Charge-Off Rate (Credit Card)

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 likewise be calculated understandably to show the total percentage of credit card balances in default.

Instructions to Calculate Credit Card Charge-Off Rates

The charge-off rate is equivalent to the value of credit card fund balances in default partitioned by the total outstanding balance on cardholder accounts. The interaction is ordinarily finished as follows:

The charge-offs that are written off by a credit card company are totaled for the year.
The credit card company deducts any payments they received from defaulted purchasers to show up at the net charge-off total.
The net charge-off total is separated by the average loans outstanding.

What Does a Charge-Off Rate (Credit Card) Tell You?

A credit card charge-off rate is a measure utilized while examining credit card loan performance. Companies regularly compute charge-off rates for all categories of loans on their balance sheet. A credit card is regularly charged off when an account is in default, which for the most part results when the credit card company hasn't received basically the base payment in more than 180 days.

As such, borrowers can commonly gather loan delinquencies for as long as 180 days before a loan is charged off and thought about in default. In any case, a few lenders work out their charge-off rates utilizing loans that are in default past 120 days.

Lenders as a rule integrate loss reserves into their expense management programs to check the effects of charge-offs. Now and again, lenders might in any case have the option to receive repayment on defaulted debt due to continuous debt assortment activities.

In the event that a credit card company has tight lending standards, meaning it just loans to the most creditworthy consumers, it's probably going to have a lower charge-off rate than companies with looser lending standards.

Charge-off rate data can be an important measurement 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 expanding. Loan-loss reserve levels are additionally one more important measure for credit card company investors since companies normally designate loan loss reserves in light of 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 additionally accumulated to show charge-offs by loan categories. Industry participants ordinarily follow charge-off rates to comprehend and integrate charge-off trends into the risk management program. Overall, economic conditions can essentially affect charge-off rates with higher unemployment being a lead catalyst for increases in charge-offs.

Illustration of Credit Card Charge-Off Rates

The Federal Reserve reports industrywide charge-off rates quarterly by loan category. As of the principal quarter of 2020, credit card loans from all commercial banks had a charge-off rate of 3.76%. The credit card charge-off rate was higher when compared to the 0.93% charge-off rate for other consumer credit products.

As we stated before, economic conditions impact credit card charge-offs. "For instance, in the fourth quarter of 2009, at the level of the Great Recession, the credit card charge-off rate for the industry was 10.51%. Thus, we can see that the better economy in subsequent years has prompted lower charge-offs when compared to the recession in 2009.

Illustration of How to Use Charge-Off Rates (Credit Cards)

Below is a portion of the investor show from the credit card issuer, Capital One Financial Corporation (COF). At the lower part of the table, we can see that Capital One recorded a net charge-off rate of 2.63% in Q4 of 2020 for their Credit Card division, down from 4.31% in a similar period in 2019. The following are a couple of focal points from their report:

The charge-off rate of 2.63% was below the average rate of 3.76% reported by the Federal Reserve Bank for a similar period.
The net charge-off rate for Capital One credit cards has been declining over the long haul.
Investors hoping to invest in Capital One ought to monitor the charge-off rate trend to check whether it keeps on working on in the forthcoming quarters. In the event that it does, Capital One could see an increase in profitability or earnings. Nonetheless, assuming the rate increases fundamentally, that may be an indication that the economy is debilitating, 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 currently in default. At the end of the day, it's anything but a predictor of defaults, yet all things considered, it's a retrogressive looking indicator.

Likewise, credit card charge-off rates can fluctuate among financial companies. For instance, a bank that has a small portion of its outstanding loans in credit cards might have a lower charge-off rate than a company that principally issues credit cards. In any case, the bank with a lower charge-off rate could not really be a better investment. It's important to take a gander at the charge-off rates for all of the credit products that a bank offers to show up at a complete image of a bank's credit quality.

Features

Both charge-offs and loan-loss reserves can influence a credit card company's profitability.
The credit card charge-off rate shows the percentage of credit card balances in default as compared to the total amount of credit outstanding.
Investors who own stock in credit card companies ought to monitor whether charge-off rates have been stable, or whether they have been decreasing or expanding.