In this episode of Looking Ahead, Crowe LLP Partner Mandi Simpson talks with Al Dominick about what’s driving greater focus on environmental, social and governance (ESG) issues, and explores some of the fundamentals that boards should understand. She also sheds light on how boards can consider shareholder return and balance long-term ESG strategy with a short-term view on profitability, and provides tips on how boards can better focus on this important issue.
One of the biggest challenges facing all bank directors is the voluminous amount of information they need to read and comprehend before every board and committee meeting. More than a third of the board members responding to Bank Director’s 2021 Governance Best Practices Survey reported that not all directors review materials before board meetings — reducing the effectiveness of their boards.
Board and committee meeting packets — most of which are distributed electronically through secure board portals — can easily reach several hundred pages, particularly at large banks with complex operations. The packets are typically distributed several days in advance of board and committee meetings, often on a Thursday or a Friday, so directors have the weekend to read through them.
It is difficult to subscribe a best practice to board packets because they often reflect what board and committee members want to see. But there are certain standards that should apply. At a minimum, the board packet should provide a comprehensive overview of the bank’s performance, while highlighting any issues of concern that require the board’s attention. At the committee level, the packet should provide an overview of relevant areas that a particular committee is working on.
Packets should be well organized and include a complete agenda for each board and committee meeting, along with any supplemental information that is provided. There is a general tendency to provide more information than less, but it should be easily accessible to the directors.
It’s also important that the information be contextualized. The quality and utility of the information from a governance oversight perspective is generally more important than the sheer quantity of what’s being provided.
James A. McAlpin Jr., a partner and global leader of the banking practice group at Bryan Cave Leighton Paisner, says that board packets often include too much irrelevant information. McAlpin also sits on the board of Hyperion Bank, a $300 million asset community bank in Philadelphia. “I don’t need a listing of every new loan, because I don’t know these borrowers,” he says. “I need a listing of what the trends are. What is the net interest margin? What are the concentrations?” Concentration risk was a big problem for many banks during the financial crisis, McAlpin adds. “It didn’t happen over a period of one or two months, it happened over a period of time, and no one got it because no one was focused on that as a trip wire,” he says.
And the packets themselves shouldn’t be viewed as stone tablets that came down from Mount Sinai. Boards should periodically review whether the packets’ structure and organization, as well as the information being provided, still meets directors’ needs. “You may be comfortable with the board package, but when was the last time everybody, including your committee chairs, said, ‘Do we like the format? Do we like the information presented?’” says McAlpin. “‘What’s missing?’ Very few boards have that conversation.”
The board at Community Bank System, a $15 billion regional bank holding company headquartered in DeWitt, New York, meets 10 times a year. There is also a separate board for Community Bank, N.A., the holding company’s banking subsidiary. Holding company directors also serve on the bank board; the meetings occur back to back. Meetings of the board’s three standing committees — audit, compensation and governance — usually occur before the two board meetings. Lead Director Sally A. Steele, who joined the board in 2003 and served as chair from 2017 to 2021, says the holding company and bank boards, as well as each committee, receive their own packet with a separate agenda and supplemental information.
There’s a lot to read before meetings, according to Steele. The audit committee packet in particular can be expansive, running to as many as 300 pages. The packets for the compensation and governance committees, as well as the holding company and bank boards, are generally smaller. But taken all together, Steele says, the information “can be really voluminous.”
Should a director attempt to read every single page if the board packet runs several hundred pages? That may be impractical — and perhaps unnecessary. Steele practices something that might be described as selective reading. “It depends on which [packet] you’re talking about,” she says. Steele is not a member of the audit committee and thus does not attempt to dig through that particular pile of information, even though she and all other non-audit committee members receive it. “Do the folks on [the audit] committee read all of it? I honestly believe they do. You can tell by the questions they ask,” she says.
As the board’s lead director, and previously as its chair, Steele reads both board packets in their entirety, as well as the packets of the committees she does serve on. “I would guess most directors focus on the committees they’re on, and the material that’s there, and then probably the bank board and holding company material,” she says. “It’s a lot of information.”
Steele believes it is the responsibility of every director to come to board and committee meetings well prepared. That includes having sufficiently reviewed the information that has been sent out in advance, even if members haven’t read every word. In fact, the Community Bank System board goes through an annual assessment process that is administered by its governance committee, and preparedness is a key part of the evaluation. “In our boardroom, it would not go over very well if people were not prepared,” she says. “I think it’s part of your fiduciary obligation to be prepared for meetings. Goes without saying.”
Plowing through an expansive board packet can be a challenging exercise for new directors who don’t have enough experience to prioritize what they must read word for word over what they can more lightly review. McAlpin believes it would be helpful if one of the more experienced directors “would offer to talk to them over lunch, or meet privately and go through the packet with them to get some sense of what has happened historically and what the packet is,” he says. “I think most boards do not do a very good job of new director orientation.
When Community Bank System recruits a new director, the board tries to lighten the new member’s load by assigning the individual to only one committee. But Steele sees no way around the fact that most new directors will have a steep learning curve, and that includes plowing through the board packet and knowing how to prioritize what’s in it.
“I’ve never found that you can have too much information,” Steele says. “There comes a point in time where you understand what’s important and what’s not. Then you get to choose if you feel it’s important enough for you to spend time on. … I just think there’s a price you pay for being a new director, and it’s figuring out and understanding what’s important and what’s not important.”
There are few things in life that remain unchanged for their entirety, and that is certainly true of corporate boards of directors. A board’s ability to plan ahead for retirements, unexpected departures and shifts in business scale is imperative in maintaining a successful franchise.
As the cornerstone of leadership, the board’s composition plays a critical role in a corporation’s performance. In the banking sector, the board’s commitment encompasses the shareholders, to whom it has a fiduciary obligation, and to its management team, for which it has oversight responsibility. The board’s collective experience and knowledge of its members provides tremendous value, empowering the trajectory of the bank’s strategy.
But without the proper strategies in place, even the most robust board rooms are vulnerable to unexpected changes in the industry. An estimated 50% of all boards are operating without a strong succession plan. The absence of sufficient forethought poses incredible risk to a bank’s present and future stability. In contrast, establishing a foundation for preparedness through a board assessment process can help ensure the board is aligned to the strategic direction of the bank, and is prepared to address an ever-evolving business landscape.
The ideal board assessment approach allows for a standardized, yet customizable process. With careful attention to the uniqueness of every institution, the right steps will allow directors to examine their board’s strategic alignment to the functional and industry expertise needed to support the bank’s growth. A thorough assessment generates a “road map” of future director needs, along with updated governance framework. The assessment process can be led by the governance committee, the lead independent director, the chairman or a third-party firm. Here is the process we recommend:
Having conversations with board stakeholders that are focused on the bank’s long-term vision and short-term objectives will shape the strategy of the organization. This should also take into account the unique culture of the bank’s management team, coupled with any shareholder dynamics that can help guide the framework output and objectives.
Develop a list of director questions and conduct one-on-one interviews with each director. Some categories of questions to ask include director professional background, contributions and engagement, director aspiration and a deep dive on director profile and skills. We also recommend developing a skills matrix as an effective tool to assess directors.
Future Board Framework
A healthy director composition analysis requires that the board compile a thorough report that includes the findings of the board interviews and member assessments. Directors should have candid discussions about the skills and expertise the board needs to fill identified gaps and needed changes. Directors should revisit all governance elements such as terms and limits, size of board, committee structures, election process and succession issues, among others. We recommend that bank directors develop a final three-year board framework plan to implement the identified changes.
Boards should follow this plan to refresh overall board governance, implementing new processes over time as to not dispute important social and cultural matters. Boards should also use a director refreshment plan to bring on new directors that fill experience and skills gaps identified as part of the board assessment process.
Often, a third-party firm is brought in to lead the overall assessment and refreshment process, working closely with the chairman or the board’s governance and nominating committee. Given the complexities of crafting and gauging a board’s optimal composition, a firm can be helpful with managing that assessment process from beginning to end. Additionally, a third party can help recruit a strategic director with the needed industry and functional expertise, with the added benefit of bringing forward a more diverse candidate pool to consider.
Strong bank boards continue to adapt to strategic objectives and maximize shareholder returns. Time and time again, companies that thrive consistently focus on going deeper with corporate board best practices. For emerging institutions, going through the assessment process for the first time is typically challenging; this process inherently implies impending change. Boards that regularly engage in director assessment and revisit their overall governance framework tend to produce better shareholder returns. Is your board focused on how to elevate the oversight function for the organization?
The financial institutions examined in Bank Director’s 2021 RankingBanking study, sponsored by Crowe LLP, demonstrate the fundamentals of successful, long-term performance. What can we learn from these top performers — and how should bank leaders navigate today’s challenging environment? Crowe Partner Kara Baldwin explores these issues, based on the lessons learned in the RankingBanking study, and shares her own expertise. To view the complete results of the 2021 RankingBanking study, click HERE.
- Weaving Digital Into Your Bank’s Strategy
- Being Efficient Without Being “Cheap”
- Today’s Uncertain Credit Environment
- Considerations for Bank Boards
When it comes to emergency succession planning, banks prepare for the worst and hope for the best.
The coronavirus crisis has reminded us of the importance of emergency succession planning at banks, as well as related disclosure considerations. Boards must create emergency succession plans in the event a key executive become incapacitated. Some institutions may need to activate these plans during the pandemic and may wish they had spent more time detailing them in calmer, more predictable times.
“When you think of disasters, a lot of people think of natural disasters and don’t really think about pandemics. That’s where that succession planning comes in: Not that we wouldn’t have this for a natural disaster, but the chances of somebody dying is pretty small,” says Laura Hay, a managing director at executive compensation firm Pearl Meyer. “Here, there’s a much higher likelihood of, at least temporarily, needing some additional support.”
The coronavirus pandemic may last for months, if not over a year, in the United States. There were about 800,000 confirmed cases and about 40,000 deaths as of April 22, according to economic data firm YCharts; 4.16 million tests have been administered. Some groups are at higher risk for a severe illness from Covid-19 than others, according to the Center for Disease Control and Prevention, including adults over than 65 and individuals who have underlying medical conditions.
Executives and directors at many banks are particularly vulnerable, based off this. Seventy-two percent of CEOs at institutions participating in Bank Director’s 2019 Compensation Survey were 55 or older; 2% were older than 74. Board members were in the same demographic, with a median director age of 64.
At least one financial firm has disclosed a death of an executive due to Covid-19: Jefferies Group CFO Peg Broadbent died of complications related to the coronavirus in late March, according to Jefferies Financial Group.
Spirit of Texas Bancshares Chairman and CEO Dean Bass took medical leave after contracting the coronavirus, according to an April 7 regulatory filing from the Conroe, Texas-based bank. The board appointed Chief Lending Officer David McGuire to serve as interim CEO and director Steven Morris to serve as acting chairman in his absence. Bass resumed his duties at the $2.4 billion bank on April 13, according to a subsequent filing.
Emergency succession plans differ from long-term succession plans in key ways, Hay says. It is prudent for boards to inform the individual who will be appointed interim or successor in an emergency to prepare them for the role, while directors may want to keep their thoughts on long-term succession plans under wraps. More than one-third of respondents to Bank Director’s 2019 Compensation Survey had not designated or identified successors for the CEO.
“People need to get more detail in their plans, and they should not just focus on the CEO,” Hay says. “You need to identify and communicate who that person is, and probably allow them to talk about how a succession would work, with a certain level of detail.
In times like these, banks may want to extend contingency planning to the board as well. This will not be a theoretical exercise for some companies, Hay says; a director at one of her clients recently died from Covid-19. Other directors may be available to step in, though banks should have conversations about appointing an acting committee head who could fill the potential vacancy.
Another major consideration for banks during the pandemic will be the decision to disclose a diagnosis or illness of an executive. Securities rules gives “substantial discretion” to boards weighing the material nature of such disclosures, according to a January article by Fenwick & West attorneys. A disclosure is only necessary when there is “‘a present duty to disclose’ and the information is considered ‘material,’” they wrote.
The wide range of Covid-19 symptoms and outcomes means the disclosures will probably be on a “case by case” basis, factoring in the materiality of the individual or affected operations, says John Spidi, a partner in the corporate practice group at Jones Walker.
“In those cases where it is not completely clear disclosure is required under SEC regulations, it’s probably a good idea to make the disclosure if the individual involved has a material impact on the company or its results of operations,” he says.
Boards may even opt to not disclose if the executive can continue performing their key duties, which seems to be what Morgan Stanley did after Chairman and CEO James Gorman tested positive for Covid-19 in mid-March. Gorman led regular calls with the bank’s operating committee and board of directors in self-isolation. He shared the news in early April via a video message to employees, saying that he did not experience severe symptoms and has fully recovered, Reuters reported.
Hopefully very few banks will need to activate their emergency succession plans, but Hay says creating detailed strategies protects shareholders and keeps operations stable during an otherwise chaotic time.
“If you don’t have a plan, or your plan is super high level where you have to think about how you’re actually going to deploy it, you’re behind the eight ball,” she says.
Success in executing a bank’s growth strategy — from acquiring another institution to even selling the bank — begins with the discussions that should take place in the boardroom. But few — just 31%, according to Bank Director’s 2020 Bank M&A Survey — discuss these issues at least quarterly as a regular part of the board’s agenda.
Boards have a fiduciary duty to act in the best decisions of shareholders, and these discussions are vital to the bank’s overall strategy and future. Even if management drives the process, directors must deliberate these issues, whether it’s the prospective purchase or another entity of selling the bank.
The survey affirms the factors driving M&A activity today: deposits, increased profitability and growth, and the pursuit of scale. There are common barriers, as well; price in particular has long been a sticking point for buyers and sellers.
M&A plays an important role in most banks’ strategies. One-quarter intend to be active acquirers, and 60% prefer to focus on organic growth while remaining open to making an acquisition.
However, roughly 4% of banks are acquired annually — a figure that doesn’t line up with the 44% of survey respondents who believe their bank will acquire another institution this year.
Conversations in the boardroom, and the strategy set by the board, will ultimately lead to success in a competitive deal landscape.
“Having strong, frequent communications with the board is very much part of our M&A process, and I can’t emphasize how important it is,” says Alberto Paracchini, CEO at Chicago-based Byline Bancorp. The $5.4 billion asset bank has closed three deals in the past five years. “With proper communication, good transparency and frequent communication as to where the transaction stands, the board is and can be not only a great advisor but a good check on management.”
The board at Nashville, Tennessee-based FB Financial Corp. discusses M&A as part of its annual strategic planning meeting. Typically, an outside advisor talks to the board at that time about the industry and provides an outlook on M&A. Also, they’ll “talk about our bank and how we fit into that from their perspective,” including potential opportunities the advisor sees for the organization, says Christopher Holmes, CEO of the $6.1 billion asset bank. Progress on the strategy is discussed in every board meeting; that includes M&A.
So, what should directors discuss? Overall, survey respondents say their board focuses on markets where they’d like to grow (69%), deal pricing (60%), the size of deals their bank can afford (57%) and/or specific targets (54%).
“It starts with defining what your acquisition strategy is,” says Rick Childs, a partner at Crowe LLP. Identifying attractive markets and the size of the target the bank is comfortable integrating is a good place to start.
At $6.1 billion asset Midland States Bancorp, strategic discussions around M&A center around defining the attributes the board seeks in a deal. Annually, directors at the Effingham, Illinois-based bank discuss “what do we like in M&A — deposits and wealth management and market share,” says CEO Jeffrey Ludwig. “[We] continue to define what those types of items are, what the marketplace looks like, where’s pricing today.”
Given the more than 400 charters in Illinois, the board sees ample opportunity to acquire, and the board evaluates potential deals regularly. The framework provided by the board ensures management focuses on opportunities that meet the bank’s overall strategy.
The board at $13.7 billion asset Glacier Bancorp, based in Kalispell, Montana, is “very involved in M&A,” says CEO Randall Chesler. Management shares with the board which potential targets they’re having conversations with and how these could fuel the bank’s strategy. “We start to show them financial modeling early on [so] that they can start to understand what a transaction might look like,” he says. “They’re really engaged early on, through the process and afterwards.” Once a transaction goes through, the board keeps tabs on the status of the conversion and integration.
Having M&A experience on the board can aid these discussions. Overall, 78% of respondents say their board includes at least one director with an M&A background.
These directors can help explain M&A to other board members and challenge management when necessary, says Childs. “They can be a really valuable member of the team and add their experience to the overall process to make sure that it isn’t all groupthink; that there’s somebody that can challenge the process, and make sure [they’re] asking the right questions and keeping everybody focused on what the impact is.”
A number of banks don’t plan to acquire via acquisition. How often should these boards discuss M&A? More than half of survey respondents who say their bank is unlikely to acquire reveal that their board discusses M&A infrequently; another 20% only discuss M&A annually.
Jamie Cox, the board chair at $265 million asset Alamosa State Bank, based in Alamosa, Colorado, says her bank strongly prefers organic growth. Still, the board discusses M&A quarterly at a minimum. “We would be remiss if we ignored it completely, because opportunity is always out there, but you’ve got to be looking for it,” she says. “Whether it’s your key strategy or a secondary strategy, it’s always got to be on the table.”
In charter-rich Wisconsin, Mike Daniels believes too many community bank boards aren’t adequately weighing whether now’s the time to sell. “I don’t want to be as bold as to say that they’re not doing their fiduciary responsibility to their shareholders, but are they really looking at what their strategic options are?” says Daniels, executive vice president at $3.1 billion asset Nicolet Bancshares and CEO of its subsidiary, Nicolet National Bank.
Green Bay, Wisconsin-based Nicolet has an investment banker on staff who can model the financial results for potential acquisition targets. “We’re having M&A dialogue on a regular basis at the board level because we can do this modeling — here’s who we’re talking to, here’s what we’re talking about, here’s what it would mean,” says Daniels.
The board sets the direction for what the bank should evaluate as a potential target. How success is measured should derive from those initial discussions in the boardroom.
“We’re real disciplined on that tangible book value earnback and making sure there’s enough earnings accretion,” says Ludwig. A deal isn’t worth the effort if earnings per share accretion is less than 2% in his view. Any cost saves or revenue synergies are factored into the bank’s earnback estimate. “We’re fairly conservative on the expense saves and diligent about getting at least what we’ve disclosed we could get, and we don’t put any revenue synergies in our model.”
Bank Director’s 2020 Bank M&A Survey, sponsored by Crowe, surveyed more than 200 independent directors, CEOs and senior executives to examine acquisition and growth trends. The survey was conducted in August and September 2019. Bank Director’s 2020 RankingBanking study, also sponsored by Crowe, examines the best M&A deals completed between Jan. 1, 2017, and Jun. 30, 2018, detailing what made those deals successful. Additional context around some of these top dealmakers can be found in the article “What Top Acquirers Know.” The Online Training Series also includes a unit on M&A Basics.
Business conditions, financial markets and competitive landscapes are always changing. But perhaps there is no arena of business undergoing a more significant transformation at the moment than corporate governance.
Whether driven by activists investors, regulators, institutional shareholders, governance gadflies or best practices, corporate governance is in the crosshairs for many organizations today. And in the banking sector — where some in Washington have placed a bullseye on the industry’s back — an enhanced focus on governance is the order of the day.
Bank boards today would be well served to pay close attention to three important aspects of governance: board composition, size and director age and tenure. When left to their own devices, too often inertia will set in, causing boards to ignore needed enhancements to corporate governance and boardroom performance. Even in the private company and mutual space, there is room for improvement and incorporation of best practices if a bank wants to continue to remain strong and independent.
Some governance advocates adopt a certain viewpoint that downplays an institution’s history. “If you were building the board for your bank today at its current size, how many of the existing directors would you select for the board?” the viewpoint goes. This obviously ignores historical contributions and the context that took the bank to its current state. However, as the old saying goes: “What got you here often won’t get you there.”
For many institutions — particularly those that have grown significantly through acquisition — the size of the board has become unwieldy. Oftentimes, executives doled out seats to get a deal done; in some extreme cases, boards now have 16, 18, 20 — or more — directors.
While this allows for ample staffing of committees, pragmatically there may be too many voices to hear before the board can make decisions. At the same time, banks with only six or seven directors may not be able to adequately staff board committees, and perhaps operate as a “committee of the whole” in some cases. Often times, this low number of directors implies a high level of insularity.
Research from sources including both Bank Director and the National Association of Corporate Directors suggests that the average board size is between 10 and 11 directors, including the CEO. Furthermore, the CEO is now typically the sole inside director, unless the CEO transition plan is underway and a president has been named as heir apparent to the CEO role (similar to KeyCorp’s September 2019 succession announcement). Too many or too few directors can impede a board’s effectiveness, and 75% of public boards have between nine and 12 directors.
Board composition, of course, speaks to the diversity seated around the board table. Whether you accept the prevailing sentiment or not, there is ample evidence that boards with more diverse perspectives perform better. In order to garner more diverse viewpoints, the board needs to be less homogenous (read: “not full of largely middle-aged white men”) and more representative of the communities served and employee demographics of today and tomorrow. And let’s not forget about age diversity, which helps to bring the perspectives of younger generations (read: “vital future customers and employees”) into the boardroom. One real world example: How would you feel if your bank lost a sizable municipal deposit relationship because a local ordinance required a diverse board in order to do business with an institution? It can happen.
Lastly, many boards are aging. The average public director today is 63 — roughly two years older than a decade ago. And as directors age and begin to see the potential end of their board service, a number of community bank boards have responded by raised their mandatory retirement age and prolonging the inevitable. Yet with rising tenure and aging boards, how can an institution bring on next-level board talent to ensure continued strong performance and good governance, without becoming unnecessarily large? Boards need to stay strong and hold to their longstanding age and tenure policies, or establish a tenure or retirement limit, in order to allow for a healthy refresh for the demands ahead.
High-performing companies typically have high-performing boards. It is rare to see an institution with strong performance accompanied by a weak or poorly governed board. Boards that take the time to thoughtfully optimize their size, composition and refreshment practices will likely improve the bank’s performance — and the odds of continued independence.
Joining a bank board can be a bewildering experience for some new directors. There’s a lot to learn, including new, confusing abbreviations and financial metrics specific to the banking industry. But with the right approach, bank boards and nominating/governance committees can make the experience easier.
Onboarding new directors and more quickly acclimating them to the world of depository institutions is essential to ensuring banks have a functioning board that is prepared to navigate an increasingly changing and complex environment. It can also reduce potential liability for the bank by ensuring its members are educated and knowledgeable, and that no one personality or viewpoint dominates the boardroom.
Banking differs from other industries because of its business model, funding base, regulatory oversights and jargon. Directors without existing knowledge of the industry may need one to two years before becoming fully contributing members who can understand the most important issues facing the bank, as well as the common parlance.
Proactive boards leverage the chairperson to create an onboarding process that is comprehensive without being overwhelming, and tailor it to suit their institution’s particular needs, as well as the skill sets of newly recruited board members. The chair can work with members of the nominating/governance committee and executives like the chief financial officer to create a specific onboarding program and identify what pertinent information will best serve their new colleague.
Bank Director has compiled the following checklist to help strengthen your bank’s onboarding program.
1. Help new directors understand their role on the board.
New directors often come in with a background in business or accounting, skills that are useful in a bank boardroom. But business success in one industry may not readily translate to banking, given the unique aspects of its business model, regulations and even vocabulary associated with financial institutions. New directors can access insights on “The Role of the Board” through Bank Director’s Online Training Series.
Banks are uniquely regulated and insured. Directors should be able to appreciate the role they serve in their oversight of the bank, as well as the role regulators have in keeping the bank safe and sound, and ensuring prudent access to credit.
2. Provide an overview of the banking industry.
Directors often aren’t bankers and will need to be acquainted with the business of banking broadly.
With this overview will come the distinctive terms and acronyms that a new director may hear tossed around a boardroom. Boards should either create or provide a glossary with definitions and acronyms of terms, including the principal regulators and common financial metrics.
Click HERE to access Bank Director’s Banking Terms Glossary.
3. Provide an overview of your bank’s business model and strategy.
Directors will need to understand the bank’s products, including how it funds itself, what sort of loans it makes and to whom, as well as other services the bank provides for a fee. They will also need to learn about the bank’s credit culture, capital regime and its approach to risk management, including loan loss reserving.
4. Create a reading list.
There are a number of internal and external resources that new board members can access as they become acclimated to the ins and outs of bank governance. Internally, they should have access to recent examination reports, call reports, and quarterly and annual filings, if they exist. They should also access external resources, like Bank Director’s Online Training Series, the Federal Reserve Bank of Kansas City’s 2016 publication, “Basics for Bank Directors,” and “The Director’s Book,” published by the Officer of the Comptroller of the Currency.
5. Schedule one-on-one meetings with the management team.
A new board member will need to understand who they are working with and the important roles those individuals play in running a successful bank. Their onboarding should include meetings with the management team, especially the CFO for a discussion about the financial metrics, risk measurement and health of the bank. It may also be prudent to schedule a meeting with other executives who oversee risk management at the bank.
6. Schedule one-on-one meetings with members of the board and key consultants.
New directors should sit down with the heads of board committees to understand the various oversight functions the board fulfills. The bank may also want to reach out to the firms it works with, including its accounting, law and consulting firms, to chat about their roles and relationship with the company.
7. Emphasize continuing education.
Boards should convey to new members that they expect continued education and growth in the role. One way to achieve this is through conference attendance, which can provide intensive and specialized education, as well as a community of directors from banks in other geographic areas that new members can learn from. Direct new board members to events hosted by your state banking association, if available, or sign them up for annual conferences like Bank Director’s Bank Board Training Forum.
Look for conferences that offer information calibrated to a director’s understanding, starting with basic or introductory instruction suited for new directors. The conferences should also facilitate discussion among directors, so that they can learn from each other. As a director grows in the role, the board can seek out more specialized training.
Successful onboarding should help new directors acclimate to the world of banking and become a productive member of the board. Boards should expect their directors to become comfortable enough that they go beyond thoughtful listening and ask intelligent questions that reinforce the bank’s strategy and its risk management.
Developing a positive relationship with regulators is important for any bank. How can banks foster this?
There’s no one better to answer this question than a former regulator.
Charles Yi served as general counsel of the Federal Deposit Insurance Corp. from 2015 to 2019, where he focused on policy initiatives and legislation, as well as the implementation of related rulemaking. He also served on the FDIC’s fintech steering committee.
In this interview, Yi talks about today’s deregulatory environment and shares his advice for banks looking to improve this critical relationship. He also explains the importance of a strong compliance culture and what boards should know about key technology-related risks.
BD: You worked at the FDIC during a time of significant change, given a new administration and the passage of regulatory relief for the industry. In your view, what do bank boards need to know about the changes underway in today’s regulatory environment?
CY: While it is true that we are in a deregulatory environment in the short term, bank boards should focus on prudent risk management, and safe and sound banking practices for the long term. Good fundamentals are good fundamentals, whether the environment is deregulatory or otherwise.
BD: What hasn’t changed?
CY: What has not changed is the cyclical nature of both the economy and the regulatory environment. Just as housing prices will not always go up, [a] deregulatory environment will not last forever.
BD: From your perspective, what issues are top of mind for bank examiners today?
CY: It seems likely that we are at, or near, the peak of the current economic cycle. The banking industry as a whole has been setting new records recently in terms of profitability, as reported by the FDIC in its quarterly banking profiles. If I [were] a bank examiner, I would be thinking through and examining for how the next phase of the economic cycle would impact a bank’s operations going forward.
BD: Do you have any advice for boards that seek to improve their bank’s relationship with their examiners?
CY: [The] same thing I would say to an examiner, which is to put yourself in the shoes of the other person. Try to understand that person’s incentives, pressures—both internal and external—and objectives. Always be cordial, and keep discussions civil, even if there is disagreement.
BD: What are some of the biggest mistakes you see banks make when it comes to their relationship with their examiner?
CY: Even if there is disagreement with an examiner, it should never become personal. The examiner is simply there to do a job, which is to review a bank’s policies and practices with the goal of promoting safety and soundness as well as consumer protection. If you disagree with an examiner, simply make your case in a cordial manner, and document the disagreement if it cannot be resolved.
BD: In your presentation at the Bank Audit & Risk Committees Conference, you talked about the importance of projecting a culture of compliance. How should boards ensure their bank is building this type of culture?
CY: Culture of compliance must be a focus of the board and the management, and that focus has to be communicated to the employees throughout the organization. The incentive structure also has to be aligned with this type of culture.
Strong compliance culture starts at the top. The board has to set the tone for the management, and the management has to be the example for all employees to follow. Everyone in the organization has to understand and buy into the principle that we do not sacrifice long-term fundamentals for short-term gain—which in some cases could end up being [a] long-term loss.
(Editor’s note: You can learn more about building a strong culture through Bank Director’s Online Training Series, Unit 16: Building a Strong Compliance Culture.)
BD: You served on the FDIC’s fintech steering committee, which—in a broad sense—examined technology trends and risks, and evaluated the potential impact to the banking system. Banks are working more frequently with technology partners to enhance their products, services and capabilities. What’s important for boards to know about the opportunities and risks here?
CY: Fintech is the next frontier for banking, and banks are rightly focused on incorporating technology into their mix of products and services. One thing to keep in mind as banks increasingly partner with technology service providers is that the regulators will hold the bank responsible for what the technology service provider does or fails to do with regard to banking functions that have been outsourced.
BD: On a final note: In your view, what are the top risks facing the industry today?
CY: I mentioned already the risks facing the industry as we contemplate the downhill side of the current economic cycle. One other issue that I know the regulators are and have been spending quite a lot of time thinking about is cybersecurity. What is often said is that a cyber event is not a question of if, but when. We can devote volumes of literature [to] talking about this issue, but suffice for now to say that it is and will continue to be a focus of the regulators.
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Bank directors face a myriad of expectations from regulators to ensure that their institutions are safe and sound. But there’s one thing directors do that regulators don’t actually ask them to do.
“There’s no requirement or even suggestion, that I’m aware of, from any regulators that says, ‘Hey, we want the board involved at the loan-approval level,’” says Patrick Hanchey, a partner at the law firm Alston & Bird. The one exception is Regulation O, which requires boards to review and approve insider loans.
Instead, the board is tasked with implementing policies and procedures for the bank, and hiring a management team to execute on that strategy, Hanchey explains.
“If all that’s done, then you’re making good loans, and there’s no issue.”
Yet, 77 percent of executives and directors say their board or a board-level loan committee plays a role in approving credits, according to Bank Director’s 2019 Risk Survey.
Boards at smaller banks are more likely to approve loans than their larger peers. This is despite the spate of loan-related lawsuits filed by the Federal Deposit Insurance Corp. against directors in the wake of the recent financial crisis.
The board at Mayfield, Kentucky-based First Kentucky Bank approves five to seven loans a month, says Ann Hale Mills, who serves on the board. These are either large loans or loans extended to businesses or individuals who already have a large line of credit at the bank, which is the $442 million asset subsidiary of Exchange Bancshares.
Yet, the fact that directors often lack formal credit expertise leads some to question whether they should be directly involved in the process.
“Inserting themselves into that decision-making process is putting [directors] in a place that they’re not necessarily trained to be in,” says James Stevens, a partner at the law firm Troutman Sanders.
What’s more, focusing on loan approvals may take directors’ eyes off the big picture, says David Ruffin, a director at the accounting firm Dixon Hughes Goodman LLP.
“It, primarily, deflects them from the more important role of understanding and overseeing the macro performance of the credit portfolio,” he says. “[Regulators would] much rather have directors focused on the macro performance of the credit portfolio, and understanding the risk tolerances and risk appetite.”
Ruffin believes that boards should focus instead on getting the right information about the bank’s loan portfolio, including trend analyses around loan concentrations.
“That’s where a good board member should be highly sensitized and, frankly, treat that as their priority—not individual loan approvals,” says Ruffin.
It all boils down to effective risk management.
“That’s one of [the board’s] main jobs, in my mind. Is the institution taking the right risk, and is the institution taking enough risk, and then how is that risk allocated across capital lines?” says Chris Nichols, the chief strategy officer at Winter Haven, Florida-based CenterState Bank Corp. CenterState has $12.6 billion in assets, which includes a national correspondent banking division. “That’s exactly where the board should be: [Defining] ‘this is the risk we want to take’ and looking at the process to make sure they’re taking the right risk.”
Directors can still contribute their expertise without taking on the liability of approving individual loans, adds Stevens.
“[Directors] have information to contribute to loan decisions, and there’s nothing that says that they can’t attend officer loan committee meetings or share what they know about borrowers or credits that are being considered,” he says.
But Mills disagrees, as do many community bank directors. She believes the board has a vital role to play in approving loans.
First Kentucky Bank’s board examines quantitative metrics—including credit history, repayment terms and the loan-to-value ratio—and qualitative factors, such as the customer’s relationship with the bank and how changes in the local economy could impact repayment.
“We are very well informed with data, local economic insight and competitive dynamics when we approve a loan,” she says.
And community bank directors and executives are looking at the bigger picture for their community, beyond the bank’s credit portfolio.
“We are more likely to accept risk for loans we see in the best interest of the overall community … an external effect that is hard to quantify using only traditional credit metrics,” she says.
Regardless of how a particular bank approaches this process, however, the one thing most people can agree on is that the value of such bespoke expertise diminishes as a bank grows and expands into far-flung markets.
“You could argue that in a very small bank, that the directors are often seasoned business men and women who understand how to run a business, and do have an intuitive credit sense about them, and they do add value,” says Ruffin. “Where it loses its efficacy, in my opinion, is where you start adding markets that they have no understanding of or awareness of the key personalities—that’s where it starts breaking apart.”