Prompt Corrective Action Orders Do Not
Effectively Forecast Bank Failures

A firm on the internet, using Prompt Corrective Action orders, provides an unofficial Problem Bank list of 1,004 financial institutions. IDC Financial Publishing, Inc. (IDC) used its published first quarter 2011 ranks, which measure the safety and soundness of banks and thrifts, to evaluate this unofficial list. IDC has ranked 99% of all failures since 1989 with ranks less than 75 (Lowest Ratios) up to 5 months prior to failure. IDC ratings of 75-124 are below average, 125-164 average, 165-199 excellent, and 200-300 are superior. Of the list of 1004 unofficial problem banks, only 315 were rated a 1 by IDC, potential for near term failure. An additional 315 were rated 2-74, on IDC’s Watch List for potential failure or high risk. The below average category had 169 banks, the average category had 111, excellent rated banks with Prompt Corrective Action Orders were 54, and superior rated banks on the list numbered 39. Only 63% of the unofficial list matched IDC’s watch list. Banks with good to excellent and even superior ratings equaled 37% of the unofficial list. Dragging down the good with the problem financial institutions, using a single indicator, does not seem appropriate in the sensitive area of banking.

The next test of using Prompt Corrective Action Orders to forecast problem banks examined all banks with action letters requiring capital actions, numbering 736 in total from first quarter 2008 to the first quarter of 2011. Action orders not requiring capital changes are far less severe corrective actions.

* Action orders requiring increased capital
** Bank failures with capital changes on action orders
*** IDC rank less than 75 for quarter prior to action order

Since January 1, 2008, bank and thrift failures totaled 369, of which 172 had Prompt Corrective Action Orders for capital increases. IDC’s watch list, rankings of 74 or less, missed only 3 out of the 172 using published ranks available when the action orders were issued. Simply, since 2008, using Prompt Corrective Action Orders to build an unofficial list of potential bank failures is ineffective. IDC ranks were 98% correct on the 172 banks with action orders for capital increases. Even using action orders which required increases in capital ratios, the vast majority by quarter since January 1, 2008 did not fail.

IDC does not feel it is appropriate to use a single indicator, such as action orders, to forecast problem banks. The reputation of a bank is too valuable to list it as a problem bank or hint of potential failure on the basis of one ineffective indicator.

This article is authored by John E. Rickmeier, CFA. Mr. Rickmeier has over 30 years of experience in evaluating depository institutions. As CEO of IDC Financial Publishing since its founding in 1984, Mr. Rickmeier and his analytical team currently evaluate and rank quarterly over 16,000 banks, thrifts, and credit unions. IDC ratings of financial institutions have become the standard in evaluating the safety and soundness of institutions issuing brokered certificates of deposit. IDC ratings are also used by the Federal Reserve banks, Fannie Mae, Freddie Mac, Ginnie Mae, insurance and credit card companies, state and municipal governments, financial firms specializing in brokered certificates of deposit, individuals and institutions investing in certificates of deposit, and individuals concerned about their bank safety rating.

Mr. Rickmeier can be reached at IDC Financial Publishing, Inc., 700 Walnut Ridge Drive, Suite 201, Hartland, Wisconsin 53029. Voice 1-800-525-5457 or email info@idcfp.com Website for IDC Financial Publishing Inc. www.idcfp.com