Red Sky Morning: What’s Ahead for Banking?

Like proverbial sailors, bankers across the country are paying attention to unsettling signs that point to a challenging year ahead. Indeed, the declining economy, faltering credit markets, and heady bank competition, set against an uncertain political year, are converging to create the need for steady hands at the helm.

With these and other issues on the barometers of U.S. banking institutions, Grant Thornton LLP, in association with Bank Director magazine, recently conducted the 15th Bank Executive Survey, a comprehensive study that seeks to capture bank executives’ opinions and plans for the year ahead. In this report, Bank Director presents the 2008 survey results, along with personal interviews with executives and additional perspective from Grant Thornton’s professionals.

Casting a wide net, the survey findings cover many pertinent topics, including the national economy, growth strategies, credit and lending, technology, risk management, corporate governance, and compensation. In each area, we gauge the direction and importance of long-term trends and inform directors and officers on emerging hot topics. In certain sections, we provide additional relevance by noting results cross-referenced by institution size (large and small banks are defined as those above or below $500 million in assets) or bank ownership structure (public, private, or mutual).

The national economy powers every aspect of corporate and personal business, and the financial services industry is particularly vulnerable to changes in its momentum. After experiencing months of lagging indicators and wafer-thin spreads, the Federal Reserve Board finally offered relief to financial institutions in January when it imposed an emergency rate cut of 0.75 percentage points, bringing the cost of borrowing down to 3.5%. The Fed further reduced the rate by another half-point eight days later, and once again in March, in an effort to further bolster the economy.

Earlier this year, speaking at a Senate Banking Committee hearing, Federal Reserve Board Chairman Ben S. Bernanke stated, “The outlook for the economy has worsened in recent months, and the downside risks to growth have increased.” He pledged to tackle the credit crunch, saying the central bank “will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks.”

While it remains to be seen whether these measures will noticeably boost 2008’s economic growth, at the close of 2007, respondents of the Bank Executive Survey easily recognized the storm clouds ahead. When asked about their outlook for the national economy in 2008, 56% characterized their mood as “pessimistic,” compared with only 13% who felt that way last year. Only 9% said they were “optimistic,” compared with 43% the year before. Executives’ outlook for banking reflected similar changes. Fifty-four percent of those surveyed are pessimistic about the outlook for the industry; only 10% were optimistic, with a slightly higher percentage (14%) noted at smaller institutions. As a whole, these results reflect the highest percentage of bankers’ pessimism regarding the national economy and general business since this survey question was asked in 2004.

“Clearly, bankers believe there is more fallout ahead for the national economy,” says John Ziegelbauer, managing partner of Grant Thornton LLP’s financial institutions practice. “And based on their outlook for their local real estate markets, many of them see more difficult times ahead. The historic write-offs we have seen recently only confirm that bankers were correct in their prognostications.”

Proactive measures

Yet there is hope on the horizon, and bankers interviewed for this article talked with us about some of the steps they are taking to prepare for what’s coming. “Our objective is to build liquidity throughout the year, which will allow us to be in a better position to meet loan demand in 2009 as the economy begins showing signs of recovery,” says Thomas Rokisky, president and CEO of CNB Bank Inc., a $283 million institution based in Berkeley Springs, West Virginia.

Ed Barham Jr., president and CEO of $3.2 billion StellarOne Corp., Culpeper, Virginia, tells how his company recently completed a merger of equalsu00e2u20ac”in part to address the need to gain efficiencies and grow the company more effectively. “The outlook for us is that we are focusing on cost control and pristine underwriting,” Barham says. While revenue growth is a goal, he says there’s no doubt underwriting will take priority this year. “I believe 2008 is going to be a tough year for all banks.”

Charles N. Funk, CEO of $561 million Iowa State Bank & Trust, Iowa City, says there’s no substitute for common sense and paying attention to the signs ahead. “We have believed for some time that the real estate market was too exuberant. For the past few years, we were very careful in granting loan requests with higher loan-to-value ratios.” Funk explains that while his market “has not tanked,” it is showing signs of stress. “We’ve become even more vigilant in addressing problems as soon as they are identified,” he says. “[T]he fact that we did not chase marginal deals in the past few years is currently serving us well in this environment.”

In times like these some bankers often feel they ought to create a cushion for possible losses by increasing their reservesu00e2u20ac”a notion that is not uncommon, but not necessarily recommended. “Most bankers and boards know there is a fine line on what constitutes prudent loan loss reserves and what might be classified as a less accepted earnings management strategy,” cautions TK Kerstetter, president and CEO of Board Member Inc, publisher of Bank Director. “I don’t want to suggest that they are necessarily mutually exclusive, but this process is certainly handled these days under a fairly bright light by outside accountants.”

Another area bankers are looking at proactively is human resources, where the survey again illustrates a fairly conservative outlook. For instance, the number of executives reporting staff increases has declined, with 36% of the survey population reporting planned increases, compared to 63% last year. Slightly more larger institutions said they expect staff increases (42%) in 2008 compared with those reporting from smaller institutions (32%).

At press time in early spring, there is much speculation about when the economy will hit a trough and then pick up speed again. In December, the largest percentage of respondents (47%) projected the real estate market would hit bottom between June and December 2008. On a related note, 31% (in December, prior to the rate cuts) felt the Federal Reserve Board was doing a good job of managing the economy; 21% disagreed with that statement, and about half of the bankers were somewhere in the middle.

Despite the pervasive sense of pessimismu00e2u20ac”or perhaps because of itu00e2u20ac”bankers are employing steps to ensure strategic growth and good performance in 2008. Many bankers say they will be implementing new technology solutions to expand retail delivery networks and build better relationships with customers. The old saying “capital is king” is as true today as always, but in the face of such strong competitive forces, many bankers might also agree “customers are king.”

Head-to-head competition

Banking institutions are fiercely vying for deposits and loans, and as the Bank Executive Survey results have shown year after year, nearly all executives say their most formidable competitors are each other. Overall, 76% of bankers polled ranked competition from community banks as their highest concern, and 60% said they plan to track funds from those institutions in the coming year.

Garnering the second-highest percentage of responses (70%) were credit unions, which continue to vex the banking industry from the standpoint of customer attrition. Nearly two-thirds (65%) of those surveyed are concerned about the number of retail customers their bank is losing to credit unions; 41% are worried about losing commercial customers. In a related question, nearly half of those polled believe the rules governing credit union conversions to bank charters are too stringent.

Interestingly, while concern about competition from other community banks and credit unions remains similar to last year, only 48% of bankers said they have a high concern about competition from megabanks, a much lower percentage than was reported in 2007, when 68% rated megabanks as a high concern. Broken down by bank size, 41% of smaller banks are highly concerned about megabanks, compared to 59% of larger bank respondents.

Emerging as a significant new competitive threat to traditional banking is the growth of Internet banks, which 41% of bank executives rated as a high concern this year, compared to just 34% who identified this as a high concern the year before, and only 21% who noted it two years ago. With demographics shifting dramatically and the consumer public becoming highly mobile and computer-savvy, this trend comes as no surprise and will likely gain momentum in future studies.

Among other categories, bankers rated competition from mortgage companies, brokerage firms, and other nonfinancial companies as moderate concerns for 2008, similar to previous years. In particular, the survey shows the threat from industrial loan companies has weakened, which may indicate a lessening of tension following the withdrawal of Wal-Mart’s and Home Depot’s charter applications. While this is an area to watch in 2008 and beyond, it doesn’t currently appear to be blinking strongly on the radar for most bankers.

Looking at these results by institution size, executives from larger banks tended to rate competition from mutual funds, Internet banks, brokerage firms, other large banksu00e2u20ac”and, interestingly, even competition from community banksu00e2u20ac”as higher concerns than did respondents from smaller institutions. Smaller institutions appear slightly more concerned about government-sponsored entities, industrial loan companies, and other nonfinancial companies.

Market reach and products

Bankers admit they face cutthroat competition from nearly every direction, yet overwhelmingly, those surveyed believe they are on the right track with their businessu00e2u20ac”two-thirds of bank executives agree their bank is doing a great job delivering what customers want and need. Moreover, almost half said they do not foresee repricing their current products and services in 2008.

But how will they profit under their current retail structure? Most indicate they will leverage the power of both new and existing customers within their market. Harnessing the power of loyal customers appears to be the key: Fully 91% said they intend to grow and compete more effectively by increasing cross-selling efforts to current customers. But that alone isn’t enough, as 76% of bank executives said they also plan to conduct promotions to attract new customers to existing products and services. Both of these areas reflect higher efforts to attract growth than in previous years.

Bankers are also charting paths for growth by exploring new territory, both through organic expansion and acquisition. Fifty-four percent of bankers polled said they are planning to open branches in new geographic areas in the next three years, with a higher percentage (63%) of larger-bank executives affirming this fact. A slight uptick was noted among those who said they planned to purchase branches from another bank in a new market, again with higher percentages reported from larger institutions (32%). The percentage of executives who planned to open new branches in existing markets (44%) and who planned to acquire another bank or financial services organization (34%) remained steady compared with previous years, although differences were again notable when comparing large and small banks, with larger banks tending to demonstrate more aggressive expansion plans. Overall, a more conservative tone was noted: While 45% of executives are forecasting increases in branch office construction, this number is down from 51% last year. The institution’s size will likely play a role in plans for construction growth: 55% of larger institutions anticipated growth in branch construction, compared with 38% of smaller institutions.

The survey also measured banks’ interest in a host of specific products and services and their expectations for expansion of those lines over the next three years. Products offered by, or those planned to be offered by, the highest percentage of banks include electronic bill payment, remote deposit, home equity lines of credit, adjustable rate mortgages, and second mortgages. Products and services that saw an uptick in interest this year compared to data available from last year include stored-value cards, remote deposit, health savings accounts, electronic bill payment, and electronic bill presentment. One new area measured this year was mobile banking, which 31% of larger-bank executives say they plan to offer in 2008, compared with 21% of smaller institutions that plan to do so.

There are notable differences in product offerings when large and smaller institutions are compared. Larger institutions are far more likely to offer, or plan to offer, online loan applications, nontraditional mortgages, reverse mortgages, remote deposit, and credit report access. Smaller banks have slightly higher expectations to offer home equity lines of credit over the next three years.

Technology

The tidal wave of operational change brought about by the Internet and the availability of wireless devices has had an enormous ripple effect on financial products and servicesu00c2u00ad, which banks of all sizes are embracing. “We expect technology to continue to create operational efficiencies and enhance service and product delivery to our customers,” says CNB Bank’s Thomas Rokisky.

Yet while the delivery of banking services via the Internet will continue to be a priority at most institutions, Brian Thomas, CEO of Clear Mountain Bank in Bruceton, West Virginia, emphasizes that the key behind technological success is the human element. “I would foresee most [of our] investment [to] be in peopleu00e2u20ac”additional staff with specific technical expertise.”

According to the survey, in 2008, many banks will be developing better means to promote their customers’ Web-based interactions; 39% of executives from smaller banks and 54% of those from larger institutions said they plan to expand their institution’s presence on the Internet over the next three years. Likewise, 25% reported they plan to provide customers with mobile banking options via cell phones, Blackberrys, and the like. Plans for expansion of more traditional technologies, such as ATMs, decreased significantlyu00e2u20ac”only 15% said they plan to expand ATM locations in the future, compared to 26% last year.

While expanding and improving technology is necessary, it does come with a price tag. Accordingly, 66% of bank executives expect technology expenditures to increase in 2008u00e2u20ac”a higher percentage than any other category. This closely mirrors their expectation for such expenditures in 2007, when 73% of those surveyed planned to increase technology spending. Moreover, this year, tech expenditures are expected to top what many might consider the expenditure black holeu00e2u20ac”complianceu00e2u20ac”which 56% of the survey population say they also believe will increase. It is important to note that in many cases, these two areas actually overlapu00e2u20ac”bankers interviewed for this story noted their chief technology expenditures involved systems to improve Bank Secrecy Act, Anti-Money Laundering, and Home Mortgage Disclosure Act compliance.

While the percentage anticipating technology cost increases is somewhat less than 2007, it is difficult to say whether this reflects an across-the-board tightening or a normal cyclical decrease after a period of spikes in technology spending. Some bankers say they are catching their breath after undergoing major initiatives the year before. For example, says Hunter Padgett, president and CEO of Marine Bank, a $375 million bank in Marathon, Florida, “after nearly tripling our operating square feet in the past two years, including significant investments in technology, I would say our technology focus in 2008 will be managing what we have.”

“Considering the environment we are facing in 2008, it will be interesting to see just how many institutions roll out IT expansion projects this year,” notes Greg Anglum, an audit partner at Grant Thornton LLP. “But given the emphasis that regulators are now placing on their IT exams, there may be compelling reasonsu00e2u20ac”even as there is a need to contain costsu00e2u20ac”to upgrade or invest in new systems.”

Fueling the bank: Funding concerns

With major initiatives in place to ramp up technology and bolster products, services, and customer relationships, there is no doubt that banks’ ability to raise funds at a reasonable cost will be a linchpin in their success.

This year’s survey demonstrates bankers’ keen awareness of their challenges in this regard. Eighty-one percent agree that finding adequate funding sources will be important to their banks’ success, with a slightly higher response (85%) noted for larger institutions. The market for the once-buoyant pool of trust-preferred securities has all but dried up, and any bank issuing common equity is likely staring at a steep price for dilution, dampening two commonly used options for funding.

Fully 92% of bankers surveyed said they anticipate using core deposits to fund their bank’s growth in 2008u00e2u20ac”a number nearly identical to last year, although in the current market, their ability to do so may be severely hampered by steep competition and higher rates than in the past, according to Grant Thornton’s Ziegelbauer.

Breaking down the survey population, the Northeast region reflected a slightly higher reliance on brokered deposits to fund growth in 2008. And out of the nearly three-quarters of executives who anticipate using Federal Home Loan Bank advances in 2008, a higher percentage (80%) was reported from larger institutions. A higher percentage of larger banks (31%) also anticipated use of loan sales for funding this year, compared with smaller institutions (20%). Interestingly, bankers who are more optimistic about the national economy reported a higher interest in issuing common equity and appear to be more bullish about the return of trust-preferred issuances in future months.

There’s no avoiding it: Risk is inherent in every asset and liability on the bank’s balance sheet, and yet the proper management of that risku00e2u20ac”along with an occasional serendipitous eventu00e2u20ac”is what truly enhances bank performance. Thus wisdom and experience, along with sharp-as-nails analytic skills, are needed to leverage the most value for shareholders with the least amount of risk. We posed several issues to bankers in this year’s survey to ascertain their opinions on their risk concerns.

Scanning for icebergs

The concept of risk is wide ranging and its modes are nearly infinite in variety. And while many business risks are acceptable, if improperly managed, some might very well tip the bank, its management, board, and owners toward a perilous outcome. To home in on risk areas that are top priorities for bankers in the current environment, the survey asked executives to rank their levels of concern for several risk areas. Not surprisingly, the largest grouping of respondents (45%) rated regulatory compliance issues most contentious. The second-largest percentage of executives (41%) marked online data security risk, followed by interest rate risk (39%) and credit risk (37%).

When these results are tabulated by institution size, smaller banks’ concern with regulatory compliance far outshadowed other risks; for larger banks, credit risk raised the most apprehension. Among the various ownership structures, nearly twice the number of respondents from mutual banks reported concern over interest rate risk as private banks. A larger percentage of public institutions rated credit risk as a major concern when compared with either private banks or mutuals.

From our in-depth interviews with bankers, the area of online fraud emerged as a looming spectreu00e2u20ac”one that smaller banks, as well as large ones, are grappling with more and more. Ed Barham of StellarOne Corp. says when his institution was undergoing its recent merger of equals, he placed high importance on the enhanced ability of the merged institution to ferret out fraud. Like many other bankers, Barham believes online fraud is migrating downstream from the megabanks to the smaller institutions, which are even more susceptible to its risks. “It’s an ongoing loss for us each and every year, even while we continue to step up our efforts,” he states. “We’ve got constant monitoring, 24/7.”

M. Russell Marshall, president of $1.2 billion First Victoria Bank in Victoria, Texas, agrees online security is a huge responsibility today. “Online remains a top priority of our company and a focus of examiners,” he says, adding that First Victoria has implemented several new security measures in its online delivery channels to tighten security. “Our most recent step was the addition of watermarks to our online channels to prevent spoofing and phishing.” Marshall further adds that while the topic of managing online risk is a key concern for management, it is critical to the bank’s board as well. “We review the implementation of new security measures with the board of directors,” Marshall says.

Risk management

Because it is the management, rather than the elimination, of risk that is the key to safe and sound performance, the survey posed several questions to executives to ascertain the strengths and weaknesses of their risk management programs. By far, most executives believe their programs are effective, with higher percentages of large banks demonstrating confidence in this regard. “Audit committees face more scrutiny than ever before and are becoming far more involved,” says Rick Huff, an audit partner in Grant Thorton’s Philadelphia office. This is especially true, he says, at larger banks, “which tend to face greater reporting pressures, and thus ask questions and challenge management more frequently.” Sixty-seven percent of those surveyed said they have the appropriate mix of risk management resources to properly understand the risks they face.

But risks often lie under the surface, as borne out by the unfortunate case involving the French bank, Sociu00c3u00a9tu00c3u00a9 Gu00c3u00a9nu00c3u00a9rale. Cases like this should “serve as the impetus [for banks] to reexamine their own risk management models and systems and inspire renewed diligence enforcing internal and supervisory controls” writes Steven Goldberg, a principal in Grant Thornton LLP’s advisory practice in a recently published article on the aftereffects of the SocGen case. The bottom line, asserts George Mark, audit partner for Grant Thornton: “An independent internal audit function is essential, and boards and management must take it upon themselves to be proactive.”

To combat fraud and other unacceptable risks, the mainstay of an effective risk management program is the board’s audit committee, which, in some cases, is being bolstered by a separate risk management committee.

Ron Sable, a director at Capitol Bancorp, a $4.9 billion holding company based in Lansing, Michigan and Phoenix, says multiple committees are often needed to traverse all the risk areas banks face today. “At Capitol, we have a technology committee and a risk committee in addition to the audit committee. We consider it most important to have that overlap, and issues often get addressed in more than one committee. IT simply has too great a role to play as a business driver for it not to be directly tied to our overall strategy and execution,” he explains.

On a positive note, this year’s survey results show that most banks are confident their committees are handling this function appropriately: Eight out of 10 bankers surveyed reported that their bank’s audit committee understands its oversight role and performs that function effectively, and 60% believe their internal audit function would uncover a material fraud if it existed within the organization.

Navigating the credit storm

With regular announcements of megabanks’ faltering credit lines and weakening asset values, the trickle-down effect of the U.S. credit crisis is palpable, with about half (49%) of executives surveyed agreeing they are concerned that credit issues will have an adverse impact on their bank. To address the whirlpool of risk in the nation’s credit markets, most bankers are reviewing and, in some cases, altering their underwriting and pricing practices. Examined by asset size, executives from larger institutions are even more alarmed, with 57% agreeing they are concerned about potential adverse effects, compared to 46% of smaller banks. Indeed, bankers participating in the survey acutely reflected this awareness: less than half (46%) affirmed confidence in the appraisals supporting loans the bank underwrites; just 22% have confidence in the appraisals supporting loans the bank purchases. On a more positive note, 62% affirmed their confidence in the bond rating system, and 62% reported no specific exposure from subprime loans, Alt-A investments, or investments backed by those securities.

Bankers readily identified specific credit indicators to watch over the coming year, as noted by their responses to anticipated changes in their credit portfolios. The most prominent changes involve expected swells in the number of delinquenciesu00e2u20ac”which 56% of large-bank executives noted in 2007 compared with 42% of smaller institutions. On the whole, bankers also believe credit card fraud losses as well as commercial loan losses and the number of foreclosures will grow in 2008. Once again, these fears were more prevalent among larger-bank executives than those from smaller institutions: 48% of large-bank executives believe foreclosures and commercial loan losses will rise in 2008, compared to 37% and 36%, respectively, of smaller-bank officers.

So what are bankers planning to do to deflect these anticipated hits? Nearly half said they had already tightened their underwriting standards in 2007, and another third said they plan to do so in 2008. Most are taking a hard look at their portfolios to ferret out any weak spots before trouble hits.

“We haven’t had the direct issue of subprime, but obviously we are contaminated by all the economic doldrums that are associated with the real estate market right now,” says StellarOne’s Barham. “We’re doing a lot of shock testing to our existing portfoliou00e2u20ac”in particular, our acquisition and development (A&D) portfolio, so we stay on top of those credits, since they are more susceptible.” Adds Russell of First Victoria, “We also have been aggressively reviewing, shocking, and grading our loans accordingly.” Marshall says an often overlooked component of the asset ledger is the investment portfolio, so “we have reviewed our investment portfolio as well, to see how our insured municipals would be rated outside of their insurance coverage.”

Another important aspect of managing loan risk today is ensuring there is a strong internal audit function, says Randall L. Fewel, president and CEO of Inland Northwest Bank, a Spokane, Washington institution with just under $300 million in assets. “This helps keep the quality of the loan portfolio high, and it is a significant, positive factor in dealing with safety and soundness and with compliance examiners.”

The bottom line: These days, you just can’t assume things are going right just because a blowup hasn’t yet occurred. Says Stephen J. Goodenow, president of Bank Midwest, a $475 million bank in Okoboji, Iowa, “From where we sit, our macro risk is impacted by every loan we put on our books. Solid underwriting and pricing for risk on an individual, or micro, basis should mitigate exposure on a macro basis.”

Unquestionably, as the shareholders’ fiduciary, the bank’s board of directors sets the tone for performance goals and plays a key advisory role in all strategic matters, with the chairman at the helm. And good governance dictates that the board of every financial institution, be it public, private, or mutual, plays a significant role in creating value for shareholders through prudent and ethical practices and sound and responsible oversight.

The results of the Bank Executive Survey reveal that while the vast majority (88%) of CEOs and other officers believe good corporate governance is important to their banks’ success, many are not confident that they are reaching their potential in this regard. Just over half (58%) of executives agree that their board of directors is helping management grow the bottom line and enhance shareholder value. A somewhat larger group (67%) say the board is in a better position to help improve bank performance and shareholder value compared with five years ago. But more than a quarter of executives feel the audit committee sometimes becomes too involved with management matters.

Individual interviews offer more enlightenment on how banks believe their boards work successfully with management. For instance, Dan Doyle, president and CEO of $472 million Central Valley Community Bank, in Clovis, California, wholeheartedly agrees that good corporate governance is central to a bank’s ongoing success. “I think we have a perfect example in light of the subprime impact on the financial services industry,” he says. “As far back as 2004, our bank looked at the securities being offered and at subprime, and we made the decision that while it appeared to provide higher yield investments and increased volume and fees to the lending arena, it did not make sense, and the risk was not worth the apparent reward. I think this is a good example of why governance is critical.”

Bank Midwest’s Stephen Goodenow believes a good corporate governance policy establishes accountability and lays the groundwork for a working relationship between management and the board. “A good governance policy will create some independent oversight of critical ‘decisioning’ processesu00e2u20ac”such as compensation or larger loans,” he states. Such independence is critical, agrees Iowa State Bank & Trust’s Charles Funk, who tells how his outside directors have met without management in the room on a semiannual basis for the last couple of years. “Positive and constructive comments nearly always come from these conversations,” he says.

“While I have yet to see convincing data that proves that a bank with a smaller number of directors or a mandatory retirement age correlates to better bottom-line performance, the logic of a well thought through governance guidelines program, or even a code of conduct policy, has to have a positive influence on building shareholder value,” says Board Member Inc.’s Kerstetter. “If only for the reason that bank management and the board get to spend more of their time on strategic issues than solving problems attributable to a poor governance structure.”

Behind all the numbers, technology, and brick and mortar, the bank’s most fundamental resource is its people, and thus the impact of compensation issues and trends on the performance of the institution cannot be underestimated. Therefore, it is crucial for bank executives and boards to stay abreast of pay trends and compliance issues related to compensation to ensure their practices are competitively aligned with peers and to create a workplace that motivates sales and loyalty.

Compensation transparency

Like a rogue wave, the SEC’s final ruling on proxy disclosure of executive compensation rolled over all publicly traded institutions in 2007. To comply with these new rules, management of all publicly traded companies performed many complex analyses for their compensation discussion and analysis (CD&A), including formulas and rationale used to determine executive and board compensation awards. There was much written about both the burden of work required by the new regulations as well as the unknown effect of such transparency in the marketplace.

More than a year later, much of that concern has dissipated. While the SEC meted out punitive measures for a few companies, in general, most were able to adequately comply with the requirements, although SEC officials are urging fuller, more explicit details in next year’s CD&As.

The Bank Executive Survey asked executives to assess their experience with complying with the new rules and to share their thoughts on what result it is likely to have with regard to pay practices. About a third believe the required SEC disclosures will help eliminate egregious severance pay; another third think it will result in moderate decreases to overall pay. Almost half believe the rules will result in no long-term effect.

“Most banks have been very diligent with the first year’s proxy disclosures,” says Henry Oehmann, director of National Executive Compensation Services for Grant Thornton LLP. “If there is an area that may need attention, it is in linking how the compensation plans and programs actually resulted in the reported compensation data. The addition of key elements such as performance measures and bonus formulas would add considerable value to shareholders’ understanding of the link between performance and compensation. I expect to see more of this with this next round of proxies.”

So was the SEC’s reaction to investor and public outcry against corporate pay justified? Interestingly, despite the overwhelming amount of media coverage in the last year over highflying executive pay and benefit practices, the majority of bank executives polledu00e2u20ac”96%u00e2u20ac”say they have not had to face questions from shareholders or the public about the bank’s executive compensation program.

Elements of pay

In terms of the types of compensation executives are receiving, most banks award cash compensation (94%), followed by stock options (41%) at the executive level. A greater number of respondents from larger institutions reported receiving stock options, restricted stock, and stock appreciation rights, a pattern that followed suit among all cross-tabulated groups.

2008 will bring many challenges to U.S. bank executives as they strive to identify funding sources, grow revenue, and pursue additional market share at a time when the economy is struggling to revive. While bank executives are well aware of the challenges ahead, they are looking beyond the current months to solidify customer relationships and leverage profitable business while maximizing cost containment strategies. Strong leadership, good governance, and intense risk management will be necessary to chart these duel courses and steer their banks toward a clear horizon.