The Leadership Conundrum

When Integra Bank Corp.’s board replaced its chief executive officer with an interim leader in May, it appointed a board member to take the helm. The Evansville, Indiana-based bank, with $3.5 billion in assets, has been hard hit by underperforming residential construction loans, contributing to a $28.5 million net loss in company earnings in the first quarter, versus a $5 million gain for the same period a year earlier.

To help change course, the bank tapped Michael Alley, a former banker who joined the board in April, to be its interim CEO. Alley is charged with finding a long-term successor, a task that has been made both easier and harder in today’s new banking environment. No doubt there are more executives sending out resumes these days, but finding the right leader to bring a bank back to prosperity may be more challenging than ever before.

“You really have to be a whole banker,” Alley says. “You have to have a complete understanding of the entire sales, risk management, and operations process. CEOs must be able to comprehend how all those elements come and work together to create the kind of financial strength and profitability you have to have to sustain yourself.”

In the wake of bank bailouts, increased regulatory scrutiny, and tightening lending standards, financial institution boards face a tough assignment when it comes to CEO succession planning.

Banks that neglect to give succession plans enough attention might find themselves falling behind competitors due to inadequate leadership, so much so they become the target of acquisitive banks. Failing to plan can also result in unwanted attention from regulators. Simply put, a bank’s future is at stake, executives and consultants say.

With several high-profile flameouts on record, some of the nation’s largest financial institutions serve as a cruel reminder to the importance of making sure the CEO is qualified. Gone are the days of finding an executive who concentrates on closing deals and boosting growth.

“It used to be that if you wanted to grow a franchise, you would find someone experienced in growth,” says Ray Hoops, head of the six-member CEO search committee on Integra’s board and the recently retired president of the University of Southern Indiana. “If you had a troubled franchise, you would bring in a turnaround specialist. Yet now the person that comes in has to have a broader set of skills than in the past.”

Financial acumen ranks high nowadays, with CFO backgrounds prized over all others. “The problem is that traditional CEOs in the bull market didn’t have to roll up their sleeves about accounting risks,” says John Kim, global co-head of financial services in the Wall Street office of Heidrick & Struggles, an executive search firm headquartered in Chicago. “In a new era of CEOs, they just can’t nod their head without having the knowledge base.”

Plugging the Leaks

Leadership at financial institutions is certainly being put to the test. Commercial banks and savings institutions lost $26.2 billion in the fourth quarter of 2008, compared to a $575 million profit for the same period a year earlier, according to the Federal Deposit Insurance Corp. It was the first quarterly loss since 1990. FDIC institutions also charged off $37.9 billion of bad loans in the fourth quarter, more than twice the $16.3 billion from the same period in 2007. While institutions earned $7.6 billion in the first quarter this year, the figure is down from $19.3 billion in the first quarter 2008. Asset quality remains a major concern of the agency, with member institutions increasing aggregate loan losses 64% to $60.9 billion in the first quarter versus the same period a year ago.

To be sure, it could be argued bank boards were unprepared for what hit the industry last year. Of seven major bank failures or bailouts, none had an adequate succession plan, says Roger Kenny, a vice chair of CTPartners’ Board Consulting Practice in New York. “Everyone scrambles to get someone through a search firm at the last minute,” he explains.

Yet the topsy-turvy world of banking has a silver lining, serving as a wake-up call to bank boards, says Clarke Murphy, a managing director at executive search firm Russell Reynolds Associates’ New York office. “The boards themselves are being more aggressive about their own composition and they are pressing harder on the succession planning of the CEO, because there have been way too many financial services companies with thousands of employees ending up with no one to run them next.”

For institutions that have had trouble with loan losses, the board must decide quickly whether to change its leader. If it is interested in preserving the company, a board needs to find a long-term successor who knows how to right the ship and plug the leaks. “The first thing you have to do is assure the survival of the company,” Hoops says. “I don’t think anyone believes that is in question [at Integra]. But that has got to be the first priority. If you don’t find someone who can assist in that, the ball game is altogether over with.”

To be sure, many boards these days are mulling over CEO replacements. “Anytime a business or an industry goes through a down cycle like the one we are in, the flaws of management become exposed,” says Alan Kaplan, president and chief executive officer of Kaplan & Associates, an executive search firm based in Wynnewood, Pennsylvania. “Boards should be saying, ‘Do we really have the right CEO and people in all the right chairs on the senior team?’ What is reasonable to hold management accountable for and what is not? You can’t hold management accountable for the stock market and the rapid decline in valuations. But you can hold them accountable for specific performance.”

And while finding competent replacements can be a tough task for bank boards, it is a necessary one and, arguably, its most important duty. “Succession planning is hard,” says Marvin N. Schoenhals, chair and former president and chief executive officer of WSFS Financial Corp., a $3.5 billion thrift in Wilmington, Delaware. “Because there are so many variables, it is very hard to do. Yet, even though it is hard, you need to develop a disciplined process that ensures you are doing this as a board with respect to your CEO. And whether you designate one potential candidate or half a dozen, make sure there are very specific development plans in place and that management is held accountable for those development plans.”

Developing the Right Talent

“There are lots of people out there,” Kaplan says. “But there is always a hierarchy in the quality of people who are available. The most talented people who are currently available have the most options and get snapped up fairly quickly.”

Bank boards need to consider whether the bank can develop talent from within or must look outside. If a bank prefers to tap an insider, it needs to get started early on a successor. WSFS Financial groomed its current president and CEO, Mark Turner, for about five years before he took the helm in 2007. “He had the right talent, ambition, and enough experience,” says Schoenhals, in listing several characteristics that made Turner the one tapped to replace him. Working in Turner’s favor was his financial background, including having been hired as the thrift’s controller and then working as chief financial officer and chief operating officer. Turner is very bright, a team leader, and someone “who wants the whole team to succeed,” Schoenhals says. “He is coachable and always learning. You clearly have to be willing to make decisions as CEO, even when the information is more ambiguous than you would like.”

When grooming someone from within, banks need to develop very specific objectives to test the candidate and prepare him or her for the job. “That is critical to succession planning,” Schoenhals says. Since Turner came from a financial background, Schoenhals had the retail banking division report to him to give him experience in the area. Training also was important. Turner, with a Wharton School MBA already in hand, pursued a master’s degree in executive leadership from the University of Nebraska-Lincoln, a program cosponsored by the Gallup Organization. He also assumed the role of chief operating officer in 2001 to help prepare him for the role of CEO.

Indeed, all candidates will have strengths and weaknesses, so boards need to identify what is important and unique about their particular organization and then identify the qualities of a leader to match.

Asheville Savings Bank, at $724 million institution in Asheville, North Carolina, also hired its current president and CEO from within. Suzanne S. DeFerie took the helm in January 2008, replacing John Dickson, who retired and currently serves as a director on the board. For the interview process, the board had whittled down its search to five external candidates and DeFerie. While all of the candidates were well qualified, the board went with DeFerie given her technical skills and her integrity. “The board needs a CEO in which they have absolute confidence,” Dickson says. “The board knew Suzanne, her technical skills, her social and ethical skills. Anytime you go outside, no matter what you do in an interview process-whether you are talking to somebody for three hours or a couple of days-it is really difficult to assess all that. The risk is greater going outside.”

Reaching Outside the Bank

Still, banks often find that inside prospects are not enough, despite allowing for time to groom internal executives, says Tim O’Rourke, president and chief executive officer of Matthews, Youngu2013Management Consulting, based in Hillsborough, North Carolina. “If they did not have the opportunity to experience multiple markets or different periods of economic ups and downs, they may not be prepared in this economic environment,” O’Rourke says.

Home Federal Bancorp, a $660 million financial institution in Nampa, Idaho, has aimed to transition its balance sheet from a classic thrift to one more like a commercial bank. The savings bank appointed Len Williams, a former head of business banking at Fifth Third Bank, as CEO in January 2008. Williams was hired as president in 2006, with the goal of replacing Dan Stevens, the current chair and former CEO.

Given the thrift’s goals of growing its commercial banking accounts, especially in small business, it looked to Williams to fill the gap and chart the course to take it to the goal of being a $3 billion bank to $4 billion bank. “We just didn’t have the internal firepower,” Stevens says. “We were looking for someone who knew how to run a larger organization.”

Employing an executive search firm can streamline the process by allowing the bank board to focus on interviewing final candidates rather than going through the laborious task of screening applicants. Cornerstone International Group, an executive search firm based in Los Angeles, typically makes about 500 telephone calls to develop a prospect list of 40 to 50 candidates for phone interviews. That in turn is whittled down to a dozen candidates for in-person board interviews.

The Board’s Role

Of course, boards can cast a net both inside and out. Asheville Savings Bank combined both an internal and external search. The board wanted someone who had a mastery of technical skills as well as a sense of integrity and community involvement. “We worked with the consultants and of course they made suggestions,” says Asheville board chair John Cross. “But we emphasized personal experience in commercial and retail lending.” Adds his colleague Dickson: “We really needed someone who would carry on the bank’s conservative yet growth-minded strategy looking forward, so that we could continue to grow and maintain independence.”

How much of the board gets involved depends on the bank. Asheville’s board used all nine of its members in the search, since it was nimble enough and all the board members all wanted to be involved and were committed to the process. In the final round, the board conducted three-hour interviews of six candidates. Matthews, Young came up with an interview guide to help the directors balance their questioning. Three directors were assigned to be lead questioners for each interview, in a rotating format.

Boards also need to make sure thorough reference checks are done with the final candidates. Usually reference checking entails three phone calls at 10 minutes each, when in reality, the process should involve 15 to 20 references at an hour each, says William Guy, chair and chief executive officer of Cornerstone. “The referencing process is one of the most important evaluating tools, and it is the poorest used of all the tools,” he says. “You are not going to get to the truth in 10 minutes.”

Finally, boards also need to make sure they have the right composition within their own ranks to select quality leaders. “We have to start with the boards to get the CEOs we need for the future,” says Kenny of CTPartners. “We have to select the board members who have these same qualities.”

In the end, there are few things that are more important for a board to do well than to ensure it has the right executive leadership in place. And although it’s true the buck stops with the board, it’s the CEO and top executives who are charged with daily decision making and managing the institution with integrity. It’s the board’s job to ensure not only that the right executive talent, with a proper compensation plan, is in place, but that there is a process for the continual cultivation of talent for the future.

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