PORTFOLIO ANALYTICS
Your Charge-Off Number Isn’t Telling You Enough
Knowing how much you charged off matters. Understanding which accounts produced those losses—and when—is what makes the information actionable.
By Tim Wood, CPA | Aspire CFO
An operator tells me:
“Our charge-offs have been pretty consistent.”
My first question is usually: Consistent how?
Are we talking about the number of accounts charged off? The dollars charged off? A percentage of the portfolio?
And, more importantly, are we considering the pool of originations that actually produced those charge-offs?
A monthly charge-off number is useful. But by itself, it doesn’t tell you enough about what’s happening inside your portfolio to make good decisions about underwriting or collections.
Start With the Accounts
Suppose you charged off $100,000 this month.
Before deciding whether that’s good, bad or simply consistent with recent history, I want to understand what produced that $100,000.
Start with the individual accounts.
When was each account originated?
When was it charged off?
What was the original amount financed?
How much was ultimately charged off?
Were there recoveries?
Those details begin to tell the story behind the number.
Two portfolios can each report $100,000 of charge-offs while having very different underlying performance.
When the Loss Occurs Matters
An account originated six months ago that has already charged off is very different from an account that performed for several years before eventually becoming a loss.
Both may appear in the same month’s charge-off total.
But they shouldn’t necessarily lead you to the same conclusion.
Where an account charges off in its lifecycle matters.
If losses are beginning to occur earlier, that may tell us something about newer originations. If accounts are surviving longer before charging off, that tells us something different.
The timing can also help us ask better questions.
Are particular origination periods performing differently?
Are losses occurring earlier or later than they have historically?
Has loss severity changed?
Are recoveries affecting the ultimate loss?
Are changes in underwriting or collections showing up in portfolio performance?
An aggregate monthly charge-off number can’t answer those questions.
Put the Loss Back Into Its Origination Pool
This is where static-pool analysis becomes valuable.
Rather than looking only at losses occurring during a particular month, static-pool analysis groups accounts based on when they were originated and follows the performance of those pools as they mature.
Now we can put the losses back into context.
Consider two groups of accounts that each generate $100,000 of charge-offs.
If one came from $500,000 of original originations and the other came from $1 million, those aren’t equivalent results.
The same applies to timing. If one pool reaches a particular level of cumulative losses after 12 months while another doesn’t reach that level until much later in its lifecycle, that distinction matters.
Looking at origination pools allows us to compare portfolio performance on a more consistent basis and see how losses develop over time.
The Goal Isn’t Another Report
Static-pool analysis can easily become another spreadsheet or report that gets produced every month and then filed away.
That’s not the point.
The analysis should influence decisions.
If newer pools are producing losses earlier than historical pools, we should understand why.
Did underwriting change?
Did the customer profile change?
Did deal structure change?
Are customers financing more?
Did collections practices change?
If performance is improving, we should understand that too.
The objective isn’t simply to identify that something changed. It’s to understand the underlying drivers well enough to determine whether changes to underwriting, collections or other operating decisions are warranted.
Don’t Let a Consistent Number Create False Comfort
Charge-offs are important. They tell you what you’ve actually lost.
But a charge-off number without context can create a false sense of consistency.
Know which accounts charged off.
Know when they were originated and when they failed.
Know what was originally financed, what was ultimately charged off and what was recovered.
Then put those losses back into the context of the origination pools that produced them.
Because knowing how much you lost is only the beginning. Understanding where the loss came from—and when—is what helps you decide what to do next.
Related Insight: What Should a Fractional CFO Do for an Independent Auto Finance Operator?
What Are Your Charge-Offs Actually Telling You?
Aspire CFO uses portfolio and static-pool analysis to help independent auto finance operators understand where losses are developing and what deserves attention.