What Today’s Bank Boards Are Worried About

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Unknown regulatory impact, slow economic recovery and increased risk of liability have created a tough environment for even the most skilled director of a financial institution to navigate. This year’s Bank Chairman/CEO Peer Exchange hosted by Bank Director in Chicago this past week provided an opportunity for today’s banking leaders to gather for candid discussions on topics ranging from risk oversight to managing the CEO-board relationship.

Over the course of a day and a half attendees representing banks of all asset sizes from across the country met in small peer groups to challenge and support each other on the top issues keeping them up at night. The results of those sessions formulated a theme throughout the event that reflected the need for more skilled management, risk management processes, and a solid strategic plan.

Strong Management & Stronger Boards
During his industry overview presentation, John Duffy, Chairman & CEO of Keefe, Bruyette & Woods Inc., reminded the audience that the cause of many bank failures could be traced back to a dominant CEO and a compliant board, a correlation not lost on the majority of attendees as they shared their desires to cultivate a strong leadership team and board of directors.

With so many new regulations, directors fear that their management team doesn’t have the right skills, talent or vision to take their institutions through the fire. Where there is a lack of strong leadership, board members are struggling to find the discipline to ask the tough questions. As a fundamental role of the board, attendees expressed the need for processes and shared best practices for dealing with these sensitive personnel issues.

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The Risks of Risk Management
In a peer exchange summary session, Paul Aguggia, partner of Kilpatrick Townsend & Stockton LLP, noted that many bank leaders are not insensitive to the importance of risk management. They have embraced the need to implement processes and procedures to better manage their institutions’ risks; however several have expressed frustration with the lack of industry standard ERM best practices and instead have found themselves slaves to ratios and quantitative driven requirements. Boards are looking for direction from the government and finding none that emphasize process rather than a list of common risks.

In addition, bank executives are trying to determine the role of a risk manager, what qualities they should look for in a candidate and whom that person reports to in the organization. With the regulatory and fraud risk top of mind for today’s directors, many community bankers are still worried that they won’t be able to compete in a marketplace impacted from this latest round of rigorous regulations.

Prove You Planned It
Financial institutions are not going to be as profitable as they once were, and as a result, their approach to business is going to have to change, noted Jim McAlpin, partner for Bryan Cave. A solid strategic plan is not only something today’s bank boards are reevaluating; regulators are, too. Today’s examiners are spending more time looking at strategic planning to determine what that institution will be doing over the next five years. Bert Otto, deputy comptroller, central district for the Office of the Comptroller of the Currency asked the group to look at their strengths, focus on what they do best, perform the proper due diligence, and document that plan thoroughly.

We’ve been through this before: Corporate governance ratings don’t work

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Following the S&L crisis twenty years ago, a number of banking trade organizations, usually in association with a directors and officers liability (D&O) insurance company, trotted out the idea that directors should be accredited. Banks were told that if they sent their boards to special programs on corporate governance, the directors would be accredited and this would save the bank money on D&O policies. The organizations then offered the accreditation programs and made money on them. And if the D&O was placed with the preferred insurance company, the association made a finder’s fee.

However, D&O insurance is a hand written policy, so a discount on your policy is not transparent. It is like getting a discount on a house or a used car. In a negotiated process, how would you be able to tell what kind of discount you actually got?

D&O prices are determined by an underwriter who tries to anticipate how likely it is that you or your bank will be sued. If your bank recently merged, had its CAMELS rating take a beating or saw an ugly drop in the value of its shares, the underwriter either will not write it or charge a great deal of money to cover you. The board’s accreditation won’t affect the price.

The accreditation and corporate governance rating concept was recycled right after Sarbanes Oxley passed in 2002 when Institutional Shareholder Services (ISS, which is now part of MSCI) created a corporate governance rating for publicly traded companies.  ISS then asked the same companies to pay them a consulting fee through its RiskMetrics brand to figure out how to improve their corporate governance. Since ISS voted a great number of shares for institutional investors, companies paid more often than they would publicly admit.

MSCI is changing this business model because it failed to have predictive value in the latest crisis. In fact, as reported by the Huffington Post: “Exactly fourteen days before Lehman Brothers Holding[s], Inc. filed for bankruptcy in September 2008, ISS gave Lehman a corporate governance rating of 87.6 percent, meaning that Lehman’s corporate governance in ISS’ view was better than 87.6% of other diversified financial companies. ISS also doled out generous ratings to other ailing financial companies such as Washington Mutual, which was rated by ISS as being ‘better than 44.3% of S&P 500 companies and 95.6% of [b]ank companies’  just weeks before it’s [sic] undoing. And if that was not enough, a few days before AIG scurried to put together an emergency loan, ISS rated AIG as being ‘better than 97.9% of S&P 500 companies and 99.2% of [i]nsurance companies.’”

Our partner Bill Seidman used to say: “When the tide goes out you get to see who was swimming without their shorts on.” The tide went out and corporate governance ratings took a beating.

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There is a big difference between accreditation and education. Educated boards are stronger boards.

Right now, if I were serving on a bank board I would be drilling into the issues that really affect the health of the bank. I would be asking about our strategic plan around the coming wave of M&A and if we had a firm idea of what the bank was worth. I’d want to hear what the regulators are saying about our bank and how the Dodd-Frank Act might affect our institution. I would focus on how we pay our people, especially the CEO and the top five key leaders, and how we are developing our bench. I would want to hear about pockets of opportunity for lending and how much we know about our customers. I would attend highly focused programs, talk to my director peers and talk to auditors, lawyers and consultants that work with banks regularly to identify the coming challenges and opportunities. And of course I would read Bank Director. (Yes, that is a plug for our magazine).

I think that a toolbox of information for a board is far better that a one-time, one-size-fits-all accreditation process that focuses on corporate governance in a traditional sense.