Washington State Department of Financial Institutions has listed on their website “IDC has a remarkable track record of identifying deteriorating or improving performance months, and sometimes years, before it becomes apparent to other ranking companies.” From 1990 to 2018, there were 1,423 failures of banks. Of these, 89% (1,272 banks) were ranked less than 125 by IDCFP up to 17 months before failure. Further, 73% (1,033 banks) were rated less than 125 by IDCFP up to 29 months before a collapse.
IDC Financial Publishing’s (IDCFP) CAMEL ratings of banks, savings institutions, and credit unions range from 300 (the top grade attainable) to 1 (the lowest). From the early 1990’s, through today, institutions using IDCFP’s CAMEL ranks determined that ratings lower than 125 were deemed below investment grade. This article discusses banks which issued brokered CDs, how IDCFP’s ranking of these banks predicted institution failure and the banking crisis of 2008 to 2009, and also provides an outlook for the future.
The red line in Chart I plots the numbers of banks with an IDCFP rank less than 125. The number of these high risk banks reached peak levels in the early 90’s (A, Chart I), following the banking crisis in the late 80’s. The number of high risk banks issuing brokered CDs then declined and stabilized at low levels until 2006.
IDCFP’s Ranks Forecast the Banking Crisis of 2008 - 2009
In early 2006, the number of banks with an IDCFP rank below 125 began to accelerate (B). At the end of that same year, banks with a rank of 125 or higher, peaked at 1800 (C) and began a decline. Together, the change in the numbers of these banks forecast the crisis of 2008-2009. The peak and decline in the red line (D) illustrates the end of the banking crisis, and the beginning of the resolution of high risk banks.
The second quarter of 2009 produced the largest number of institutions with an IDCFP rank below 125, reaching peak level (see Chart I). In 2009 Q2 all banks with brokered deposits, time deposits and CUSIP numbers for outstanding CDs numbered 2,257. Out of this total, 1,177 (52%) banks were ranked 125 or higher, and 1,080 (48%) were ranked by IDCFP less than 125.
Out of the 1,080 high risk banks, 274 (25%) failed, 530 (49%) merged into a higher ranked firm, 27 (3%) are currently below investment grade, and 249 (23%) recovered, attaining a rank of 125 or above due to reduced delinquencies or improved capital ratios as of the 1st quarter of 2018.
Crisis then Recovery
The total number of financial institutions issuing brokered CDs ranked over 125 in the 2nd quarter of 2009 was 1,177 and has grown to 1,255 as of March 31, 2018. Not only did the number of investment grade institutions grow by 78 in over 8 years, but, in addition, the 804 below investment grade institutions (274 failures and 530 mergers) were replaced by new banks ranked as investment grade.
The increase in the number of institutions ranked below 125 clearly predicted the banking crisis of 2008, as early as 2006 when those numbers began to rise. The peak and subsequent decline in lower-ranked institutions also correctly forecast the end of the banking crisis in 2009. Finally, the increase in new banks issuing brokered CDs, the replacement of 804 institutions, plus the sharp decline in number of high risk banks, all illustrated the recovery period from 2010 to 2018 (E, Chart I). Use of IDCFP ranks of banks was critical for investors in brokered CDs during this recovery period.
As the Number of Higher Risk Banks Increases, So Does Risk to CD Portfolios
Similar to the period of increasing bank risk seen in 2005-2006, the year 2017 witnessed a low number of financial institutions ranked below 125, followed by an increase from 55 in 2017 to 64 in the 1st quarter of 2018. Many components of IDCFP’s CAMEL analysis reached cycle lows during this time, while the remainder is approaching cycle lows (see Table 1). Yet, the strong economy, bank deregulation and favorable interest rates drive a healthy banking environment. Banks issuing brokered CDs are expected to increase dramatically over the next few years.
From 2018 Q1 to 2021, IDCFP projects the 64 banks, currently ranked below 125, will increase to 300 institutions. On the other hand, with the continued strength of the economy and strong loan demand for select financial institutions, IDCFP forecasts the number of banks ranked 125 or higher to accelerate from 1255 in 2018 Q1 to 1700 by 2021 (see Chart I). As in the past, IDCFP’s ranks are critical for investors going forward.
John E Rickmeier, CFA
IDC Financial Publishing, Inc.
700 Walnut Ridge Drive, Suite 201
PO Box 140
Hartland, WI 53029