THE VERIBANC COLOR CLASSIFICATION SYSTEM
“It’s simple and it works!”
VERIBANC, Inc.’s two-part color code and star classification system rates financial institutions from two perspectives -- present standing and future outlook. It takes into account many financial ratios and measures, including all six factors Federal regulators utilize in determining the government’s “CAMELS” ratings. These factors include an institution’s Capital strength, Asset quality, Management ability, Earnings sufficiency, Liquidity, and Sensitivity to market risk.
This summary describes several tests of the financial strength of a bank, thrift institution or credit union. The outcome of two of these tests is a color - GREEN, YELLOW or RED. Green is the most favorable result; Red is the least favorable. Additional criteria are used to assign three stars, two stars, one star or no stars to an institution. Three stars are most preferred. No stars are least preferred.
Of course, tests such as these can provide only an overview of an institution’s financial condition. A Green, three stars rating does not necessarily guarantee that the institution is healthy, nor does a Red, no stars rating mean that it will fail. However, these tests utilize key measures employed by the federal banking agencies to evaluate the safety of financial institutions. More details are presented below.
THE EQUITY TEST
A financial institution such as a bank, a thrift institution such as a savings and loan association (S&L) or a credit union does business by lending money that it has borrowed from its depositors. Thus, its business is controlling investments of other people’s funds. In addition, it uses (and, of course, controls) money and other items of value which belong to the institution’s owners. This portion is called equity. The total of its own equity and investments which really belong to others, i.e., all that an institution controls, is called assets.
It is both good business practice and a federal requirement for financial institutions to "have a stake" in the monies they control, namely, that a certain percentage of their assets must consist of equity. In fact, if the equity of an institution drops to zero or less, it is referred to as "insolvent". For this reason, equity is often referred to as a financial cushion. It allows an institution to withstand money-losing situations without having to go out of business. The VERIBANC equity test places an institution in one of three categories:
1) If the equity is a modest percentage of assets or higher, an
institution is ordinarily
assigned the classification Green.
2) If the equity is a minimal percentage of assets, it is ordinarily
assigned the classification
3) If the equity is less than a minimal percentage of assets, the
color Red is assigned.
For institutions, which are losing money, the color can also be affected by the Income Test described as follows:
THE INCOME TEST
Even though earning money is the purpose of any business, profitability can sometimes be elusive. Banking, like any other endeavor, can encounter difficulties that cause an institution to lose money. One way of measuring the seriousness of losses is to pose the question, "How much of the institution’s remaining equity does the most recent loss represent?" The VERIBANC income test considers results in three possible ranges:
1) If the institution had no net loss (i.e., is operating profitably),
2) If the institution had a modest net loss, it is ordinarily classified
3) If the loss rate was significant, the color RED is assigned.
The color classification blends the results of both the Equity and Income Tests as follows:
||The institution’s equity exceeds a modest percentage of its assets and it had positive net income during the most recent reporting period. Of the three color categories, this is the highest based on the criteria described.
||The institution’s equity is at a minimal percentage of its assets or it incurred a net loss during the most recent reporting period. Both of these conditions may apply, if there was a net loss, the loss was not sufficient to erode a significant portion of the institution’s equity. The items which result in a yellow classification, merit your attention.
||The institution’s equity is less than a minimal percentage of its assets or it incurred a significant net loss during the most recent reporting period (or both). The items, which result in a red classification, deserve your close attention.
HOW THE COLOR CLASSIFICATION CRITERIA RELATE TO THOSE USED BY THE FEDERAL BANK REGULATORY AUTHORITIES AND FINANCIAL ANALYSTS
Banks and thrift institutions are required by law to meet a variety of capital measures. When these measures decline below certain norms, the Office of the Controller of the Currency ("OCC"), the Federal Reserve Board ("FRB"), the Federal Deposit Insurance Corporation ("FDIC") or the Office of Thrift Supervision ("OTS") initiate remedial measures and the bank is subject to additional monitoring. One norm used in the financial industry is whether or not an institution’s equity is at least 5 percent or more of assets. If an institution’s equity does not meet specified minimums, regulatory authorities usually take corrective action in the form of compliance orders.