The CAMELS Rating: How to Get Over the Hump

You Can Make a Material Difference in a Regulatory Examination.

By Roger Shumway 

Everyone thinks their own management team is great. After all, they are a part of it, so it’s very hard to be objective. But if a bank’s management are working toward the pinnacle of a “1” CAMELS rating and never receive it, they must look deep into their souls and realize that maybe they aren’t so great after all. 

In addition to quantifying a bank’s existing and potential credit risk, examiners also look into the ability of bank management to identify, measure, monitor, and control that credit risk. How well examiners believe a bank is performing in those areas has a material impact on each bank’s CAMELS  rating—made up of capital adequacy (C), quality of assets (A), quality of management (M), earnings (E), liquidity (L), and sensitivity to market risks (S).

It’s inevitable that some banks will hear negative feedback from examiners. But if those banks counter that feedback by demonstrating effective, responsive management, they can score better CAMELS ratings than banks experiencing similar issues but failing to demonstrate proactive management. 

This article offers suggestions for how management can make a material difference in CAMELS evaluations, simply by asking the right questions and then discussing them openly and honestly. 

Currently, regulators and bankers alike are noting rapid asset growth, rising cybersecurity risk, funding of loans with brokered deposits, concentrations of all types, pressure on the return on assets, and capital needs in all areas of each bank. Regulators and management want us to remember that, as noted by the FDIC, during the Great Recession “the majority of community banks failed as a result of aggressive growth, asset concentrations, poor underwriting, and deficient credit administration coupled with declining real estate values.”1

With that in mind, any bank with an eye toward improving its CAMELS number should be asking the following questions.

1. How would others rate your underwriting and credit administration? 

Is your bank’s pattern of recognition and implementation merely a response to regulatory criticism or does it anticipate changes in the economy? 

Does your bank follow its written risk appetite statement?

Is your board aware of the pattern of loan policy, loan documentation, and post-closing documentation exceptions? Is your board aware of trends in loan covenant violations, waivers, and forbearances?

Do most of the changes in your loan grade come from loan officers, loan review, or credit administration? What has been your bank’s trend of examination-recommended downgrades over the last five exams?

If your bank has an unseasoned loan portfolio (that is, one less than three years old), management’s expertise and experience are key and risk selection is critical. It will take two to three years to fully season the portfolio.

If your bank’s loan portfolio is growing faster than the market is expanding, are your results aligned with your strategy? Are you resisting competitive pressures? Are you over-risking or underpricing?

Does the bank have any new, modified, or expanded products and services? If so, have the strategic, reputation, credit, operational, compliance, and liquidity risks been quantified? Was proper due diligence performed and were approvals obtained? Were effective change-management processes to manage and control new or modified operational risks followed? How robust are the performance and monitoring? Were new third-party relationships entered into?

2. What are the level and trends of problem assets?

What are the trends and the level of your bank’s due loans and its nonaccruals? What has been your bank’s experience in write-offs? What trends have been noted between your most recent examination and now? 

3. Is your allowance for loan and lease losses adequate?

Examiners view ALLL as the first buffer against losses; thus, they will opine as to both its adequacy and the appropriateness of its methodology. Is the board involved in its approval?

If you have an unseasoned loan portfolio, how do you demonstrate to the examiners that your ALLL is directionally consistent? If the ALLL/total loans and leases has been 1.49%, 1.52%, and 1.48% over the last three years, the overall methodology is probably acceptable.

4. What are your asset concentrations?

There are no hard limits and no safe harbors when it comes to loans subject to the 100% and 300% of total capital guidance. Management must have expertise in its market and have in place the proper elements before reaching one of these two thresholds. 

A bank would be wise to establish its own definition of a concentration in much the same way that it does a house lending limit versus the legal lending limit, thus establishing a warning path. The higher the concentration, the more robust the management and reporting required. 

Meanwhile, the board would be well advised to understand the gap analysis between regulations and the bank.

Keep your board apprised as to the effect high-volatility acquisition, development, or construction exposure will have on risk-weighted capital.

5. Does management or the board employ third-party reviews?  

To hold management accountable, does either the board or management employ third-party reviews? Is the scope of the reviews dictated by the board? Who reviews the findings?

6. What is your management’s level of expertise?

Please be cold fact honest in answering the following questions:

  • Do the examiners absolutely trust management and can management present itself as a student of regulations and refer easily to them? 
  • Is management seasoned not only in their positions, but through economic cycles? 
  • How well does management exhibit knowledge of the markets the bank serves?
  • Is management combative with the examiners? 
  • How many regulators meet with just one member of your management team when they have significant issues to discuss? 
  • Does management disregard what the examiners bring to its attention? 
  • How quickly and thoroughly does management respond to regulator findings? Are findings cleared easily by the examiners? 

Also remember that management is evaluated on how well it can recognize asset quality (this will make or break the bank), enforce risk appetite, avoid over-risking and underpricing, manage concentrations, leverage independent
reviews, and stay true to proven standards.

ACI Coverage Ratio

Adversely classified items (ACI) are comprised of classified loans and investments, OREO, etc., divided by equity capital plus ALLL.

As stated, the examiners’ options or ranges are broad and overlapping, giving them discretion—and, again, giving management the option to shine (or not).

Examiners are watching for the following key red flags: 

  • Willingness to approve policy exceptions or forgive loan covenants.
  • Elevated asset and funding concentrations.
  • High levels of historical or planned growth.
  • Entering new lines of business.

Based on the above, there truly is a range between CAMEL ratings of 2 in each category. Let’s review some examples and see where a bank may be rated. Each bank is unique and the examiner in charge is granted leeway depending on the specifics of each case.

Are brokered funds bad? Yes and no. What is the difference for your bank? How does your strategic plan address brokered funds? How does it relate to your asset tenure?

Is a decrease in your efficiency ratio good? Yes and no. Is your loan growth outpacing your ability to properly manage your assets?

Is a 40% ACI ratio bad? Yes and no. An example may best illustrate this point:

Bank A

  • ACI ratio = 40%.
  • Lending markets are deteriorating quickly.
  • Examiners have identified several downgrades.
  • Weaknesses have been identified in credit administration and underwriting: Its likely rating is a 3. 

Bank B

  • ACI ratio = 40%.
  • Lending markets have stabilized.
  • Management has appropriately identified all classifications.
  • Credit administration and underwriting are satisfactory: Its likely rating is a 2.

Unofficial examiner target ranges are a starting point for rating asset quality. Ranges are intentionally broad and overlapping, which gives the examiner discretion:

  • 0% to 15% (strong).
  • 10% to 40% (satisfactory).
  • 35% to 70% (less than satisfactory, or weak).
  • 60% to 100+% (deficient or critically deficient).

Is having a business plan beneficial? Yes and no. How does it align with your strategic plan and actual operations? Is it short-term or long-term in nature? What does it emphasize? Are incentives properly aligned?

Always remember the three themes that drive examiners: 1) core earnings, 2) ALLL sufficiency, and 3) adequacy of capital. Overall, does your bank’s strategic plan tie to its risk appetite statement, tactical plan, loan policies and procedures, credit underwriting, credit risk management, policy exceptions, waivers, and expertise? All must be in alignment. If any are not, the bank is open to criticism.

A Case Study

Consider the following key factors for ABC Bank:

  • Policy exceptions are increasing.
  • During the examination there were no downgrades.
  • Underwriting in CRE is loosening to meet growth targets.
  • CRE concentrations are increasing, to 471% of total capital.
  • The loan portfolio is unseasoned.
  • Loan growth is significant, averaging 17% over the last three years.
  • The level of problem assets is moderate: a 23% ACI ratio versus 18% last year.
  • Credit administration is satisfactory.
  • ALLL level and methodology are acceptable.

Let’s understand the difference between the CAMELS asset quality ratings.

A rating of “1” indicates that asset quality and credit administration practices are strong. Identified weaknesses are minor in nature and risk exposure is modest in relation to capital protection and management’s abilities. Asset quality in such institutions is of minimal supervisory concern.

A rating of “2” indicates that asset quality and credit administration practices are satisfactory. The level and severity of classifications and other weaknesses warrant a limited level of supervisory attention. Risk exposure is commensurate with capital protection and management’s abilities.

A rating of “3” is assigned when asset quality or credit administration practices are less than satisfactory. Trends may be static or indicate deterioration in asset quality or an increase in risk exposure. The level and severity of classified assets, other weaknesses, and risk require an elevated level of supervisory concern. There is generally a need to improve credit administration and risk management practices.

So what should the asset quality rating be: 1, 2, or 3? Why? Here is what the examiner could say: 

Asset quality is satisfactory.

“The level of adversely classified assets is modest, but significant loan growth and increasing CRE concentrations have increased the credit risk profile. As of December 31, 19xx, the adversely classified items coverage ratio is 22.47%, compared to 18.53% at the prior examination. Classified items primarily consist of $5.238 million in loans in addition to $526,000 in OREO. Past due and nonaccrual loans are manageable at 1.20% of total loans. Despite reasonable credit quality metrics, a large portion of the loan portfolio is unseasoned, with annual loan growth averaging approximately 18% over the past three years. Although management has slightly relaxed credit underwriting standards for CRE and construction credits as a strategy to meet loan growth targets, examiners did not downgrade any loans during the review. The board should be aware of potential migration risk resulting from permissive standards and an increased level of policy exceptions. The methodology and level of the ALLL are appropriate at 1.47% of total loans. Credit administration practices are generally satisfactory.”

Concentration risk is rising.

“Concentration risk is elevated and increasing, but management has generally appropriate risk management practices in place. As of December 31, 19xx, non-owner-occupied CRE loans represent 471% of total capital (TC), compared to 352% at the prior examination. The concentration increases to 589% of TC when owner-occupied CRE loans are included. Construction and land loans represent 78% of TC, or 137% when including unfunded commitments. Management appropriately performs portfolio stress testing and reports concentrations to the board quarterly. However, quarterly reports can be improved by including detailed portfolio metrics such as LTV, DSCR, geographic location, and policy exceptions.”

Do you agree with that analysis? 


To summarize, management must do the following:

  1. Recognize asset quality will make or break the bank.
  2. Enforce the bank’s risk appetite.
  3. Avoid over-risking and underpricing.
  4. Manage concentrations.
  5. Leverage independent reviews.
  6. Stay true to proven standards.

Recognize that everything affects capital. Understand the importance of board oversight. Be aware that capital planning must reflect the bank’s risk profile. And heed the lessons from the financial crisis. 

Roger Shumway is executive vice president and chief credit officer at the Bank of Utah. He can be reached at



1. From testimony by Jon T. Rymer, inspector general of the FDIC, before the Subcommittee on Financial Institutions and Consumer Credit, U.S. House Committee on Financial Services, March 20, 2013.