How safe are your

company's dollars inyour bank? How doyou know? As thefinancial officer you

are responsible for making surethat your company's assets areprotected and that you will haveaccess to your company's moneyat all times. One of the things youcan do to protect your business istouseabankratingservice.Thereareanumberofprivatefirmsthatcompare the financial data of aparticular institution to that of itspeers and to all banks nationally.These firms provide a variety ofreports with a wide range ofprices. However, before you evenbegin looking for a rating com-pany, there are some steps youshould take. First of all, you

whatCanTheyDoForYou?by Earl R. Hoenes

should determine whether or not your company has an investmentpolicy and, if they do, exactly what it contains. To protect yourselfandyourbusiness,youshouldworkfromasimplebutcomprehen-sive policy. Here's a sample.

sEmouoN CRITERIA FOR BANlrsA OverviewA bank on the list of qualified banks for investment and bankingservices must meet minimum criteria, which are defined below.Banks failing to meet the minimum criteria or which, in thejudgement of the chief financial officer, fail to offer adequatesafety, will be removed from the qualified list. Although a bankis on the qualified list, it will still be required to pledge collateralon all deposits and investments.

The company will use a commercially available rating serviceto implement financial statement evaluation criteria. Bank ratingcriteria are calculated using publicly available financial informa-tion obtained from the release of preliminary reports of conditionand income for the federal government. Data obtained from thebank rating service will include the factors used by regulators andbank executives to judge an institution's safety and soundness:

1. Capital Adequacy,

2. Asset quality,

3. Earnings, and4. Liquidity.

8. Minimum Criteria for SelectionThe chief financial officer may approve a bank if all of thefollowing criteria are met:

1. The financial institution must be insured by the FederalDeposit Insurance Corporation.

2. Only banking corporations incorporated under the laws ofthe State of XXXX or of the United States shall be ap-pointed as depositories of funds for the company.

3. The bank MUST meet the following financial guidelines (tobe determined by your company):

a. Equity Capital of at least $2 million.

b. A pre-detemined rating standard by your rating service,OR primary capital as a percentage of total assets asfollows:

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• 5.509„or>= $500milliontotal assets

• 7.00 % for$300-$499 nil-lion total assets

• 7.25%for$100-$299mil-lion total assets

• 7.75%for$50-$99milliontotal assets

• 8.50% for< $50milliontotal assets.

Forletterofcreditacceptance,total company letter of credit ex-posure at the bank will be limitedto not more than 50 percent of thebank's equity capital.

You or members of your staffcan calculate ratios; howevermany companies have found thatgetting timely information fromnumerous banks each quarter is

both cost and time prohibitive. Unless you have a large staff offinancial analysts who know bank ratios and can accuratelyinterpret financial statements quickly, a bank rating service isprobably a cheaper and more effective way to go. An importantconsideration to keep in mind when deciding on a rating serviceis whether the service can provide data for multiple applications,such as assessments of:• Banking Relationships

• Certificate of Deposit Investments

• Letter of Credit Acceptability

• Safe Backing of Commercial Paper Investments

• Bankers' Acceptances Suitability to Policy or State Law.

In the sample investment policy, a rating of 30 points or betterautomatically eliminates the lower 30 percent of the banks fromqualifying, and on average qualifies 70 percent of the country'sbanks. But by creating a capital ratio, if a bank is NOT rated 30pointsorbetter,abankinthelower30percentratingsgroupcouldstill be approved by the company. This is certainly not an overlyrestrictive rating. You must determine your own rating "comfortlevel" (e.g., 20, 30, 50 points, etc.).

How THE RATING SHsrEM WORKSThe rating system uses quarterly data from the federal agencies toanalyze (1) capital, (2) assets, (3) earnings, and (4) liquidity atevery U.S. bank and S&L. Each institution is given a percentilescore, where 99 is the best and a score of 0 is the worst. Forexample, a score of 50 says that half the banks scored worse onthis factor than did this particular institution.

As part of the Sheshunoff rating system, we do an annualsurvey of the presidents of all U.S. banks and S&Ls to get theirviews on safety and soundness. We then use their perspectives onwhat makes an institution healthy to weigh our ratings for greateraccuracy. The most recent survey results show that our fourfactors should be weighted: 23 percent (34 percent) for capitaladequacy,38percent(32percent)forassetquality,24percent(22percent) for earnings adequacy, and 15 percent ( 12 percent) forliquidity management (savings & loans in parenthesis). After

EARL R. HOENES is Director of Cash Management Services for Sheshunofflnfomation Services, Inc„ in Austin, Texas. Prior to joining Sheshunoff, he was theTreasurer and Finance Officer for the City of Austin.

The Botlomline . 13

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BANK RAHNG SERVICES

BANKWATCH "Thompson Bankwatch, Inc.61 Broadway, 3rd FloorNew York, NY 10006212/510-0300 FAX 212/797-2502

Bankwatch TM is a credit rating/consulting service specializing infinancial institutions: 14,000 commercial , 50 U.S . thrifts, 6 invest-ment banks and over 120 international banks (in Europe, Canada,Mexico, Asia and Australia).

RATINGS SERVICES(Available as "Ratings Only" or as part of Research Services.)U.S. Banks, international banks, thrifts, securities firms andinsurance companies (mid-1991 ).

RESEARCH SERVICES

CI.edit ProfilesIn-depth information for each financial institution rates.

Rathg Updates (Quarterly or semi-annually)One-page informative brief supporting current rating on bank.

Bankwatch Perspective"Special report on key issues, trends and special events.

Country Banking StudiesReports describing a country's banking system for 21 differentcountries.

CONSUIHNG SERVICES

Analyst Consultation Service (via telephone or visit)

ProjectAdvisorySelvice

DATA SERVICES

U.S, Data Book

lnternational Data Book

Scoring Reports

Watch Alerts

EMERGING MARKErs sERvlcEsMexico and South Korea

cAThs cONsuLTING ANAI;ysrsA DIVISION 0F FERGUSON & COMPANY1667 K Street, NW, Suite 640Washington, DC 20006202/659-8300FAX 202/659-4192

REPORTS

Cakes BancompareAratio-analyticspreadsheettoolforevaluatingthefinancialperfor-mance and condition of all 14,000 U.S. banks and their holdingcompanies. Updated quarterly.

14 . IAHA FebruarylMarch

these weights are assigned, we arrive atan overall rating for each bank or S&L.Based on overall percentile scores weassign the following ratings:

A+ 90-99A 70-898+ 50-698 30-49C+ 20-29C 10-19

The ratings are given two ways: (1) aratingisbasedonhowthisbankcomparesto all other banks in the United States, and(2) a rating is applied based on asset sizepeer groups. The above example used thepeer group ratings. You will probablywant to use peer group versus the nationalrating.

How WEEL DO Tlm RAINGspREDIor BANK PERFORMANCE?From January 1, 1987 through March 31,1989,455banksfailedintheunitedstates.Of these 455 banks, 421 had been rated asNR (0-9), 17 had been rated a C, 6 hadbeen rated a C+, and only 11 had beenrated higher than a C+. No rating systemcan detect a major defalcation or fraudu-lent financial statements until the hiddenfactors become public knowledge and thebank's financial statements have beenadjusted.

THE MEANING 0F A BANK'S"CAMEL" RAHNG

To fully understand the bank rating sys-tern, you need to understand the federalregulatory CAMEL rating system. Peri-odically, each bank receives a detailedexamination by a team of federal bankexaminers. At the end of each examina-tion,theteamwillassignaCAMELratingto the bank. A rating of " 1 " is what eachbank strives for - it says that this is aclean, well managed and profitable bankthat is worthy of the highest CAMELrating. A rating of "2" suggests that thebank is not a problem bank, but it is not aswell managed and as clean as other banksand there is definitely room for improve-ment. A rating of "3", "4", or "5", saysthat the bank is a problem bank with "3"suggesting that the problems have notbecome too serious and a "5" indicatingthe problems are very serious indeed. Abank's CAMEL rating is known only bythe federal regulators, the bank ' s board ofdirectors and its CEO, and it is a seriousbreach of regulations for any of thesepeopletodivulgeabank'sCAMELrating.

CAMEL is an acronym for ( 1) capitaladequacy, (2) assets quality, (3) manage-ment, (4) earnings, and (5) liquidity.During a bank examination, the team con-centrates on determining five things: ( 1 )Does the bank have an adequate capitalbase? (2) What is the quality of the bank' sassets? (3) How well managed is thisbank? (4) Is the bank producing adequateearnings? and (5) Is the bank maintainingsufficient liquidity. We need to examinethese five questions.

CapitalWhen a new bank is formed, the federalregulators will require that a specificamount of capital be invested in the bank.Usually this is on the order of $1 millionbut it is not unusual for a bank to start witha capital of $2 million, $5 million, or even$ 10 million. For the first three years of itsexistence,thebankhastomaintaincapitalthat equals at least ten percent of its totalassets; as the bank becomes well estab-lishedthisrequirementgraduallyslidestoa capital requirement of about six percentof total assets.

Capital is the amount of money theowners have at risk in the bank. It is acushionforproblemloans,forhardtimes,for poor earnings, for defalcations, andfor all forms of unprofitable operations. Itis also the cushion that keeps the FDICinsurance fund from taking a loss when abank must be closed. Two thirds of abank's capital must be in the form ofowner equity; the other third can be pre-ferred stock or subordinated debentures.

AssetsA bank's assets consist of ( I) loans madeto its customers, (2) investments in bondsand money market instruments, and (3)nonearning assets such as buildings, fur-niture, fixtures, equipment and the like.Problem loans are the primary cause of abank getting a poor CAMEL score. If abank's loan portfolio is clean, this factoris rated a "1", but if there are too manyproblem loans this factor is given a lowerscore depending on the severity of theproblem loans. A poorly managed in-vestment portfolio can also contribute toa poor asset score in the CAMEL rating.

ManagementThe examiners seldom give the manage-ment factor a score that is out of line withthe other factors. In other words, if thebank is well capitalized, has quality as-sets, is making money, and maintainingsufficient liquidity, it seldom gets markeddown on manage- /Co#fi.„wcdo#p¢gc26/

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CatesThriftcompareRatio Analytic product for all SAIF-insured S&Ls. Each reportcontains five years of financial history and national and regionalpeer norms. Updated quarterly.

Rapid Delivery ServiceYear-End Report of key analytic ratios on banks with more thanSl billion in assets. These reports are prepared from year-endCall Reports and are sent to clients during late February andearly March.

Cates MergerwatchPublished monthly and available on a national or regional basis,each Merger Watch mailing includes a 12-month summary, dealprofiles and index of deals.

The Bank AnalystThis Cates publication is produced every other month andrepresentstheCatesviewoncurrentdevelopmentscriticaltotheanalysis of depository institutions.

RISK RATINGS

Cakes Bank Rating SewiceA quarterly rating service that classifies banks according to fivelevels of risk. The service includes a summary of ratings onclient-selected banks, a financial Foundation Report and indi-vidual rating reports showing key ratios, rating history andsummary comments.

Cates Thrift Rating SewiceA rating service that assigns thrifts to one of five risk categories.

DUET & PHEITS CREDIT RATING COMPANY55 E. Monroe, Suite 3500Chicago, IL 60603312/368-3153

D&P provides short- and long-term credit ratings at both thebankandbankholdingcompanylevel.Ratedinstrumentsincludesenior and subordinated notes, preferred stock, commercialpaper, short-term certificates of deposit and deposit note pro-grams. D&P credit rating and credit research service providesinterested parties timely, in-depth, independent credit judge-ments. In developing a rating, D&P takes a prospective view,addressing not only the quantitative facets, but evaluating thequalitative features as well.Contact: Charles J. Orabutt, Jr., CPA, Vice President,Financial Institutions

DUN & BRADsrREFT BuslNEss CREDIT sERvlcEsContact your local Dun & Bradstreet Business Credit Servicesoffice (consult your local telephone directory).

For information about Dunswatch, call I-201 -665-5553

MONITORING SERVICES

DUNSWATCHAn online account-monitoring service that tracks throughDunsprint or Dunsprintpc.

(Continued on page 26)

The Bo[tomline . 15

BANK RATING SERVICES(Conlinued from page 15 )

PRA FINANCIAL NETWORK, INC.4701 Auvergne, Suite 1Lisle, Illinois 60532708/963-Or|r|4

The Prudent Man Analysis Report is based on formulas thatassessthecredit-worthinessofaninstitutionfromthedepositor'sperspective.Anoverallcreditratingisassignedbytheformulaas well as ratings for individual strength components such asliquidity and credit risk.

The Prudent Man Analysis Report is available in two fomats:

The Traditional ReportCan be ordered for any bank in the United States. It is appro-priate for financial directors. Average Cost, S 125.

The EXpres§ ReportAgraphic-orientedreportappropriateforalllevelsoffinancialandmoneymanagers.ItcanbeFAxedtoyoursitewithinhoursof order.PMA also offers full consulting and money management ser-vices and offers the only Private Deposit Insurance Program inthe United States.

SHESHUNOFF INFORMAHON SERVICES, INC.One Texas Center505 Barton Springs RoadAustin, TX 78704512/472-2244,I -800-456-2340

Sheshunoff Information Services, Inc., has been providinginformation on banks and S&Ls since 1971. Their ratings arebased on the key CAMEL criteria used by the regulators tojudge an institution's health.

The Financial Institution Performance Rating ServiceTheArmualsubscriptionservicegivesyoufourreportsperyear(one each quarter). The client chooses up to 10 banks or S&Lsof their choice. You also get the Sheshunoff Annual Report on

Be¥o¥jnfga{8i¥eess):%a£]g5£So°rf:nai±uaan]a:;rbesncdris#:tns.failures-ratings

The Financial Institutions Rathg SewlcesQuarterly volumes cover every U.S. bank, S&L and bank

§§;:;netEhf:o°#:i::n¥afc:th&:i°nQeA:::a:n:n:;¥:s:u:r:a:i;;§1#:1i:S:;;L¥htf:Ori$245 for the bank holding company service.

The Banks of Your State

:no-odke;Psh24d5atfaor°:d3[ytr9oryna%#p£;ens.y°urstate.$299forthefirst

The Bank Report28-page report on you bank. $85 for each report.

Pricing Bank ServicesReportonwhatbanksofdifferentsizesandmarketsarechargingfor specific services. $175 for each copy.

26 . IAHA FebruarylMarch

BANKRATINGSERVICES(Continued from page 15 )

ment. The management factor looks atsuch things as the adequacy of the bank' swritten policy and procedures manuals,how the board functions, the quality of itsdata processing system, the experienceand training of the bank's staff, and simi-lar kinds of issues.

EarningsA bank that has good earnings can retainenough money to keep itself well capital-ized. Earnings can also cover mistakes inthe loan portfolio and in liquidity man-agement. A highly profitable bank canwork its way out of almost any kind of asituation, whereas an unprofitable bank isin trouble no matter what else is happen-ing at the bank.

hiquidityAll banks must maintain the capability offunding the loans needed by their cus-tomers and all deposit withdrawals. Aslong as a bank can do these two things, ithas sufficient liquidity. As soon as a bankcannot fund deposit withdrawals it mustclose its doors. All banks must have asystem of managing liquidity so that theywill always have sufficient cash to coverdeposit withdrawals and customer loandemand. During each bank examination,this system is closely monitored by theexamining team and the bank receives aliquidity CAMEL score.

Please note that the bank examiners'scoring of these five factors is always asecret that is known only by federal regu-latory officials and a few insiders at thebank. As a private citizen or a publicfinance official you will NOT have ac-cess to this information. But also note thatfour of the five factors can be scoredbased on a careful analysis of a bank'sfinancial statements. (The factor that doesnot show up in financial statements ismanagement.)

SUMMARYBank rating services are an excellent re-source for anyone who needs to knowmoreabouttheirbanks,abouttheindustryor about how the the rating systems work.There are many good services available,several of which are listed in this article.If you do your homework and take thetime to find out all you can about yourbank and how it stacks up, then you havedone your job to protect your company' sassets. .