The board of Umpqua Holdings Corp. in Portland, Oregon, schedules its annual retreat nearly a year in advance. Directors and members of the executive team spend months carefully choreographing a program of presenters and reviews aimed at making board members full partners with management as they contemplate together the long-term strategy challenges facing the company.
Itu00e2u20acu2122s a big effort. But when pretty much the entire agenda was scrapped just weeks before last Octoberu00e2u20acu2122s gathering, there was little, if any, dissent from directors. The reason was simple: Just as the date approached, the impact of the subprime mortgage crisis and related housing-price implosion was becoming clear. While $8.2 billion Umpqua didnu00e2u20acu2122t have much to do with creating those troubles, it sure was beginning to feel their effects in terms of asset quality and funding. The threat of an economic downturn and eroding credit quality in other lending areas, such as commercial real estate, meant things could get worse. u00e2u20acu0153The wheels were starting to come off a little,u00e2u20ac recalls David Frohnmayer, president of the University of Oregon, and an Umpqua director since 1996.
The board needed time to discuss and consider the implications and to plot a response. By fate, the retreatu00e2u20acu2122s timing made it the perfect vehicle for those deliberations. u00e2u20acu0153We junked the entire program and rearranged the discussion topics on the spot to make everything relevant to the situation at hand, and the decisions we wanted management to make,u00e2u20ac Frohnmayer, 67, says. u00e2u20acu0153The focus of the entire retreat shifted clearly to how we were going to work through this.u00e2u20ac
A month later, Umpquau00e2u20acu2122s board held a rare special meeting to grapple with many of those same issues. About the same time, the audit committee began holding more telephonic meetings to monitor the ever-shifting economic sands, while weekly loan approval meetings took on a greater sense of urgency. By January, the board was ready to sign off on a $17.8 million loan loss provision, recorded in the fourth quarter, which slashed per-share earnings to 16 cents for the quarter, versus 42 cents a year earlieru00e2u20ac”a signal to shareholders that the company was serious about taking on the issues confronting it.
u00e2u20acu0153We decided not to dribble out bad news a little at a time,u00e2u20ac Frohnmayer explains. u00e2u20acu0153We said, u00e2u20acu02dcletu00e2u20acu2122s prepare for the worst case, and not get stuck in a state of denial thinking we can somehow escape a tidal wave thatu00e2u20acu2122s affecting the entire industry.u00e2u20acu2122u00e2u20ac
Combined, Frohnmayer judges, the enhanced vigilance has u00e2u20acu0153demonstrated a high degree of suppleness and flexibilityu00e2u20ac on the part of directors. While board members have asked plenty of probing questions, the overall tone has been one of support for long-time CEO Ray Davis and his executive team as they battened down the hatches and communicated with shareholders. u00e2u20acu0153Itu00e2u20acu2122s about guidance and providing management with a reality check,u00e2u20ac he says. u00e2u20acu0153The economic situation right now is permanent whitewater. The board can provide some perspective, and a second set of eyes on important decisions.u00e2u20ac
Umpquau00e2u20acu2122s board is far from alone in piling on extra hours, resources, and brainpower in responding to turmoil in the financial markets. The housing-price bubble, liquidity crisis, and accompanying mortgage meltdown have hit many banksu00e2u20acu2122 operations and income statements hard. In the fourth quarter of 2007, the industryu00e2u20acu2122s net income was $5.8 billionu00e2u20ac”its lowest since 1991, and down 83% from the $35.7 billion earned in same period a year earlier, according to the Federal Deposit Insurance Corp.
Larger banks were most affectedu00e2u20ac”25% of banks with more than $10 billion in assets reported losses. But more than half of all banks and thrifts saw an earnings decline compared to the year-earlier quarter, while the average return on assets for the industry was a meek 0.18% , versus 1.20% a year before. The biggest culprits: Net charge-offs, which almost doubled in the quarter to $16.2 billion, and loan loss provisions that ballooned to $31.3 billion, the largest gain in 20 years.
Share prices have been pummeled in the process. For the year that ended on February 29, the Keefe Bruyette & Woods Bank Stock Index fell more than 23%, with some high-profile companies that boasted large mortgage exposures, such as Citigroup, Washington Mutual, and E-Trade Financial Corp., falling by more than half.
With an additional 1.7 million adjustable-rate mortgages slated to reset to higher rates in the next two years, most experts agree weu00e2u20acu2122re not out of the housing woods yet. In 2008 alone, some $355 billion in ARMs will reset, $260 billion-worth of them held by subprime borrowers least able to afford higher payments, according to a study by Deutsche Bank Securities. Another $30 billion lie in the low-documentation alt-A category.
How bad could things get? Nouriel Roubini, a respected economics professor at New York Universityu00e2u20acu2122s Stern School of Business, predicts that home prices could decline nationally by as much as 10% in 2008, and by nearly 30% in total before the housing slump is done. That would leave as many as 15 million homeowners with u00e2u20acu0153negative equity,u00e2u20ac their houses worth less than the amount of their mortgages, who would have a great incentive to simply walk away.
Forget the simple notion that consumer spending will slow because people can no longer use their homesu00e2u20acu2122 equity as piggy banks. Thatu00e2u20acu2122s kidu00e2u20acu2122s stuff. Under Roubiniu00e2u20acu2122s scenario, total mortgage defaults could approach $1 trillion.
Already, the effects are spilling over into the broader economy, and other asset classesu00e2u20ac”commercial real estate, auto and credit cards among themu00e2u20ac”are showing signs that they could follow the path of mortgages. u00e2u20acu0153Every day we obsess about how bad it could get,u00e2u20ac Richard Fairbank, CEO of credit-card giant Capital One Financial Corp., told investors in a January conference call of the potential for losses. Nearly $2 billion had been set aside to cover bad loans, Fairbank added, but that might not be enough. u00e2u20acu0153The real answer is, nobody knows.u00e2u20ac
Want to get really scared? Roubini predicts that before itu00e2u20acu2122s over, a large regional or national bank might fail, followed by a wave of corporate defaults, hedge fund failures, and other calamitiesu00e2u20ac”what he calls u00e2u20acu0153a vicious circle of losses, capital reduction, credit contraction, forced liquidation, and fire sales of assets at below fundamental prices.u00e2u20ac Total length of a severe recession: Six months, minimum, and maybe much longer. There is, he asserts, u00e2u20acu0153a rising probability of a catastrophic financial and economic outcome.u00e2u20ac
This might sound alarmist, but the FDIC is girding for the worst. In February, it brought some 25 former employeesu00e2u20ac”many veterans of the savings-and-loan crisisu00e2u20ac”out of retirement to help out with whatu00e2u20acu2122s expected to be a crush of bank failures. One industry observer, who asks not to be identified, predicts that u00e2u20acu0153well over 100u00e2u20ac banks and thrifts will go belly-up by the end of 2009, with particularly high concentrations in Rust Belt states, such as Michigan and Ohio, and those with once-high-flying real estate markets, including Florida and Nevada.
Itu00e2u20acu2122s been nearly two decades since the industry has faced turmoil this widespread and pervasive. For bank directors, the majority of whom have taken on their roles in an era where growth was subtly valued over risk-management, todayu00e2u20acu2122s tough operating conditions and gloomy outlook are both uncomfortable and frustrating; the rising sense of risk, palpable.
Some feel embittered, perhaps rightly so. Brad Rock, chairman and CEO of $1.1 billion Smithtown Bancorp in Smithtown, New York, and present chairman of the American Bankers Association, notes that the bulk of community banksu00e2u20ac”including his ownu00e2u20ac”didnu00e2u20acu2122t participate in the subprime fiasco. u00e2u20acu0153Weu00e2u20acu2122ve never done a single subprime mortgage. Weu00e2u20acu2122ve never done an alt-A loan or a 2/28 loan with a teaser rate,u00e2u20ac Rock says.
Nevertheless, plenty of banks are getting caught up in the fallout, and must prepare for and respond to the likelihood that the credit contagion could spread to other lending areas. u00e2u20acu0153Some of the smaller banks that didnu00e2u20acu2122t cause these problems are feeling hurt, thereu00e2u20acu2122s no doubt about it,u00e2u20ac Rock says. u00e2u20acu0153But a little bit of mud is getting on everyone, whether theyu00e2u20acu2122re responsible for causing the problem or not.u00e2u20ac
This couldu00e2u20ac”and probably willu00e2u20ac”turn ugly for some directors. Ralph Sharp, head of the financial services risk management and compliance group at Venable LLC, a Washington, D.C. law firm, predicts that regulators will be wielding civil money penalties and other enforcement actions more liberally against individual directors and boards whose failures to follow through leave banks vulnerable to calamity.
If a bank suffers big lossesu00e2u20ac”or worseu00e2u20ac”regulators will likely examine such factors as attendance and the minutes of full board and committee meetings, looking for evidence that directors asked appropriate questions, understood the risks and were willing to challenge management decisions. u00e2u20acu0153Directors have to keep in mind that, at the end of the day, they could be on the hook with the regulators if things go wrong at their institutions,u00e2u20ac Sharp says.
Look for more lawsuits, too. In January, directors and officers of National City Corp. were slapped with a class-action suit, alleging that the big Cleveland-based banking company issued u00e2u20acu0153materially false and misleading statementsu00e2u20ac in early 2007 about the risks of subprime holdings in its portfolio. Big earnings declines in the third and fourth quarters of the year were followed by a cut in the quarterly dividend, to 21 cents from 41 cents, and a 60 percent drop in share prices from early-2007 highs.
Board members at several other banking companies, including Washington Mutual, E-Trade, Huntington Bancshares, and BankAtlantic Bancorp, also have been hit with suits related to the mortgage mess. And that could be just the beginning. u00e2u20acu0153Weu00e2u20acu2122re going to see more class-action securities suits, more suits from borrowers who canu00e2u20acu2122t pay their loans back,u00e2u20ac says Ron Glancz, head of Venableu00e2u20acu2122s financial services group. u00e2u20acu0153In terms of litigation, itu00e2u20acu2122s going to be a lot like the S&L crisis.u00e2u20ac
Expect additional pressure during this yearu00e2u20acu2122s proxy season, as well. Unhappy with big drops in earnings and share prices, some investor groups are specifically targeting board risk-management committees at Citigroup and Wachovia, among others, demanding they justify their institutionsu00e2u20acu2122 large exposures to subprime mortgages. Wachoviau00e2u20acu2122s per-share earnings plummeted to 3 cents during the same period, versus $1.20 a year earlier.
Wachoviau00e2u20acu2122s board u00e2u20acu0153signed off on managementu00e2u20acu2122s decision to substantially increase exposure to mortgage risk in 2006u00e2u20ac through its acquisition of Golden West Financial Corp., a big California thrift, says William Patterson, executive director of CtW Investment Group. u00e2u20acu0153This proxy season, shareholders will demand accountability, starting with the individual directors most responsible.u00e2u20ac
While Umpquau00e2u20acu2122s board hasnu00e2u20acu2122t been sued, KBW analyst Matthew Clark says institutional investors that own more than half of its shares are getting restless. Directors say theyu00e2u20acu2122re satisfied that the company is moving in the right direction, but clearly they are feeling the heat. u00e2u20acu0153Weu00e2u20acu2122re all aware of a heightened share of responsibility and risk,u00e2u20ac Frohnmayer explains. u00e2u20acu0153More of our waking hoursu00e2u20ac”whether weu00e2u20acu2122re conversing with each other or notu00e2u20ac”weu00e2u20acu2122re thinking about these issues, trying to ensure that the bank is on top of things.u00e2u20ac
So whatu00e2u20acu2122s a smart board to do to help its institution navigate this kind of terrain? And what should individual directors do to protect themselves from vulnerability? The specifics of an individual boardu00e2u20acu2122s posture depend largely on the institution and the things that make it uniqueu00e2u20ac”its business lines and geography, its past risk-management practices, the CEOu00e2u20acu2122s demeanor and directorsu00e2u20acu2122 tolerance for risk going forward. No matter the circumstances, however, itu00e2u20acu2122s clear that greater director care, diligence, and time is mandated.
Most board members already are devoting more time to oversight, in the form of both extra and longer meetings, and many are getting more hands-on with operations and strategy. They are sharing their own individual skill sets, experiences, and connections, offering insights on local economies and individual clients with a bit sharper edge than in good times.
Frohnmayer, for instance, regularly taps the forecasting prowess of economists at his school, bringing those analyses to the board, and takes comfort from fellow board membersu00e2u20acu2122 backgrounds in key industries like timber and communications.
Board members also are reviewing with closer scrutiny everything from the quality of individual loans and the cash flows of those borrowers to broader risk-management practices. The nine directors of Grand Bank & Trust of Florida, a $490 million real estate lender in hard-hit West Palm Beach, Florida, are feeling the pressure.
Russell Greene, Grandu00e2u20acu2122s CEO and a director, says the climate in his market u00e2u20acu0153is all gloom and doom.u00e2u20ac Two years ago, the loan committee used to meet every week to approve new loans. Now, the pipeline is dry, and directors on the committee spend their time reviewing loans and borrowers, reappraising properties and the like, looking for trouble. Some directors have gone so far as to offer individual advice to troubled borrowers. u00e2u20acu0153When I organized the bank nine years ago, I told them to expect to spend one hour a month being a director,u00e2u20ac he says. Today, most average 12 to 15 hours. u00e2u20acu0153I lied,u00e2u20ac he says. u00e2u20acu0153Itu00e2u20acu2122s become a part-time job.u00e2u20ac
Managing shareholder expectations, directors say, is difficult. In many cases, thereu00e2u20acu2122s not much to be done beyond focusing on the business. u00e2u20acu0153Weu00e2u20acu2122re performing well, but as a public company, weu00e2u20acu2122re caught in the marketu00e2u20acu2122s view of small-cap banks,u00e2u20ac says David Bochnowski, 62, chairman and CEO of Northwest Indiana Bancorp in Munster, Indiana. Northwestu00e2u20acu2122s share price was recently riding about 20% off of its 52-week high.
Ken Daly, CEO of the National Association of Corporate Directors, says some boards are responding to investor concerns by reworking employment contracts with CEOs to add claw-back provisions that allow the company to recoup bonuses and other pay earned by strategies that look good in the short-term, but turn out to be longer-term busts. u00e2u20acu0153When things collapse a couple of years down the road, the loss usually falls on shareholders,u00e2u20ac he explains. u00e2u20acu0153You want a mechanism so that when people do incredibly risky things that blow up, and get rewarded for it, you can get some of that money back.u00e2u20ac
To be sure, the pain isnu00e2u20acu2122t uniform. Some are capitalizing strategically on the turmoil, seizing upon recent Federal Reserve rate cutsu00e2u20ac”and the relative lack of competition from mortgage brokersu00e2u20ac”to bulk up on high-quality housing loans. u00e2u20acu0153Weu00e2u20acu2122re having our best year ever, and itu00e2u20acu2122s almost directly because of the mortgage problems,u00e2u20ac says William Donius, CEO and a director of $1.2 billion Pulaski Financial Corp., a big thrift in St. Louis. Pulaski boosted its capital levels by $500 million in 2006, and originated $1.6 billion in mostly high-quality housing loans last year.
u00e2u20acu0153I donu00e2u20acu2122t want to sound cocky, but our business model is doing very well in this environment,u00e2u20ac Donius says. u00e2u20acu0153Having less competition has helped us gain market share, and itu00e2u20acu2122s given us some pricing power, which is helping margins.u00e2u20ac
For others, the present situation carries a whiff of opportunity. United Western Bancorp in Denver reduced its exposure to the mortgage business a couple of years back, which has left it in relatively good shapeu00e2u20ac”at least for the time beingu00e2u20ac”and poised to jump on a growth opportunity if the right one presents itself. u00e2u20acu0153Yes, weu00e2u20acu2122re hunkering down a bit with respect to underwriting standards and credit quality,u00e2u20ac says Robert Slezak, a former chief financial officer for online brokerage Ameritrade Holdings Corp., and now chairman of $2.1 billion United Westernu00e2u20acu2122s audit committee.
But, u00e2u20acu0153suddenly, weu00e2u20acu2122re faced with the prospect that some of our competitorsu00e2u20acu2122 stocks have been hit hard and theyu00e2u20acu2122re weakened,u00e2u20ac Slezak adds. u00e2u20acu0153That could present us with an opportunity to expand through acquisitions or to move aggressively on their market.u00e2u20ac
There are other pockets of relative prosperity around the country. And itu00e2u20acu2122s almost always true that one companyu00e2u20acu2122s calamity is anotheru00e2u20acu2122s opportunity. Even so, be careful not to be duped.
Smart directors realize that the world and its financial systems are simply too interconnected today for problems in one geographic or business-line area not to somehow spill over into other sectors. Liquidity markets are global, asset-quality is slipping across the board and capital has become pricier and harder to come byu00e2u20ac”even if your bank has done nothing at all to lay the groundwork for todayu00e2u20acu2122s troubles.
Frohnmayer says some competitors in Umpquau00e2u20acu2122s markets are u00e2u20acu0153in a state of denial,u00e2u20ac about just how rough things could get. And judging by the feedback from consultants and analysts, the same dynamics appear to be at play elsewhere, too. With mounting signs of deeper economic troubleu00e2u20ac”the dollaru00e2u20acu2122s weakness, rising energy prices, the mounting costs of the Iraq war, the trade and federal budget deficits, not to mention all of the lending troublesu00e2u20ac”this is no time to be complacent or lazy.
Board members arenu00e2u20acu2122t expected to run the businessu00e2u20ac”thatu00e2u20acu2122s something best left to management. As fiduciaries in a regulated industry, however, they are expected to provide crisp day-to-day oversight, and ask the really tough questions. Bankingu00e2u20acu2122s role in the economy is simply too central to expect anything else. With credit problems plaguing the marketplace, those queries need to be more hawkish, especially when it comes to such sensitive issues as liquidity, securities portfolios, and asset quality.
Aggressively challenging managementu00e2u20acu2122s strategy and assumptions is an uncomfortable notion for some directors, especially at the community-bank level. Many, especially those at smaller institutions, are what Eugene Ludwig, a former comptroller of the currency and now CEO of Promontory Financial Group, a Washington, D.C. consulting firm, calls u00e2u20acu0153community worthiesu00e2u20acu00e2u20ac”civic leaders with good intentions who often lack strong financial backgrounds and took their board seats to gain business contacts and prestige, or out of a sense of local obligation. Many were invited to join the board by the CEO.
u00e2u20acu0153These are very polite people who arenu00e2u20acu2122t accustomed to pressing for answers, and they get embarrassed asking questions that they think might sound nau00c3u00afve,u00e2u20ac Ludwig explains. Yet in the present environment, u00e2u20acu0153you canu00e2u20acu2122t be embarrassed. If you donu00e2u20acu2122t understand something, it probably means there are other people at the table who donu00e2u20acu2122t, either.
u00e2u20acu0153If management canu00e2u20acu2122t explain something to you in plain English, it usually means they donu00e2u20acu2122t understand it themselves, or are dissembling,u00e2u20ac he adds. u00e2u20acu0153As a board member, you really have an obligation to get answers that leave you satisfied.u00e2u20ac
Trust your instincts. Outside directors might feel more at home in a manufacturing plant or retail store, but most have enough business experience to sense when something merits closer examination. Supplement that with plenty of readingu00e2u20ac”of newspapers, financial publications, and board materialsu00e2u20ac”and come prepared to ask enough questions to satisfy yourself that the institution is on the right path. u00e2u20acu0153You need to make sure youu00e2u20acu2122re educated and understand the exposures and the risks, and how the bank is protecting itself,u00e2u20ac Sharp says.
The specific lines of questioning will vary by institution, but some broad basics should be addressed: Does the institution have a plan to address further liquidity squeezes? Are capital levels and the overall balance sheet strong enough to withstand a prolonged downturn, or is proactive action required? Is the bank positioned to withstand fluctuating interest rates? What would happen if a couple of large loans went bad?
u00e2u20acu0153You ought to be asking, u00e2u20acu02dcIs our allowance adequate? Is our capital adequate? Is our funding adequate?u00e2u20acu2122u00e2u20ac Glancz says. And if youu00e2u20acu2122re not getting good information from management, u00e2u20acu0153then you ought to look externallyu00e2u20ac”to auditors or lawyersu00e2u20ac”to get the answers.u00e2u20ac
One area drawing a lot of attention is commercial real estate. In a January speech to the Florida Bankers Association, Comptroller of the Currency John Dugan noted that more than one-third of all community banks have CRE exposures of more than 300% of capital. The OCC has been sounding alarm bells for nearly four years about the high concentrations, yet many bank managements and boards have dismissed those warnings. Now, 3.34% of all construction and development loans in Florida are classified as nonperforming, and the figure is expected to rise. The national average is about 2% . u00e2u20acu0153We see clear signs of CRE credit quality declining,u00e2u20ac Dugan said, which could mandate added regulatory action.
For boards, Glancz says, this amounts to a call to action, in the form of obtaining new appraisals, bumping up loan-loss provisions and closely monitoring capital levels. u00e2u20acu0153Itu00e2u20acu2122s a shot across the bow. The Comptroller is saying that if you donu00e2u20acu2122t do something about this, we will,u00e2u20ac he explains. u00e2u20acu0153Directors need to make sure their internal controls and audit functions are up to the task, and that theyu00e2u20acu2122re getting good information from management, or they could find themselves in trouble.u00e2u20ac
A handful of other hot-button areas also are drawing a lot of attention, including capital management and the uncomfortable options available for raising more capital to strengthen balance sheets. Citigroup, for instance, has caught some bad public relations for taking capital from government-run sovereign investment funds in the Middle East and Singapore, with some critics charging that thereu00e2u20acu2122s a political motive behind those infusions.
For smaller banks, the pricing of trust-preferred offerings has risen sharply in the past year. u00e2u20acu0153I price it constantly, and the rates have nearly tripled,u00e2u20ac says J. French Hill, chairman and CEO of $220 million Delta Trust & Banking Corp. in Little Rock, Arkansas. u00e2u20acu0153Investors arenu00e2u20acu2122t stupid. If you need capital right now, the thinking is that youu00e2u20acu2122re in trouble.u00e2u20ac For some banks, that leaves shrinking the balance sheet as the only real capital-management tool availableu00e2u20ac”and not an attractive one, at that.
Securities portfolios are another big topic of interest. Most banks own bonds backed by mortgages or municipalities and had good reason to believe they were sound investments: Not only were they given high marks by ratings agencies, such as Standard & Poors or Moodyu00e2u20acu2122s, they also were insured. Now, many of those ratings have proven to be flawed, and some big insurers, such as Ambac Financial Group, are teetering.
u00e2u20acu0153Across the gamut, weu00e2u20acu2122re looking harder at investment securities,u00e2u20ac says Deltau00e2u20acu2122s Hill. u00e2u20acu0153The board is asking management to be cautious about the ratings and structures of what weu00e2u20acu2122re putting into that portfoliou00e2u20ac”especially with regard to fixed-income securities that have ratings enhanced by bond insurance. u00e2u20acu00a6 Directors are definitely staying abreast of the news and how it impacts their own fiduciary obligations.u00e2u20ac
For directors whose institutions are faced with trouble now, experts say figuring out what went wrong is a necessary prelude to cleaning up the mess and preparing for an uncertain future. Was the banku00e2u20acu2122s strategy flawed? Was there a breakdown in governance or oversight? If so, whatu00e2u20ac”or whou00e2u20ac”was responsible?
As delinquencies have risen, Grand Banku00e2u20acu2122s Greene says his board has placed a special emphasis on not trying to assign blame. u00e2u20acu0153Weu00e2u20acu2122ve said, u00e2u20acu02dcno finger-pointing,u00e2u20acu2122u00e2u20ac he explains. u00e2u20acu0153Thereu00e2u20acu2122s no, u00e2u20acu02dcWho brought this loan in?u00e2u20acu2122 Weu00e2u20acu2122re all in this together. u00e2u20acu00a6 Nobody wants to get blamed.u00e2u20ac
In some extreme cases, boards have acted swiftlyu00e2u20ac”under intense shareholder pressureu00e2u20ac”to change the banku00e2u20acu2122s leadership. Citigroup (Charles Prince III) and E-Trade (Mitchell Caplan) are among the companies that have ousted their chief executives after reporting big losses. Smaller banks are feeling the pain, too. At $2.5 billion Vineyard National Bancorp in Corona, California, CEO Norman Morales resigned in late January. While no reason was given for the move, it came just six days before the company reported a whopping $4.11 per-share loss in 2007.
Ellen Hexter, director of the Conference Boardu00e2u20acu2122s Integrated Risk Management Center of Excellence, says, generally speaking, the subprime woes are the result of governance breakdowns at the bank board levelu00e2u20ac”failures to keep tabs on key functions like strategy and risk. u00e2u20acu0153Banks are in the business of buying and selling risk, and they ought to be good at pricing it,u00e2u20ac she explains. Yet during the housing boom, many boards lost their discipline, authorizing management to chase yields in a hot market that simply wasnu00e2u20acu2122t sustainable, and thus, got burned.
The NACDu00e2u20acu2122s Daly, a former financial institutions auditor with accounting giant KPMG, says many of the boards heu00e2u20acu2122s seen were spoon-fed information by management, but u00e2u20acu0153didnu00e2u20acu2122t really understand the strategies being undertaken by their institutions well enough to provide proper oversight.u00e2u20ac
Looking to the future, board members need to learn from those mistakes to u00e2u20acu0153ensure that connections are drawn across different kinds of risk in the companyu00e2u20ac”market risk from your trading desk, your asset-liability mix, etc.,u00e2u20ac Hexter says. u00e2u20acu0153You need to look at the full array of risks strategically, and get more involved in monitoring the various kinds of risk a bank faces.u00e2u20ac
Scenario planning can be extremely usefulu00e2u20ac”both as a tool for peering into the future and as a foundation for deeper questioning and discussion of key issues and challenges. A good scenario analysis can help directors to understand the challenges the bank faces and provide some comfort that managementu00e2u20acu2122s assumptions about, say, the economyu00e2u20acu2122s direction or asset-quality trends, match up with their own.
Ludwig tells of a recent meeting with the board of one large bank, which went through a variety of management-led bad- or worst-case scenarios to examine how they would impact the business. u00e2u20acu0153They were stress-testing for different circumstances,u00e2u20ac he recalls. u00e2u20acu0153What if housing prices drop another 10%? What happens if we have increases in our commercial loan book? What happens if credit-card delinquencies increase?
u00e2u20acu0153It was a very impressive and helpful exercise,u00e2u20ac Ludwig adds, and one that left board members feeling that they had a better grasp of where the bank stood and how it would respond to shifting economic conditions.
Hexter says one of the biggest dangers presented by the current environment is overreaction. Many boards have been reining in management on expenses and risk-taking, which is fine, but not so much that long-term growth opportunities are lost. u00e2u20acu0153You want the pendulum to swing back, but not too far,u00e2u20ac she says. u00e2u20acu0153As a board member, you want to be strategic and forward-looking. You need to react to the situation, but the worst thing you can do is lose sight of the future.u00e2u20ac
Daly says directors need to be more assertive and demand greater and more detailed discussion of strategy, so they understand what the institution is doing. u00e2u20acu0153The real question is, what kind of information are the directors getting, and from whom, to help them understand the risks theyu00e2u20acu2122re taking?u00e2u20ac he says.
u00e2u20acu0153Look at your meeting agendas,u00e2u20ac Daly suggests. u00e2u20acu0153If all of your agenda time is taken up by Powerpoint presentations and talking heads, then the likelihood of you having the necessary in-depth discussions about the risks of your strategy is minimal.u00e2u20ac
And if you ask all the right questions and donu00e2u20acu2122t feel comfortable with the answers youu00e2u20acu2122re hearing? Speak up, Glancz says. u00e2u20acu0153If you donu00e2u20acu2122t agree [with a decision endorsed by the majority of the board], itu00e2u20acu2122s important to bite the bullet and say, u00e2u20acu02dcI want to go on the record as opposing the action the bank is taking.u00e2u20acu2122u00e2u20ac It might not make you the most popular director at the table, but getting such a statement in the minutes could help stave off liability if the decision turns out to be a bust.