What Makes Activist Investors Go After Banks

activism-11-6-17.pngShareholders of public companies pushing to nominate activists in the boardroom are becoming more common. Boards of directors aren’t necessarily keen on the idea, although it’s becoming frequent enough that attitudes among board directors are becoming more accepting as they become accustomed to it.

Proxy Access Is Changing Relationships Between Directors and Shareholders
Board directors and shareholders clearly have different motives and perspectives about the demographics of board seats, especially when it comes to their views on proxy access.

Some of the larger public companies use a proxy access system. Companies that use the proxy access system typically have a governance committee or nominating committee that recruits and vets board candidates to fill the slots of board directors whose terms have ended. The board secretary prepares a proxy card with a listing of board director nominees and mails it out to the shareholders. Most share classes offer shareholders one vote per share. Shareholders can then vote for candidates on the slate by proxy or in person at the annual shareholder’s meeting, or write in a candidate of their own choosing. Activist shareholders and large shareholders favor the proxy access system because directors represent their interests and proxy access gives them a strong say in the choice of board directors.

The proxy access system is not as popular with directors as it is with investors. Board directors assess the expertise, talents, diversity and independence of boards when forming the voting slate. Nominating committees feel that they know what the board needs to help the company progress, so they should be able to select the nominees with little or no interference from shareholders.

Activism May Potentially Disrupt the Integrity of Corporate Governance
As activism begins to invade boardrooms, many are questioning other longstanding principles of good corporate governance and whether they still have meaning in today’s financial arena. For example, directors have typically had board terms that are staggered. The reason for this is to maintain some sense of tenure, history and experience on the board. In today’s climate, groups of formidable investors believe that directors should be elected every year. This approach gives shareholders the right to clean house when profit margins are lagging.

In recent decades, it has been common for directors to serve on multiple boards. Changes in the financial industry call into question whether directors who sit on many boards can truly meet the time constraints to effectively strategize and comply with the growing set of regulations. Weak boards create a climate that is ripe for activists to gain control. Large companies are prime targets for activists when they have large boards with weak skill sets and overly long-term appointments.

Procter & Gamble Is the Largest Company to Face a Proxy Fight
Procter & Gamble is one such large company that is facing the possible intrusion of an activist shareholder. Nelson Peltz is the CEO and founder of Trian Fund Management. With 3.3 billion P&G shares, Trian is one of Procter & Gamble’s largest shareholders. Trian has been dissatisfied with Procter & Gamble’s repeated poor returns. Their solution is to nominate and elect Nelson Peltz to the board of directors. As Peltz has a reputation for being a billionaire activist, the P&G board is justifiably concerned.

Trian cites many reasons for putting an activist on the board. In addition to disappointing shareholder returns, Procter & Gamble’s market share is deteriorating, and while they’ve cut some costs, the cost of bureaucracy is excessive.
Trian says that the culture of Procter & Gamble’s board is highly resistant to change, so it’s no surprise that the pressure is making them uneasy. Trian shareholders have given the board chances to improve results in the past, but their strategies have been unsuccessful. Now, Trian is insisting on the addition of a financially motivated, independent director, and they’ve chosen Peltz. Trian shareholders are not being completely unreasonable. They are offering to reappoint whichever director loses his or her board seat, once Peltz gets appointed.

Defending Against Activists
No board is exempt from the risk of a proxy fight, especially when earnings reports are not showing good results. The best defense against activism is to work at keeping performance metrics high. Companies experiencing a downturn for any reason would do well to spend time on researching which activists may have their eyes on a board seat. Knowing who is interested in joining the board will help directors anticipate what the activist wants to change and have some plans in place if a proxy fight looks imminent.

Preparing Your Bank to Fight Shareholder Activists

activism-9-25-17.pngThe financial sector has not been immune to the growth in shareholder activism seen in recent years, and certain trends have emerged that make “bank activism” distinct from other parts of the economy. Understanding these trends, the statistics underlying them and their ramifications can help determine the steps banks should take in advance to ensure the best possible outcome should a contentious engagement with an activist ever occur.

First, financial companies, particularly banks, are among the firms most frequently targeted by activists. In recent years, 21 percent of activist targets have been in the financial sector, second only to technology companies. This focus on the financial services industry has stayed relatively consistent post-financial crisis, with banks comprising the majority of these financial targets, although that may fluctuate some from year to year. Thus, as activism continues to grow, the frequency at which banks are targeted can likely be expected to grow as well.

Campaign Breakdown by Sector, January 16 – July 17


Banks as Percentage of Activist Targets


However, bank targets are significantly smaller than targets in other sectors. Due in part to the complex regulatory regime for banks versus other industries, the main driver for bank activism is to pursue a sale, a strategy usually easier to deploy at smaller companies due to the larger universe of viable buyers. Therefore, banks targeted by activists from January 2016 through July 2017 had a mean market capitalization that was 47 percent smaller than nonbank targets over the same period.

Smaller banks may have fewer resources to respond to an activist. For example, their finance, legal and IR/PR functions may be managed by just a handful of employees, meaning the time and attention required of staff, management and the board can be much bigger. In that case, distraction from the day-to-day duties of running the business can be disproportionately larger.

While activists outside of the banking sector are usually industry generalists, bank activists are normally sector-specialist investors. The majority of bank campaigns are currently undertaken by a few hedge funds that invest nearly all of their portfolios in financial companies—primarily banks—and practically all of their previous campaigns have been against banks.

Prominent Activist Investors in Banks


Therefore, these activists have extensive knowledge of the industry, the individual banks and their management teams, and most importantly the decision-makers at other institutional investors that invest in this sector. They also have a successful track record of forcing bank targets to initiate a sale, a marked difference from other sectors where an activist typically is a relatively new fund with little activism or proxy fight experience.

A bank activist may have a generally benign relationship with management and the board, and be a significant shareholder of a small-cap bank for quite some time before agitating. However, when market conditions evolve to support a possible sale, the dynamic can change quite dramatically, potentially leading to transformative change—for better or worse—within a short time. For example, Basswood Capital had been a key shareholder at Astoria Financial Corp. for more than 15 years before filing its 13D and demanding a sale of the company. Astoria capitulated just a few months later, and its acquisition by Sterling Bancorp is expected to close in the fourth quarter 2017.

These factors underscore how bank activists are both experienced and sophisticated, while their targets may be relatively less prepared to effectively respond and, if need be, protect the long-term interests of their shareholders in a public battle. As a result, bank activists are more successful than activists in other sectors at winning board seats, where they can aggressively push forward their agenda. From January 2016 through July 2017, activists were successful in getting board representation at bank targets 32 percent of the time, versus only 26 percent in other sectors.

In this environment, mid- and small-cap banks must be proactive in preparing for, and hopefully avoiding, a confrontation with an activist. First, banks must periodically assess their strategy versus alternatives an activist may demand, and effectively articulate and execute on that strategy. Although not a guarantee, the strongest defense is performance, knowing where you may be vulnerable to criticism by an activist and preemptively trying to mitigate that. Second, banks should develop an activism response plan and team, including members of management and the board, and a ‘go-to’ team of outside advisors with experience in bank activism. Finally, banks should regularly seek feedback from their shareholder constituencies, and be aware of their views on certain issues and how to resolve them. Given how suddenly an activist situation can occur, it is critical to be ready in advance.