Sorting Necessary from Noise: How to Focus Your Board’s Time


Director liability has expanded dramatically over the last decade. As pressures on bank boards intensify, their time has become constrained. How can board members protect themselves while building value for their institution? We can win if we play offense; below are 11 focal points for bank boards.

Focus on value creation. Few banks connect executive compensation and return for shareholders. Too many boards accept mediocre performance by executives, who should be enriched for growing tangible book value per share (TBVS), earnings per share (EPS) and franchise value, not the bank’s asset size.

Understand what drives value. An institution’s stock price is driven by multiples of TBVS and EPS, which reflect the market’s perception of the risk profile of the bank. By looking to build value for investors, boards can put in place the proper strategies to achieve their goals, and manage the risk, governance and regulatory environments.

Implement an enterprise risk management program (ERM). An ERM program does more than satisfy regulatory guidelines to establish an internal risk assessment program. The process also aligns the interests of different stakeholders, and improves the bank’s culture by instilling risk management responsibility, accountability and authority throughout the entire organization. It can boost the institution’s ability to raise new capital at higher multiples, fix liquidity and increase earnings. Finally, ERM enhances the strategic planning process by analyzing clearly delineated paths with the associated risk and rewards of each.

Stay educated. Board members have a limited time to stay up-to-date on the issues impacting the banking industry. Custom bank education, using the bank’s data, provides the most flexibility for directors. Topics should include emerging issues, economic developments, capital markets trends and regulatory pressures, as well as each topic’s direct impact to the directors’ institution.

Adopt governing principles. Prevent corporate drift by setting concrete principles which prevail above strategy or tactical solutions. Some examples are to achieve a specified CAMELS rating, eliminate regulatory orders, only consider a sale if market multiples reach a pre-determined level, or to set specific compounded annual return of TBVS over the next 3 years.

Validate corporate infrastructure. An ineffective corporate structure could mean that more regulatory agencies are examining your institution than necessary. Boards should discuss the value of their holding company, registering their stock, the appropriateness of the bank’s charter and target capital composition at least annually.

Commit to talent management. Many senior managers will retire over the next few years, but a proper talent management program encompasses more than succession planning. An annual management review helps the organization prepare for the future, but a robust program further enables banks to attract, retain and motivate employees.

Control the balance sheet. Between 2004 and 2007, the last rate rise, interest expense at depository institutions tripled. While models are necessary to understand the risk, the only way to turn this into a strategic advantage is to conduct price sensitivity analysis, customer retention analysis and customer loyalty studies.

Streamline corporate governance. The board’s primary responsibilities include setting the strategic direction for the bank, creating and updating policies, and establishing a feedback monitoring system for progress. Though conceptually simple, a typical director’s time is strained. Time spent on board matters can be streamlined by centralizing information under one system, using consent agendas, spreading policy approval dates, utilizing video technology, educating the board using bank specific data, and appropriately scheduling committee meetings.

Perform customer segmentation. Historically, banks have analyzed growth opportunities by assessing geographic boundaries. Today, institutions must now know and sell to their customers by identifying target customer profiles, developing products to profitably serve those customers, analyzing where those customers live, understanding how they communicate and building delivery channels specific to those customers.

Have a capital market plan. What is the institution worth on a trading and takeout basis? Who can we buy? Who would want to buy the bank and why? Should the institution consider stock repurchases or higher dividends? Regardless of size, every institution needs to ask itself these questions, and memorialize the discussion in an integrated capital markets plan.

Does Market Volatility Impact Bank M&A?


While the volatility in the stock market garners the attention of investors, it is also a worrisome topic for bank boards. As the Federal Reserve considers its first rate increase in close to 10 years—and China’s growth outlook continues to wane and impact economies around the world—bank boards have to consider the impact on their growth strategies, including any planned capital raises, IPOs or mergers and acquisitions.

Certainly, unexpectedly large swings in daily share prices make it difficult to price a potential M&A deal. This comes in an environment where bank M&A volume has not increased much, if at all, depending on how you look at the numbers. As you can see in the chart below, we have had just 34 deals with a value of more than $50 million year to date through Sept 7, 2015, which puts us slightly below the rate of 2014, according to Mark Fitzgibbon, a principal and the director of research at investment bank Sandler O’Neill + Partners.

Most bank deals are smaller than $50 million in value, however. In an upcoming article for BankDirector.com, Crowe Horwath LLP, a consulting and accounting firm, looked at all deal volume through June 30, 2015, and found 140 deals, slightly above last year’s volume in the same time frame of 130 deals.

Clearly, the lion’s share of the transactions has been small bank deals, and we have not seen many large transactions this year. Fitzgibbon is of the opinion that there are three dynamics that have slowed the pace of consolidation: (a) recent market volatility makes it tough to price deals, (b) large banks have generally been more internally focused than M&A focused, and (c) regulators have been slow to approve some deals, giving pause to some buyers.

This complements the perspectives of Fred Cannon, executive vice president and global director of research at Keefe, Bruyette & Woods, who reminded me that the pace of M&A “is simply a lot slower than it was prior to the crisis, and those of us who remember pre-crisis M&A, it will likely never be the same. We don’t have national consolidators buying up banks, and regulation does not allow the same speed of consolidation we previously had.”  In Cannon’s words, “volatility certainly slows deals a bit, but it postponed deals rather than stopped them.”

Contrast that with initial public offerings, which can really take a beating in a volatile market. Depending on the market and the individual bank’s potential value, it may no longer make sense to price an IPO, or it may make sense to delay it.

Here, I agree with Cannon’s assertion that a weak market is “more detrimental to IPOs than M&A. With M&A, the relative value of the buyers’ currency is often more important than the absolute level.” So if values fall for both the buyer and seller, the deal may still make sense for both of them. For potential deal making, market volatility is rarely good news, but it may not be as bad as it seems.

Is Your Board Suitably Engaged?


board-effectiveness-9-2-15.pngI was in a board meeting the other day for one of my community bank clients. The president of the bank, let’s call him Hank, had just finished giving a presentation to the directors about a new product that the bank was considering rolling out. When the president finished giving his presentation, the chairman leaned back in his chair, locked his hands behind his head and declared: “Well, that was a very nice presentation Hank. Frankly, if it is good enough for Hank, it is good enough for me.”

Suffice it to say that this vignette does not depict a highly functioning board of directors. Sadly, however, it is not uncommon to hear similar conversations in boardrooms across the country, particularly in smaller community banks. It is this type of deferential attitude that can result in regulatory fallout for directors and the institutions they serve. Most lawsuits brought by the Federal Deposit Insurance Corp. in the wake of a bank failure are brought on the basis of the board being “asleep at the switch.” This article will provide a couple of helpful tips that you should consider implementing to make sure that your board remains suitably engaged to oversee the bank’s management and create maximum value for the institution’s shareholders.

  • Your board should reflect the make-up of the bank’s customer base and the communities it serves. A diverse group of directors representing the predominant industry groups in your bank’s markets will ensure that your board has the appropriate expertise and understanding of the unique issues facing the bank and its customers. This will help you ask the right questions and accurately evaluate the risks presented by customers and other issues the bank faces.
  • Choose a strong, but thoughtful chairman. Oftentimes, a board can be dominated by the individual running the meetings and decisions of the board largely reflect the thinking of the chairman. While it is important to select a chairman who is not afraid to make decisions, that person should also be open and thoughtful to differing opinions and should not discourage robust discussion of the issues. To this end, it is often a good idea to bifurcate the role of chairman from the CEO of the institution. An independent chairman can maintain an objective perspective and not develop tunnel vision, which can often result from being “too close” to the issues.
  • Maintain board visibility during regulatory examinations. One thing that bank examiners like to see is that the board’s engagement extends beyond the boardroom itself.  It is a good idea to have representatives from the board of directors stop in to see the examiners once or twice during the examination process. It can be as casual as simply checking in to make sure everything is going alright, or to answer any questions that have arisen during the exam that have not yet been adequately addressed by bank personnel. Examiners are often impressed when board members take an active interest in the examination process and engage with the examiners other than during the meeting to present the results of the exam.
  • Don’t let your meetings get hijacked by one issue. It is very easy for one issue to dominate a board meeting, particularly an issue that a number of the directors are passionate about. It is critical to maintain a manageable agenda and to have appropriate leadership to be able to stay on task during meetings. Otherwise, one of two things can happen: (i) other equally important issues can be given short shrift and hasty decisions can be made, or (ii) meetings can drag on for hours and directors can become more interested in their other obligations than in the business at hand. If it appears that a more robust discussion on an issue is warranted than the allotted time would permit, the chairman should table the issue for the next meeting (or a special meeting if time is of the essence), in order to make sure that appropriate consideration is given to all agenda items.

The items covered in this article only scratch the surface of how to keep your board suitably engaged. The important take-away, however, is that a failure to adequately run the board could result in significant harm to the institution and personal liability for the directors. The board of directors of an insured financial institution is the gatekeeper of the institution and should actively and meaningfully participate in overseeing and directing the operations of the institution.

M&A: How to Review Deals at the Board Level


8-6-14-Bryan-Cave.pngMany bank boards are considering a sale of their institution for a variety of reasons—heightened regulatory burdens, board and management fatigue, or an opportunity to partner with a growing bank are just a few. But while the financial crisis has taught important lessons about bank management, for many bank directors, the sale of their financial institution is uncharted territory. As you typically only have one opportunity to get it right, directors considering a sale should focus first on establishing a sound process around the board table.

Although it is rational for directors to worry more about specific aspects of the proposed deal than procedural matters, we have found that establishing an appropriate process for considering a possible transaction is often a prerequisite for success on the business issues. Moreover, in today’s world of heightened scrutiny of board actions, directors cannot neglect procedure and expect to fulfill their duties of loyalty and due care. In most states, fulfilling those duties gives directors the benefit of the business judgment rule, which insulates directors from liability provided the decision is related to a rational purpose.

In the context of a sale, most directors can meet their duty of loyalty by acting in good faith to achieve the best result for the company and its shareholders and by disclosing any conflicts of interest to the board prior to the beginning of the deliberations. But with respect to the duty of care, establishing a thorough process leading to a sale is key. A recent court case decided in Georgia provides a helpful roadmap.

In the recent opinion on FDIC v. Loudermilk, the Georgia Supreme Court, in applying the business judgment rule to bank directors, distinguished between claims alleging negligence in the decision-making process from claims that do no more than question the wisdom of the decision itself. The court’s opinion indicates that claims relating to the board’s process will be subject to more scrutiny in the context of litigation than claims that ask the court to be a Monday morning quarterback for board decisions made in good faith.

Considering the emphasis on the board’s deliberation and diligence in making business judgments, it falls on the directors to ensure that the board puts into place procedural controls as it considers a strategic transaction. Hallmarks of a strong process include the following:

  • Having a meaningful strategic plan. Prior to entering into a discussion of a significant transaction, the board, with the help of management, should have formed a strategic plan, complete with financial projections, for continuing to operate independently. This exercise will give the board a base case against which offers can be compared.
  • Hiring the right experts. The duty of care doesn’t require directors to become experts in legal or technical financial matters, so building the right team of investment bankers, accountants and lawyers is essential. Experienced professionals who understand and care about the strategic plan of the bank, rather than pushing a particular result, will add value to the board’s process.
  • Doing your homework. Selling the bank is perhaps the most important decision you’ll make, so studying the board packet in advance of the meeting (and making sure there is ample time to study it), asking good questions, and pushing management and your experts for answers that make sense are all part of discharging your duties. The selling bank should not be pressed by artificial deadlines that hinder due deliberations by directors.
  • Documenting the process. Corporate minutes allow the board to document its consideration of a potential transaction, and while the minutes shouldn’t be a play-by-play of the discussion, they should summarize the key points from each meeting and establish that appropriate steps were taken by the board.
  • Speaking with one voice. For most community banks, directors are the face of the institution to its community. Once the deal is announced, work with management to communicate some simple talking points with your shareholders. It is fair to acknowledge the big picture risks, but be sure to emphasize the strategic view of the board. While this messaging isn’t technically part of the deliberative process, communicating with shareholders that an appropriate process took place can pay future dividends.

Bank directors certainly find themselves living in interesting times, with their obligations and responsibilities changing rapidly. But if a board fosters communication and participation around the board table to reach a deal, the directors can discharge their duties successfully, and bring value to their shareholders.

Three Things Bank Boards Can Do to Improve the Use of Technology


2-26-14-emily-tech.pngThere is little doubt that technology is rapidly changing lifestyles, not to mention banking. More than half of all Americans owned a smartphone in 2013, up from 35 percent just two years prior, according to the Pew Research Center.

Jack Schultz, chairman at Effingham, Illinois-based Midland States Bancorp, which has $1.7 billion in assets, says his bank’s board and management keep an eye on the competition from both inside and outside the banking industry, and then rapidly adapt. He uses mobile banking as an example. “It’s a much quicker game than what it was 5 or 10 years ago,” he says.

Technology moves at a rapid pace, and much of that change could result in better service to potential and current clients, all while making the institution more efficient. Here are some items that bank boards can consider to avoid becoming irrelevant.

  1. Add a board member with expertise in technology or innovation.
    “Because of the way that the industry is changing so quickly, I think that having people who have a background in technology and innovation is a strong attribute for the board,” says Schultz. Not only do these board members need to understand what technology will be important to customers, but they also need to understand the impact of cyber security risk on the institution and, due to the reliance of many small institutions on third-party technology, how to oversee vendor management. “Every single bank is a consumer of technology,” says Ryan Gilbert, himself a technology expert and director at Sacramento-based River City Bank. Gilbert is chief executive officer of BetterFinance Inc. (formerly known as BillFloat), a financial technology company which helps consumers manage their bills and provides small loans to consumers and small businesses through lenders. While many banks have lawyers, real estate professionals and doctors with expertise in areas like business development or compliance, many board members do not fully understand the technology the bank relies on. “There is a significant knowledge gap that’s out there,” Gilbert says.

    But finding these directors can be a challenge. “Most people like me don’t want to be on bank boards,” Gilbert says. Aside from the liability posed by serving on a bank board, he says that the difference between the banking industry, focused on safety and soundness, and the technology sector, focused on innovative problem-solving, can result in a culture clash. “Working with banks as a financial innovator is super difficult,” he says. “Banks and regulators put the ‘no’ into innovation.”

  2. Add a technology committee to the board.
    “I think all boards should have an IT [information technology] committee” focusing on the bank’s technology needs, including external vendors, says Gilbert. Technology is a significant part of the bank’s budget, with industry spending in the U.S. expected to increase by almost 10 percent by 2015, according to research and consulting firm Celent. More than half of spending was allocated to external services and software in 2013, and Celent expects the industry’s reliance on vendors to increase.

    “Unfortunately many banks, or bankers, do not get very involved in IT matters, and prefer to either outsource or really not lend too much attention to these issues,” says Agustin Abalo, who uses his expertise as a former chief information officer at Banco Santander International, a subsidiary of Spanish global bank Banco Santander, to chair the IT committee of BAC Florida Bank, a $1.3 billion-asset institution headquartered in Coral Gables, Florida. This board-level committee is composed of three independent directors and several officers, including the bank’s president, chief risk officer, chief operating officer and chief information officer. Abalo says that just like other committees focus on relevant risks, like large loans, IT committees can help tackle the growing issue of cyber-crime. He recommends that the IT committee keep the board informed about the bank’s technology needs and related budget requirements.

  3. Focus on technology that improves the user experience and makes the bank more efficient.
    “Usability, which is a massive focus for [financial technology] companies and Internet start-ups, really hasn’t been a focus in banking,” says Gilbert, making it critical for boards that want to set the institution apart to ensure that the customer experience—both in person and online—is positive.

    Mobile banking continues to have a big impact on the industry, and when done right, can result in satisfied customers and a more efficient institution. “Access and convenience are key to the customer,” says Dustin Luton, chief executive officer at Covina, California-based Simplicity Bank, a savings bank with $867 million in assets. “They want things on their own timeline.” If more tasks, like cancelling a debit card or stopping payment on a check, can be done through mobile or online banking, it’s convenient for customers. It can also allow branch and call center staff to better focus on customers that need more assistance or want more products and services from the bank. “These little things will make the difference in the long run from a customer perspective, all these little things that [customers] just don’t really think about,” says Luton.

Part I: Best Practices of Bank Boards


good-board.jpgToday’s banking industry is constantly being buffeted by waves of financial, regulatory and operational challenges. The increased regulatory burden and related costs impact every financial institution in both the approach to doing business and the expense of doing business. The industry is in transition, with no clear path forward. As a result, there has never been a greater need for well functioning, informed and courageous boards of directors of banks and bank holding companies. There has also never been a more important time for board members to keep in mind that their responsibilities can be boiled down into one simple goal: the creation of sustainable long-term value for shareholders.

Achieving long-term value for shareholders may seem an elusive goal in the current environment. On more than one occasion, bank board members have commented to me that they feel they are now working for the benefit of the regulators. However, as with any time of turmoil and change, the challenges we now face will pass. As bank boards look for ways to strengthen their institutions, they should not overlook the opportunity to strengthen themselves as a group. One way of doing that is to adopt the practices of the most effective boards of directors.

Over the past several decades my partners and I have attended hundreds of bank board meetings, for institutions ranging in size from under $100 million in assets to well over $10 billion. Regardless of the size of the entity, we have noticed a number of common characteristics and practices of the most effective boards of directors. This is the first in a series of articles which will describe the 10 best practices we have observed among highly effective boards of directors. In this article I focus on two fundamental best practices – selecting good board members and adopting a meaningful agenda for the board meetings.

Best Practice No. 1 – Select Good Board Members

Some of the most challenging and distracting issues a board can face are those related to its own members. These issues typically arise in connection with conflicts of interest between board members and the banks they serve, or when board members experience financial stress. They can also arise when there are personality clashes in the boardroom or when one or more board members seek to dominate the conversation. The best time to avoid such issues is during the selection process for new directors. Compromise and wishful thinking in the selection of directors will almost always dilute the effectiveness of the board as a whole. Key characteristics of good directors include:

  • Independence – being free of conflicts.
  • Time to devote to the job – including time to gain knowledge of the industry, to prepare for board meetings and to participate in committees.
  • Attention – being fully engaged and proactive as a board member.
  • Courage – having a willingness to deal with tough issues.
  • Curiosity -possessing an intellectual curiosity about the bank, the financial services industry and the trends impacting both.

A group of good, solid and dependable board members is, in my experience, preferable to a big-hitter, all-star line-up of directors. A board is most effective when it acts as a group, with a culture in which all members can voice their opinions, and in which probing, and sometimes difficult questions can be asked. Dominant personalities and board cultures in which constructive debate never occurs have contributed to the demise of many banks in the current downturn. Careful selection of new board members, keeping in mind the strengths and weaknesses of the other members of the board, is well worth the time and effort involved.

Best Practice No. 2 – Adopt a Meaningful Agenda

Take the time to review, revise and update your board agenda. I’m aware of several banks that are using the same approach to board meetings and the same agenda as 30 years ago. The absence of any objection from board members may only mean that they are drifting off to sleep during the half-hour-long financial presentation. Board members greatly appreciate a shift to a more efficient and effective agenda, with a focus on committee reports and presentation of only meaningful information about the condition and operations of the bank .This can free up substantial time for the board to focus on the overall direction and progress of the bank. 

Most directors only visit the bank once or twice a month, which makes a full understanding of the bank’s plans and status very difficult. There needs to be an educational element in board meetings. Most directors have an ongoing need, and desire, for growth and development in their understanding of the banking industry. With such education, directors can become more effective in their recognition and understanding of the risks to be monitored, as well as the factors that most influence a bank’s strength and performance.

Board packages should be delivered well in advance of each meeting in order to provide the directors with adequate time to prepare. Committee chairs should be prepared to give concise but informative reports at the meeting. Financial and operational presentations by management should focus on telling the board members what time it is, not how the watch was built. This approach can result in more interesting and informative board meetings and will likely result in greater interaction and contribution by the board members.

Links to the other 3 parts in this series

Originally published on October 25, 2011.

Postcard from the Bank Audit Committee Conference


Jack_Audit_13_blog.pngUpon receiving (with great relief!) a gentleman’s C in the one accounting course I took in college oh-so-many years ago, I vowed to steer clear of the topic from then on. It’s almost impossible to spend the better part of your working life as a financial journalist and not pick up a little bit of accounting knowledge along the way—and I have, although I have been home schooled so-to-speak rather than formally educated, and I still find the discipline to be a little mystifying.

It’s because of this arms-length relationship I’ve long maintained with accounting that I’m always a little surprised by how much I enjoy our Bank Audit Committee Conference, which took place June 5-7 at the JW Marriott in Chicago. This was our seventh year for the event and we attracted 330-plus attendees, most of whom were bank audit committee chairs or members. We don’t really talk about accounting issues all that much at this conference. Instead, we dive into some really fascinating non-accounting topics like government-mandated stress tests, cyber risk, regulatory compliance, enterprise risk management, whistle blowers and forensic investigations.

In recent years, the audit committee has become the most important board at most banks because just about everything of any significance that happens inside of a bank ends up passing through the audit committee in some form or fashion. The audit committee’s significance in the world of public companies was greatly elevated 11 years ago by the Sarbanes-Oxley Act, which among its many provisions made the audit committee responsible for overseeing the company’s relationship with its outside auditor.

If that was the first shoe to fall, the second shoe was the 2007-2008 financial crisis, which led to a greatly heightened emphasis by the bank regulatory agencies on risk governance at the board level. While a growing number of bank boards (especially at the larger institutions) have established separate risk committees, most institutions still handle risk governance oversight through their audit committees. I think it’s fair to say that the financial crisis was a wakeup call for most banks that they needed to do a better job of managing risk at the operating level, and that directors had to improve their understanding as well. Certainly the regulators expect bank boards to be taking a leading role in setting the institution’s risk appetite and monitoring its risk profile on a regular basis.

As you might expect, there were a lot of risk topics on the conference agenda, including overviews of enterprise risk management, board level risk committees and risk dashboards. Two sessions in particular stood out for me. One was a panel discussion that I moderated on cyber risk. I think you could describe the contest between banks and criminal hackers as an arms race in which the banks might be falling behind. Because of the creativity and sheer doggedness with which hackers try to penetrate banks, audit and risk audit committees need to make sure their management teams are placing as much emphasis on cyber security as possible. This is not an area of strength for most bank directors—they need to educate themselves about cyber risk so they can ask intelligent questions about their institution’s security practices. Over the next decade, cyber risk might end up replacing credit risk as the greatest threat facing the banking industry.

KKabat.pngThe other session that I thought was particularly insightful was a keynote presentation by Fifth Third Bancorp CEO Kevin Kabat. The Cincinnati-based bank was one of the top performing institutions in the country before it hit a rough patch prior to the financial crisis. Kabat made a compelling argument that Fifth Third’s resurgence owes a great deal to the cutting-edge risk management practices that began to develop even before the crisis.

Banking is a risky business, and managing that risk has become job one for many bank audit committees.

Part 4: Best Practices for Bank Boards


relay-baton.jpgI frequently speak to groups of bank CEOs and directors at state and national conferences.  One of my favorite topics is “best practices for bank boards.”  The audience reaction always confirms my belief that bank boards of directors all face the same fundamental challenges, regardless of the size or geographic location of the bank and the shareholder base which they serve.  Boards of directors are groups of people, and every group of people develops its own set of shared expectations and priorities.  It can be helpful for a bank board to occasionally take the time to reflect on its approach to self governance and decision making, especially when this is done by examining the experience and success of other boards of directors in the industry.

This is the fourth and final article in a series on best practices for bank boards. This series of articles describes ten of those best practices.  In this article, I will discuss the last two best practices—developing real board leadership and making use of special purpose board meetings.

Best Practice No. 9 – Develop Real Board Leadership

 Every board should periodically evaluate whether it has effective leadership.  Just as no director has a “right” to sit on a board, which gives rise to the need for director assessments and evaluations, leadership positions also are not tenured.  To be effective, a leader must be engaged, prepared for meetings, willing to take on difficult issues, and, in my view, willing to lead by example.  Burnout and growing complacency can be expected in all leadership roles.  It is in the best interest of the board, the bank and its shareholders for the board to have the ability and willingness to recognize and address these issues when they arise, and not delay action.

If the CEO is also chairman of the board, is that arrangement working for the board?  A test for whether such an arrangement is working is for the non-management independent directors to consider whether the board is truly making its own decisions.  If not, then reconsider the existing leadership structure and, at a minimum, appoint a lead director to bring more balance to the board’s decision making process and better ensure a flow of important information to the board.

Also, consider rotating committee leadership on a regular basis, particularly among the most important committees such as the audit, asset-liability and loan committees.  Fresh leadership perspective can be an effective risk management tool.

Best Practice No. 10 – Make Use of Special Purpose Board Meetings

Have at least two meetings a year dedicated to focusing on the bank’s strategy and why it works (or should work) and its strengths and challenges.  Include in one such meeting a discussion of “Buy, Sell or Hold,” since management needs to know the direction of the board on this fundamental issue in order to effectively run the bank and position it for the future.

Consider scheduling a special meeting to address any questions or concerns that directors may have but won’t express in a regular board meeting.  For example, in this time of increased regulatory burden and more aggressive regulatory enforcement, many directors are interested in knowing what their personal liability exposure is and what protections exist, whether they ask or not.  Directors also are very interested these days in hearing a more complete description of the impact of the Dodd-Frank Act and the scope of authority and impact of the Consumer Financial Protection Bureau.

Finally, consider setting aside most or all of a board meeting to have the directors hear directly from the key senior staff of the bank.  This can be helpful for the board to gain confidence in the bank’s overall management team, and it can also be a source of insight into the strength of the institution.  Good banking is fundamentally about good people, and in-person communication is the best way for the board to take the measure of the bank’s people.

I wish you and your board great success. The other articles in this series are below:

Sharing Directors Brings Added Experience to Your Board, But Could Cause Problems


DropFiles.jpgMany financial institutions, particularly community banks, have enhanced the experience level of their boards by adding a director who is a banker or serves on the board of another financial institution.  In general, utilizing a director who has current experience with another financial institution is a great way to add valuable perspective to a variety of issues that the board may encounter.  In addition, as private equity funds made substantial investments in financial institutions, they often bargained for guaranteed board seats.  The individuals selected by private equity firms as board representatives often serve on a number of different bank boards.  As market conditions have led to increased bank failures, however, a problem has resurfaced that may cause some financial institutions to take a closer look at nominating directors who also serve other financial institutions: FDIC cross-guarantee liability.

The concept of cross-guarantee liability was added to the Federal Deposit Insurance Act by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA).  The pertinent provision states that any insured depository institution shall be liable for any loss incurred by the FDIC in connection with:

  • the default (failure) of a “commonly controlled” insured depository institution; or
  • open bank assistance provided to a “commonly controlled” institution that is in danger of failure.

This means that if two banks are “commonly controlled” and one of them fails, the other bank can be held liable to the FDIC for the amount of its losses or estimated losses in connection with the failure.  As many of us see each Friday, the amounts of these estimated losses are often quite high.  In fact, the FDIC’s estimated losses for 2011 bank failures were approximately 20 percent of total failed bank assets for the year.  Accordingly, the prospect of cross-guarantee liability can be a tremendous financial issue for the surviving bank.

The concept of cross-guarantee liability was developed in response to some perceived abuses by multi-bank holding companies during the 1980s.  In those instances, one or more institutions owned by a multi-bank holding company failed, causing significant losses to the FDIC, while the other subsidiaries of the multi-bank holding remained open and viable, allowing the holding company to continue to profit from their operations while the FDIC was stuck with the losses from the failed institutions.  With authority to assess cross-guarantee liability now in hand, however, the FDIC has shown a willingness to assert cross-guarantee liability under facts that would not be considered by most to be abusive.  In this cycle, the FDIC appears to be willing to take full advantage of the assessment authority granted to it by FIRREA, using cross-guarantee liability as a “sword” to provide a recovery to the Deposit Insurance Fund.

The imposition of cross-guarantee liability starts with an assessment of control.  Whether institutions are “commonly controlled” for purposes of determining cross-guarantee liability depends upon whether each institution is under the control of a common entity under the Bank Holding Company Act of 1956, as amended (BHC Act).  Because the determination of control is made under the BHC Act, the Federal Reserve’s BHC Act control guidance is a useful guide. However, this guidance is very dense and can be quite complicated, requiring a review of the ownership structure, management practices, and other business affiliations of the two institutions.  However, one thing is clear:  In questions of control, institutions that share “management officials”—common directors and/or executive officers—are generally more likely to be found to be under common control than those that do not, all other factors being similar.

As a result, institutions with directors who serve on other bank boards or as officers of other banks should assess potential cross-guarantee risk through the director nomination process.  Nominating committees (or other committees of the board reviewing director qualifications) should ask the following questions:

  • Does the individual serve on as a director or officer of another financial institution?
  • Is there a basis for determining that the two institutions are under common control?  Answering this question will likely require consultation with legal counsel.
  • Is the other financial institution in a financial condition that is less than sound?

If the answer to all of these questions is “yes,” the nominating committee should think carefully about whether nominating that individual is a good idea.  In addition, institutions guaranteeing board seats to investors (such as in connection with a private equity investment) should consider an exception to the nomination requirement when the election of the representative could create a risk of assessment of cross-guarantee liability.

A risk assessment requires an in-depth factual, legal and financial analysis. There are few organizations that will find out this issue places them at risk, but it’s worth attention because the consequences can be severe. As a result, an assessment of this risk should be an integral part of the annual nomination process.