Can You Trust Bankrate’s Bank Safety Ratings?

In case you haven’t been paying attention, bank failures are on the rise. Given this little tidbit of nerve jangling information, I’ve recently spent some time writing about the safest online banks, as well as the banks at greatest risk of failure.

With that as a backdrop, I though it would be interesting to take a look at the reliability of Bankrate’s Safe & Sound rating system, upon which my list of safest online banks was based. This is admittedly a very anecdotal account, but it’s interesting all the same…

About Bankrate’s Safe & Sound rating system

For starters, just what is the “Safe & Sound” rating system?’s Safe & Sound service is a proprietary system designed to provide information on the relative financial strength and stability of U.S. commercial banks, savings institutions and credit unions. The system employs a series of twenty-two tests to measure the capital adequacy, asset quality, profitability, and liquidity (CAEL) of each rated financial institution. Individual performance levels are determined from publicly available regulatory filings and are compared to asset-size peer norms, industry standards and key absolute benchmarks. Combined results form the basis for our Composite CAEL and Star Ratings…

So the system purportedly provides insight in the financial strength of stability of commercial banks in the United States. The star ratings work as follows:

5 stars – Superior
4 stars – Sound
3 stars – Performing
2 stars – Below peer group
1 star – Lowest rated

The majority of banks fall into the 3-4 star range.

A closer look at a recent failure

So how does the system perform when it comes to predicting failures? As I said, this is highly anecdotal, but… On July 25th, First Heritage Bank, N.A. of Newport Beach, CA was closed down by the Office of the Comptroller of Currency, and the FDIC took it into receivership. So what did Bankrate have to say about all of this? Well…

As of the date of the failure, First Heritage Bank had a 3-star rating, indicated that this bank was “performing.” In fact, even as I write this, First Heritage is still listed as having a 3-star rating:

For the sake of comparison, ING Direct has a 3-star rating just like First Heritage, whereas E*Trade Bank, HSBC Direct, and Emigrant Direct all have 2-star ratings. The top online bank right now is Everbank with a 4-star rating.

Lessons learned

The biggest lesson here is that Bankrate’s ratings can’t be viewed as an absolute indicator of bank health. While I have little doubt that the banks that they rate as being unhealthy are indeed unhealthy (e.g., IndyMac had a 1-star rating prior to their failure), it’s clear that an apparently healthy rating doesn’t necessarily mean that a particular bank is a safe bet.

It remains unclear (at least to me) whether this particular case was due to a flaw in Bankrate’s methodology (or the underlying data), or due to the fact that the Safe & Sound ratings are only updated quarterly — a lot can change in a few months. Regardless, this is just another reason that you should never exceed FDIC insurance limits, no matter how much confidence you have in your bank.

Hat tip to Sam for pointing out this article.

6 Responses to “Can You Trust Bankrate’s Bank Safety Ratings?”

  1. Anonymous

    I agree with Paul. We simply do not know, and bankrate cannot know, the extent of a bank’s leverage and derivatives in the “undocumented” investment vehicles. that’s the reason we are in the credit mess, because there was and is no “real” value on some of these investment vehicles that were used as leveraged investments.

  2. Anonymous

    I always wondered about those ratings. This was an interesting article.

    Paul, if a depositor has more than $100,000 there are many ways to be insured at one bank. Most people have at least a couple of family members they can list as beneficiaries. $100,000 is just for a single account owner. Go to the FDIC website for information on revocable trust accounts. All you need to do is ask the bank rep to put Payable on Death on a CD or other
    account. Each trust account is insured up to an additional $100,000 per qualified beneficiary. (i.e., spouse, child, sister, brother)

    You can also go to a CDARS partner. There are about 2,000 banks that belong to CDARS and unless you have more than $50 million, you just get one statement, one interest rate and each account is FDIC insured up to $100,000.

    I don’t understand why other states don’t carry SIF or DIF like the banks in MA. They are insurance funds that cover all amounts above the FDIC limit. See and

  3. Anonymous

    I’m not positive, but I believe the following may explain why ING Direct has a relatively low Bankrate score:

    “COUNTRYWIDE had 94,000 foreclosures last year. By comparison, ING has had just 15 out of 100,000 in its eight-year history as a mortgage lender. So what’s the online bank’s secret? Unlike other lenders, who have sliced, diced, and sold off their loans to Wall Street, ING has kept all $26 billion of its loans on its books … [Says Arkadi Kuhlmann, CEO of ING Direct, many banks resell] their mortgages, and with no skin in the game, underwriting standards suffer.” (Jon Birger, Fortune, 3/17/2008, “ING dodges subprime: only 15 foreclosures for the bank since 2000.”)

    If a bank “improves” its bottom line on paper by lumping its loans, good and bad, into one jumbo security and then selling that security to some Wall Street firm, then it’ll probably look better — and its numbers will crunch better — to outside entities like Bankrate, whose formulas many not take into account the funny numbers. I’d have to know more about how Bankrate crunches its numbers to be sure, but I suspect this is the case.

    Frankly, I’m quite happy to keep my hard-earned money in a bank in which the CEO is actually keeping an eye on underwriting standards, regardless of its Bankrate star ratings. Bankrate’s ratings can be useful, but take them with a grain of salt — and never, never exceed FDIC insurance limits on any bank accounts anywhere.

  4. Anonymous

    one problem may be bank “investments” include derivatives and leverage. I suspect its difficult to gage the volatility of these, even by professionals, and alot of banks are hoping and praying for no black swan events.

    also, I don’t know if the $100k FDIC is getting adjusted for inflation. $100k is way less purchasing power than even 10 years ago, especially in the context of the housing bubble. It could get tedious for people to have 1/2 dozen bank accounts, along with a myriad of brokers, and other money oriented accounts.

  5. Anonymous

    That is some very interesting news. Not sure how Emigrant Direct, HSBC Direct, and ING Direct are all rated so low but like you said, Bankrate isn’t the end-all when it comes to the health of institutions. I have always believed that it is important to do your own research into such matters and use sites like Bankrate as a guide. Of course, the tiny regionals are going to be more suspect than the century-old institutions but anything can happen in this day and age. I’m sure all of this won’t help change the misconceptions regarding online banking. I attempted to that on myself, but only time will tell what happens from here.

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