gross charge-offs for the year -- that is all loans that have been written off by the bank as probably uncollectible.
Subtract from the gross charge-offs the total amount of charged-off loan money that has actually been recovered from delinquent borrowers over the year. This gives the net charge-off amount.
Divide this net charge-off amount by the average level of loans outstanding over the year, to give the annualized net charge-off rate.
Tips
If you only have one quarter’s results available, complete the calculation, then multiply by four to obtain the annualized rate. If you have one month, multiply by 12.
References
Tips
- If you only have one quarter’s results available, complete the calculation, then multiply by four to obtain the annualized rate. If you have one month, multiply by 12.