Michael Cahill, the president and chief executive officer at Tower Financial Corp. in Ft. Wayne, Indiana, is looking for a new director to serve on the board of his $661 million-asset community bank—although he’s not looking for just for any director. Cahill expects that acquisitions will play an important role in Tower’s growth strategy over the next several years, but the bank has never done an acquisition and the collective experience of the bank’s 16-member board—which is largely comprised of local business leaders and educators, many of whom helped start the bank in 1999—includes little, if any, hands on experience with takeovers. Cahill would also like to have someone with a banking background, particularly if he or she lived through the commercial real estate crisis and its aftermath in the early 1990s, when bank failures reached pandemic proportions and the U.S. economy plunged into a deep recession.
Sound familiar? Today, the industry still is recovering from a collapse of the residential and commercial real estate market a few years ago that resulted in hundreds of billions of dollars in loan losses, and it now faces the chilling possibility of a double-dip recession.
The 51-year-old Cahill, who had served as Tower’s chief financial officer and chief operating officer before becoming CEO in 2008, is one of its most experienced executives. “Most of my lenders started their careers in the late 1990s,” he says. “What went wrong in the late 1990s? Nothing. We need that banking background.”
But finding a former banker with M&A experience has proven to be a little tougher than Cahill had anticipated. Ft. Wayne is a community of 250,000-plus people in northeastern Indiana, so there is certainly a reservoir of talented people there—but not necessarily retired senior bankers. “It’s really tough finding someone like that,” he says. “There are limited prospects (in Ft. Wayne). I think I’m going to have to look out in the region.”
Tower isn’t the only bank that’s trying to expand its talent base to cope with the most difficult operating environment the industry has seen in 20 years. Institutions of all sizes will be hard pressed to grow their revenues given the weak U.S. economy and new federal regulations that have further diminished their profitability. Bank CEOs and boards will need to emphasize a different set of skills if they expect to survive over the next several years. It wasn’t very hard to rack up record profits when the economy was booming back in the mid-2000s, but those days are over.
“The challenge for most banks today is figuring out how they are going to make money,” says Hal Reichwald, a partner and co-chair of the financial services group at the law firm Manatt, Phelps & Phillips in Los Angeles.“How will the regulatory environment effect how we have done it in the past, and from a strategic perspective how will we do it in the future?”
“For banking, and for all industries, there is a new normal in terms of expectations and prevailing conditions,” says Theodore Dysart, vice chairman and executive recruiter Heidrick & Struggles in Chicago.
But just having the right set of skills might not be enough. What banks also need are strong leaders who can guide their organizations through the most challenging operating environment in two decades. Dysart resorts to a military metaphor. “How do you get people to charge up a hill when every piece of the body is screaming not to go?” he asks. Skills and experience are important, Dysart agrees, but “the leadership part has become so much more important than ever before.”
Banking’s “new normal” is characterized by limited growth opportunities, increased federal regulation and diminished investment returns. The U.S. economy has stalled after a shallow recovery following the 2008-2009 recession, so loan demand is down. Most banks are flush with deposits but having a tough time putting that money to work. Competition for small business and middle market customers that want to borrow is fierce. “Earning asset growth is a zero sum game,” says Mark McCollom, a senior managing director at Griffin Financial Group in Reading, Pennsylvania. “If you’re growing, you’re growing at the expense of a competitor.”
“Bankers are frustrated,” adds Sam McCullough, chairman and CEO of Griffin Holdings Group, Griffin Financial’s parent company, and the former CEO of Meridian Bancorp. “They’re trying to make loans and can’t do it.”
A slew of new regulations, including the Dodd-Frank Act, have driven up compliance costs and cut into the industry’s profitability. A provision in Dodd-Frank known as the Durbin Amendment has resulted in an approximate 54 percent reduction in the interchange revenue that banks historically have received from debit card transactions, from an average of 44 cents per transaction to approximately 24 cents. The new rate was set by the Federal Reserve and took effect October 1. Banks with less than $10 billion in assets are exempt from the restrictions, although it’s unclear whether competitive pressure from large institutions will permit them to continue charging higher rates.
Bank holding companies also face the prospect of higher and more stringent capital requirements under Dodd-Frank, which ultimately will drive down the industry’s return on equity (ROE) because banks will be forced to use less leverage. “I’m not going to say that no one will ever earn 15 percent ever again, but you’re going to have to work a whole lot harder to get it,” says Walt Moeling, a partner at the law firm Bryan Cave and co-chairman of its financial institutions practice group. Most banks will probably have ROEs in the 11 to 12 percent range, Moeling adds.
Thanks to the more difficult operating environment, privately held banks—and smaller public banks with thinly-traded stocks—might find they can’t raise fresh capital at any price despite the new regulatory imperative. “The challenge is that the capital just isn’t out there for (those institutions),” says McCollom.
To help their banks survive in today’s low growth and intensely regulated environment, CEOs will need to emphasize certain skills that were not as important when the economy was booming and the real estate market was a powerful engine that helped drive both revenue and earnings growth. For a start, CEOs will have to develop their deal-making skills because takeovers might be best way to grow earnings and drive up the stock price in the face of continued poor loan demand. “CEOs will need to have financial acumen and M&A acumen because consolidation is going to continue and most successful banks will combine organic growth with M&A,” says McCollom.
CEOs at smaller banks that might have relied heavily on real estate lending for growth will also have to strengthen their retail marketing skills. “They’ll have to show a willingness to go off the norm in terms of bank products and services,” says McCollom. “And they’ll have to understand the wants and needs of every generation, from baby boomers who are nearing retirement to Gen X’ers who are a very different breed of cat.”
In a similar vein, bank CEOs will also need to become more comfortable with technology as the industry’s transaction- and asset-driven operating model expands to take on more of a consultative role, helping baby boomers prepare for retirement or Gen X’ers start college funds for their young children. This evolution of the bank into the role as an information broker can only be accomplished through investment in new technology that allows a bank to segment its customer base and develop a needs-based marketing strategy, says Paul Schaus, president at CCG Catalyst Consulting Group in Phoenix, Arizona. “The CEO used to be an up and coming lender,” Schaus adds. “Now you need to look at a technology company for a bank CEO.” That might be a slight exaggeration, but certainly bank CEOs will need to understand how the smart use of technology can help their institutions expand their strategic focus, and just being a good lender won’t be enough if there aren’t enough good loans to go around.
And with the federal government having assumed such an intrusive role—both in the form of new regulations like Dodd-Frank, and in the form of tighter day-to-day supervision—CEOs will have little choice but to focus more attention on managing the bank’s relationship with its prudential regulator. “This has become a bigger piece of the CEO’s job,” says John Dugan, a partner with Covington & Burling in Washington and a former comptroller of the currency. “Rightly or wrongly, regulatory compliance is becoming an increasingly important part of the job and it’s incumbent on management and the directors to be more sensitive to the issue.”
One skill that bank CEOs have always needed—but will need even more in the coming years—is a feel for leadership. Banks are creatures of the economy, and it’s easier to lead other bankers when a strong economy creates opportunities for you than it is when a weak economy forces you to create them on your own. Heidrick & Struggles’ Dysart says that when selecting a new CEO, it’s important to match a candidate’s experience and skill set with the future direction of the company. But he says it’s equally important to understand the prospective CEO’s value system because it offers a window into how they are likely to run the company. “I don’t think you can select a leader without considering both,” he says. And if Dysart had to choose between experience and values, he would give a slight edge to the latter. “I can backfill for the (lack of) experience,” Dysart says. “The piece that I can’t fix is where the person’s head is at when they get up in the morning. That’s the only thing I can’t fix.”
Of course, bank boards of directors will find themselves similarly challenged by a difficult operating environment in the years ahead. The reality is that many smaller banks have boards made up of local business people whose primary purpose is to bring in other small business customers through referrals. These directors are not necessarily equipped to help the CEO steer the institution through the shoals of a treacherous environment—although that will have to change. Going forward, boards will have to demonstrate a much firmer grasp of the fundamentals of banking than has too frequently been the case. Moeling, who has counseled bank boards for years on a variety of issues, has witnessed their lack of understanding first hand. “I’ve been in board rooms where directors said, ‘We don’t borrow money.’ They didn’t understand that deposits are essentially a loan from consumers! They need to have a better understanding of what drives bank profitability.”
Boards will also have to hold the CEO and his or her management team accountable for their performance, which in theory has always been the case, but in actual practice was not necessary when industry earnings were showing strong year-over-year growth in the mid-2000s. In the tougher environment that will most likely prevail during the next several years, it will be easier to identify the underperformers, and boards won’t have the luxury of patience. “They need to change how they behave as directors,” says McCullough at Griffin. “They have to be willing to fire the CEO, or fire the head of lending.”
At the same time, boards can also help their CEOs by bringing in new directors who have specific skills and experience that match critical needs of the institution. Like Tower Financial, many boards are looking to recruit directors who have M&A experience on the assumption they will probably have to become active acquirers if they’re going to be able to grow. McCollom says other people with skill sets that boards might seek to add through director recruitment include a marketer, accountant or an attorney who understands the bank regulatory environment. “The CEO can lean on these people as a resource,” he says. Bank boards also should look for new directors with professional experience in finance if that happens to be a gap in the board’s collective experience—and that person could very well be a retired banker, says Reichwald at Manatt. “I don’t think that CEOs like having former bankers on the board because they don’t like being second guessed, but it’s not a bad idea,” he says. “It would demonstrate to regulators that the board is doing its job.”
One area where CEOs and their boards need to collaborate more effectively is strategic planning. Planning was less important when the economy was growing and businesses of all stripes were borrowing. Those banks that wanted an extra kick could find it lending to real estate developers and builders. But that market is pretty much dead and the regulators are wary of real estate concentrations anyway. “If you plan on being vital and growing, you’ll have to find other sources,” says Dugan.
Indeed, planning becomes crucial when it’s not entirely clear what the best plan is. According to Moeling, too many banks have ginned up their annual business plan at a cursory two-day planning retreat, with limited input from the board. This practice was acceptable when economic growth was strong enough to make even an average bank highly profitable, but it doesn’t work in a weak economy. “In retrospect, strategic planning was much more important than people thought,” he says. “There was too much emphasis on the short term and not enough emphasis on the long term. As we go into a period of time when growth clearly will be slow and will not accelerate like it did in 1993 and 1994, the strategic orientation has to be better.”
Banks can also expect their regulators to take a much closer look at the strategic plans. “Who sets the strategy for the bank?” asks Reichwald. “The regulators want there to be a very close working relationship between management and the board. The board has to be an active participant going forward.”
Over the next few years, CEOs and their boards will have to wrestle with the existential question of why they are here. “Business plans become much more realistic when they start out with the big picture rather than ‘do we really want a Walmart greeter in the lobby?’” Moeling says. “Are we going to build for five years and sell? Are we going to acquire? Are we going to stay local or expand?”
These are all questions that Soren Kierkegaard, the father of existentialism, might have asked if he had been a banker. Or as Moeling puts it, “Where are we going with this?” |BD|