CAMELS – Compliance Guru

The FDIC released FIL-17-2016 today, which will increase the examination cycle for community banks meeting certain criteria from 12 months to 18 months, thereby potentially decreasing one of the most intrusive events in the bankers life.

The criteria is as follows:

Must be less than $1 B in assets
Must have a CAMELS composite rating of “1” or “2”
Must be well-capitalized
Must be well-managed
Must not have undergone any change in control during the previous 12 months
Must not be under an enforcement order or proceeding.

The 18 month examination cycle was previously not available to any community bank smaller than $500 million in assets, but now any bank smaller than 1 B will qualify, provided they meet the other criteria.

This is good news for already overly-burdened and otherwise healthy institutions, but what concerns me is the definition of “well-managed”. All of the other criteria is objective, and pretty easy to define and establish. But how will the regulators define well-managed? For example, if the institution had a single, non-material, repeat finding in their last exam, could that reflect poorly on management? After all, responsiveness to recommendation from auditors and supervisory authorities is one of the elements that make up the CAMELS management component.

And is it even possible for an institution to rate a composite score of “1” or “2” if it is not well-managed? Here is an extract from the FDIC Uniform Financial Institutions Rating System (UFIRS) relating to management:

Composite 2 : Only moderate weaknesses are present and are well within the board of directors’ and management’s capabilities and willingness to correct.
Composite 3: Management may lack the ability or willingness to effectively address weaknesses within appropriate time frames.

7 Reasons Why Small Community Banks Should Outsource IT Network Management

Based in this I think it’s highly unlikely that a bank could score a “2” and be poorly managed.

Anyway, time will tell how examiners define well-managed, but this is certainly a step in the right direction and should bring much needed relief to many institutions.

One thing that’s clear from the examination feedback I’ve received from financial institutions in 2013 is that examiners are spending less time in their safety & soundness examinations on the CAMELS “C”, “A”, & “L” (capital, asset quality and liquidity) issues, and more time on the “M” & “E” (management and earnings) issues. (There was some additional guidance released on the “S” issue by the FDIC in October, but so far we haven’t seen “sensitivity to interest rates” become a big deal for examiners.)

I’ve taken a deep dive into the 2013 FDIC financial institution data, and the following charts explain why I believe the trend towards less C, A & L, and more M & E scrutiny will continue. The first chart is a count of total failed institutions per year since 2007:

So 2013 saw a return to pre-crisis levels of bank failures, which, while still somewhat high by historical standards, definitely reduced the pressure somewhat. In the next graph I plot the number of “problem banks” (defined here) over the same period , which should give us some indication of the overall health of the banking industry:

As you can see, problem banks are not quite at pre-crisis levels but do show a definite downward correlation with bank failures, and I believe we’ll see that trend continue.

This next chart depicts average net operating income (left scale) against total count of unprofitable institutions (right scale):

As you can see, both indicators are trending in the right direction, which should indicate a continued de-emphasis on C, A & L in future examinations…and increased earnings pressure. Notably however, smaller institutions are likely to face more earnings scrutiny than larger institutions, because although they did not experience the same level of losses early on as larger institutions, they are also taking longer to return to profitability:

So how will all of this impact institutions going forward? If you’ve had a federal examination in the last 6-9 months you’ve probably already heard some variation of the following from your examiner: “Great, your problem assets are under control, now why aren’t you profitable (or more profitable)?” (Of course at this point you might be tempted to mention things like increased deposit insurance assessments, reduced fee income, and increased regulatory burden, but you know it won’t matter…) So certainly the increased focus on “E” will continue, but because the number of institutions still losing money is inversely proportional to size, the smaller you are the more “E” scrutiny you’re likely to get.

However regardless of asset quality or earnings, I believe that increasingly “M” will begin to take center stage in 2014, because at the end of every banking crisis since 1980 there has been a post-mortem analysis of the causes and the regulatory gaps that should be addressed going forward. And that always leads back to “M”, because ultimately regulators believe that all problems facing financial institutions should have be foreseen and avoided by competent management taking a more active role in the affairs of the institution. More on that, and how to prepare for it, in a future post.

Tag: CAMELS

FDIC Expands Criteria for 18 Month Exam Cycle

The criteria is as follows:

7 Reasons Why Small Community Banks Should Outsource IT Network Management

A Look Back at 2013…and a Look Ahead – Part 1 (charts edition)