Health Check of Governing Documents

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governane-3-23-18.pngLike laws and regulations applicable to financial institutions, corporate governance best practices are not static concepts. Instead, they are constantly evolving based on changes in the law, the regulatory framework and investor relations, among other matters. When was the last time the governing documents of your financial institution were reviewed and updated? The governing documents of many financial institutions were prepared decades ago, and have not evolved to reflect or comply with current laws, regulations, and corporate governance best practices. In fact, in the course of advising financial institutions, we have come across numerous governing documents that were prepared prior to the Great Depression. Although such documents may still be legally effective, operating under them may subject your financial institution and its board of directors to certain legal, regulatory and business risks associated with antiquated governance practices. As such, reviewing and, if necessary, updating your financial institution’s corporate governance documents is not just a matter of good corporate governance but also an exercise in risk mitigation.

Certain common—yet often alarming—issues may arise from the use of outdated governing documents. These include:

  • Indemnification provisions may be inconsistent with and unenforceable under applicable law. Likewise, most governing documents also contain provisions providing for the advancement of expenses to directors and officers in connection with legal actions relating to their service to the financial institution. In addition to legal compliance concerns, these provisions should be carefully drafted to ensure that the financial institution is not required to advance expenses to such officer or director with respect to a lawsuit between such person and the financial institution.
  • Voting procedures may be inconsistent with applicable law and/or best practices. These practices may also be inconsistently defined and conflict with relevant governing documents of a single financial institution.
  • Procedures to prevent or discourage shareholder activism or a hostile takeover of your financial institution could be inadequate.
  • Rights of first refusal or equity purchase rights contained in different, but operative, agreements among shareholders and the financial institution could be inconsistent.
  • Provisions limiting the liability of directors and officers of your financial institution may be inconsistent with and unenforceable under applicable law, or such provisions inadvertently may be more restrictive than permitted under applicable law.
  • Non-competition and non-solicitation provisions contained in various agreements applicable to the same director or executive officer could compete with one another.
  • Shareholder agreements for financial institutions could be structured in a fashion such that the Federal Reserve deems the agreements themselves to qualify as a bank holding company under the Bank Holding Company Act of 1956. For instance, based on guidance previously issued by the Federal Reserve, this unexpected outcome could occur if your financial institution’s shareholder agreement contains a buy-sell provision and is perpetual in term. These are common terms of shareholder agreements designed to protect a financial institution’s Subchapter S election, so bank holding companies that are Subchapter S corporations are being required by the Federal Reserve to amend their shareholder agreements to limit the terms to 25 years. Without such an amendment, the Federal Reserve takes the position that a Subchapter S shareholder agreement, in and of itself, can be deemed a bank holding company.

The board of directors and management team can protect the financial institution from these risks by following a few simple steps to update its governing documents.

  • Locate your governing documents. These could include the financial institution’s articles or certificate of incorporation, bylaws, committee charters, shareholder agreements, buy-sell agreements, corporate governance guidelines or policies, intercompany agreements, and tax sharing agreements.
  • Review and analyze the financial institution’s governing documents to identify any risks or areas for improvement, or areas that could be updated to reflect current laws and to incorporate current best practices.
  • Revise the financial institution’s governing documents to mitigate identified risks, address legal deficiencies and reflect current best practices.
  • Develop a procedure for monitoring changes in applicable laws and best practices that affect the institution, and implement an ongoing process for addressing any such changes in a timely manner.
  • Finally, designate a committee of the board of directors (e.g. the governance committee) or a member of the management team to manage the monitoring procedure established for this purpose.

Although simple, following these steps will help to prevent or mitigate many of the legal, regulatory and business risks that may arise as a result of operating under outdated governing documents and, more importantly, strengthen your financial institution’s corporate governance practices in a manner that better positions the board of directors and management to effectively oversee your financial institution and protect against unwanted shareholder activism.

Five Issues Bank Boards Should Consider Now

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governance-12-18-17.pngThere are a number of significant issues and emerging trends affecting U.S. companies and the economy, both of which are crucial to the health and vibrancy of the financial institutions sector. In this environment, it is imperative that bank executives and board members think about five key issues in evaluating their strategic plans. These are areas in which changes have already taken place or are on the verge of being implemented.

1. Regulatory changes
Financial institutions face a number of regulatory and accounting changes. First, a new rule under the Home Mortgage Disclosure Act requires 48 new or modified data points, which will allow regulators to determine if unfair lending practices are occurring. The new rules promise to be expensive to implement.

Institutions growing via acquisition should consider how adoption of the CECL model will affect accounting for loans, securities and other affected instruments at the target institution. And the new standard for revenue recognition issued jointly by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) could prove more challenging than many institutions realize.

2. Tax reform
Banks have expanded to new markets to generate loan growth in response to a challenging rate environment. However, many have not considered the state and local tax liabilities for loans originated outside of their physical footprint. To date, certain states have not rigorously enforced compliance, but banks could be on the radar as cash-strapped state and local governments face revenue shortfalls.

If Congress passes a tax reform bill that lowers the corporate tax rate, institutions in a net deferred tax asset position will need to realize the adverse effect that the new rate would have on the value of its assets. The impairment of the value of the deferred tax asset would need to be recognized upon the effective date of the tax change, resulting in a corresponding decrease in regulatory capital. Institutions may consider increasing their deferred tax liabilities as part of their year-end tax planning process to minimize the impact of any rate decrease on the value of the deferred asset. Further, the expected impact should be factored into capital planning. Institutions that have made a subchapter S election should also monitor the outcome of individual tax reform in combination with corporate tax reform to determine if the subchapter S election remains the most tax-efficient model for operations.

3. Data management
Financial technology firms capture the same consumer data that community banks do, but typically are more effective in their ability to leverage and capitalize on it. Large banks are harnessing this data as well, but smaller banks may not have the resources to make the effort profitable. The data may be residing in multiple systems, or it may be inaccurate or outdated. But the ability to efficiently capture and leverage data will fundamentally change how banks go to market and drive profitability. Banks that want to capitalize on the consumer data they already have will need to make a strategic decision to imitate fintech companies or partner with them.

In addition, regulators are increasing reporting requirements for institutions as a way to conduct efficient, ongoing monitoring, which is fundamentally changing the way regulatory exams are conducted. Institutions that can leverage data for risk management purposes will see better regulatory outcomes and improved profitability.

Cybersecurity remains an immediate threat, and regulatory scrutiny in this area has ramped up accordingly. Banks need to have an effective data security plan in place to deal with the threats that come with gathering so much information.

4. Labor and workforce
A lack of qualified workers may constrain growth, service and innovation if not addressed from a strategic perspective. It has become particularly difficult to find qualified and well-trained credit analysts and compliance officers in a tight labor market. Given most community and regional banks’ focus on commercial real estate lending, the projected shortage of qualified appraisers presents a significant challenge. Banks in smaller markets are particularly challenged in attracting and retaining talent, but they can partially or completely outsource many responsibilities, such as those in information technology, asset liability management and regulatory compliance. A thoughtful approach to outsourcing can assist in maintaining core activities while allowing internal resources to focus on strategic activities.

5. Changing consumer preferences
As customers move to digital channels, acquiring new customers—and increasing wallet share of existing customers—should be top areas of strategic focus throughout 2018. Boomers are shifting from accumulating wealth to maintaining and preserving it, and as a group they prefer a mix of in-person and digital interactions. In an effort to retain these customers, many banks are modernizing branches into sleek, welcoming locations with a number of amenities and educating this demographic on the ability to leverage digital channels in a secure manner, while also responding to the digital demands of younger consumers.

Banks need to find the balance between the digital and the personal, and be agile enough to respond to these changing preferences.

Improving Governance By Using Board Portals

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board-portal-12-11-17.pngIf you counted the minutes in a day that you save because of technology, it would add up to quite a bit. With so many issues confronting financial boards, adequate time for strategic planning is a valuable commodity, so time is exactly what busy board members of financial institutions need.

Changes in the economy and the financial markets have complicated matters for boards of all sizes. Larger banks and conglomerates are finding it difficult to adapt to increasing regulations. Community banks are finding it harder to compete with larger banks. At the same time, financial institutions are finding it difficult to provide the level of technology that their customers want and need, in addition to other significant strategic issues.

Board portals help directors focus more of their time on strategic decisions. These portals have all of the features that directors need, and ensure that the information they need is available to them wherever they are, while also remaining secure.

Preparing board handbooks manually with paper copies and binders places a huge burden on the board secretary. Every time a board meeting approaches, the secretary spends countless hours copying and collating documents, and filing them into the proper sections of the handbook. Updating a board portal requires some work on the part of board secretaries, but they only have to upload a document one time. And secretaries can limit access to certain documents only to the people who need to view them.

In addition to the time savings, board portals provide material and environmental savings. Financial institutions save the cost of reams of copy paper, other office supplies and the labor to assemble board books. The savings can net banks upwards of $1,100 per board meeting. Board portals are environmentally friendly as well. Banks and credit unions contribute less paper to the landfills, and they expend less electricity to produce it. According to a recent analysis by Diligent, boards of banks and credit unions can save up to $10,000 a year by using a board portal.

Board Portals Provide Mobility and Improve Security
There’s nothing worse than the panic that a director of a bank feels in learning that an important piece of paper is missing from the board book. This could happen easily enough with busy board members who travel often for business and pleasure as they juggle suitcases and briefcases in cars and on airplanes. Board portals let busy directors access their board documents with ease on any electronic device, including laptops, tablets and phones. Directors no longer need to lug heavy board books through busy airports and risk valuable information getting into the wrong hands. Most board portals have a double authentication process with a user ID, password and scrambled PIN code, so even if an electronic device gets lost or stolen, sensitive board information remains safe and secure.

Choosing a Board Portal
While board portals are generally intuitive and user-friendly, some directors who are not adept at technology may find that they have a learning curve. But most board directors adapt quickly with a little training and experimentation.
Board portals for banks are a single tool that stores meeting materials, communications, bylaws, archived documents and more in neatly arranged files. Many of the features that board portals provide are of great use to directors, particularly board rosters, board biographies, electronic surveys, voting history and shared notations. Many portals also have a built-in time tracker, so directors know how much time they are spending on board business. This feature can help boards evaluate whether directors are dedicating enough time to board service to comply with proper governance principles. Once they get used to the tool, board members appreciate the ease of posting news items, linking documents, sharing agenda items and calendars, and using the chat and email features. Premium products may also include offline capability, which is an important feature for many bank board directors.

Look for a board portal product that is easy to use and that has knowledgeable customer service support that is available around the clock. As with most products that consumers buy, less expensive board portals aren’t necessarily the best value. Board directors will spend a significant amount of time on the portal, so it’s best to conduct a thorough review of the features, usability, speed and functionality before investing in a portal. The right board portal will do all that you need it to do and more.

Should the Wells Fargo Board Resign?

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resign-5-5-17.pngWhat’s the minimum percentage of votes a director should get at the company’s annual shareholder meeting?

At San Francisco-based Wells Fargo & Co.’s recent shareholder meeting held April 25 in Ponte Vedra, Florida, nine of the 15 directors won re-election with less than 75 percent of the vote, even though there were no other candidates. Three of them plus the current chairman, Stephen Sanger, won with less than 60 percent of the vote, following last year’s revelation that thousands of employees had sold customers more than 2 million unauthorized accounts over several years to meet aggressive corporate sales goals. Then-CEO John Stumpf lost his job, and as did Carrie Tolstedt, the head of retail banking.

The question now is whether directors will lose their jobs as well. Sanger acknowledged that the vote last month wasn’t exactly a home run for the board.

“Wells Fargo stockholders today have sent the entire board a clear message of dissatisfaction,’’ he wrote in a statement. “Let me assure you that the board has heard the message, and we recognize there is still a great deal of work to do to rebuild the trust of stockholders, customers and employees.”

There was no word on whether Sanger intends to step down soon, but he did tell reporters after the meeting that he and five other directors would retire during the next four years when they reach the board’s mandatory retirement age of 72. Sanger turned 71 in March.

Directors on other bank boards have taken the hint when shareholder votes showed a loss of confidence. Following JPMorgan Chase & Co.’s London whale trading scandal, two directors stepped down in 2013.

Receiving less than 80 percent of the vote in a no-contest election is a pretty clear sign of discontent, says Charles Elson, a professor of finance at the University of Delaware and the director of the John L. Weinberg Center for Corporate Governance. (He also happens to be a Wells Fargo shareholder.) Most directors garner more than 90 percent of shareholder votes, he adds.

Some of Wells Fargo directors could barely get support from half the shareholders. “The vote is significant,’’ Elson says. “It’s probably time to refresh that board.”

The board’s own conduct may have raised further questions about whether members were fit to meet their responsibilities. A report compiled by Shearman & Sterling LLP, a law firm working for the board, said in April that the board wasn’t aware of how many employees had been fired for sales-related practices until 2016.

The Los Angeles Times first reported on the extent of the problem in 2013 in a series of investigative stories. In 2015, the city of Los Angeles filed a lawsuit against Wells Fargo related to the practices. [For more on how “Wells Fargo Bungled Its Cross-Sell Crisis,” see Bank Director’s first quarter magazine.]

“Sales practices were not identified to the board as a noteworthy risk until 2014,’’ the board’s investigation found. “By early 2015, management reported that corrective action was working. Throughout 2015 and 2016, the board was regularly engaged on the issue; however, management reports did not accurately convey the scope of the problem. The board only learned that approximately 5,300 employees had been terminated for sales practices violations through the September 2016 settlements with the Los Angeles City Attorney, the [Office of the Comptroller of the Currency] and the [Consumer Financial Protection Bureau].”

The report blames senior management, such as former CEO John Stumpf, a decentralized organizational structure and a culture of deference to the business units for missed opportunities in handling the problems sooner.

But the report also notes that the board could have handled things differently, by centralizing the risk function sooner than it did, for example. A decentralized risk framework meant the company’s chief risk officer was reduced to cajoling the heads of the different business units for information, each of whom had their own chief risk officers reporting to them. Also, the board could have required more detail from management.

Wells Fargo has lost unquantifiable sums in reputational costs and damage to its brand. It has paid about $185 million in settlements with regulators and recently paid out $142 million in a class action settlement with customers. It still is grappling with the loss of new customer accounts.

At this point, a board refresh—starting with the directors who polled less than 60 percent of the shareholder vote—might be the right signal to send.

Bank Compensation and Wells Fargo: The End of an Era

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compensation-10-21-16.pngOne of the biggest scandals among big banks in years is still unfolding as Bank Director heads into its annual Bank Executive and Board Compensation Conference Oct. 25 to Oct. 26 on Amelia Island, Florida. Wells Fargo & Co. announced last week the immediate retirement of CEO John Stumpf, with Chief Operating Officer Tim Sloan taking on the CEO job, as the board struggled to deal with public outrage over accusations that the bank’s employees had opened more than two million fraudulent accounts on behalf of customers to game aggressive sales goals.

The case raised questions about compensation and governance at the most basic level: What impact did the bank’s incentive package have on employee behavior, if any? What impact did the bank’s sales culture and sales goals have on the behavior of employees? What did the bank’s management know about fraudulent account openings and what did it do to stop it? If management failed to stop the fraudulent activity and benefited financially from it, should compensation be adjusted for those individuals, and if so, by how much?

These are all issues of extreme importance to Wells Fargo’s board, whose independent members are conducting an investigation, but also, to any board. No one wants to have a scandal of this magnitude take place while they serve on a board. If employees are complaining about bad behavior and bad culture, how does your bank handle it? How are you ensuring that complaint patterns from employees and customers are recognized and reported to upper management? Should the board also get these reports? What types of behavior are your incentives and sales goals motivating?

Wells Fargo’s board and now, Tim Sloan, are in the unenviable position of having to change the bank’s consumer banking culture even as they try to assess what went wrong. The pressure is strong to show the public and government officials that it is taking action quickly. Wells Fargo has said that as of Oct. 1, it had ceased all sales goals for branch-level employees and instead will start a new incentive program based on metrics related to customer service and risk management.

Since the sales culture had been very much a part of Wells Fargo’s identity, and higher than average profitability, investors are wondering how this will impact the bank’s financial performance. Keefe, Bruyette & Woods analysts Brian Kleinhanzl and Michael Brown downgraded the stock to market perform and wrote last Friday that “Wells’ management doesn’t know what the consumer bank will look like in the future.”

The stock price has fallen to $45 per share as of Wednesday afternoon from $50 per share at the start of September, before the announcement of a $185 million settlement over the issue with regulators and Los Angeles officials, who had sued the company. Is this the end of an era for Wells Fargo? I think so, as major changes will need to be made.

Community bankers tend to point to scandals like this as a way to differentiate themselves from the big banks. Many of the community banks I know don’t have an aggressive sales culture, let alone sales quotas. It’s also easier to know what’s going on in a small bank than one with more than $1 trillion in assets. Still, many bank boards in the wake of the scandal may be asking questions about their own sales culture, their incentive packages and compliance with company policies and ethical standards. Regulators are certainly asking these types of questions of banks, and I expect this to continue in the wake of the scandal. For more on the topic of culture, and determining your bank’s culture, see Bank Director magazine’s fourth quarter 2015 issue.

When we talk about compensation, we may talk about salaries, stock grants, deferrals and clawbacks. But what we’re really talking about is how to motivate employees to do a good job for the bank. And if you don’t have the culture to match what’s good for the bank and your shareholders, you don’t have much.

Bank Compensation and Governance in the New Era

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governance-9-28-16.pngNew compensation and governance standards are impacting boards of directors in all industries, but even more so in banking, which has more regulatory requirements and is under greater scrutiny. The recent Wells Fargo & Co. $185 million settlement over alleged accounts opened without customer permission illustrates that even the most admired banks with seemingly solid risk management practices can succumb to these challenges. Scrutiny of board oversight, risk management processes and incentive plans will continue to increase.

Recently proposed Dodd-Frank Act incentive compensation rules seek to mandate specific incentive design features that regulators believe will mitigate risk taking. If finalized as proposed, incentive arrangements will require both financial and non-financial measures and be subject to increased controls, documentation, governance and oversight by boards of directors, most notably the compensation committee. Larger banks ($50 billion in assets or greater) will be required to defer compensation over multiple years and include forfeitures, risk adjustments and clawbacks for top executives and other employees defined as “significant risk takers.

Publicly traded banks face additional pressures and scrutiny from shareholders. Shareholder advisory votes on executive pay have influenced pay program designs and practices. Today, there is a greater focus on long-term compensation that aligns executives with shareholder interests. Pay and performance is more rigorously assessed and criticized. Proxy disclosure has shifted from basic compliance with Securities and Exchange (SEC) requirements to a “marketing-based approach” for companies to communicate the rationale and results of their pay programs. Engagement with shareholders also is increasing.

Below are some of the characteristics that will define the board’s role in this new era:

  1. Reinforce Risk Culture: As highlighted by the Wells Fargo situation, everyone from the branch manager to the board of directors needs to embrace a culture of sound risk management practices. Boards need to help reinforce a culture of risk management, monitor compliance and ensure there are consequences for bad risk behavior at all levels of the organization. Whether it calls for termination of employee(s) or clawback/forfeiture of compensation, accountability should be meaningful. Significant compliance failures can put a spotlight on board oversight.
  2. Challenge Status Quo: The recent focus on the age, tenure and diversity of board members reflects a perception of potential entrenchment among boards of directors. The real issue isn’t necessarily age or tenure but rather ensuring board members are willing to challenge the status quo, ask potentially unpopular questions and embrace different perspectives needed to ensure the bank continues to succeed in an increasingly competitive and complex environment. Incorporating this behavior in board evaluations can reinforce acceptance of diverse perspectives.
  3. Proactively Recruit for Future Skills: As banks change their strategies on cyber risk, technology and product innovation, the composition of the board of directors must also evolve. The nominating committee should proactively define the future skills and experience needed on the board and strategically fill board positions (e.g. seek board candidates that meet multiple needs, such as someone with public company and technology expertise). In addition, ongoing board education should be formalized to ensure current members receive up-to-date information on industry trends and regulations.
  4. Embrace Engagement: As their risk oversight role increases, board members can expect to have more discussions with regulators. Public company board members are also becoming more involved in shareholder engagement. For example, lead directors and/or compensation committee chairs are increasingly participating in discussions with shareholders. Boards should discuss the objectives, messages, roles and processes related to these discussions.
  5. Drive Strategy Through Compensation: As banks continue to evolve their strategic plans to respond to the changing competitive landscape, it is equally as important to select incentive measures that reflect and support these goals. The compensation committee should ensure the portfolio of metrics used in the annual and long-term plans communicate to participants, regulators and shareholders how performance is measured and what will be rewarded. Without alignment between goals and strategic plan, the bank could be expending dollars inefficiently and potentially motivating the wrong behaviors.

These are just some of roles for the board in a post-financial crisis era. Use this list to start a dialogue on how your board’s composition, processes and oversight might need to change to adapt to the new environment.

Understanding the Board’s Role in Cybersecurity

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cybersecurity-3-7-16.pngUnfortunately, despite the recent prevalence of cyberattacks and data breaches, many businesses neglect cybersecurity or, if they do pay attention, view cybersecurity as a technical issue for senior management. However commonplace lax oversight of cybersecurity may be in other sectors of the economy, bank directors cannot afford to neglect or delegate responsibility for cybersecurity—bank boards must be actively involved.

Regardless of size, no bank is completely safe from a cyberattack. Every bank should assume that a cyberattack will occur and, when it does, at least one defense will fail. Hackers constantly test cybersecurity defenses, transform their attack methodology, and exploit weaknesses, which, all too often, are the access points used by third-party vendors providing critical services.

Banks are expected to take steps to prevent intrusions, prepare for the possibility of cyberattack, and have processes in place to resume business continuity. Bank examiners look to see if a bank has an integrated system of technology, processes and practices employed to protect networks, computers and data from attack. Bank examiners also look to see whether the board, as the driver of governance controls, is actively involved with senior management in development of a robust approach to cyber risk. Poor cybersecurity measures and lax board oversight can result in a bad IT exam, which, in turn, can negatively affect a bank’s management component rating (even though cybersecurity falls under the IT component). Worse still, a poor cybersecurity review may also negatively affect a bank’s safety and soundness rating.

As with many complex issues facing banks, the board must take steps to ensure that it is well advised regarding technological issues and has a thorough understanding of the bank’s inherent risk environment. A good first step is to make the Federal Financial Institution Examination Council’s (FFIEC) Cybersecurity Assessment Tool a part of the bank’s governance framework. The assessment tool is a two-part repeatable process review that helps banks identify their risks and evaluate cybersecurity maturity. The first part gauges the bank’s inherent risk profile, which identifies risks and threats (both internal and external), corresponding to the activities, services and products offered by the bank. The second part – the cybersecurity Maturity review – tests the maturity of the bank’s cybersecurity program, including board involvement and oversight of that program.

The board is ultimately responsible for cybersecurity, but it is not necessary that each director have a detailed technical understanding of the underpinnings of cybersecurity safeguards. Many boards appoint a board-level IT committee to take the lead on cybersecurity. Regulators expect the IT committee to own primary responsibility for the bank’s IT strategic plan, including making the board comfortable that the IT strategic plan aligns with the bank’s business strategy. As part of that process, the IT committee can incorporate the FFIEC assessment tool into its review and approval of bank IT policies, management of information security systems, training of other board members and bank management, and approval of IT budgets. Most importantly, because the IT committee is responsible for running periodic independent testing to monitor compliance, the assessment tool can be used to aid the IT committee in holding management accountable for identifying, measuring, monitoring and mitigating IT risks. Boards lacking an IT committee must work closely with senior management to tackle all of the tasks normally delegated to the IT committee and may want to consider hiring an outside consultant to advise the board on cybersecurity technologies and best practices.

The regulators have indicated that cybersecurity is going to be a key topic for exams during 2016. Federal regulators have also directed examination staff to incorporate the assessment tool into their review of bank cybersecurity and risk management. While there have been no reported civil money penalties to date related to a bank’s failure to adequately ensure cybersecurity, it is only a matter of time before examiners resort to supervisory and enforcement powers to ensure that banks adequately address cybersecurity risk. Moreover, as the scope of liability for cybersecurity risk grows, banks can be sure that insurance companies, plaintiffs’ attorneys and activist shareholders will scrutinize bank boards’ oversight of cybersecurity.

Proactive integration of the assessment tool into a bank’s governance and risk oversight framework will put the board in a better position to demonstrate satisfactory compliance on these points during an exam, help avoid any downgrade to the institution’s exam rating, and mitigate exposure to the bank and its customers from inevitable cyberattacks.

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

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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.

Strategic Planning for Bank Boards: Proactive Governance in the New Regulatory Environment

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planning.jpgSweeping new regulations and unprecedented scrutiny of the banking industry have combined to place a greater emphasis on the role of boards of directors in the leadership of banks. Although the board’s primary responsibilities have not changed—to maximize shareholder value and to hire, compensate and supervise qualified management—there is now a greater need to address these responsibilities within the context of a well considered strategic plan.

Many bank boards primarily employ a month-to-month approach to the oversight of their institutions, which can result in heavy reliance on bank management to chart the strategic course of the bank. It is valuable for a board occasionally to set time aside to take stock of the bank’s strengths, weaknesses and opportunities, and then proactively engage in a process of determining the strategic goals and direction for the bank. This gives the board a frame of reference within which to measure the performance of the bank going forward, and it will give management a clearer sense of the goals to be pursued and how aggressively to pursue them.

In our experience, directors can be skeptical of the benefits of strategic planning sessions – their enthusiasm dampened by visions of a day spent listening to consultants equipped with PowerPoint decks and sharing the latest buzz words. Too often, such sessions focus on tactical, not true strategic, issues. We recommend that board members be included in preparation for the planning session, in an effort to make the session more relevant to them and to foster a sense of ownership of the process. One approach is to seek input from the directors through short questionnaires in which they can describe their vision for the bank’s future, share their thoughts and analysis regarding the bank’s performance and its strengths and weaknesses, and indicate their preference of strategy for maximizing value to the bank’s shareholders. Such questionnaires are valuable in sharpening the focus of the strategic planning session.

A well crafted strategic plan is only as good as the people who will implement it. Since it involves future plans, the board should consider the depth, quality and enthusiasm of the bank’s senior management team. The question to be asked is do we have the right people to accomplish our goals, and are they in the management roles which are best suited for their skill sets, personalities, and energy levels? The board’s analysis should not be limited to senior management, but should also include the board members themselves. There has never been a more demanding time to be a bank director. Gone are the days when three or four members of a ten-person board can, or should, be expected to fill the gaps created by inattentive or non-involved board members. Good strategic planning will result in goals and objectives for the key people as well as for the organization.

A detailed description of best practices for a strategic planning session is beyond the scope of this brief article, but we have two suggestions for topics to begin the planning session and to lay the foundation for a productive strategic discussion:

  • Orienting the Board to the “New Normal.”  In order to formulate a viable strategic plan, it is helpful for the board members to have an informed appreciation of the overall environment in which the bank is operating. This should include an overview of the developing regulatory environment, a description of how the bank’s local and regional market areas are performing, and a description of how the bank is performing relative to its peers. Consider bringing in a trusted professional to provide this information, as the impact on the board can often be greater from an outside assessment. Providing this baseline information should also lessen the chance that anecdotal or speculative information shared by a board member will take the planning discussion off track. Such a presentation might also include information on the lower expectations for stock price and acquisition multiples in today’s market, which may come as a surprise to some board members.
  • The Threshold Question. The threshold question to be addressed in strategic planning is the board’s general vision for the bank’s future. Does the board think the bank should “buy, sell or hold” in the near to intermediate term? The answer to this threshold question can drive the direction of the discussion, and lead to more fruitful and specific conversation in the planning session. For example, if the board believes the bank should be positioned for sale, management will need to be careful about entering into new long-term contracts or commitments. If, on the other hand, the board believes the institution should position itself as an acquirer, steps will need to be taken to ensure sufficient capital. Care should be taken in this threshold discussion to engage the full board in the conversation. Almost everyone will have an opinion on this topic, and they should be encouraged to share it with the group.

In our experience, there is no magic formula for successful strategic planning. Each bank board is different because it consists of a unique collection of individuals. We suggest that you tailor your board’s strategic planning session to the needs of your bank and the desires of the board. The important part, as in beginning an exercise program, is to take the first step.  Schedule a strategic planning meeting, get input in advance from board members, and make sure you address the most important issues facing your bank. Be proactive in planning for your bank’s future and for securing a worthwhile return for its shareholders.