Can Small Banks Play the Innovation Game?


innovation-4-27-17.pngWhen it comes to innovation, community banks generally don’t have the resources—either financial or people—to compete with the country’s largest banks—where the technical staff focused just on innovation alone is probably several times larger than a smaller institution’s entire workforce.

Of course, no one expects smaller banks to compete with a megabank like Wells Fargo & Co., but there are smaller institutions that are playing the innovation game very well.

One of those is Radius Bank, a Boston-based bank that has approximately $1 billion in assets and four years ago made the radical decision to close all of its branches except for one, and convert its local brick-and-mortar retail operation to a digital platform that operates nationally. President and CEO Michael Butler, who appeared on a panel of like minded bankers at Bank Director’s FinXTech Annual Summit in New York on April 26, said that one of the more challenging aspects of that decision was changing Radius’ culture to support its new business strategy. Not all of the bank’s employees were happy about the change in strategy, and Butler said there has been approximately a 50 percent turnover in the bank’s workforce over the last four years. Many of the older employees who resisted the change have been replaced by younger, more tech savvy employees who normally would choose to work at a tech company rather than a bank. Butler said the company has spent a lot of time trying to create the kind of “vibe” that will attract those kind of individuals. “It’s a lot about the people you bring into your organization,” said Butler. At 57, Butler has the background of a traditional banker even though he has led the charge towards digitalization. “My job as the grey hair is to not let them kill themselves,” he joked about some of the bank’s younger staff members.

Another panel member—Jay Tuli, senior vice president for retail banking and residential lending at Leader Bank, a $1 billion bank located in Arlington, Massachusetts—was instrumental in creating ZRent, an online portal that the bank launched in January 2015. It enables landlords to automatically collect rent payments via ACH transactions. ZRent has been a successful customer acquisition tool for Leader Bank, and it is now licensing the software to other banks that want to use it.

Radius and Leader Bank are both located in the Boston area (Arlington is just six miles northwest of the city), so they have the advantage of taping a deep talent pool in one of the country’s most attractive locations, with a number of highly regarded universities in their backyard. Like Radius, Leader Bank has seen a big turnover in its staff over the last eight years. Tuli said that the average age of its 300 or so employees is 31. “There’s a lot of young talent in Boston, and we’ve benefited from that,” he said.

So, if being located in a large urban market is a key element in the innovation game, how to account for the success of Somerset Trust Co., a $1 billion bank headquartered in Somerset, Pennsylvania, a small community situated about 80 miles southeast of Pittsburgh? Somerset had just 6,277 residents according to the 2010 census. A third panelist, Chief Operating Officer John C. Gill, said the bank has always placed a very high premium on having excellent technology, and sees this as a critical component of its organic growth strategy. Only about 19 percent of its consumer banking transactions occur in the branch today. It sees innovation as an imperative despite its rural location.

Somerset has learned to play the innovation game by partnering up with fintech companies. A couple of years ago, Somerset teamed up with Malauzai Software in Austin, Texas, to develop a mobile banking solution that allows Somerset’s retail banking customers to securely check balances, use picture bill pay and remotely deposit checks from any location or device. There are banks much larger in size that are still working on delivering these capabilities to their retail customers. Working with another fintech company, Bethlehem, Pennsylvania-based BOLTS Technologies, Somerset has also launched a new mobile account opening platform that has greatly reduced the time it takes to open a new account, and is expected to save the bank approximately $200,000 a year. Somerset and BOLTS were finalists in the 2017 Best of FinXTech Awards, which were announced at the event.

Gill said that Somerset is very comfortable partnering with fintech companies to develop product capabilities that it would not be able to develop on its own. “Banks have the customers and low cost funding,” he said. “Fintech companies bring innovation.”

Risk Versus Return in M&A Transactions


transactions-2-20-17.pngMergers and acquisition (M&A) transactions need to be looked at from a risk versus return perspective. Participants in deals, both the buyer and seller, should understand the value proposition of the transaction and determine whether it is better to continue to grow and thrive organically or execute on a deal. Understanding value drivers and how to optimize value is the key to prospering in the future.

1. Know your value and what drives it.
There are both value creators and value detractors that exist for every company. It might be weak internal controls, a consent order or a multimillion-dollar, unfunded pension that weakens your deal prospects. On the other hand, you may have strong core deposits, strong profitability metrics or an experienced and actively engaged management team with deep client relationships that drive growth and value.

Value detractors specific to each company can be corrected over time. As the risk profile of the company improves, it is shown that valuation multiples will also improve. A company that has many value detractors can improve its risk profile over time. By improving its risk profile, the company increases the market’s perception of the value of the company, leading to higher valuation multiples. As your institution’s comparative value to the market changes over time, you must conduct periodic valuations to understand what the company’s current value is and what is driving it.

2. Understand your bank’s strategic paths, value and the execution risks of each path.
Once a company has a better understanding of its current value, it must understand the different decision tree paths available. Each of these paths will have a resultant present value of the company based upon executing on each path into the future. The risks and return associated with each path needs to be assessed. Below is an example of a strategic decision tree with five different paths. Each of these future strategic paths is modeled to determine the resultant present value resulting from each scenario path.

community-bank-chart.png

Not only is a present value calculated for each path, but the key risks and value drivers for each path need to be determined as well. For instance, if the company remains independent (path A), a key risk is that it may not be able to attract and retain key talent necessary for the company to thrive in the future.

In addition to the execution risks associated with each path, the financial value of the company under each scenario is also based upon a set of assumptions. Those assumptions must be reviewed carefully and the management team and the board of directors must critically review and sign off on those assumptions. More specific to M&A transactions, here are some of the major factors that impact an M&A deal:

  • Price: A stronger buyer currency shortens the work-back period of tangible book value dilution in a stock transaction.
  • Form of Consideration: Cash may decrease the work-back period of dilution in a transaction relative to utilizing stock consideration, due to higher earnings per share accretion, but utilizing cash will reduce the amount of capital at the combined entity.
  • Cost Savings: Acquisition of smaller banks and in-market deals will generally have higher savings (30-50 percent), while market or business line expansions generally have somewhat lower savings (25-35 percent).
  • Synergies: Deals can provide many synergies such as higher legal lending limit, greater franchise, new combined customer base, new sources of fee income, complementary loan and deposit products, or additional management bench depth for the combined entity.
  • Transaction Expenses: These are nonrecurring expense items and therefore should not be included in the pro forma combined income statement going forward but will impact tangible book value per share (TBVS) dilution and work-back period. Transaction expenses should generally be 7-12 percent for community bank deals and levels outside the range should be reviewed.
  • Mark-to-Market Assumptions: The target gets marked-to-market in a deal and these marks will initially impact TBVS upward or downward. The marks will be amortized/accreted through earnings over time. The marks generally have a bigger initial impact on TBVS and the earnings impact will be taken over a longer time period.

3. Recognize that a good deal on paper does not translate to a successful resultant entity.
Even with an extensive review of the assumptions, modeling and financial aspects of a transaction, a good deal on paper does not necessarily translate into a successful entity. Merger integration will make or break an institution’s ability to realize value in a transaction. Practical issues including vendor selection, branding and employee retention impact restructuring expenses. Social issues, such as corporate culture and leadership structure, define the bank moving forward.

Remember that there is an inherent risk versus return tradeoff in every M&A transaction. Understanding your institution’s risk profile, corporate culture, and all possible strategic paths will mitigate risk and maximize return.

Shaking Up Traditional Banking


banking-strategy-2-10-17.pngUnlike some executives, David Becker likes to be told what he’s doing wrong. The chairman and chief executive officer of First Internet Bank in Fishers, Indiana, says bank interns speak to the senior leadership team at the end of their internships to discuss ways the bank could improve. He expects the same of staff throughout the organization.

“[Our hire] is the dissatisfied banker,’’ he says. “They were in an organization that had a boatload of rules and policies. We take the banker who says, ‘What if we did this?’ We want the person who questions the day-to-day operations.”

Running the bank in such a way has paid off.

The bank’s holding company, $1.8 billion asset First Internet Bancorp, grew loans 31 percent last year from the year before, to $1.3 billion. Net income grew to $12.1 million from $8.9 million in 2015. The bank’s return on average assets was 0.81 percent in the fourth quarter of 2016, and its return on average equity was 11.24 percent. First Internet has its headquarters in Fishers, a suburb of Indianapolis, and a loan production office in Tempe, Arizona, and that’s it. With a focus on digital banking, First Internet can grow its loan book nationally while keeping expenses low. One of its niches is digitally savvy investors who own properties or businesses in multiple states because the bank can accommodate lending that may take place in different parts of the country.

Investment bank Keefe, Bruyette & Woods has an outperform rating on the stock, in part based on its cheapness relative to the bank’s performance. The bank will have to continue to grow to achieve efficiencies, because internet banks have to pay slightly more for deposits than other banks do, says Michael Perito, a KBW analyst who follows the stock.

Becker feels as if the big banks are getting consumers more accustomed to digital banking, and therefore, more likely to leave for digital-only banks. When he first started the internet bank in 1999, customers had to deposit checks by sending them in the mail to the bank. Now, they can just remotely deposit them through the bank’s mobile banking app. If customers use another bank’s ATM, First Internet reimburses them for up to $10 per month in surcharges—making up for the bank’s lack of a branch network.

The bank has been growing lately in part because it is hiring seasoned bankers to tend to its loan book of mortgages, commercial real estate and consumer loans. Becker says the bank has managed to survive by building slowly and carefully in its early years, so as not to overstep its infrastructure. “The team we have on board are all folks at the senior level that worked at multistate, large, regional banks and have the expertise and the ability to help us grow to that multi-billion-dollar position,’’ Becker says. “It is all about the people. We can create computer tools and algorithms, but at the end of the day, somebody has to talk to you if there is a problem and know how to underwrite a loan.”

The bank is acutely focused on customer service, and in its early days, it didn’t hire anyone right out of high school or in their first job. “We needed talented people who could handle anything that came in the door,’’ Becker says. There are no tellers per se, and everyone who works in customer service needs to handle multiple functions, from wire transfers to starting a new deposit account. Staffers can communicate with their customers on the phone, in online chat rooms or via email. They keep track of customer reviews on sites such as Yelp, because bad reviews can damage the company’s reputation. Software vendors are held to account, and the bank doesn’t sign any long-term contracts with vendors, Becker says.

Although the bank relies on vendors rather than developing its own software, it follows the workplace ethic of a tech company: a 24-hour gym is available, and people can show up in jeans to work every day. “We use technology to revolutionize the banking process,’’ Becker says. “There really isn’t any limit to our potential growth. Are we a drop in the bucket in the whole community of financial services? Yes. But the consumer is coming our way. We are getting better at it and we are bigger day by day.”

The Bank Executive of the Future: Agile and Focused on Talent


bank-executive-1-23-17.pngToday’s bank leader remains under more pressure than at any time since the financial crisis. Tangible skills still matter, such as commercial credit experience, risk management and strategic planning.

Nevertheless, the real challenges may lie in developing the key leadership requirements for institutional success, and in the navigation of the managerial challenges which lie ahead. Here are three intangible but particularly important qualities for the future bank leader’s success.

Cultural Agility and Adaptability
Let’s face it: while middle-aged white men still dominate the C-suite in banking, the growth markets—and new and future employees—do not fit this profile. Consider these points:

  • Women today constitute a majority of bank employees in many institutions, with rising penetration in senior management roles.
  • Non-Caucasian children are now a majority of births in this country.
  • More new businesses are started by women and minority members of our communities than by Caucasian males.

What this says about our bank’s future opportunities for growth is that bank leaders and line personnel need to develop a true appreciation for the varied needs of different customer constituencies. And employees will likely need additional training to be in a position to service a wider array of customer profiles.

Bank leaders, then, need to lead this charge. It takes training to be able to meet differing customers at their comfort level, rather than expecting potential clients or prospective employees to relate to us. After all, your future team members will be just as diverse as your future customers.

Workforce Flexible
The nature of today’s multigenerational workforce is no secret.

Here’s a recent statistic from Gallup and highlighted by the American Bankers Association: of the four current workforce generations, millennials were notably the least engaged, with only 29 percent feeling connected to their employers. Furthermore, according to research from private equity firm Kleiner Perkins and the industry association Independent Community Bankers of America, the millennial generation seeks meaningful work, high pay, a sense of accomplishment, training and development as well as flexibility—in that order. Yet this same generation is known for being empathetic, humanitarian, environmentally concerned and generally caring. So, how do banks connect with these future leaders to attract them and keep them in the fold?

Here’s where I believe banks hold a hidden advantage over many other industries. There is no industry that is more community-minded or supportive of local organizations with time and money than community banks. Yet too often we take this proud and locally minded commitment for granted, when we should be shouting it from the rooftops, especially when we are recruiting up-and-coming talent or even rookies straight from college.

We also need to make sure that banks have revisited the traditional timelines of career advancement that former bankers like me grew up with. While some veteran bankers may disdain the up-and-comer who expects rewards and recognition much faster than previously provided, we need to accept that times are simply different. As a technology-enabled, team-oriented, community-minded industry, we need to reinforce that “this is not your grandfather’s bank” in our recruiting messages and performance feedback.

Talent Focused
Despite the continued consolidation of the industry, the ranks of folks who can capably lead a bank in today’s climate is simply not keeping pace with the need to replace retiring CEOs and C-level executives.

In the battle for new loans in crowded markets, the banks with more and better lenders on the street will win. Remember that stars have the most options as to where they will deploy their talent. “A” players will usually choose an opportunity where they are working with or for a well-known leader, and where they feel they are best set up for success.

Top talent wants to work with other top performers, and a bank CEO who can attract top players gains a significant competitive edge.

Banks that choose to play it safe with regards to talent—whether in the executive ranks or in the hiring of revenue generators—do run the risk of being penny-wise and pound-foolish. Don’t skimp on getting as many difference-makers on your team as possible.

Summary
The difference between banks that will be able to grow and remain independent may come down to the soft skills of their leaders—how the bank adapts to changing employee and customer markets, navigates the different workplace expectations of its up-and-comers, and whether the bank approaches the talent market strategically. Failing to shift focus to these factors may come at a very high price.

Want to Attract Millennials? Just Ask Them What They Want


millennials-1-11-17.pngHarrisburg, Pennsylvania-based Centric Bank, with $463 million in assets, wants to attract young customers to do business with the bank, and the up-and-coming talent needed for its future success. To make that happen, CEO Patricia Husic and her team are going straight to the source by partnering with a local young professionals’ organization.

In early 2016, Husic addressed Harrisburg Young Professionals (HYP), a civic organization with members averaging 25 to 35 years old, as part of a breakfast series that brought in CEOs from the community to speak to the group. Soon after, she and Derek Whitesel, HYP’s executive director, met at Husic’s request to discuss how the two organizations could partner to create an advisory board to help the bank understand the unique qualities of the millennial generation.

“It’s such an important piece for us, as a community bank, to look at how we make ourselves relevant to the millennial group” as clients and potential employees, says Husic.

On paper, the millennial generation should be a boon for the banking industry. Working millennials in the U.S., at 53.5 million, surpassed Generation X (52.7 million) and the baby boomers (44.6 million) in the 1st quarter 2015, according to Pew Research, which defines millennials as those born after 1980. The financial needs of millennials are growing, as they balance record levels of student loan debt with traditional desires like home ownership. But the first digital generation is also more open to up-and-coming mobile providers to meet its financial needs and has been reticent to work for the traditional banking industry, whose reputation has taken a beating since the financial crisis.

Centric isn’t the first bank to establish a millennial advisory group. Since 2009, Minneapolis-based U.S. Bancorp has selected millennial employees to provide input on various company initiatives, from mobile app design to employee benefits. Nearby Mid Penn Bancorp, in Millersburg, Pennsylvania with $1 billion in assets, formed its own millennial advisory board in 2016 to better meet the needs of younger customers. Like Centric, the group is comprised of employees and local professionals.

Centric’s millennial advisory board held its first meeting in November 2016. Each member has committed to a two-year term and will meet quarterly for one to two hours to discuss what millennials want and need from financial institutions and employers, and to outline strategies to attract and retain millennial customers and employees. Eight members are bank staff—all millennials—and eight, including Whitesel, come from HYP. Different industries and skill sets are represented.

Two co-chairs—Nicole Cooper, a teller manager from Centric, and Trevin Shirey, an HYP member and business development manager at an internet marketing company—are responsible for organizing the meetings and setting the advisory board’s agenda. Millennials on the advisory board are uncompensated but will have direct access to Centric’s board of directors, with the co-chairs presenting quarterly updates to the board and leadership team that outline key initiatives and progress toward goals.

The partnership doesn’t just benefit Centric. “There [are] a lot of movers and shakers [on Centric’s board] that are highly involved in the Harrisburg community, so being able to connect those eight young professionals to those people directly is ultimately a great opportunity for them to network in the community and get to advance their professional careers,” says Whitesel. Husic adds that membership on the board should be a “great resume builder.”

The first task to be completed by the group has advisory board member Cody Wanner—the co-founder of video production company CAP Collective—documenting the bank’s online account opening process. The group will review the footage and offer its input. “We’re all going to sit together and watch,” says Husic. “If we don’t hear the unfiltered feedback, how do we make ourselves a better bank?” Next, the group plans to focus on the bank’s mobile app, again recording the experience. Centric also plans to bring in companies identified as leaders in mobile app development for demonstrations.

Husic plans to measure the success of the millennial advisory board’s recommendations, and the bank’s implementation of them. Is Centric moving the needle when it comes to acquiring millennial accounts? Are more young job seekers interested in working at the bank? Currently, 15 percent of Centric’s employees are millennials. Husic wants to get closer to 30 percent, and for Centric to gain a reputation as an “employer of choice” for younger workers.

Attracting millennial employees is important to the long-term sustainability of the bank, Husic says, and she’s open to the advisory board’s input—even if it takes her a little out of her own personal comfort zone. “They said, ‘did you ever think about getting a dodgeball team together?’” says Husic, who is open to the idea but reticent to play herself. “I’ll bring the snacks,” she says.

The Battle for Bank Talent: Trends and Strategies


Motivated, talented employees always have been critical to the success of financial services organizations, meaning there always has been competition to attract high-performing employees. However, recent research indicates that competition has heated up considerably in the past few years, making it even more important for banks to stay abreast of current trends in compensation and human resource practices.

Trends in the Battle for Talent
The most recent indicator of the intensifying competition for talent can be found in the Crowe Horwath LLP 2016 Financial Institutions Compensation and Benefits Survey. Of the many trends in compensation, incentive and benefits strategies that are tracked in this annual survey, three areas were particularly revealing in 2016:

Employees are changing jobs at the fastest pace in at least a decade, with both officer and nonofficer turnover trending sharply upward over the past two years. Some turnover is the result of consolidations or performance issues, but most turnover represents the voluntary departure of employees–usually at a significant cost to the banks.

employee-turnover.PNG

Bank staffing strategies appear to have recovered from the recession. More banks today are planning for normal growth in staffing (35.6 percent), while the number of banks planning to maintain (34.1 percent) or reduce (3.6 percent) staffing levels is declining to pre-recession levels.

staffing-plans.PNG

The percentage of banks that plan to implement above-market compensation strategies has increased steadily over the past four years. In the 2016 survey, 28.5 percent of banks reported their strategy was to pay more than 10 percent above the market average.

compensation-strategy.PNG

Taken together, these three trends–higher turnover, expected staffing increases, and growing use of above-market compensation strategies–suggest that the battle for talent is likely to continue and intensify.

Factors Driving the Competition
Viewing the survey results through the lens of current industry experience, one might reasonably conclude that bank compensation strategies are no longer responding to recession and credit crisis concerns. The survey responses suggest that banks are now being driven by a new set of economic and competitive factors including:

  • Employee expectations: As memories of recession-driven job insecurity fade, events such as bank consolidations, increased profitability and rising executive compensation are catching employees’ attention. The increased turnover rate suggests that high performers in search of better opportunities are more willing to take a chance and make a move now.
  • Growth strategies: Although mergers or acquisitions often are associated with net reductions in payroll, bank consolidations also can create demand for managers and executives who are more experienced in handling larger organizations. Other market strategies—such as enhanced digital banking or a relationship-banking approach—also can drive demand for employees with technical or consultative-selling skills.
  • Technology: Just as technology affects some of the skills needed to serve bank customers, it also is changing some employer-employee relationships. The “gig economy,” where short-term contract workers provide specialized services to multiple employers, has not yet affected most traditional bank jobs but certain positions—marketers, data analysts and website or mobile banking developers, for example—often can be filled by contract workers rather than full-time employees.
  • Competition: Banks with strong market positions in commercial lending or other desirable business lines sometimes find themselves on the defensive as they ward off competitors trying to lure away their most productive employees. Often banks end up offering selective pay boosts and bonuses to discourage so-called “lift out” strategies, in which a competitor lures away key managers or an entire department.

New Approaches to the Battle for Talent
Putting more emphasis on pay—particularly performance-based pay or incentives—is one way to attract and retain high performers. But higher pay scales are not the only solution.

Many banks that are consistently regarded as “employers of choice” are not the highest paying employers in their markets—or even the highest paying among comparable banks. Instead, they shift a portion of their workforce investments toward maintaining benefit programs and work cultures that promote work-life balance.

Some banks now present employees with an annual “total rewards statement” that spells out all the investments their employers are making in them. Such statements can help motivate employees by reminding them of their value to the organization. Individual personal recognition, status and career opportunities can also be powerful motivators.

Regardless of the specific mix of techniques that are used, the intensifying battle for talent means banks will need to pursue a deliberate, multifaceted approach to attract, motivate and retain the talented and high-performing employees they need to pursue their business strategies.

Taking on the Toughest Challenges


As bank leaders explore different avenues for growth, they must also weigh the risks that could threaten their institution. In this panel discussion from Bank Director’s 2016 Bank Audit & Risk Committees Conference, led by President & CEO Al Dominick, Dale Gibbons of Western Alliance Bancorp., Lynn McKenzie of KPMG and Bill Fay of Barack Ferrazzano Kirschbaum & Nagelberg focus on the key issues that bank boards and executive teams need to address, from third-party vendor risk to strategic growth.

Highlights from this video:

  • Top Issues for Audit & Risk Committees
  • Aligning Growth Strategy & Risk
  • Evaluating Partnership Opportunities
  • Addressing Technology & Cybersecurity as a Board

Mega-Acquirers: Compensation Practices That Make a Difference


As football coach Lou Holtz famously stated, “In this world you’re either growing or you’re dying, so get in motion…” In the past two years, 545 banks have been acquired—the highest level of activity since 2006 to 2007. During this busy cycle, the regional public banks between $5 billion and $50 billion have enjoyed greater profitability than either their smaller or larger counterparts.

With improving financial markets, increasing regulatory requirements, and decreasing margins, some of these regional banks have been executing an acquisition growth strategy for several years. Pearl Meyer identified 22 “mega-acquirers,” banks in the top quartile of regional banks ranked by three-year asset growth. These mega-acquirers have averaged a three-year asset growth rate of over 30 percent, compared to just over 7 percent for other regionals. Not only do they outperform in asset growth, but also on a number of other key financial metrics.

Median Financial Performance of Mega-Acquirers Versus Other Regionals (as of 12/31/2015)

  3-yr Asset CAGR (%) Price/Tangible Book (%) TSR CAGR (%) Diluted EPS after Extraordinary Items CAGR (%)
1-Yr 3-Yr 5-Yr 1-Yr 3-Yr 5-Yr
Mega Acquirers (n=22) 31.58 171.48 21.63 21.56 16.55 25.56 20.12 9.82
Other Regionals (n=89) 7.30 158.87 7.62 15.19 9.97 3.39 6.85 5.29

CAGR: Compound Annual Growth Rate
TSR: Total shareholder return defined as stock price appreciation plus dividends Source: S&P Global Market Intelligence

Pay Differences
While there are many factors that can influence financial success, we looked specifically at whether or not mega-acquirers structure executive compensation differently. The answer is yes and no. The median pay of CEOs for the mega-acquirers and other regionals aren’t markedly different. The mix between base salary, annual incentives, and long-term incentives for CEOs also were generally consistent for all regionals. There were, however, three key differences.

  • Mega-acquirers manage to results. Fewer mega-acquirers have an annual incentive plan with a discretionary component (33 percent versus 46 percent for other regionals), potentially inferring that mega-acquirer executives are accountable for achieving financial goals regardless of the external environment.
  • Mega-acquirers focus on both revenues and cost. While all regionals use net income as a metric equally, mega-acquirers are more likely to include an efficiency ratio in their annual plans (27 percent versus 17 percent for other regionals).
  • Mega-acquirers tend to use more time-vested restricted stock and fewer performance shares. Curiously, mega-acquirers are getting good financial results without the use of performance-based equity. Eighty-two percent (82 percent) of mega-acquirers provide time-based equity awards to their CEOs versus 73 percent for other regionals. Prevalence of performance-based shares is 36 percent for mega-acquirers versus 51 percent for other regionals.

While we can only speculate why there is a greater preference for restricted stock rather than performance shares, there are a couple possibilities. First, performance shares often vest based on achieving operational metrics. The argument may be that future operational performance is a function of what is acquired and this can be hard to pin down even if it is measured on a relative basis. Second, while median stock ownership for mega-acquirer CEOs is similar to other regionals, it is more than twice that of regional CEOs at the 75th percentile. There may be a strong desire by some of the mega-acquirers to ensure that the CEO has meaningful share ownership and is willing to achieve this through time-based vesting. In our experience, actual share ownership is what drives behavioral shifts and creates shareholder alignment.

Considerations
These pay differences are subtle. However, when you combine strategy, financial results, and pay practices together, the implications provide for compelling discussion in the boardroom.

Has the use of discretion in incentive plans gone too far? Discretionary components are inappropriately used if they are a way of explaining away poor performance on the defined metrics. Discretion is best used when it is a qualitative assessment of non-financial results or where it is difficult to determine financial outcomes due to acquisition or other factors. Establishing what will be evaluated qualitatively at the beginning of the year, rather than at year-end also fosters discipline in using appropriate discretion.

If there aren’t meaningful differences in CEO compensation values, are you getting what you are paying for? Holding CEOs and their executive teams accountable for strategy deployment and financial results is a primary board responsibility. Open and honest feedback coupled with active oversight can ensure the bank is getting value from its compensation dollars.

Are you evaluating the CEO on the right things? Simply focusing the CEO’s evaluation on whether the bank made its numbers that year is insufficient. A more holistic view of the role using seven characteristics should be considered:

  1. Strategy and Vision
  2. Leadership
  3. Innovation/Technology
  4. Operating Metrics
  5. Risk Management
  6. People Management
  7. External Relationships

Conclusion
Compared to both smaller and larger banking organizations, regional banks have enjoyed relatively strong performance despite a challenging operating environment—and mega-acquirer performance has been even stronger. Has executive pay design played a role in the success of mega-acquirers? The differences in design are small, but potentially impactful—a tighter link to performance, a stronger focus on operational effectiveness, and for some, a higher level of long-term equity ownership.

How to Get Ready for a Safety and Soundness Exam


soundness-exam-4-14-16.pngThere are few events in the life of a bank that are more important than a safety and soundness examination by the institution’s primary regulator. A passing grade means the bank will be able to execute its growth strategy, including acquisitions, product development and business expansion, with little interruption or objection from their regulator. Not only does a failing grade mean that bank’s major growth initiatives will probably be put on hold, but its management team will have to spend both time and money fixing the deficiencies—resources that otherwise would be spent on more productive pursuits. Gary Bronstein, a Washington, DC-based partner at Kilpatrick, Townsend & Stockton LLP, offers advice to bank management teams and boards for how to prepare for an exam in an edited conversation with Bank Director Editor in Chief Jack Milligan.

Preparing for a Safety and Soundness Examination
The first thing, which is probably the most important thing, is for management and the board to review any deficiencies or matters requiring attention from the prior exam and make sure those have been addressed. The regulators will verify and review the effectiveness of any corrective action taken after a prior exam. A few other things that are perhaps a little less pressing but still important to consider include any changes in the bank’s business activities since the last exam. You might want to take a look at your policies and procedures to make sure that those have been updated to reflect the new activities. For example, if the bank is engaging in a new lending activity or a new subsidiary activity, do the policies and procedures reflect what they’re doing? Also, if you’re expanding to new markets, that also may require a look at the policies and procedures.

It’s also important that you prepare your employees for the examination process. You ought to make sure that they’re aware of the exam, that it’s coming, what the schedule is, when the examiners will be there and where they’ll be located. Remind employees of simple things about office protocol that you might take for granted, such as not having business discussions in public areas where they may be overheard by an examiner, and not to leave documents laying around in conference rooms and photo copiers that examiners might have access to and that might contain sensitive information that you’re not ready to provide. Employees should be knowledgeable about the policies and procedures for which they’re responsible, because they may be asked to talk about it.

Approximately 30 to 90 days before the exam, the bank will receive what’s called a first day letter, which talks about the scope of the exam. That is to be taken seriously. It’s important to do your homework, relative to that letter and what’s in it. The other thing that’s worth looking at is each of the federal banking agencies have an examination manual that’s posted online. It sets forth the supervisory and examination objectives. That’s absolutely worth reviewing. It’s a good idea to appoint a point person at the bank who is responsible for handling all inquiries that arise during the exam. And when you gather information for examiners, keep a record of what you’ve gathered so that in case anything gets lost, you have a record of it.

The Importance of the Initial Meeting With the Examiners
It’s important to think in advance of an exam about the opening meeting that will take place with the examiners. It’s important to make a good first impression because that can set the tone for the exam. You should probably have your full executive team present for that. I don’t think it’s necessary to have board member at that initial meeting because most banks generally think of an exam, certainly at the initial stage, to be more of a management function, rather than a board function. It might be a good idea to have your compliance officer present, as well as key officers in charge of particular business units. You might start off the meeting by talking about issues that were raised during the prior exam and address those up front. Address some changes that have taken place at the bank since the last exam so that the examiners are well-informed of what has taken place. Set the ground rules for how this is going to unfold in terms of how long they’re going to be there, what days of the week and the person to contact.

Other Pre-Examination Considerations
Take care of logistics, such as where the examiners are going to sit. Make sure they have access to things that they need because that sets a nice tone. It’s a good idea to be proactive. Sometimes you have new examiners who are not familiar with your bank, so it’s a good idea to start off with a summary of your business, where you’re headed and what your control environment looks like. Also, you might consider self-identifying issues or problems, but don’t do that without being prepared to provide a remediation plan of how you’re going to deal with those issues.

And make sure your files are organized because it sets a bad tone if you’re having difficulty finding things and it takes a long time, so organize your files related to things you expect the examiners are going to look for.

Conducting a Mock Examination
Some banks conduct a mock regulatory examination, which may help you prepare for the process and identify areas to focus on. It could be performed by someone at the bank who is experienced in having gone through a number of exams, so they’re familiar with how the examination process takes place. Or you could use an outside consultant who walks you through an initial meeting, gets you prepared for issues that would typically arise during the exam. What happens if the examiner approaches you about X, Y or Z? How are you going to respond? What happens if you disagree with an examiner? Who’s going to be the spokesperson and how can you effectively address the disagreement?

Handling Difficulties as They Come Up During the Exam
Issues regularly come up during an exam. They could be tactical in nature. It might be the examiner taking a position that there’s been a regulatory violation. Is that based upon a law or regulation? It might not, in fact, be a violation, but there may be a disagreement. It might be a reasonable and understandable disagreement. It may not be. It may be a misunderstanding about something that the bank is doing that they’re actually not doing. It can be a mistake. Some of the examiners are inexperienced and like any person, an examiner can make a mistake. The question becomes, how do you proceed?

My first piece of advice for disagreeing with an examiner is this: Proceed with caution. The last thing you should do in communicating with the examiner is to dress that person down, or berate the person. I’ve seen that happen and things deteriorate quickly. That’s a bad idea in almost any scenario but it’s certainly a bad idea when you’re dealing with an examiner or regulator. You should never be condescending or disparaging. I think it’s important to be non-defensive, factual, unemotional and just set forth why you disagree. If it’s done in a constructive manner, it should go pretty well.

The importance of dealing with problems as they come up
Whether it’s a regulatory violation or some other significant issue that arises during the exam, the bank should make every effort to try to get it resolved, hopefully while the examiners are still there, but certainly before the examination report is issued. If it’s a regulatory violation, it’s a good idea to get the lawyers involved, whether it’s in-house or outside counsel, to get an opinion about whether or not the situation does rise to a regulatory violation and then address it head-on, but again in a constructive way. Hopefully, it can be solved by resolution as opposed to a heated argument.

The board’s role in preparing for a safety and soundness examination
The one thing the board can be doing all year long is to make sure that any discussions about board oversight of management is properly recorded in the minutes, because the examiners are going to look at the board minutes and I’ve heard it said on many occasions that from an examiner’s perspective, if it’s not in the minutes, it didn’t happen. That’s not to suggest that you should have a stenographer on hand to record every word, but it ought to be a fair summary of what discussions have taken place, particularly with respect to the prior exam. It’s important to have a record that these issues were discussed, that the exam was discussed, the response was discussed and questions were asked.

It is important that there be a tone at the top communicating that the examination process is important, and that begins with the board and the senior management team. As far as board involvement is concerned, certainly if it’s a troubled bank, the board is going to be more involved in the examination process and there’s the expectation that the board will be. With a healthy bank, you might have the chair of the audit committee be available as needed. Issues that may be discussed include the internal audit process and the internal controls environment. The audit committee chair is the most credible person to discuss those issues.

Managing the post-examination process
As always, management is on the front lines and the board is performing an oversight function. I think it’s important after the exam to have open lines of communication with the examiners, particularly with an issue that might be unresolved, because I think it’s important to vet those issues, provide additional information, and hopefully correct those issues before a final report is released, so that kind of back-and-forth communication between management and examiners is important. If there are any issues of significance, those ought to be brought to the board’s attention as soon as possible so that the board is aware of it. If they’re significant enough, the examiners are going to want to meet with the board, so the board needs to be well informed before any meeting takes place with the examiners.

The final report ought to be reviewed carefully and a well thought out plan for correcting any problems ought to be developed. The written response ought to be delivered in a non-defensive and factual way, without getting combative. I think it’s important not to over-commit to remediation and corrections because the last thing you want is to commit to doing something and you’re unable to deliver. It’s important at the board level that there be a written record of discussions about the exam process, the report, the response and it’s important that management fully report to the board about the issues that arose during the exam. The board ought to be engaged and ought to challenge management about the areas of concern that were raised during the process, because ultimately, the board is going to be held responsible if there are any repeat violations of issues raised during the exam.

Building An M&A Blueprint



Scale is driving buyers and sellers today, with acquirers seeking growth and sellers seeing scale as an obstacle. Christopher Olsen of Olsen Palmer outlines how both buyers and sellers can plan for a successful deal, and explains how even banks focusing on organic growth strategies will be impacted by consolidation.

  • Scale and M&A
  • A Buyer’s Plan
  • A Seller’s Plan
  • Impact on Organic Growth Strategies