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.

1. IDCFP’s CAMEL Ranks Explained
The “C” in CAMEL: Capital Requirements in Banks
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:
 Tier 1 Leverage Capital Ratio (Tier 1 capital divided by Tier 1
assets) of 5% or higher.
 Total Risk Based Capital Ratio (Tier 1 + Tier 2 capital divided by
risk-based assets) of 10% or higher
• Tier 1 Risk Based Capital Ratio (Tier 1 capital divided by risk-
based assets) of 6% or higher

2. 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.

3. “C” Relative to Other CAMEL Components
One type of risk in a bank or savings institution occurs when
return on equity (ROE) is negative, destroying equity capital.
The risk is amplified when elements of ROE are negative, such
as the return on financial leverage (ROFL). When the after-tax
returns on operating earnings assets (ROEA) is exceeded by
the after-tax cost of adjusted deposits and debt, the result is a
negative leverage spread. Multiplying a negative spread by an
institution’s financial leverage creates an even greater loss, or
a negative ROFL. Currently, a negative ROFL has been
exhibited in an increasing number of banks. As the Federal
Reserve raises the federal funds rate to 3% or above over the
next two years, rising costs of funding, combined with low
levels of operating returns, could create continued losses in
net income for firms with negative earnings (“E”), and
potentially affect more financial institutions.

4. Although the total number of banks ranked less than 125 by
IDCFP continues to decline, certain components of the CAMEL
rating are exhibiting warning signs of risk to come. As shown in
Table I, column “E,” more banks began exhibiting negative
ROFL in 2017 Q4, resulting in negative earnings. In addition,
there was a small increase in institutions yielding narrow profit
margins with high standard deviations in this margin over time,
shown in column “M.”
The other 3 components of IDCFP’s CAMEL are still declining or
holding, indicating some time before a reversal and potential
financial crisis. “C,” or institutions with capital that is deemed
insufficient, is still declining, currently at 45. “A,” or institutions
with less than 5% adequate capital*, did not change from the
previous quarter, holding at 63. Finally, “L,” or institutions with
negative liquidity in balance sheet cash flow and substantial
loan delinquency, is also still declining, currently at a level of 8
institutions (see Table I).
*Tier I capital adjusted for loan delinquency minus loan loss reserve.

5. Table I

6. 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 2nd 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 3rd quarter of 2005 through the 1st quarter of 2006,
and then began to rise.

7. As seen in Table II below, commercial banks and savings
institutions with insufficient capital reached a low of 47
institutions in the 3rd quarter of 2006. Financial institutions with
less than 5% adequate capital* reached a low count of 29 in the
3rd quarter of 2005. Banks and savings institutions with a lack of
profitability, or low and unstable margins, reached a low of 178
in the 4th quarter of 2005. The commercial banks and savings
institutions with severe negative earnings due to leverage
reached their low of 185 in the 4th 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 1st quarter of 2006.
*Tier I capital adjusted for loan delinquency minus loan loss reserve.

8. History of Early Warning Indicators
The number of commercial banks and savings institutions
ranked below 125 reached a low in the 2nd 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 3rd quarter of 2005 through the 1st
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 3rd quarter of 2006. Financial institutions
measuring adequate Tier 1 capital, adjusted for delinquency
below 5%, reached a low count of 29 in the 3rd quarter of 2005.
Banks and savings institutions with a lack of profitability, or low
and unstable margins, reached a low of 178 in the 4th quarter of
2005. The commercial banks and savings institutions with
severe negative earnings due to leverage reached their low of
185 in the 4th 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 1st quarter of 2006.

9. Table II

10. 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 years later.
IDCFP’s ranks are critical for investors to monitor financial
institutions.
For further information or to view our products and services please feel
free to visit our website at www.idcfp.com or contact us at 800-525-5457
or info@idcfp.com.
John E Rickmeier, CFA
President
jer@idcfp.com
Robin Rickmeier
Marketing Director
IDC Financial Publishing, Inc.
700 Walnut Ridge Drive, Suite 201
PO Box 140
Hartland, WI 53029
P 800-525-5457
P 262-367-7231
F 262-367-6497