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.
1. Begin with the gross charge-offs for the year -- that is all loans that have been written off by the bank as probably uncollectible.
2. 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.
3. Divide this net charge-off amount by the average level of loans outstanding over the year, to give the annualized net charge-off rate.
- 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.
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