Net Charge-Off (NCO)
Candlefocus EditorNCO is the difference between gross charge-offs and recoveries of delinquent debt. Gross charge-offs are the total losses that a lender incurs when a borrower fails to repay a loan. Recoveries are collections of a portion of the loan principal plus interest that the lender is able to recoup. The net charge-off is the sum of all losses remaining after subtracting all reclaims obtained.
NCO is used to help lenders assess the risk of their current and past loans. It is a useful tool to determine how well a lender is able to collect money owed, as well as to gain insights into how efficiently they are managing their loan portfolios. The worst-case scenario would be if a lender had a high net charge-off ratio, meaning it was not able to recover a significant portion of its loans.
The Federal Reserve Bank tracks aggregate net charge-off ratios for banks in the U.S. This allows the Federal Reserve to get a better understanding of the financial stability of the banking industry and to calculate the overall risk level. The Federal Reserve considers lending institutions with net charge-off ratios greater than 2% to be a riskier investment.
Net charge-offs are an important measure for lenders in understanding their credit risk and evaluating the performance of their loan portfolio. By understanding their net charge-off levels and monitoring them regularly, lenders can better prepare and manage their own risk exposer. The Fed’s analysis of the banking industry’s net charge-off ratios is a key part of financial stability in the U.S. banking system.