IDC Financial Publishing, Inc. (IDCFP) uses the acronym CAMEL to represent the financial ratios used to evaluate the safety and soundness of commercial banks and savings institutions. This article explains how IDCFP uses the capital requirements ratios in banks as a component of its CAMEL ranking system, and why it is valuable and important to monitor.

Capital ratio requirements used by the FDIC to determine if an institution is well-capitalized are:

1. 1. Tier 1 Leverage Capital Ratio (Tier 1 capital divided by Tier 1 assets) of 5% or higher.
2. 2. Total Risk Based Capital Ratio (Tier 1 + Tier 2 capital divided by risk-based assets) of 10% or higher
3. 3. Tier 1 Risk Based Capital Ratio (Tier 1 capital divided by risk-based assets) of 6% or higher

IDCFP also reviews enforcement actions by the FDIC to determine if an institution is required to file a written “Capital Plan” to increase capital above the threshold of ratios indicated above. As an example, a letter of consent for an institution might require a Tier 1 leverage ratio of 9% vs. the standard 5%. IDCFP then uses the 9% threshold as the Tier 1 requirement until the enforcement action is terminated.

IDCFP’s 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 our ranks determined that ratings lower than 125 were deemed below investment grade. Commercial banks and savings institutions with capital ratios below the requirements outlined above have “insufficient capital” and, therefore, receive an IDCFP rank below 125.

A Forecast for the Next Banking Crisis

Out of the 5,589 total commercial banks and savings institutions, IDCFP has identified 1,352 that have outstanding brokered deposits. Using this group of 1,352 institutions, and tracking institutions ranked less than 125 within this group, provides a forecast for the next era of banking problems in 2021.

Table I illustrates this trend when examining these commercial banks and savings institutions ranked less than 125 by IDCFP with our CAMEL analysis (see Table I).

• The number of institutions reached a low of 55 in the second quarter of 2017.
• The “C” component, or institutions with insufficient Capital fell to a low of 2 in the first quarter of 2018 and increased in the second quarter.
• The “A” component represents institutions lacking Adequacy of capital to cover delinquency with less than 5% risk-adjusted capital. These institutions declined to a low of 5 in the fourth quarter of 2017.
• The “M” component, which uses Margins as a measure of management continues to decline, reaching a low level of 14 in the second quarter of 2018.
• The “E” component represents institutions exhibiting negative Earnings or returns on financial leverage (ROFL). These institutions fell to a low of 17 as early as the third quarter of 2016.
• Finally, the “L” component, which represents Liquidity, or negative balance sheet cash flow, fell to 0 in the second quarter of 2018.

When examining institutions with outstanding brokered deposits, there is an increase in the number among these ranked less than 125 by IDCFP. The current trend shows the number of these institutions in most components of CAMEL have hit a low and are rising. This group of institutions ranked less than 125, and having brokered deposits, points to another potential banking problem in 2021 (see Table I). Similarly, in 2005 and 2006, IDCFP’s CAMEL ranks under 125 of all institutions forecast the 2008 and 2009 banking crisis. (See Table II).

Table I

All 5 categories of rank, Capital, Adequacy of capital, Margins as a measurement of management, Earnings from operations and leverage, and, finally, Liquidity, together provide a timely indication of risk and potential failure. An increase in the number of banks ranked under 125 in all components of CAMEL is required to confidently forecast a future banking crisis.

Early Warning Indicators in History

The number of commercial banks and savings institutions ranked below 125 reached a low in the 2^nd quarter of 2006, two years before the banking crisis in 2008. More importantly, leading up to this point, 4 out of the 5 components of CAMEL also reached lows from the 3^rd quarter of 2005 through the 1^st quarter of 2006, and then began to rise.

As seen in Table II below, commercial banks and savings institutions with insufficient capital reached a low of 47 institutions in the 3^rd quarter of 2006. Financial institutions with less than 5% adequate capital* reached a low count of 29 in the 3^rd quarter of 2005. Banks and savings institutions with a lack of profitability, or low and unstable margins, reached a low of 178 in the 4^th quarter of 2005. The commercial banks and savings institutions with severe negative earnings due to leverage reached their low of 185 in the 4^th quarter of 2005. Finally, institutions with high loan delinquency and negative balance sheet cash flow, or negative liquidity, reached their low of 2 in the 1^st quarter of 2006.

*Tier I capital adjusted for loan delinquency minus loan loss reserve.

Table II

As seen in history, the increase in the number of financial institutions with IDCFP’s CAMEL ranks below 125, or below investment grade, forecast the bank financial crisis a few years later. IDCFP’s ranks are critical for investors to monitor financial institutions.

To view our products and services please visit our website at www.idcfp.com . For further information about our CAMEL ranks, or for a copy of this article, please contact us at 800-525-5457 or info@idcfp.com.

John E Rickmeier, CFA, President, jer@idcfp.com

Robin Rickmeier, Marketing Director