The document discusses CAMELS ratings, which are assessments by bank regulators of financial institutions' overall financial condition and operations. CAMELS ratings range from 1 to 5 based on evaluations of Capital adequacy, Asset quality, Management, Earnings, Liquidity, and Sensitivity to market risk. Lower CAMELS ratings, especially a composite score of 3 or below, can subject banks to regulatory enforcement actions. The document urges bank directors to understand CAMELS ratings and their impact, as ratings influence access to capital, insurance costs, and talent recruitment.

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CAMELS RATINGS:
What They Mean
and Why They
Matter
WHITE PAPER

2. 2 CAMELS RATINGS: WHAT THEY MEAN AND WHY THEY MATTER
Executive Summary
I
n terms of regulation, there is no single number more important to a
bank than its CAMELS rating. All bank directors should have a firm
Lorraine “Lori” M. understanding of the meaning of CAMELS ratings and the profound
Buerger
is an attorney at Schiff impact these ratings have on the bank. This article will describe the
Hardin LLP and member
of the firm’s Financial elements that go into a CAMELS rating and the potential consequences of a
Institutions Client
Services Group. Lori’s low score.
practice concentration is
on corporate transactions,
with a particular focus
on banking regulation As opposed to other regulatory measures (such as, for example, the OCC’s risk assessment system,
and FDIC-assisted which focuses on the categories, quality and direction of prospective risk to an institution),
transactions. Prior CAMELS ratings are primarily a point-in-time assessment of its component factors.
to joining the firm,
Lori spent 15 years
representing corporations Banks deemed to be “problem” banks are generally those with composite CAMELS ratings of 4 or
in the areas of regulatory/ 5, and those with composite ratings of 3, 4 or 5 may be subject to regulatory enforcement actions.
legislative affairs. She
can be contacted at
Recently, the Federal Deposit Insurance Corp. (FDIC) had more than 800 banks on its list of
lbuerger@schiffhardin.com “problem” institutions out of more than 7,300 banks and thrifts. Many of them are not expected to
survive.
In today’s business and financial environment, banks are complex and often extremely large
institutions. Each, of course, has its own unique relationship with its prudential regulators.
However, whether your financial institution’s primary federal regulator is the Office of the
Comptroller of the Currency, the FDIC, or the Federal Reserve Board, your regulator’s overall
view of the safety and soundness of your institution, regardless of its size, complexity and scope, is
summarized in your bank’s overall CAMELS rating.
Meaning of the CAMELS Score
CAMELS ratings are the result of the Uniform Financial Institutions Rating System, the internal
rating system used by regulators for assessing financial institutions on a uniform basis and
identifying those institutions requiring special supervisory attention.
© DirectorCorps 2011

3. 3 CAMELS RATINGS: WHAT THEY MEAN AND WHY THEY MATTER
Regulators assign CAMELS ratings both on a Component #2: Asset Quality
component and composite basis, resulting in a The rating of the asset quality of a financial
single CAMELS overall rating. When introduced institution is based upon:
in 1979, the system had five components. A • adequacy of underwriting standards, soundness of
sixth component—sensitivity to market risk—was credit administration practices, and appropriateness
added in 1996. The regulators that year also of risk identification practices;
added an increased emphasis on an organization’s • level, distribution, severity, and trend of problem,
management of risk. classified, nonaccrual, restructured, delinquent and
nonperforming assets for both on- and off-balance
The six component areas are: sheet transactions;
• adequacy of the allowance for loan and lease
• C—Capital adequacy losses and other asset valuation reserves;
• A—Asset quality • credit risk arising from or reduced by off-balance
• M—Management sheet transactions;
• E—Earnings • diversification and quality of the loan and
• L—Liquidity investment portfolios;
• S—Sensitivity to market risk • extent of securities underwriting activities and
exposure to counterparties in trading activities;
The ratings range from 1 to 5, with 1 being the • existence of asset concentrations;
highest rating (representing the least amount • adequacy of loan and investment policies,
of regulatory concern) and 5 being the lowest. procedures and practices;
CAMELS ratings are strictly confidential, and may • ability of management to properly administer
not be disclosed to any party. its assets, including the timely identification and
collection of problem assets;
Component #1: Capital Adequacy • adequacy of internal controls and management
The capital adequacy component focuses upon: information systems; and
• level and quality of capital; • volume and nature of credit documentation
• overall financial condition; exceptions.
• ability of management to address emerging needs
for additional capital; Component #3: Management
• nature, trend and volume of problem assets, and The component rating regarding the capability
the adequacy of allowances for loan and lease losses and performance of management and the board of
and other valuation reserves; directors is rated upon:
• balance sheet composition; • level and quality of oversight and support by the
• risk exposure represented by off-balance sheet board and management;
activities; • ability of the board and management to plan for,
• quality and strength of earnings; and respond to, risks;
• reasonableness of dividend; • adequacy and conformance with appropriate
• prospects and plans for growth, as well as past internal policies and controls;
experience in managing growth; and • accuracy, timeliness and effectiveness of
• access to capital markets and other sources of management information and risk monitoring
capital, including support provided by a parent systems;
holding company. • adequacy of audits and internal controls;
• compliance with laws and regulations;
• responsiveness to recommendations from auditors
and supervisory authorities;
© DirectorCorps 2011

4. 4 CAMELS RATINGS: WHAT THEY MEAN AND WHY THEY MATTER
• management depth and succession; funds management strategies, liquidity policies,
• extent of dominant influence or concentration of management information systems and contingency
authority; funding plans.
• reasonableness of compensation policies and
avoidance of self-dealing; Component #6: Sensitivity to Market Risk
• demonstrated willingness to serve the legitimate The sensitivity to market risk component is based
banking needs of the community; and upon:
• overall performance of the institution and its risk • sensitivity of the financial institution’s earnings to
profile. adverse changes in interest rates, foreign exchange
rates, commodity prices or equity prices;
Component #4: Earnings • ability of management to identify, measure,
The rating of an institution’s earnings focuses upon: monitor and control exposure to market risk;
• level of earnings, including trends and stability; • nature and complexity of interest rate risk
• ability to provide for adequate capital through exposure arising from non-trading positions; and
retained earnings; • where appropriate, the nature and complexity
• quality and sources of earnings; of market risk exposure arising from trading and
• level of expenses in relation to operations; foreign operations.
• adequacy of the budgeting systems, forecasting
processes and management information systems; Potential Consequences of Low CAMELS Scores
• adequacy of provisions to maintain the allowance An overall CAMELS score of 3, 4 or 5 can expose
for loan and lease losses and other valuation a financial institution to any of the informal and
allowance accounts; and formal enforcement actions available to federal
• earnings exposure to market risk such as interest regulators. These regulatory tools include a menu
rate, foreign exchange and price risks. of memorandums of understanding, consent orders,
cease and desist orders, written agreements and
Component #5: Liquidity prompt directive action directives, imposed in an
The liquidity component rating is based upon: escalating manner if an institution’s CAMELS
• availability of assets readily convertible to cash scores do not improve or continue to degrade.
without undue loss; Enforcement actions can affect the bank in a variety
• adequacy of liquidity sources compared to present of ways, including influencing access to capital,
and future needs and the ability of the institution to insurance costs and the ability to recruit and
meet liquidity needs without adversely affecting its maintain talent in your organization.
operations or condition;
• access to money markets and other sources of To avoid being potentially subject to any
funding; enforcement measure, monitoring CAMELS
• level of diversification of funding sources, both on- scores—and fully understanding the factors that can
and off-balance-sheet; influence their composition—should be a primary
• degree of reliance on short-term, volatile sources of concern for every bank director.
funds, including borrowings and brokered deposits, to
fund longer term assets;
• trend and stability of deposits;
• ability to securitize and sell certain pools of assets;
and *The opinions expressed are those of the author
• capability of management to properly identify, and do not represent the views of the firm or its
measure, monitor and control the institution’s partners. This article does not constitute, and
liquidity position, including the effectiveness of should not be treated as, legal advice.
© DirectorCorps 2011