The document discusses IDCFP's CAMEL ratings system for evaluating the financial health of banks, credit unions, and savings institutions. It explains that the "A" in CAMEL represents the adequacy of Tier 1 capital. An adjusted Tier 1 capital ratio below 5% indicates insufficient capital and loan loss reserves to cover loan delinquencies, resulting in a rating below 125. While total banks rated below 125 continue to decline, some CAMEL components like returns on financial leverage are exhibiting warning signs of increased risk. The number of institutions rated below 125 using all CAMEL components would need to increase to confidently forecast a future banking crisis. Historically, increases across most CAMEL components preceded the 2008

1. IDCFP’s CAMEL Ranks Explained
The “A” in CAMEL: Adequacy of Tier 1 Capital
IDC Financial Publishing, Inc. (IDCFP) uses the acronym CAMEL to
represent the financial ratios used to evaluate the safety and
soundness of commercial banks, savings institutions and credit
unions. This article explains how IDCFP measures the adequacy of
capital, the “A” component of its CAMEL ranks, and why it is valuable
and important to monitor.

2. The “adequacy of capital” component of CAMEL measures the
amount of adjusted Tier 1 capital. Tier 1 capital is adjusted by
subtracting the amount of loan delinquencies (loans that are 90
days past due, nonaccrual loans, plus repossessed assets) in
excess of loan loss reserves. An adjusted Tier 1 capital ratio
below 5% indicates insufficient capital and loan loss reserves to
cover loan delinquencies and results in an IDCFP rank less than
125.
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.

3. “A” Relative to Other CAMEL Components
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
returns on financial leverage (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% adequacy of 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).

4. Table I
All 5 categories of rank, Capital, Adequacy of capital, Margins as a
measurement of management, Earnings from operations and financial
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.

5. 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.
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% adequacy of 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 financial
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.

6. Table II

7. 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.
For further information or to view our products and services please
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