Net Charge-off (NCO) is a term used to describe the amount a lender is unable to recover from a borrower’s debt. It is an important measure that lenders use to evaluate the credit risk of its borrowers. NCO represents the amount owed to the lender after all available recovery options have been exhausted.

NCO 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.