Surveillance 101: Tracking bank degradations over time.

Case Study: Alliance Bank of Culver City, California

Alliance Bank was taken over by the FDIC last week and the assets sent to California Bank & Trust, a unit of Zions Bank. The Alliance case was typical case of a small institution that got trapped in the aftermath of a deflating bubble. It ended life the owner of a growing portfolio of foreclosed properties stemming from a lending default rate dragging operational earnings deep into the negative. Their Aggregate Loan Default Rate went from a miniscule 26bp (basis points) to 496bp and their Loss Given Default rate was 96%.

As it has been doing with regularity, the FDIC performed it's designated regulatory function taking the troubled entity into the arms of a better positioned and healthier financial institution. In fact, the degradation of Alliance's position took approximately nine months to gestate. The bank's overall stress ratings over time are shown below.

IRA Bank Stress Ratings: Alliance Bank, Culver City, CA
Sep-08 - F
Jun-08 - F
Mar-08 - B
Dec-07 - A
Sep-07 - A+

Like many other institutions who were caught in the bubble a migration of business from income producing to dead weight ensued. Non-Conforming assets went from $17.7M in Sep-07 to $96.5M in Sep-08. During the same time Real Estate Owned(REO) went from $1.1M to $16.6M.

Note: I was interviewed about Alliance on Monday by KNBC-TV Los Angeles. The segment aired on Tuesday Feb. 10.

IRA Bank Reports Timing - Why Mid-Quarter?

IRA reports are based on FDIC CALL/TFR Reports. We need these more detailed reports to accomplish the level of bank safety and soundness analysis that we do. Bear in mind that IRA’s bank analytics covers all FDIC reporting institutions. Of these only some are publicly traded companies. Our analysis engines run detailed analytics on the universe of active U.S. bank holding companies as well as the individual unit institution members of a holding company.

Timing of production is keyed to the FDIC’s internal processing schedules. The FDIC holds release of the master dataset for each quarter’s filings for 45 days to perform internal cleaning prior to releasing it for analytics use. We get the data and process it to build the industry stress statistics typically just before the FDIC does its’ mid-quarter press conference. We try to release our reports to coincide with the FDIC conference date provided the FDIC arrived on time. An email is sent to all clients informing you that the reports have been updated.

FYI, catalogs of SEC filings for public companies are available on the IRA website. SEC filings contain top level information on companies aimed primarily at stock investors. They typically begin to appear just before the 30 day point after the end of the reporting period, hence the end of month follies in the markets. That’s a little ahead of the FDIC’s much more comprehensive data needed for safety and soundness analysis on banks to help assess the risk within a person/company’s cash and cash equivalents assets. Different portion of the wealth portfolio.

- Dennis

The thing about economics ...

Humans are creatures of hope. It occurs to me that we place too much blind faith in things sometimes. Take economics. The thing about macro models is that they depend on input that has been smoothed and homogenized far below the noise levels of real life. Sort of like smoothing loan collateral pool risk into simplified spreadsheet factors. Economics too often depends on the systems finding balance presuming computational isolation from discontinuitues, externalities and outliers. The law of unintended consequences always applies when we simplify. Murphy's leverage is amplified by the alchemy of theories reaching far beyond their stable linearity. When you hear someone say "it's not perfect but it's better than nothing" that's the sound of a match being lit in a room full of dynamite. Sometimes we forget that we are the monkeys with keyboards trying to write Shakespeare.

So here's one for you to ponder. The same colleges that train some of the best economists also train some of "the best" structured finance designers. It's the same math. I'm just sayin'.

- D

TARP and Tangibles

Here's something interesting. We computed the IRA Tangible Equity Capital Ratios for Largest Bank Holding Companies
. The link takes you to an excel file containing four worksheets covering 3Q2008 and year-end for 2007, 2006 and 2005.

The technique for this requires rolling up the bank only assets of each of the units of a BHC to make the computation. We actually set the computers up to run the metric for all 5,000 or so bank holding companies for every reporting quarter we have in our databases. Naturally the popular press seems fixated on the top tier. The "Prime Solution" for the U.S. economy probably lies in deploying TARP money among the best of breed of the 5,000 though.

Enjoy the peek at the tip of the iceberg.

- Dennis

IRA Bank Stress Ratings. Why Letter Grades?

Professional bankers live and die by their CAMELS rating. The system uses a grading method ranging from 1 to 5 (1 = best) and is used as part of official interactions between the bank and its' regulator. The six factors in a CAMELS are,

C - Capital adequacy
A - Asset quality
M - Management quality
E - Earnings
L - Liquidity
S - Sensitivity to Market Risk

CAMELS include privileged information on objective numerics, subjective discussion and judgement and external exposure analysis measures that help the regulator determine whether a bank is being run adequatetely or requires prompt corrective intervention.

Pattern Analysis to find "The Signal in the Noise"

IRA analysis uses publicly available information to perform similar analyses to the CAMELS process but using an outside observer approach. We opted to design a system that concentrates on bank stress indicators because this is what "main street Americans" actually worry about.

Unless one is a regulator, it's impossible to talk in detail to every bank in the United States. So we designed a more clinical statistical analysis approach to characterize behavior patterns at the census level (looking at all FDIC filers ... yes all!) to replace one-on-one subjectivity. The objective of our system is to allow a consumer to locate a bank's performance both in terms fundamental safety and soundness and in competitive context with its' peers. We believe this improves transparency for depositors as well as the decision matrix process for investors.

Why letter grades?

When we looked at how to set up the final grading scale we were sensitized to the need to make the grading system intuitive for consumers by the media. So instead of emulating the CAMELS 1 to 5 scale we opted for the more familiar report card of A to F letter grades.

In the CAMELS system a bank is considered well run if it has an overall CAMELS rating of 2 or lower and has issues if that rating slips to 3 or higher. Anecdotal comparisons to the IRA Bank Stress Index rating system indicate that one can expect the following,

IRA A+ generally finds banks with CAMELS 1
IRA A finds banks with CAMELS 1 and 2
IRA B finds banks with CAMELS 2 and 3
IRA C thru F corresponds to banks with CAMELS ranging from 3 to 5

CAMELS ratings seem to move more slowly than IRA Risk Ratings which are computed on a per period basis algorithmically. This makes sense given that CAMELS involve deeper private information examinations of an institution to complete.

We think the IRA rating may function like a leading indicator but it's hard to tell because one cannot get a look at all the CAMELS and their inputs unless one is at the FDIC. We do have the structure of the EXAM table in our computers, but not the content. Doesn't matter. If we did the law is such that we could only show the results to the regulators anyway.

- D