Digital Deniers Need Not Apply

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There are few bankers who understand the process of digital transformation better than Mike Butler.

Beginning in 2014, Butler oversaw the evolution of Boston-based Radius Bancorp from a federally chartered, brick-and-mortar thrift to one of the most tech-forward banks in the country. Radius closed all its branches except for one (federal thrifts are required to have at least one branch) and adopted a digital-only consumer banking platform.

The digital reinvention was so successful that in February 2020, LendingClub Corp. announced a deal to buy Radius to augment that marketplace lender’s push into digital banking. Now Butler is off on another digital adventure, this time as president and CEO of New York-based Grasshopper Bancorp, a five-year-old de novo bank focused on the small business market. Like Radius, Grasshopper operates a digital-only platform.

Butler will moderate a panel discussion at Bank Director’s upcoming Acquire or Be Acquired Conference focusing on the importance of integrating bank strategy with technology investments. The conference runs Jan. 30-Feb. 1, 2022, at the JW Marriott Desert Ridge Resort and Spa in Phoenix.

Butler says that successful transformation begins with the bank’s executive management team and board of directors, where discussions about technology need to be an integral part of strategic planning. And most importantly, management and the board need to see digital transformation as crucial to the bank’s future success. Butler says there are still plenty of “digital deniers” among bankers who believe they can be successful without strengthening their institution’s digital capabilities.

“Have you embraced the kinds of changes that are taking place inside the industry?” Butler says. “And do you have a very strong cultural commitment to be a part of that change? When you do that, you start to look to technology as the enabling driver to get you to that place.”

Management teams that are just starting out on a path to digital transformation can easily find themselves overwhelmed by the sheer number of potential projects. “The most important thing to do is to prioritize and recognize that you cannot do this all at once,” Butler says. “It would be a mess if you tried. Pick two to three things that you think are critically important.”

A third element of a successful transformation process is finding the right person to lead the project. “You’ve got to have the right talent to do it,” Butler says. “That leader better be somebody who has been pushing it rather than you push it on them as CEO. You can’t say, ‘Joe, you’ve been running branches for 30 years, do you believe in digital? Eh, kind of. Okay, I want you to put in a digital platform.’ That’s not going to work.”

Butler goes so far as to say that only true believers should run those fintech projects. “You cannot do this without people that have the passion and the belief to get to the other side, because you will hit a lot of roadblocks and you’ve got to be able to bust through those roadblocks,” he says. “And if you don’t believe, if you don’t have the passion, there’s a lot of reasons to stop and go a different way.”

Butler might not seem the most likely person to be a digital change agent. He spent 13 years at Radius and pursued a branch banking strategy in the early years. Prior to joining Radius, Butler was president of KeyCorp’s national consumer finance business. He did not come from the fintech sector. He has a traditional banking background. And yet as Butler is quick to point out, Radius didn’t reinvent banking, it reinvented the customer experience.

The fact that Butler lacked a technology background didn’t deter him from pursuing a transformational strategy at Radius. He was smart enough to see the changes taking place throughout the industry, so he understood the business case, and he was also smart enough to surround himself with highly committed people who did understand the technology.

In building out its digital consumer banking platform, Radius worked with a number of third-party fintech vendors. “I wasn’t making technology decisions about whose technology was better, but I surely was making decisions about the companies that we were partnering with and what type of people we were willing to work with,” Butler says. “I met every single CEO of every company that we did business with, and that was a big part of our decision as to why we would partner with them.”

At Grasshopper, Butler says he prefers the challenge of building a new digital bank from scratch rather than converting a traditional bank like Radius to a digital environment. Sure, there are all the pain points of a startup, including raising capital. But the advantages go beyond starting with a clean piece of paper from a design perspective. “It’s really hard to transform a culture into something new inside of an organization,” Butler says. “So, I’d say the upside is that you get to start from scratch and hire the right people who have the right mindset.”

Directors’ Defense Against the Pandemic Impact on Credit

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Bank directors and management teams must prepare themselves and their institution for the potential for an economic crisis due to the COVID-19 outbreak.

This preparation process is different than how they would manage credit issues in more traditional economic downturns; traditional credit risk management tools and techniques may not apply or be as effective. Directors and others in bank management may need to consider new alternatives and act quickly and deliberately if they are going to be successful during this very difficult time.

The traditional three lines of defense against quickly elevating credit risk may not work to prevent the credit impact of the new coronavirus and its consequences. The “horse is out of the barn” and no existing, normal risk management system can prevent some level of losses. This pandemic is the proverbial black swan.

The real questions now are how can banks prepare to deal with the related issues and problems?

Some institutions are likely to be better prepared, including those with:

  • A strong capital base.
  • Good, conservative allowance reserve levels.
  • Realistic credit risk assessments and portfolio ratings prior to the pandemic.
  • Are poised to take part in a potential acquisition.
  • A good strategic approach that is not materially swayed by quarterly earning pressures.
  • A management and board that “tells it like it is” and is realistic.
  • Good relationship with regulators, CPA firms, professionals and investors.

What are a bank’s options when trying to assess and manage the pandemic’s impact?

  • Deny the problem and kick the can down the road.
  • Wait for the government and regulators to provide solutions or a playbook for the problems.
  • Sell the bank — most likely at a big discount if at all.
  • Liquidate the bank, likely only after expending capital, with assistance from the Federal Deposit Insurance Corp.
  • Be proactive and put in place processes to deal with the problem and consequences.

There are some steps a bank can take to be proactive:

  • Identify emerging and potential problems and the options to handle them, and then create a plan that is strategic, operational and provides the best financial result.
  • Commit to doing what’s right for the bank, its employees, customers and community.
  • Enhance or replace the current credit risk management system with a robust identification, measurement, monitoring, control and reporting program.
  • Adopt an “all hands-on deck” to improve focus and deal with material issues in a priority order, deferring things that do not move the needle.
  • Assess internal resources and consider moving qualified personnel into areas that require more focus.
  • Seek outside professional assistance, if needed, such as loan workout or portfolio analysis and planning.
  • Perform targeted reviews of portfolio segments that are or may become challenged because of the pandemic and potential fallout, along with others may have had weaker risk profiles before the pandemic.
  • Communicate the issues such as the magnitude of the financial challenge to employees, the market, regulators, CPAs and other professionals who provide risk management services to your bank.
  • Deal with problems head-on and decisively to maintain credibility and respect from various constituencies while achieving a superior result.

It is best for everyone in the bank to work together and act quickly, thoughtfully, honestly and strategically. There will, of course, be some expected and understood need in the short term for increases in allowance provisioning. If planning and actions are executed well, the long-term results will improve the bank’s performance and enhance its credibility with the market, regulators and all other professionals. Just as valuable as an outcome is that your bank’s reputation will be enhanced with your employees, who will be proud to have been part of the effort during these difficult times.

What Your Compensation Committee Calendar Should Look Like

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compensation-3-12-19.pngA goal-oriented calendar can be the difference between a productive year and a nonproductive one for compensation committees.

Planning for the year goes beyond scheduling meetings. Compensation committee chairs should have a thoughtful plan that encompasses the goals of the committee for the year. A detailed and in-depth calendar can help both new chairs and experienced chairs craft a plan for the year that considers the short- and long-term needs of the bank.

This article provides planning tips and a cheat sheet for the core topics that should be on the committee’s annual schedule. Though the cheat sheet is specific to public banks, private banks can use the list as well.

What’s on The Agenda
The old saying goes “what gets written down, gets done.” Having a written document sets a roadmap for the year and provides your committee a timeline to stay on track. You don’t need to reinvent the wheel.

Start with the committee charter, which provides a job description for the committee’s responsibilities. Review the past year’s calendar, agendas and meeting minutes for a head start in creating your annual agenda and stick to it throughout the year.

Identifying key topics at the beginning of the year allows for communication across all stakeholders: members of the committee, your management team, and outside legal and compensation advisors.

Topics should cover both short-term and long-term items. For example, if you are looking to request more shares for your equity plan, this process should start well in advance, and may include updating your equity plan document, modeling ISS and Glass Lewis share guidelines, and redesigning your grant methodology.

Getting your outside advisors involved early can help you avoid last-minute surprises.

Frequency of Meetings
Typically, public banks hold four to six meetings in a year. This allows the committee sufficient time to cover key topics and to review the goals of the committee. In any given year, the agenda may require additional meetings for special events including merger and acquisition activity, creation of new incentive plans and other events.

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What (And When) Should Be on The Calendar
Below are key topics that should be on the regular calendar for public banks as well as additional items for consideration any time during the year. The sample covers a typical schedule, however, there is flexibility depending on the subject.

In any given year, items should be evaluated both in terms of the current short-term and the longer term needs of the bank 24 months or more from now.

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Balancing the Relationships of Constituents

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investor-1-16-19.pngOftentimes, as supporters of community banks, we can perceive an inquiring shareholder might not favor the bank remaining independent. But there are times when this perception might be warranted.

Shareholders, in the end, are still people. Though they align into different groups with different interests, people are ultimately in charge. Often, it is a misunderstanding of the role of management and the board, the bank’s role, the shareholder’s role, and the goals and objectives of each that cause distractions.

Here are several points to consider.

Management and the board
Management must understand that they work for the board. The board works for the shareholders. The amount of influence any board can have is directly correlated to its collective ownership of the company. Without a meaningful stake, outside investors will have the most say. If the board doesn’t own 100 percent of the stock, it has a fiduciary duty to the other shareholders. This seems an elementary concept, but if the board and management team don’t really understand the legal and practical implications of ownership and reporting, it can precipitate a communication breakdown and misalignment of interests.

Insiders must align independent shareholders’ interests with their own and avoid setting themselves up for a lifetime job to only serve themselves.

Transparency and communication
Banking is one of the most transparent industries in the U.S., so communicate often with your shareholders. A lack of communication and transparency leads to mistrust and misalignment of interests. If the bank is private, then a quarterly newsletter with summary financials should be included, along with book value per share and market value per share, if known or done by a third party. At minimum, book value per share should be provided.

Market for stock
If the bank is public, this is not much of an issue, but privately-held banks need a market of some kind. The bank should get a valuation once a year, and engage a third party to make a market in the stock or facilitate communication between shareholders with knowledge of last trades.

Pricing is important. If you have your private bank stock selling for tangible book or less, an enterprising shareholder may seek to put the bank in play for control value.

If the private bank stock is selling at 1.5 to 2 times tangible book value, it makes it much more difficult to put it in play, and most shareholders feel thankful for the rich minority valuation. Valuation can be very important as a strategy for independence.

Types of shareholders
When adding shareholders during a capital raise, consider their investment horizon, type, and propensity for involvement and activism. An ongoing assessment of these qualities is very important.

Generational transfers can change all these goals, and if the bank’s management and board are not prepared for these different investment goals, it can be a shock.
Private equity funds are short term, focused on internal rate of return (IRR) and controlling, or at least heavily involved, as investors. Some institutional investors are passive and long term. Some are very familiar with long-term community bank investing, and some are not.

Local, long-term community-based individuals can make wonderful investors but can present problems as well. A good investment banking advisor will categorize these diverse investor types and offering type situations, and analyze them with the bank.

Inquiring shareholders
When a shareholder asks about performance, liquidity or selling the bank, your first reaction is key to setting the tone. You should always take a meeting, listen and politely consider your response.

This will probably be a two-meeting process. Two things to make certain: Don’t bring your lawyer and investment banker to the initial meeting, and certainly don’t ignore the shareholder.

Bringing the bank’s lawyer and investment banker, and ignoring the shareholder are two responses by management teams and boards that have things to hide. Attorneys and investment bankers may provide you counsel and advice but need not participate in the initial meeting.

The bottom line
Hold an annual or semi-annual meeting at your bank to address potential shareholder issues. Frequently, too little importance is placed on all constituent groups involved in the success of the bank and its future.

The management team and the board can and should be steering toward a successful future for their bank, and doing so with satisfied shareholders.

Twelve Steps for Successful Acquisitions

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acquisition-11-21-18.pngOftentimes bankers and research analysts espouse the track records of acquisitive banks by focusing on the outcomes of transactions, not the work that went into getting them announced. As you and your board consider growing your bank franchise via purchases of, or mergers with, other banks, consider these steps as a guideline to better outcomes:

  1. Prepare your management team
    Does your team have any track record in courting, negotiating, closing and integrating a merger? If not, perhaps adding to your team is warranted.
  2. Prepare your board
    Understand what your financial goals and stress-points are, create a subcommittee to work with management on strategy, get educated about merger contracts and fiduciary obligations.
  3. Prepare your largest shareholders
    In many privately held banks there are large shareholders, families or individuals, who would have their ownership diluted if stock were used as currency to pay for another bank. It is important to get their support on your strategy as the value of their holdings will be impacted (hopefully positively) by your actions.
  4. Prepare your employees 
    While you cannot be specific about your targets until you need to broaden the “circle of trust,” let key employees know that their organization wants to grow via purchases. They will deal with the day-to-day reality of integration, get them excited that your organization is one they want to be with long-term.
  5. Prepare your counsel
    Just as some bankers focus on commercial or consumer loans, some law firms focus on regulatory matters, loan documents or corporate finance. Does your current counsel have demonstrated experience in merger processes? In addition, your counsel should help to educate your Board about the steps required to complete a transaction.
  6. Prepare the Street
    We have seen in recent months several large bank acquisitions announced where the market was unpleasantly surprised; a bank they viewed as a seller suddenly became a buyer. Some of these companies have since underperformed the broader bank market by 5 to 10 percent. If it has been several years between acquisitions, prep the market beforehand that you might resume the strategy. BB&T recently laid parameters for going back on the acquisition trail. And while their stock was down some on the news, it has since more than recovered.
  7. Prepare your IT providers 
    Most customers are lost when you close your transaction by the small annoyances that come with a systems conversion. Understand if your current core systems have additional capacity or begin to get systems in place that can grow as you grow.
  8. Prepare your regulator(s)
    Whether it is the state, the FDIC, OCC or the Fed, they generally do not like surprises. Get some soft guidance from them on their expectations for capital levels and growth rates. Before you formally announce any merger, with your counsel, give the regulators a courtesy heads-up.
  9. Prepare your rating agency
    If you are a rated bank, think about your debt holders as well as equity holders, especially if you need access to acquisition financing. Share with them the broad plan of growth and your tolerances for goodwill and other negative capital events.
  10. Prepare your financing sources
    Do you have a line-of-credit in place at the holding company that could be drawn to finance the cash portion of acquisition consideration? Have you demonstrated that you can fund in the senior or subordinated debt markets, perhaps by pre-funding capital? Are there large shareholders willing to commit more equity to your strategy?
  11. Prepare your targets
    If the Street does not know, and your shareholders do not know, and your bankers and lawyers do not know, then the targets you might have in mind also will not know you are a buyer. Courting another CEO is a time-consuming process, but completely necessary and should be started 12-18 months before you are in the position to pull the trigger. Your goal is to be on their “A” list of calls, and have the chance to compete, either exclusively or in a controlled auction process.
  12. Prepare to walk away 
    After you have done all this work, it is easy to get “deal fever” when that first process comes along. Sometimes you need to recognize it is a trial run for the real thing and be prepared to pack your bags and go home. The best deal most companies have ever done is the one they didn’t do.

A Roadmap for Productive Board Discussions

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bank-board-10-11-18.pngYou can’t drive a car to a new destination without a roadmap, and a board can’t conduct a productive meeting—and ultimately, effectively oversee the organization—without a well-thought agenda that keeps meetings focused on discussing what’s important, and helping the board stay proactive on the potential opportunities and threats facing their bank. What’s placed on that agenda, and when it’s discussed, differs a bit from bank to bank. But there are several issues that should be on every agenda, and some that should be addressed regularly, albeit less frequently.

At every meeting
Bank board agendas don’t differ from a standard corporate agenda in many respects. There should be a call to order, review and approval of minutes from the previous meeting, and a review of reports.

For a bank, every meeting should include a review of financial reports, with the chief financial officer on hand to address questions and discuss items in detail. Directors will also want to review loan reports, at which point the board will typically hear from the senior loan officer. Reports from the committee chairs should also be heard at every board meeting.

New business will include updates on strategic initiatives, including milestones and progress. Actions taken by the bank to address regulatory concerns should also be addressed, though how frequently this item appears on the agenda will depend on how much hot water the bank is in with its examiners. Trends impacting the growth and financial performance of the bank should also be discussed.

Old business should also be addressed in the agenda, and it’s an area often overlooked by banks, according to Bob Brown, a managing director at Kaplan Partners and board member at $84 million asset County Savings Bank in Essington, Pennsylvania. He previously spent 40 years at PwC. If management was instructed to take a certain action, or the board decided it would circle back to an issue, those matters shouldn’t be dropped.

Regular items to address
Risk, cybersecurity and technology are top concerns for bank boards, but directors are split on how often these topics need to be discussed by the full board. Twenty-six percent of respondents to Bank Director’s 2018 Risk Survey said their board discusses cybersecurity at every meeting, compared to 37 percent who do so quarterly. Half of the respondents to the 2018 Technology Survey said their board discusses technology at every meeting, compared to 37 percent who cover the topic quarterly.

The board should discuss management and incentive compensation semiannually, advises Brown. And don’t forget the auditors: Internal auditors should address the board semiannually, and external auditors annually.

Board education should be woven into the agenda at least quarterly, and should cover a variety of topics relevant to directors’ level of expertise as well as any ongoing regulatory, economic or competitive concerns. Regularly bringing in outside experts can also stimulate productive dialogue among board members.

Every year, the board should review board and committee charters, as well as key policies and loan loss reserves. The makeup of the board should also be assessed annually, using a board matrix or evaluation, or both. A board matrix is a grid that lists all the directors on one axis, and the skill sets and attributes needed on the board on the other. This check-the-box-style exercise can be an easy way to identify gaps where additional expertise is needed.

Strategic planning should occur annually and will drive the agenda by setting the priorities that the board will want to follow up on throughout the year. “That then drives what senior management does,” says Jim McAlpin, a partner and leader of the financial services client service group at the law firm Bryan Cave Leighton Paisner. Does the bank need to renew its contract with its core vendor, or seek another solution? Does it make sense to build a new branch? These decisions should be fueled by the strategic plan. “It’s good to take stock, set direction and plan, and then over the course of the next year refer back to that plan and refer back to the priorities when engaging with the CEO,” he says.

McAlpin recommends that strategic planning take place off site if possible, with the board spending a half day or day talking about the bank’s strategic direction.

The board chairman—or the lead director, if the chairman is not independent—often develops the agenda, with input from the chief executive. Committee chairmen should also weigh in to ensure those areas are addressed. Individual directors should feel welcome to contribute to the agenda, and there should be room to speak up during meetings. “A good agenda should include a line item in which the chair asks if there are any additional matters the directors think should be addressed,” says McAlpin.

An annual discussion that sets the agenda for the year—tied to the strategic planning session—can help boards better drive what’s on the agenda, says Brown. The governance and nominating committee can then take that conversation and finetune the scope of the board’s agenda for the year, with input from the board before it’s finalized.

Getting the right input
It’s important to hear from other members of the management team and ask questions directly of the heads of the respective areas of the organization, rather than relying on one source—the CEO—for that information. Ideally, the board should hear from the CFO at every board meeting to address financial matters. The heads of legal, compliance, human resources and information technology should also be available to address their areas of expertise, when needed. McAlpin recommends asking open-ended questions to gain their perspectives and address any of the board’s concerns. “If I were a board member, I’d rather [their answers] be unfiltered,” rather than through the CEO, he says.

Brown also recommends that the board hear from business line leaders at least annually, to better understand these important areas of the business.

Aside from better understanding the bank, it’s important for the board to understand the depth of the management team. “Perhaps the most important role a board has is selecting and evaluating the CEO,” says Brown. “Succession planning is a key responsibility, and understanding the management team’s depth, strengths and weaknesses of management team members, and having the chance to see them in action … is really important.”

Independent directors should also make time to discuss issues without management present, in an executive session, advises Brown.

Facilitating effective discussions
The board agenda will structure the discussion, but it’s on the board to ensure those discussions are fruitful. First and foremost, materials should be provided in advance, so directors have time to prepare.

Remote participation has become more common as technological solutions like web conferencing make this option easier and can be a good way to attract younger candidates with diverse backgrounds, who may still be building their careers, to the board, says Dottie Schindlinger, vice president at Diligent. But make sure discussions are secure. Don’t reuse the same conference call number and passcode every time—this can easily be accessed by a disgruntled ex-employee, for example, who then gains access to sensitive conversations. And directors shouldn’t use their personal emails to discuss board matters. Web portals, such as that offered by Diligent, can help boards store and access information, and communicate safely.

Remote attendance can have its disadvantages, and there are always directors who tend to dominate a discussion. An effective facilitator—usually the chairman or lead director—will overcome these hurdles and ensure everyone’s voice is heard. Pointed, open-ended questions can help engage introverted board members. Making sure one director speaks at a time cuts out crosstalk and helps remote directors understand what’s discussed.

McAlpin emphasizes that it’s important to have an actual discussion—not just directors passively listening to what the CEO has to say, or other members of management, or the committee chairs. And this underscores the need to assemble a strong board. “Some of the most effective CEOs, I’ve found, are those who purposefully build a strong board—a board consisting of board members with a range of strong experience, good insight and a willingness to share feedback and make suggestions,” he says.