IDC’s Ratings of Banks and Thrifts
Confirmed by IDC’s Stress Tests

IDC Financial Publishing, Inc.’s (IDC) stress tests banks, bank holding companies, and thrifts on a quarterly basis. The stress test projects potential net write-downs based on percentage loss expectations of the FDIC and Federal Reserve but subtracting the loan loss reserves and pre-tax profit and loan loss provision. The adjusted Tier I capital and assets, reduced by net write-downs, provides a worst case Tier I capital ratio. Given a worst case Tier I ratio less than 4% determines the required new Tier I capital addition.

IDC rates banks and thrifts from 1 (the lowest) to 300 (the highest) with a rating of 74 or lower establishing the watch list of problem banks. All but 2 banks with a stress test capital requirement of 100% of current Tier I capital were rated 74 or lower (mostly ratings of 1). All thrifts with a stress test requirement of 100% of current Tier I capital were rated 74 or lower (mostly ratings of 1). A similar result occurred in the stress tests on bank holding companies.

Too Big to Fail

The stress test on bank holding companies revealed two large institutions with sizeable capital requirements. IDC estimates Bank of America Corporation requires $51.9 billion in new Tier I capital using the same stress test applied to all banks, bank holding companies, and thrifts. Bank of America announced on May 7th a need for $33.9 billion more in Tier I capital. The increase in stress test net write-downs was due to a second quarter 2011 decline in loan loss reserves and pre-tax profit. The IDC estimate of $51.9 billion or 34% of current Tier I capital coincided with an increase in the 5-year CDS level from 150 in July to 400 on August 23 and 340 in early September of 2011. Bank of America raised an estimated $20 billion in new equity in August 2011.

The second bank holding company with large capital requirements was MetLife, Inc. IDC estimated new Tier I capital in the amount of $43.4 billion, or 116% of current Tier I capital, was needed. Coincident with the timing of the new capital required, the CDS level of MetLife rose from 150 in July to 300 in late August 2011. Mortgage securities and other investments increased from $150 billion as of March 31, 2009 to $271 billion on June 30, 2011. The stress test percentage loss estimate of 24% on these loans created a chronic need for new capital. Loss rates on these securities less than 24% would reduce capital required.

Mortgage-backed securities at MetLife were priced at 88.5 in the fourth quarter of 2008 and increased in value to 102.3 as of June 30, 2011. These current valuations support a lower loss expectation. A further note, IDC rates MetLife, as a bank holding company, at 124 (below average) due to their total risk-based capital ratio of 9.2%, below the well-capitalized requirement of 10%.

For a more in-depth look at IDC’s methodology and CAMEL analysis, review “how-it-Works” at IDC’s home page and view sample reports.

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.

1-Though not currently used as a component to rank financial institutions, IDC has been monitoring CDS spreads, a form of insurance on debt repayment. CDS spreads can be an indicator of investors’ lack of confidence in the ability of issuers to repay debt. These spreads represent costs on $10 million of debt.