Net Write-Offs

Net write-offs represent the difference between the loans and receivables deemed uncollectible (gross write-offs) and any recoveries made on write-offs from previous periods (recoveries) in an accounting period. The formula to calculate net write-offs is as follows.

This metric (relative to loans plus accounts receivable) provides insight into the company’s credit risk management and the current quality of outstanding loans. During periods of loan quality deterioration, net write-offs tend to increase relatively fast, while lower net write-off figures mean improved credit quality. Net write-offs are typically disclosed in supplementary financial information, and they can provide insights into a company’s financial health and the overall economic environment. Investors and regulators use them to analyze a bank or financial institution's loan performance and financial position.

All Values Are in Millions of CAD$

Source: WOWA Data Labs

Net write-offs are taken from the allowance for credit losses (ACL), a contra-asset account on a balance sheet. Gross write-offs reduce the ACL while recoveries increase it. This means that positive net write-offs reduce ACL, and negative net write-offs increase it.

Net write-offs consist of two components: Gross write-offs minus recoveries. Net write-offs represent the final reduction in the outstanding loan balance after accounting for initial write-offs and subsequent recoveries of previously written-off amounts.

It accounts for loans and receivables deemed uncollectible during a specified period. When a loan is written off (partially or fully), the written-off portion is removed from the loan portfolio and charged against a contra-asset account - Allowance for Credit Losses (ACL). Gross write-offs reflect how much a company incurred credit losses during a specified period. It is important to note that gross write-offs can be recovered, so they may be adjusted in the future.

If some previously written-off loans are recovered, they are accounted for in the recoveries. These recoveries increase the ACL and offset the gross write-offs. They occur when a borrower repays some or all of their outstanding loans that have been written off as uncollectible.

By analyzing these components, an investor or regulator can more clearly understand the net write-off's implication over a specific period. High gross write-offs relative to recoveries indicate an increased credit risk and borrower’s decreased ability to pay off their debts in full. In contrast, increased recoveries show more effective collection efforts and borrower's financial performance.

Net write-offs are not explicitly shown in the primary financial statements, such as an income statement, balance sheet, and cash flow statement. This is because they are non-cash events, so they do not directly affect the company's cash flow. Instead, it is reflected through an adjustment to the allowance for credit losses (ACL), a contra-asset account on the balance sheet. The ACL estimates potential losses from customers with unrepaid loans. This approach ensures that the corporations’s financial statements accurately reflect the financial health and loan portfolio performance.

Financial institutions provide a breakdown into gross write-offs and recoveries from previous write-offs in the Changes in Allowance for Credit Losses (ACL) statement. This statement is presented in the supplementary financial information. The net write-offs can be calculated by subtracting the value of recoveries from the gross write-offs.

In the supplementary financial information, banks and financial institutions also break down net write-offs by industry and geography and provide historical values. This is especially important information for banks and financial institutions because a large part of their business is concentrated in loans and deposits.

Suppose we want to follow the formation of the Bank of Montreal's net write-offs for Q4 2024. Looking at the supplementary financial information, we should first consider the Changes in Allowance for Credit Losses (ACL) statement.

Source: BMO Supplemental Financial Information Q4 2024.

We can see that the BMO recorded $1,414 Million in write-offs and $170 Million in recoveries during Q4 2024. We can calculate the Net Write-Offs using the following formula:

Now we know the net write-offs. Before we can dive into the breakdown of net write-offs, we can analyze what is happening with the gross write-offs and the recoveries.

We can see that the gross write-offs increased significantly during Q4 2024 compared to previous quarters. The increase is more than double from the previous quarter and triple from the 4th quarter of the previous year. This sharp increase in the write-offs may indicate a deterioration in loan portfolio performance or slacking economic conditions.

The recoveries has also increased compared to the previous quarters, but they have not increased as significantly as the write-offs. The increase in the recoveries may be due to increased write-offs from previous quarters, or it could mean that the individuals are trying harder to pay off uncollectible loans.

Now, we can look at the net write-offs to consider a more thorough breakdown.

Source: BMO Supplemental Financial Information Q4 2024.

Using this breakdown, we can see that there has been a large increase in write-offs from businesses and governments in Canada and the United States. This sharp increase may signify that some businesses struggle with slacking economic conditions. Using the net write-offs table, we can also look into what industries struggle the most with repaying loans. We can see that some of the largest net write-off increases happened in the following industries:

• Commercial Real Estate
• Wholesale Trade
• Manufacturing
• Service Industries

These industries are likely the most affected by a slowing economy, but others may be more resilient.