As Interest Rates Rise, Loan Review Gets a Second Look

In 1978, David Ruffin got his first mortgage. The rate was 12% and he thought it was a bargain.

Not many people who remember those days are working in the banking industry, and that’s a concern. Ruffin, who is 74 years old, still is combing through loan files as an independent loan reviewer and principal of IntelliCredit. And he has a stark warning for bankers who haven’t seen a rising interest rate environment, such as this one, in more than 40 years.

“Credit has more hair on it than you would want to acknowledge,” Ruffin said recently at Bank Director’s Bank Audit & Risk Conference. “This is the biggest challenge you’re going to have in the next two to three years.”

Borrowers may not be accustomed to higher rates, and many loans are set to reprice. An estimated $270.4 billion in commercial mortgages held at banks will mature in 2023, according to a recent report from the data and analytics firm Trepp.

Nowadays, credit risk is low on the list of concerns. The Office of the Comptroller of the Currency described credit risk as moderate in its latest semiannual risk perspective, but noted that signs of stress are increasing, for example, in some segments of commercial real estate. Asset quality on bank portfolios have been mostly pristine. In a poll of the audience at the conference, only 9% said credit was a concern, while 51% said liquidity was.

But several speakers at the conference tried to impress on attendees that risk is buried in loan portfolios. Loan review can help find that risk. Management and the board need to explore how risk can bubble up so they’re ready to manage it proactively and minimize losses, he said. “The most toxic thing you could fall victim to is too many credit surprises,” he said.

Some banks, especially smaller ones, outsource loan review to third parties or hire third parties to independently conduct loan reviews alongside in-house teams. Peter Cherpack, a partner and executive vice president of credit technology at Ardmore Banking Advisors, is one of those third-party reviewers. He says internal loan review departments could be even more useful than they currently are.

“Sometimes [they’re] not even respected by the bank,” he says. “It’s [like] death-and-taxes. If [loan reviewers are] not part of the process, and they’re not part of the strategy, then they’re not going to be very effective.”

Be Independent
He thinks loan review officers shouldn’t report to credit or lending chiefs; instead, they should report directly to the audit or risk committee. The board should be able to make sense of their conclusions, with highlights and summaries of major risks and meaningful conclusions. Their reports to the board shouldn’t be too long — fewer than 10 pages, for example — and they shouldn’t just summarize how much work got done.

Loan review should communicate and collaborate with departments such as lending to find out about risk inside individual industries or types of loans, Cherpack says. “They should be asking [the loan department]: ‘What do you see out there?’ That’s the partnership that’s part of the three lines of defense.”

He adds, “if all they’re doing is flipping files, and commenting on underwriting quality, that’s valuable, but it’s in no way as valuable as being a true line of defense, where you’re observing what’s going on in the marketplace, and tailoring your reviews for those kinds of emerging risks.”

Targeted Reviews
Many banks are stress testing their loan portfolios with rising rates. Cherpack suggests loan review use those results to adjust their reviews accordingly. For instance, is the bank seeing higher risk for stress in the multifamily loan portfolio? What about all commercial real estate loans that are set to reprice in the next six to 18 months?

“If [loan review is] not effective, you’re wasting money,” Cherpack says. “You’re wasting opportunity to protect the bank. And I think as, as a director, you have a responsibility to make sure the bank’s doing everything it should be doing to protect its shareholders and depositors.”

Carlyn Belczyk is the audit chair for the $1.6 billion Washington Financial Bank in Washington, Pennsylvania. She said the mutual bank brings in a third-party for loan review twice a year. But Cherpack’s presentation at the conference brought up interesting questions for her, including trends in loans with repricing interest rates or that were made with exceptions to the bank’s loan policy. “I’m fairly comfortable with our credit, our loan losses are minimal, and we probably err on the side of being too conservative,” she said.

Ruffin doesn’t think coming credit problems will be as pronounced as they were during the 2007-08 financial crisis, but he has some words of advice for bank boards: “Weak processes are a telltale sign of weaknesses in credit.” he said.

Historically, periods of high loan growth lead to the worst loan originations from a credit standpoint, Ruffin said.

“We do an unimpressive job of really understanding what’s sitting in our portfolio,” he said.

This article has been updated to correct Ruffin’s initial mortgage rate.

5 Ways Bank Boards Can Strengthen Operational Resilience

As banks face an expanding array of threats and challenges, boards recognize the need to adapt their thinking. As a result, boards are increasingly taking a new approach to operational resilience.

The topic of operational resilience calls to mind internal planning efforts to address a list of everything that could go wrong: next-generation cyberattacks and data breaches, fraud, natural disasters and the economic shocks of inflation and interest rate changes. These critical issues all require careful board oversight of risk mitigation strategies.

But what about external, customer-driven disruptions? Customers now expect seamless digital banking services and omnichannel experiences. New fintech competitors are capable of providing these amenities and are grabbing market share from traditional banks. Many traditional banks aren’t keeping up. An eye-opening 95% of bank executives “believe their current outdated legacy systems and technological capabilities are unable to fully optimize their data for customer-centric growth strategies,” according to the World Retail Banking Report 2022.

These are existential challenges and they demand the same level of attention from the board as, say, cybersecurity. Bank boards should ask themselves: How can we remain relevant in this rapidly changing landscape?

Redefining Operational Resilience
As they wrestle with new challenges and demands, many board members are opening up to a new mindset and approach to operational resilience. Today, becoming an adaptable, resilient bank requires two intertwined, customer-focused objectives:

  • Remaining relevant to customers by offering new services and conveniences.
  • Maintaining customer trust by protecting their data and money and executing transactions securely.

This balanced approach means that operational resilience can be more broadly defined as a company’s ability to build confidence and trust in its capability to adapt to changing circumstances.

Addressing Operational Resilience
Bank boards — including their audit and risk committees — can incorporate this new approach to operational resilience into their oversight activities starting with these five steps.

1. Add value creation to the board’s mandate and mindset
Boards often focus heavily on oversight of traditional risk management and compliance: protecting value. But they also should take more responsibility for creating value and guiding bank strategies to evolve services and compete with financial services startups. Both activities contribute to increased operational resilience.

2. Embrace a customer-centric point of view
Directors should approach both value protection and value creation from a customer perspective. That means working harder to understand customer needs and consider how any decision might affect customers. During board meetings, this customer focus can shape dialogues and influence the types of questions asked, even with seemingly internally focused topics. Board members also should make every attempt to connect with customers directly — for example, inviting them to board meetings to share their perspectives.

3. Allocate more time on the agenda for operational resilience
Boards rightly prioritize risk management on their meeting agendas, but competitive risks also should be part of those conversations. And risk-focused conversations should be balanced with discussions of strategy and value creation. These topics are essential to operational resilience, which means that board agendas might need to be restructured to allocate sufficient time for each.

4. Evaluate market conditions more frequently
Boards undertaking strategic planning only once a year might not be able to adapt quickly to changing economic conditions and customer needs. A more frequent cadence of market sensing is in order. For example, one bank board performs a quarterly exercise: Directors define the five most important external events that affect the current strategy and discuss any needed adjustments at board meetings.

5. Diversify board representation
Effective, dynamic boards prioritize diversity, equity and inclusion. A more diverse board offers a better understanding of the diverse needs of its customers. Establishing more female and minority representation — as well as generational diversity to include younger demographics — boards can bring fresh, diverse perspectives to discussions on value creation and customer relevance. Board members with varied professional backgrounds, beyond finance, also can enrich strategic discussions.

Disruption Is the New Normal
Over the past several years, banks have faced wave after wave of challenges and disruptions. But imagine that every disruption is a chance to improve the organization. Organizations that can do so embrace disruption, because they know they are resilient and can improve. Moving forward, the bank leaders who adopt an evolved, customer-centric approach to operational resilience — encompassing both risk management and value creation — are most likely to thrive.

3 Common Insurance Gaps at Banks

Banks must take risk management seriously – and part of managing risk is properly insuring property and casualty risk. Below are the three critical, yet commonly overlooked, areas that institutions should be aware of in addressing their property and casualty insurance program.

1. Think Deeply About the Bank’s Entire Risk Profile
Banks are a complicated risk entity without a cookie-cutter insurance blueprint. The bank business model makes banks a natural target for criminal acts, while daily operations leaves the bank exposed to a host of liability claims. We have also recently seen an increase in regulatory scrutiny related to banks, especially banks’ cyber exposure. Another factor working against the bank is the lack of set standards, guidance and/or oversight of their insurance program. These factors combined make banks particularly complicated to insure competently.

It is imperative that banks consider the entirety of their risks in ensuring they have appropriate coverage and limits. Risk factors to consider include ownership structure, recent financial performance, geographic location, loss history, makeup of the board and management, business model and growth projections. When these factors are considered together, a bank can more completely insure its risks as many of the core coverage lines (and policy forms) are unique only to commercial banks.

2. Cyber Exposure Needs to Be Addressed Under Three Separate Policies
When most banks hear cyber insurance, they think of their cyber liability policy. Most carriers consider this computer systems fraud and it is intended to respond to electronic claims when the bank’s funds are lost or stolen. A typical non-bank cyber liability policy will also include a crime component for electronic losses like fraudulent instruction and electronic funds transfer fraud.

However, there are additional coverages specifically available to banks for cyber loss. The second is the bank’s FI Bond. This is a broader policy and can carry much higher limits. Other coverages under the FI Bond include computer systems fraud such as hacker and virus destruction, as well as voice initiated transfer fraud. There is also an option to insure “social engineering” claims through the bond FI policy.

The third policy that may apply in a cyber loss is the bankers professional liability (BPL). If a bank does not carry social engineering on their bond and a customer’s account is hacked through its own system (opposed to the bank’s) the FI bond likely will not cover the customer’s stolen money. A BPL may provide coverage for depositor’s liability in this case.
Bank should make sure that all three of these policies have adequate limits, do not have overlapping coverage, and also do not leave any gaps in coverage.

3. The Areas of Greatest Exposure
Although cyber and D&O are often the first two areas of insurance a bank focuses, we believe more attention should be paid to the bankers professional liability policy. In the most basic sense, BPL covers the bank for losses arising from any service the bank provides to a customer, aside from lending activity. It’s often colloquially called Bankers E&O and is essentially broad form negligence coverage.
Conversely, lender liability is intended to cover that which BPL excludes: wrongful acts arising from a loan or lending activity. It is important that banks have lender liability included within the BPL.

There are two main reasons BPL/lender liability are important:
1. The most frequent claim for banks falls under the BPL/lender liability. In 2021, 51% of bank liability claims fell under BPL or lender liability. Cyber liability and D&O claims constituted 8% and 12% of claims, respectively.
2. Since they are usually insured under the same insuring agreement, they also usually share one limit. A borrower suit that turns into a paid claim would also erode the BPL limit.

Most peer group average BPL and lender liability limits are relatively low; it’s recommended that banks keep their limit at or slightly above average, at a minimum.

Given the complex factors above, how can you know if your bank is protected? Consider the following questions:

  • Are my financial institution and its officers protected from all the types of risk that could hurt us?
  • Do I have a partner I trust to complement my unique business and offer integrated solutions that offer the right amount of coverage?
  • How much time, productivity and fees does it cost the bank to have relationships with multiple brokers and advisors?

Insurance is complex. Threats to the security of your financial organization are ubiquitous. You should have an expert to help you navigate the process and build a tailored solution for your institution.

Current Compliance Priorities in Bank Regulatory Exams

Updated examination practices, published guidance and public statements from federal banking agencies can provide insights for banks into where regulators are likely to focus their efforts in coming months. Of particular focus are safety and soundness concerns and consumer protection compliance priorities.

Safety and Soundness Concerns
Although they are familiar topics to most bank leaders, several safety and soundness matters merit particular attention.

  • Bank Secrecy Act/anti-money laundering (BSA/AML) laws. After the Federal Financial Institutions Examination Council updated its BSA/AML examination manual in 2021, recent subsequent enforcement actions issued by regulators clearly indicate that BSA/AML compliance remains a high supervisory priority. Banks should expect continued pressure to modernize their compliance programs to counteract increasingly sophisticated financial crime and money laundering schemes.
  • In November 2021, banking agencies issued new rules requiring prompt reporting of cyberattacks; compliance was required by May 2022. Regulators also continue to press for multifactor authentication for online account access, increased vigilance against ransomware payments and greater attention to risk management in cloud environments.
  • Third-party risk management. The industry recently completed its first cycle of exams after regulators issued new interagency guidance last fall on how banks should conduct due diligence for fintech relationships. This remains a high supervisory priority, given the widespread use of fintechs as technology providers. Final interagency guidance on third-party risk, expected before the end of 2022, likely will ramp up regulatory activities in this area even further.
  • Commercial real estate loan concentrations. In summer 2022, the Federal Deposit Insurance Corp. observed in its “Supervisory Insights” that CRE asset quality remains high, but it cautioned that shifts in demand and the end of pandemic-related assistance could affect the segment’s performance. Executives should anticipate a continued focus on CRE concentrations in coming exams.

In addition to those perennial concerns, several other current priorities are attracting regulatory scrutiny.

  • Crypto and digital assets. The Federal Reserve, the Office of the Comptroller of the Currency, and the FDIC have each issued requirements that banks notify their primary regulator prior to engaging in any crypto and digital asset-related activities. The agencies have also indicated they plan to issue further coordinated guidance on the rapidly emerging crypto and digital asset sector.
  • Climate-related risk. After the Financial Stability Oversight Council identified climate change as an emerging threat to financial stability in October 2021, banking agencies began developing climate-related risk management standards. The OCC and FDIC have issued draft principles for public comment that would initially apply to banks over $100 billion in assets. All agencies have indicated climate financial risk will remain a supervisory priority.
  • Merger review. In response to congressional pressure and a July 2021 presidential executive order, banking agencies are expected to begin reviewing the regulatory framework governing bank mergers soon.

Consumer Protection Compliance Priorities
Banks can expect the Consumer Financial Protection Bureau (CFPB) to sharpen its focus in several high-profile consumer protection areas.

  • Fair lending and unfair, deceptive, or abusive acts and practices (UDAAP). In March 2022, the CFPB updated its UDAAP exam manual and announced supervisory changes that focus on banks’ decision-making in advertising, pricing, and other activities. Expect further scrutiny — and possible complications if fintech partners resist sharing information that might reveal proprietary underwriting and pricing models.
  • Overdraft fees. Recent public statements suggest the CFPB is intensifying its scrutiny of overdraft and other fees, with an eye toward evaluating whether they might be unlawful. Banks should be prepared for additional CFPB statements, initiatives and monitoring in this area.
  • Community Reinvestment Act (CRA) reform. In May 2022, the Fed, FDIC, and OCC announced a proposed update of CRA regulations, with the goal of expanding access to banking services in underserved communities while updating the 1970s-era rules to reflect today’s mobile and online banking models. For its part, the CFPB has proposed new Section 1071 data collection rules for lenders, with the intention of tracking and improving small businesses’ access to credit.
  • Regulation E issues. A recurring issue in recent examinations involves noncompliance with notification and provisional credit requirements when customers dispute credit or debit card transactions. The Electronic Fund Transfer Act and Regulation E rules are detailed and explicit, so banks would be wise to review their disputed transaction practices carefully to avoid inadvertently falling short.

As regulator priorities continue to evolve, boards and executive teams should monitor developments closely in order to stay informed and respond effectively as new issues arise.

What Directors Think About Diversity, Independence and Credible Challenge

Building a diverse board —as defined by gender, race and ethnicity — is a controversial issue in many corporate boardrooms today, banks included. An increasing number of large institutional investors and stock exchanges like the Nasdaq Stock Market are pushing for it, and a small but growing number of states either mandate it or are instituting disclosure requirements.

But not everyone is convinced that greater diversity inherently leads to better governance, as illustrated by results of Bank Director’s 2021 Governance Best Practices Survey. Fifty-nine percent of the respondents agreed that diversity as defined by race, gender and ethnicity improves the performance of a corporate board. However, 36% agreed with statement but said the impact was overrated, and 5% disagreed that greater diversity improves performance.

James J. McAlpin Jr., a partner at Bryan Cave Leighton Paisner LLP and leader of the firm’s banking practice group, is a strong proponent of board room diversity. “I have experienced the power of diversity on a bank board of which I am a member,” he says. “We have gone from a board of eight men and one woman three years ago to now a majority female board. There is a difference resulting from that positive transformation. Our board is probably more risk averse that it used to be. We seem to be better prepared as a group for meetings. And as a group we ask more probing questions.”

Sponsored by Bryan Cave, the survey polled 217 directors and chief executives at banks under $50 billion in assets in February and March of 2021. The majority of the respondents were independent board members. Almost half of the participants represented banks with $1 billion to $10 billion in assets.

Diversity is just one of many issues covered in this year’s survey. The list includes the practice of credible challenge, the desire for collegiality versus the freedom to disagree, board assessments, the board’s role in strategic planning and CEO performance evaluations. The survey results have been divided into five modules: board practices, the board/management relationship, strategic planning, board refreshment and diversity, and the role of the independent director.

The white paper also includes the insights of two experienced directors who helped us interpret the results: David. L. Porteous, the lead director at Huntington Bancshares, a $175 billion asset bank headquartered in Columbus, Ohio; and C. Dallas Kayser, the independent chair at City Holding Co., a $5.9 billion bank located in Charleston, West Virginia.

Ninety-nine percent of the survey respondents said that personal integrity was the most important attribute of an independent director, followed by the ability to exercise sound judgment at 96% and accountability at 94%.

“Regardless the size of the bank, the role of the independent director is pretty much the same,” says Porteous, who has served on the Huntington board since 2003, and as lead director since 2007. “There has to be a level of commitment, and that commitment has to be to your fellow directors. It has to be to the leadership of the organization, it has to be to the shareholders, to the community and to the regulators. If there comes a time when you just can’t dedicate that level of commitment, you should probably step down.”

To read more about these critical board issues, read the white paper.

To view the full results of the survey, click here.

Cast a Wider Net for Your Next Director

Few factors determine a corporate board’s effectiveness more than its composition, and yet many banks take a slapdash approach to the recruitment of new directors.

Even really good banks are guilty of this. When I asked the independent chairman of a bank that regularly scores well on our annual Bank Performance Scorecard, a performance ranking of the 300 largest publicly owned banks in the country, what his board’s process was for recruiting new directors, he said it really didn’t have one. The board had recruited two new directors recently, including one who was added following an acquisition, but the chairman didn’t want to hold up his board as a model for director refreshment.

Part of the problem is that director succession is not taken seriously enough at many banks, so when a vacancy does occur the board doesn’t have a tested process in place. That sets off a “who do we know” scramble that is reactive rather than proactive.

“Historically, the way most community banks have found directors is through the CEO and possibly through some directors, and it’s in a personal context,” says James J. McAlpin Jr., an Atlanta-based partner at Bryan Cave Leighton Paisner and head of the firm’s banking practice. “It’s people in the community who are known to the CEO or key board members and who seem to be qualified to serve on the board, have an interest in serving on the board. What I see changing — not dramatically, but gradually — is a sense, particularly for [small community banks] that want to become larger, that they need to go outside of their circle of friends to find individuals with skillsets that are needed or attributes that are needed.”

I think an emerging best practice for bank boards is to perform a periodic board needs assessment to determine whether the skills and experience of the bank’s current directors supports its strategic plan, particularly if that plan calls for major changes like expansion into new lending categories or geographies, or a decision to go public. This assessment essentially summarizes the skills and experience of all your directors, grouping them into categories. Smaller banks often find that they are overweighted in certain categories – CPAs and attorneys come to mind – while underweighted in categories like technology, and female and minority directors.

“It’s really a process of who can bring either expertise or business to the bank,” says Donald Musso, president of FinPro, a consulting firm in Gladstone, New Jersey, that often handles director searches for its bank clients. “And I think it’s a combination of the two that we’re seeing people look for.”

Musso cites the example of a client bank in northern New Hampshire. “This organization has been very rural, and two or three of the board members are now living in Florida, and they’ve come to the conclusion that they can’t make it work,” he says. “[These directors] can’t come up in the middle of winter for meetings, and they can’t do the meetings digitally because it’s not the same.” FinPro put together a strategic plan for the bank that calls for it to expand into new markets south of its current location, and Musso will search for new directors in those markets who can not only replace the Florida-based members but help the bank with business development. “We’re looking for people who are really well connected in those marketplaces, who can introduce us to the right business owners and the right political leaders to get quickly accepted,” Musso explains. “We know that folks from northern New Hampshire don’t have any contacts down there.”

Once you know the kind of director you want to fill a vacancy or expand the board, how do you find them? McAlpin says that board chairs (or whoever that task has been delegated to, like the governance committee) often reach out to trusted advisors for suggestions and referrals. “They’ll talk to their attorneys, their accountants, bank consultants they may know … and other bankers,” he says.

McAlpin also suggests that boards actively research their communities for good director candidates. If the chief executive officer or board chair only recruit from within their personal universe of known people, they are by definition restricting the pool of likely candidates.

“What I’ve suggested to people is if you really are looking for skill sets, mount some kind of proactive search within your market,” says McAlpin. “Have someone at the bank do some research on who’s heading up the local manufacturing plant for an automotive manufacturer. Is that a woman? Is that an African American? Who are the people making a splash in the community? So, it’s still word of mouth, but it’s a wider circle of word of mouth. That’s how I’m seeing it work.”

Musso tries to cast a wide net when fishing for board candidates. He agrees with McAlpin that boards should thoroughly research their communities when conducting their own director search. “We don’t use a search firm; we call folks directly,” he says. “So we can look up female CPAs pretty quickly. We can get lists of minority-owned businesses pretty quickly. A lot of that stuff is readily available data from Dun & Bradstreet and other sources.” Musso has found that local accounting firms that handle audits for area businesses are another good referral source. “They’ve been a huge, huge help in finding people and bringing names to the table,” he says.

And when he conducts a search, Musso is often looking for someone who can help the bank accomplish a strategic objective. “We’re constantly seeking spheres of influence,” he explains. “We want to know who is most connected to a given strategic thrust we have in the bank. That’s the ideal person. When we find them, we want to get them on the board as quickly as we can.”

Other recruiting suggestions include financial technology companies, which Musso says offer a pool of potential director candidates who can help banks manage the digital transformation process, as well as former directors who left their boards after their banks were acquired. And while they generally have a different mission, people serving on nonprofit boards are another pool of potential candidates.

These recruiting tips all tend to be reactive in nature; they are things you can do after a vacancy opens up on your board. A more proactive approach would be to establish an advisory board of local business and community leaders to not only advise the bank on important issues, but also to scout them as possible directors for the bank board.

“Particularly if your bank is in multiple geographic locations, just set up some advisory boards,” McAlpin says. “You get local business people together and buy them lunch or dinner. They get the opportunity to interact with each other, and they can talk about their business, and then you learn from them about what it is they think is important to the bank or what the bank can be doing for the community. You also get the opportunity to assess these people in terms of potential future board members.”

While smaller community banks often do their own board recruiting, larger banks often retain an experienced search firm to help them fill board vacancies. “When we’re engaged by a board to conduct a director search, they often are … engaging us to go out and find a very specific level of expertise,” says J. Scott Petty, a Dallas-based partner who leads the financial services practice at the executive recruiting firm Chartwell Partners.  “Or they’re looking for somebody that’s both bringing the expertise we’re looking for and diversity.”

The process from that point on is pretty straightforward, Petty says. He will develop a “position description” based on what the bank is looking for in a prospective candidate. “In that position description, it would be a description of the bank; it would be a description of the qualifications of the background that we’re looking for. And it would also outline if they’re a public bank and their meeting dates for the board.”

Petty says that at the beginning of any engagement, it’s important that he and the board get to know each other. “We would get together face to face to talk about their need and through that process, they would need to get comfortable with me as their ambassador in the marketplace doing the recruiting,” he says. “And that comes by just getting to know me professionally, understanding the experience that I bring to the table, understanding some of the assignments that we’ve worked on before where we’ve had success and then getting to know me a bit personally. Again, they’d have to get comfortable with me representing them and that I understand their culture. And in that process, they would need to see how I feed back the information that I’m receiving from them to give them comfort that I’m the best person to go out and execute this process for them.”

Boardroom on Fire: A Bank Chairman’s Painful Lessons from the Financial Crisis

chairman-4-9-19.png“A sheriff’s car pulls up—the bank is on lockdown.” David Butler wistfully recalls that day in 2009; the day he lost everything.

“It was pretty traumatic,” he admits. “You have to ask tough questions. Can we survive it? What do we do? What’s our exit strategy?”

The events that transpired that fateful Friday afternoon send shivers down the spines of every bank director—the worst case scenario. No, not a robbery. The other worst case scenario.

“The FDIC comes in. They lock the doors and secure all our records before anyone’s allowed to go home.”

Butler was a founding board member of Western Community Bank. Western was big, state-chartered and publicly-traded. In 2007, they acquired a chain of banks with a sizable chunk of money tied up in Florida real estate. It was a ticking time bomb—and, spoiler alert: it was about to go off.

The early fallout of the housing market crash saw Western hemorrhaging $6 million a quarter, making Butler’s board an easy target for regulators.

“The FDIC wanted litigation wherever they could get it; half the time, even where they couldn’t,” he groans. “The public wanted heads to roll and we made perfect targets.”

Western had a clean public shell; no run-ins with the SEC—they were squeaky clean. But as the recession raged on, it became clear that “clean” didn’t cut it. “People were investigated, detained even, based on what? The suspicion of malfeasance? Yet we saw banks engaging in improper, verging on illegal activity walk away scot-free.”

This federal fishing expedition left Butler with a lingering paranoia; the fear that an army of pencil pushers sporting black suits and earpieces might knock on his door to have their Mission Impossible moment at his expense.

One month into 2009, Western’s shares plunged 95 percent. The finger of blame inevitably found a target. “Our CEO was a great guy, but the recession hit him like headlights on a deer,” Butler laments. “We asked him to resign. It was one of the most painful things I’d ever done.” The resulting shuffle in leadership landed David in the role of acting chairman.

“My job primarily became keeping morale up as we scrambled to find a partner,” he recounts. “We didn’t want depositors losing money, but we didn’t want to lose depositors. If they’ve got half a million in the bank, telling them to move it is hard, but it’s the right thing to do.”

Depositors weren’t the only people Western risked losing. The FDIC shot down attempts to offer retention bonuses, leaving Butler at the mercy of employees’ goodwill. “How do you ask someone not to jump ship when they’re waist-deep in water?”

As Butler fought to keep all hands on deck, Western’s board was rocking from the turbulence of days spent sparring over the bank’s balance sheet and late-night conference calls consumed by quarrels over how and where they would stretch its tier one capital.

“You can’t measure the character of your board until it’s been strained.”

“We had our share of those who didn’t stay the course,” he concedes. “Some resigned; some pointed blame—but then there were the ones who stuck it out. Even when it looked hopeless; even when tensions ran high, their commitment never wavered. I hold those people in the highest regard to this day.”

It was an act of bittersweet mercy when, in May 2009, the other shoe finally dropped.

A cease-and-desist order earlier in the year saddled Western’s board with a bureaucratic obstacle course of audits, reorgs, policy rewrites and loan appraisals; with no less than 15 deadlined reports to the state banking commission. One of the many hoops the board was forced to throw itself through required a reevaluation of Western’s loan loss reserves; an amount they determined to be $33 million. Butler was called to meet with the FDIC shortly thereafter.

“They sat me down and told me we needed $47 million,” he says. “I told them they were about to close my bank. We all sat there silently for a minute.”

Three months later, the state banking commission seized control of Western Community Bank, just $2 million shy of meeting its reserve requirement. The bank was turned over to the FDIC and sold to a local competitor for pennies on the dollar.

Where was Butler—the man who risked it all—that Friday afternoon when they came to take it all away?

“Our legal counsel advised us to stay away from the transition to avoid any situation where we might be questioned without an attorney present,” he explains. “So my wife packed a picnic basket and we drove to the beach.”

What about the anger, the resentment, the righteous indignation at the hopelessness of it all? “There was plenty of that to go around,” he admits. “The fact that we could fail was all they needed to treat us like we would. But you reach a certain age where you don’t have time to be angry. There’s no use holding onto all that bitterness.”

A decade has passed since that Friday afternoon when Butler lost it all. Murmurs of a looming recession seep from the rich vein of alarmist gossip to circulate amongst those with a finger on the pulse. “If those kind of whispers reach your ears, it means you’ve kept one to the ground,” Butler posits. “If you’re a bank director, you’ve got a choice. You can pick that ear up off the ground and look towards the future. Or,” he adds with a grin, “you can bury the rest of your head.”

Assessing a Bank’s Culture Is Hard. Here’s One Way To Do It.

culture-6-28-18.pngIf the members of Wells Fargo’s board of directors had spent time a few years ago reading through comments on job review websites, where current and former employees post reviews of their employers, the bank might have been able to avoid its current predicament.

The phrase “sales goals” shows up in 1,253 reviews on, a popular website used by job seekers. And hundreds of those reviews were posted before Wells Fargo’s management identified sales practices as a “noteworthy risk” to the board in February 2014.

Here’s a teller in 2008:

At least on the retail side of the company, the pressure of getting sales is too high…leading to unethical selling practices which are not corrected.

Here’s a branch manager in 2009:

I saw other stores exceeding [sales goals] by 150 percent or more and initially wanted to learn from those stores . . . What I found was that they had thrown all ethics out the door. I was shocked and appalled . . . So, naturally, I alerted my manager. I reported blatant cheating to the ethics line. I alerted human resources. Nothing happened to the officers except promotions!

Here’s a personal banker in 2013:

Unethical behavior, very high sales goals, things are not done with customers’ best interests [in mind].
It isn’t easy for a bank’s directors to gauge its culture, but the fallout from Wells Fargo’s sales scandal shows how important it is to do so.

“Good news tends to travel up much more quickly” than bad news, said Elizabeth “Betsy” Duke, the chairwoman of Wells Fargo, at a recent conference on governance and culture reform hosted by the Federal Reserve Bank of New York.

One way directors can assess culture is to visit business units and attend corporate functions. “Such dip-sticking appraisal does not require detailed understanding of technology or process, but an outside board member’s opinion on the behavioral atmosphere and tone at the front line or in the engine room could be critical input,” said Sir David Walker, former chairman of Barclays plc, in his concluding remarks at the conference.

Another way is to use websites like Glassdoor. Had the directors of Wells Fargo done so, they would have known long before February 2014 that the bank’s sales practices were a noteworthy risk.

A board should also monitor job review websites because the reviews on them reflect the bank’s reputation and impact its ability to attract talent. Job seekers use these websites in the same way that diners use to choose a restaurant and apartment seekers use websites like to find a place to live.

This is especially important right now. With an unemployment rate below 4 percent, good workers are hard to come by, and the ones that are willing to switch jobs are demanding higher salaries.

We captured the challenge of a competitive labor market in our 2018 Compensation Survey, done in collaboration with Compensation Advisors, a member of Meyer-Chatfield Group, which will be published in the third-quarter issue of Bank Director magazine.

“It’s a tight labor market, and the expense to hire and retain talent is going up,” said Flynt Gallagher, president of Compensation Advisors.

A good score on job review websites helps combat this. A study published by Glassdoor in 2017 found that people who read positive reviews about a company were more eager to apply to it and recommend it to friends than they would have been if they read negative reviews.

The study also found that people are willing to accept smaller salary increases to switch jobs if they are recruited by a company with a high employee approval score relative to a company with a low score. “This is consistent with economic theory, which predicts that people will accept lower salaries in exchange for a good workplace environment or other positive features of a job,” noted the study’s authors.

It’s worth pointing out, too, that participants in the study found online reviews to be more credible than human resource awards—“The Best Place to Work in Chicago in 2018,” for example—which are often publicized by companies to attract talent.

These findings underscore the value of monitoring websites that include reviews of the company’s internal work environment. A bank’s human resources department does it, and so should its board. If Wells Fargo’s directors had done so prior to 2014, its reputation might not have since suffered so much.

Who Wants to Be a Bank Director?

governance-9-22-17.pngThe Wall Street Journal recently ran a column under the headline, “Why Would Anyone Sane Be a Bank Director?” It was written by Thomas P. Vartanian, a partner at the law firm Dechert LLP and a former general counsel of the old Federal Home Loan Bank Board, a former thrift regulatory agency that was superseded by the Office of Thrift Supervision. Vartanian pointed out that after every financial crisis over the last four decades, Congress and the bank regulatory agencies have piled a new layer of regulation on the banking industry, which has given bank directors an increasingly difficult governance task, while also raising their legal liability. I found little to argue with in that statement, and in fact, the increasing regulatory burden was the subject of a Bank Director magazine cover story in the second quarter 2016 issue.

So, to his question, why would anyone want to be a bank director? Certainly, it’s a challenging job which rarely offers a level of compensation commensurate with the time demands and liability risk. And operating in a thicket of regulations isn’t the only problem facing bank directors today. Emerging threats like cybersecurity, a challenging interest rate environment and the impact that digital commerce and fintech disruptors from outside the industry is having on the traditional bank business model are also bedeviling bank boards today. I think many bank directors serve because they are interested in banking and still see prestige in such an appointment, and because it provides an opportunity to give something back to their community.

On September 25-26, Bank Director will host the 2017 Bank Board Training Forum at the Ritz-Carlton Buckhead, in the northern edge of Atlanta. This will be the fourth year for this event (the first two years were in our hometown of Nashville, and last year we were in Chicago), and it is designed to provide bank directors with a broad perspective on many of the issues that bank boards must deal with today, including risk, compensation, governance and technology.

In his article, Vartanian pointed to a recent proposal made by the Federal Reserve Board that, among other things, would provide updated guidance on the supervisory expectations for the boards of banks and thrifts. The Fed would more clearly define the roles of the board and ensure that most supervisory findings make their way to the right hands—management teams, rather than the board. For supervisory purposes, boards of bank and thrift holding companies with more than $50 billion in assets would have several responsibilities. Here they are:

  • Set clear, aligned and consistent direction regarding the firm’s strategy and risk tolerance.
  • Actively manage information flow and board discussions.
  • Hold senior management accountable.
  • Support the independence and stature of independent risk management and internal audit.
  • Maintain a capable board composition and governance structure.

To me, those are principles of good corporate governance in a banking context that every board should internalize as their modus operandi. And it’s the kind of governance that the Bank Board Training Forum was designed to support.

The Bank Director of the Future: Diversity of Experiences and Skill Sets Matter

bank-director-2-22-17.pngWhile the requirements needed in a bank leader today continue to evolve, the same can also be said for bank directors. Boards of directors today are under more scrutiny than ever before, whether from governance advisors, shareholders, Wall Street analysts, activist investors, community leaders and customers. Even mutuals and privately held institutions face more visible scrutiny around corporate governance from their regulators and key constituents. Serving as a bank director today may still have a certain amount of prestige (depending on whom you ask), but the expectations for director performance and engagement have never been higher.

Community banks in particular tend to have long tenured board members—in many cases with decades of service. Continuity can be a good thing, provided the director skill sets continue to be relevant and the board does not become too close to the CEO, compromising objectivity. However, many bank boards have begun to focus more on the “collective skills” represented around the board table, and have started to emphasize a skill-based approach in making director retention and recruiting decisions.

There are certain skills sets which nearly every bank board likely needs more of; first and foremost in technology. So-called cyber or digital skills are paramount in today’s industry, from both risk and growth perspectives. Likewise, we often see high demand for new board members to serve as qualified financial experts—particularly in public companies—and for directors who bring risk management, strategic planning, marketing/branding, human capital or prior CEO experience to the board table. Depending on the ownership structure, many publicly traded banks are also interested in directors with prior exposure to best practices in public company governance.

However, the real place for improvement in the boardroom is often around how the board behaves. Research from numerous sources validates that how a board operates is the most critical factor of whether a board is a truly valuable strategic asset for the company. Director willingness to discuss the truly vital issues—such as strategy, CEO and board succession, transactions and risk—in an open and candid manner is an important ingredient for institutional success. CEO succession in particular can be an Achilles heel for banks if they are unwilling to deal with the elephant in the room.

One of the other weaknesses in the boardroom involves the underperforming director. According to audit and consulting firm PwC, 35 percent of directors think someone on their board should be replaced. Yet the percentage of community banks conducting peer reviews (compiled by an objective third-party to maintain confidentiality) remains low. In addition, PwC research also suggests that 25 percent of directors come to board meetings unprepared. If we truly believe in building a strategic-asset board as governance best practices would suggest, then boards have an obligation to raise their game and make some tough decisions. A board seat is a rare and precious thing, and not having every director contribute in a currently meaningful way reduces board effectiveness considerably.

The single biggest determinant in board effectiveness is the board’s willingness to address these tough topics head-on, and to do so in a non-personal, collaborative and open manner. Boards that cannot handle straight-talk, or dodge the big issues around director or CEO succession, often prove less effective, in part because they are presenting a status-quo message rather than a forward-thinking viewpoint. Fostering a boardroom culture which enables robust discussions from divergent viewpoints, in order to arrive at the best decisions, remains critical. And, while boards have had to increase their focus on checks and balances in this regulatory climate, it is important to maintain some focus on looking through the windshield and not just the rear-view mirror as well.

Lastly, diversity around the board table has become a front burner issue. Many governance experts tout a diversity of thought, perspectives and experiences as critical in order for the board to make the wisest decisions. Yet in order to garner those wider viewpoints, it is usually necessary to move beyond the classic board which still often remains stale, pale and male. Boards will need to become proactive in seeking a more diverse group around the board table, and will likely need to broaden how and from where as they think about sourcing new potential directors.

In summary, the new bank director today needs to be a subject matter expert in an important area, but also a collaborative, communicative, engaged partner in the boardroom. The more willing a board is to tackle the toughest business issues, and encourage and respect divergent views around the table, the more likely the bank will continue to be successful.