Camels

1. Summary of Camels

Objectives

• This summary intends to review the key components of CAMELS ratings.
• Understand their meaning and their applications

1. Introduction

The CAMELS rating is a supervisory rating system originally developed in the U.S. to classify a company's overall condition. It's applied to every bank and company in the U.S. (approximately 8,000 institutions) and is also implemented outside the U.S. by various banking supervisory regulators.

The ratings are assigned based on a ratio analysis made by a designated supervisory regulator. In the U.S. these supervisory regulators include the Federal Reserve, the Office of the Comptroller of the Currency, the National Company Administration, the Farm Credit Administration, and the Federal Deposit Insurance Corporation.

Ratings are not released to the public but only to the top management to prevent a possible bank run on an institution which receives a CAMELS rating downgrade.

1. Elements of the CAMELS rating

CAMELS is a tool for company valuation. The CAMELS rating is based upon 6 components:

Each of those 6 components is rated from 1 to 5:

1. Capital adequacy

1. Explanation of concept

Capital represents the resources provided by owners.

Capital is important for 2 reasons:

• The shared capital gives a little idea of the financial capabilities of a company and provides a guarantee for creditors. (economic reason)
• It provides a justification of ownership (legal reason)

Stakeholders can be ranked as follow (by order of importance):

1. State
2. Employees
3. Clients + Suppliers
4. Shareholders

1. Criterion in assessment of capital adequacy

In the study of capital adequacy, examiners reckon:

1. Capital level and trend analysis

• The capital level gives an idea of the financial capabilities of a company whereas the trend of capital will give a basic outline of the capital evolution for many years.

1. Compliance with risk-based net worth requirements
2. Composition of capital
3. Interest and dividends policies and practices

• Choose to place dividends in investment makes capital increase.

1. Adequacy of the allowance for loan and lease losses account
2. Quality, type, liquidity and diversification of assets
3. Loan and investment concentration
4. Growth plans

• Those plans have an impact on dividends policies and then on capital when dividends are used for investment.

1. Volume and risk characteristics of new business initiatives
2. Liquidity and funds management

1. Rating

1. Qualitative analysis

1. Quantitative analysis

1. Asset quality

1. Explanation of concept

Assets play an important role in the profitability of a company. They have a lifetime and they depreciate. So their valuation gives an idea of what the company uses to produce income.

Also, assets must be dispatched into a portfolio. They must be diversified in order to minimize risk. So the repartition of a company’s assets has an impact on asset quality.

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