Creating a Comprehensive ESG Approach, From Compliance to Competitiveness

Not only are investors increasingly incorporating environmental, social and governance, or ESG, factors indecisions about how to allocate their capital, but customers, employees and other stakeholders are also placing greater emphasis on ESG matters.

ESG will also continue to be a focus for regulators, with a particular emphasis on climate-related risks. It has rapidly evolved from a compliance matter to a strategic and competitive consideration; boards of directors and management teams should respond with both short-term action and preparation for the longer term. We review key developments and offer six steps that boards and management can take now to position a bank for the current ESG environment.

SEC’s Approach to Climate Change
The Securities and Exchange Commission has made considerations relating to ESG topics a top priority going forward, especially with respect to climate change-related issues. Chair Gary Gensler has charged SEC staff with developing a rule proposal on mandatory climate risk disclosure by the end of this year. Based on Gensler’s statements , the rulemaking is likely to be distinct from approaches developed by private framework providers and may not necessarily be tailored according to company size, maturity or other similar metrics.

Gensler has emphasized the importance of climate change disclosures generating “consistent and comparable” and “decision-useful” information. These disclosures may be contained in Form 10-K; given the tight timeframes associated with preparation of Form 10-K filings, this approach may require certain registrants to adjust their data collection and verification practices.

Bank Regulators’ Approach to Climate Change
Federal Reserve Chair Jerome Powell has indicated that he supports the Fed playing a role in educating the public about the risks of climate change to help inform elected officials’ policy decisions. The Fed established a Financial Stability Climate Committee to identify, assess and address climate-related risks to financial stability across the financial system, as well as the Supervision Climate Committee to help understand implications of climate change for financial institutions, infrastructure and markets.

The Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. are also taking climate risk seriously. In July, the OCC joined the Network of Central Banks and Supervisors for Greening the Financial System and announced the appointment of Darrin Benhart as its first climate change risk officer. Most recently, Acting Comptroller of the Currency Michael Hsu said the OCC is working with interagency peers to develop effective climate risk management guidance. The FDIC expects financial institutions to consider and address climate risks in their operating environment.

ESG as Competitive Advantage
Many companies have begun integrating ESG considerations into their products and strategies. Some research has shown that ESG can drive consumer preferences, with certain consumer demographics using ESG factors to differentiate among products. Younger demographics, for example, are choosing banks according to ESG credentials. Moreover, ESG considerations are becoming increasingly important to certain employee bases.

ESG issues are also top-of-mind for many investors, driven by prominent institutional investors that are linking a company’s ESG profile with its long-term financial performance and other stakeholders who want to align investments with social values and goals.

Directors and management teams should engage in an honest self-assessment of their bank’s ESG status, including determining which ESG matters are most material to their business. They should establish processes for board-level ESG strategy and oversight, along with clear management authority and reporting lines. They should also strengthen controls around ESG quantitative reporting. Ultimately, management should now consider whether and how to begin integrating ESG into commercial activities and overall strategy. With that in mind, here are six steps that boards and management can take now:

  1. Conduct a self-assessment on ESG matters, including on materiality, performance and controls.
  2. Begin preparations for an imminent SEC rulemaking on mandatory climate change disclosure that could potentially apply to Form 10-Ks in time for the 2022 fiscal year.
  3. Strengthen ESG processes and controls, while allowing flexibility for frequent reevaluation.
  4. Understand the key players in the ESG space and their varied perspectives.
  5. Establish responsibility for maintenance of a core ESG knowledge base and awareness of key developments.
  6. Monitor ESG developments as part of operational and strategic planning.

Bank M&A Survey Results: Technology, Competitive Pressures Drive Deal Activity in 2022

On Oct. 12, banking industry observers awoke to a surprise: Umpqua Holdings Corp. and Columbia Banking System announced their intent to form a $50 billion-plus franchise on the West Coast. Prior to the deal, Umpqua appeared to prioritize its organic growth strategy, Piper Sandler & Co. Managing Director Matthew Clark explained in a note published later that day. Columbia, on the other hand, seemed more interested in smaller deals. 

The combination is the latest transformative, scale-building deal announced in 2021, including M&T Bank Corp. and People’s United Financial, Webster Financial Corp. and Sterling Bancorp, and New York Community Bancorp and Flagstar Bancorp. The rationale of those deals aligns with the M&A drivers identified by senior executives and board members in Bank Director’s 2022 Bank M&A Survey, sponsored by Crowe LLP. When asked about the primary factors that make M&A an important piece of their bank’s growth strategy, more than half seek to achieve scale to invest in technology and other key areas. Further, respondents point to a complementary culture (64%), locations in growing markets (58%) and efficiency gains (56%) when asked to identify the attributes of an effective target.

“This is an exciting combination that brings together two well-respected organizations and talented teams, accelerating our shared strategic objectives to create the leading regional bank headquartered in the West,” said Umpqua CEO Cort O’Haver in a press release. Added scale will allow further investment in technology and expand the bank’s offerings, enhancing its competitive position across “high-growth, attractive markets” in Oregon, Washington, California, Idaho and Nevada. 

In an environment characterized by digital acceleration, high competition for customers and talent, and continued low interest rates, a strategic combination may prove too compelling for some to pass up.

Almost half of survey respondents say their institution is likely to purchase another bank by the end of 2022 — a significant increase compared to the previous year, and more in line with the pre-pandemic environment. Given the usual pace of M&A, it’s unlikely that most of these prospective acquirers will find a willing target. But the same factors that spur acquirers to build scale also propel sellers: 42% of respondents to Bank Director’s 2022 Bank M&A Survey say that an inability to keep pace with the digital evolution could drive their bank to sell.

Key Findings

The Right Price
Price remains a key barrier to deals, as noted by 73% of respondents. The plurality of prospective buyers (43%) indicate they’re willing to pay up to 1.5 times tangible book value for a target. Nineteen percent say they’d pay up to 1.75 times book; 9% would pay more.

Many Open to MOEs
Almost half of respondents say they’d consider a merger of equals or similar strategic combination in today’s environment. Of these, 39% say their board and management team is more likely to consider such a deal compared to before the pandemic — representing a shift in mindset for some bank leaders.

Increased Focus on ESG in M&A
While most banks are unlikely to take a comprehensive view of environmental, social and governance (ESG) issues when examining a potential deal, the majority of banks consider ESG factors when assessing strategic fit. Key among those are cultural alignment (89%), reputational risks and opportunities (73%), employee relationships/engagement (62%) and data security/privacy (51%), which can be classified as social or governance within the ESG umbrella. 

Optimism About the Economy
Almost three-quarters of respondents believe the U.S. economy will experience modest growth in 2022; 14% say it will grow significantly. Further, almost all say that businesses have recovered in their markets, though some sectors remain stressed. And while 88% report that business clients express concerns about supply chain disruptions and labor shortages, most believe that this won’t have a material impact on credit quality. 

Reduced Credit Risk Concerns
Last year’s survey found the top barrier to deals was asset quality; 63% of respondents named it the top concern. This year, just 36% express concerns about asset quality. In addition, fewer express concerns about loan concentrations in commercial real estate, retail or the oil sector.

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

Why ESG Will Include Consumer Metrics

Imagine a local manufacturer, beloved as an employer and a pillar of the community. The company uses 100% renewable energy and carefully manages its supply chain to be environmentally conscious. The manufacturer has a diverse group of employees, upper managers and board. It pays well and provides health benefits. It might be considered a star when it comes to environmental, social and governance (ESG) parameters.

Now imagine news breaks: Its product causes some customers to develop cancer, an outcome the company ignored for years. How did a good corporate citizen not care about this? You could say this was a governance failure. Everyone would agree that it was a trust-busting event for customers.

ESG, at its root, is about looking at the overall impact of a company. The most profound impact of banks is the impact of banking products. Most bank products are built for use in a perfect world with perfect compliance, but perfect compliance is hard for some people. Noncompliance disproportionately affects the most vulnerable customers ⎯ people living paycheck-to-paycheck and managing their money with little margin to spare. That isn’t to say that these individuals are all under or near the poverty line: Fully 18% of people who earn more than $100,000 say they live paycheck to paycheck, according to a survey of 8,000 U.S. workers by global advisory firm Willis Towers Watson. There is growing recognition that bank products need to reflect the realities of more and more Americans.

Years ago, Columbus, Ohio-based Huntington Bancshares started working on better overdraft solutions for customers whose financial lives were far from perfect. Currently, the $123 billion regional bank will not charge for overdrafts under $50 if a customer automatically deposits their paycheck. If the customer overdrafts $50 or more, the bank sends them an alert to correct it within 24 hours.

Likewise, Pittsburgh-based PNC Financial Services Group recently announced a new feature that gives PNC Virtual Wallet customers 24 hours to cure an overdraft without having to pay a fee.  If not corrected, an overdraft amounts to a maximum of $36 per day.

“With this new tool, we’re able to shift away from the industry’s widely used overdraft approach, which we believe is unsustainable,” said William Demchak, chairman and CEO of the $474 billion bank, in a statement. The statement alone reframes what sustainability means for banking.

The banks that become ESG leaders will create products that improve the long-term financial health of their retail and small businesses customers. To do so, some financial institutions are asking their customers to measure their current financial realities in order to provide better solutions.

For example, Credit Human, a $3.2 billion credit union in San Antonio, is putting financial health front and center both in their branches and digitally. Their onboarding process directs individuals to a financial health analysis supported by FinHealthCheck, a data tool that helps banks and credit unions measure the financial health of customers and the potential outcomes of the products they offer. The goal of Credit Human is to improve the financial health of their customers and eventually make it a part of the overall measurement of the product’s performance.

Measurement alone will not build better bank products. But it will provide banks and credit union executives with critical information to align their products with customer well being. With the implementation of overdraft avoidance programs such as PNC’s Low Cash Mode, the bank expects to help its customers avoid approximately $125 million to $150 million in overdraft fees annually. PNC benefits its bottom line by driving more customers to its Virtual Wallet, nabbing merchant fee income and creating customer loyalty in the process. PNC’s move makes it clear that they believe promoting the long-term financial health of their customers promotes the long-term financial health of the company.

Banks need to avoid appearing to care about ESG, while failing to care about customers. The banks that include customer financial health in their ESG measurement will survive, thrive and become the true ESG stars.

ESG: Walk Before You Run

Covid-19 and last year’s protests over racial injustice added to the mounting pressure corporations face to make progress on environmental, social and governance (ESG) issues — but banks may be further ahead than they believe.

“ESG took on a life of its own in 2020,” says Gayle Appelbaum, a partner at the consulting firm McLagan. Institutional investors have slowly turned up the heat on corporate America, along with community groups, proxy firms and ratings agencies, and regulators such as the Securities and Exchange Commission, which now mandates a human capital management disclosure in annual reports. Customers want to know where companies stand. Prospective employees want to know if a company shares their values. And President Joe Biden’s administration promises to focus more on social and environmental issues.

Big banks like Bank of America Corp. and JPMorgan Chase & Co. have been responding to these pressures, but now ESG is trending down through the industry. With the right approach, banks may find that these practices actually improve their operations. However, smaller community and regional banks can’t — and probably shouldn’t — merely copy the ESG practices of their larger brethren. “People have to think about what’s appropriate for their bank, given [its] size and location,” says Appelbaum. “What are they already doing that they could expand and beef up?”

That means banks shouldn’t feel pressured to go big or go home when it comes to ESG. Begin with the basics: Has your bank reduced waste by encouraging paperless statements? How many hours do employees spend volunteering in the community? “When you sit down and talk to bankers about this, it’s interesting to see [their] eyes open,” says Brandon Koeser, senior manager and financial services senior analyst at the consulting firm RSM. The pandemic shed light on how banks support their employees and communities. “The reality is, so much of what they’re doing is part of ESG.”

Robin Ferracone, CEO of the consultancy Farient Advisors, tells companies to think of ESG as a journey, one that keeps strategy at its core. “You need to walk before you run. If you try to bite [it] all off at once, you can get overwhelmed,” she says. Organizations should prioritize what’s important to their strategy and stakeholders. ESG objectives should be monitored, revisited and adjusted along the way.

Stakeholders are watching. Glacier Bancorp CEO Randall Chesler was surprised to learn just how closely in a conversation with one of the bank’s large investors two years ago.

“One of our investors asked us, ‘Have you looked at this? We see your score isn’t very good; are you aware of that? What are you going to do about it?’ And that was the first time that we started to dig into it and realized that we were being scored by ISS,” says Chesler. (Institutional Shareholder Services provides an ESG rating on companies, countries and bonds to inform investors.)

It turned out that $18.5 billion Glacier was doing a lot, particularly around the social and governance aspects of ESG. The Kalispell, Montana-based bank just wasn’t telling its story. This is a common ESG gap for community and regional banks.

Glacier worked with consultants to develop a program and put together a community and social responsibility report, which is available in the investor relations section of its website, along with other governance documents such as its code of ethics. This provided the right level of information to lift Glacier’s score. “Our benchmark was, we want to be at our peer-level scoring on ESG,” says Chesler. “[We] ended up actually better. And we continue to watch our scores.”

“Community banks have the social and governance aspects covered better than many industries because [banks are] heavily regulated,” says Joe Scott, a managing director at Kroll Bond Rating Agency. Where they likely lag, he says, is around the environment; most are just beginning to assess these risks to their business. And it’s important that banks get this right as stakeholders increasingly focus on ESG. “We’re hearing that, beyond equity and debt investors, larger depositors — particularly corporate depositors, institutional depositors, state treasurers’ officers [and] others like that — are incorporating ESG into their considerations on who they place large deposits with. That could be a theme over time— other kinds of stakeholders factoring in ESG more and more.”

A Guide to Getting CEO Transitions Right in 2020 and Beyond

Banks need to get CEO transitions right to provide continuity in leadership and successful execution of key priorities.

As the world evolves, so do the factors that banks must consider when turnover occurs in the CEO role. Here are some key items we’ve come across that bank boards should consider in the event of a CEO transition today.

Identifying a Successor

Banks should prepare for CEO transitions well in advance through ongoing succession planning. Capable successors can come from within or outside of the organization. Whether looking for a new CEO internally or externally, banks need to identify leaders that have the skills to lead the bank now and into the future.

Diversity in leadership:
Considering a diverse slate of candidates is crucial, so that the bank can benefit from different perspectives that come with diversity. This may be challenging in the banking industry, given the current composition of executive teams. The U.S. House Committee on Financial Services published a diversity and inclusion report in 2020 that found that executive teams at large U.S. banks are mostly white and male. CAP found that women only represent 30% of the executive team, on average, at 18 large U.S. banks.

Building a diverse talent pipeline takes time; however, it is critical to effective long-term succession planning. Citigroup recently announced that Jane Fraser, who currently serves as the head of Citi’s consumer bank, would serve as its next CEO, making her the first female CEO of a top 10 U.S. bank. As banks focus more on diversity and inclusion initiatives, we expect this to be a key tenet of succession plans.

Digital expertise:
The banking industry continues to evolve to focus more on digital channels and technology. The Covid-19 pandemic has placed greater emphasis on remote services, which furthered this evolution. As technology becomes more deeply integrated in the banking industry, banks will need to evaluate their strategies and determine how they fit into this new landscape. With increased focus on technology, banks must also keep up with leading cybersecurity practices to provide consumers with the best protection. Succession plans will need to prioritize the skills and foresight required to lead the organization through this digital transformation.

Environmental, Social and Governance (ESG) strategy:
Investors are increasingly focused on the ESG priorities and the potential impact on long-term value creation at banks. One area of focus is human capital management, and the ability to attract and retain the key talent that will help banks be leaders in their markets. CEO succession should consider candidates’ views on these evolving priorities.

Paying the Incoming and Outgoing CEOs

Incoming CEO:
The incoming CEO’s pay is driven by level of experience, whether the CEO was an internal or external hire, the former CEO’s compensation, market compensation and the bank’s compensation philosophy. In many cases, it is more expensive to hire a CEO externally. Companies often pay external hires at or above the market median, and may have to negotiate sign-on awards to recruit them. Companies generally pay internally promoted CEOs below market at first and move them to market median over two or three years based on their performance.

Outgoing CEO:
In some situations, the outgoing CEO may stay on as executive chair or senior advisor to help provide continuity during the transition. In this scenario, pay practices vary based on the expected length of time that the chair or senior advisor role will exist. It’s often lower than the amount the individual received as CEO, but likely includes salary and annual bonus opportunity and, in some cases, may include long-term incentives.

Retaining Key Executives

CEO transitions may have ripple effects throughout the bank’s executive team. Executives who were passed over for the top job may pose a retention risk. These executives may have deep institutional knowledge that will help the new CEO and are critical to the future success of the company. Boards may recognize these executives by expanding their roles or granting retention awards. These approaches can enhance engagement, mitigate retention risk and promote a smooth leadership transition.

As competition remains strong in the banking industry, it is more important than ever to have a seamless CEO transition. Unsuccessful CEO transitions are a distraction from a bank’s strategic objectives and harm performance. Boards will be better positioned if they have a strong succession plan to help them identify CEO candidates with the skills needed to grow and transform the bank, and if they effectively use compensation programs to attract and retain these candidates and the teams that support them.