Regulatory Scrutiny Focuses on Inadequate Strategic and Capital Planning


capital-planning-9-24-15.pngOnce again, regulators are zeroing in on inadequate strategic and capital planning processes at many community banks.

The Office of the Comptroller of the Currency (OCC) listed “strategic planning and execution” as its first supervisory priority for the second half of 2015 in its mid-cycle status report released in June. That echoes concerns from the latest OCC semiannual risk perspective, which found that strategic planning was “a challenge for many community banks.”

FDIC Chairman Martin J. Gruenberg said in May that regulators expect banks “to have a strategic planning process to guide the direction and decisions of management and the board. I want to stress the word ‘process’ because we don’t just mean a piece of paper.”

He said that effective strategic planning “should be a dynamic process that is driven by the bank’s core mission, vision and values. It should be based on a solid understanding of your current business model and risks and should involve proper due diligence and the allocation of sufficient resources before expanding into a new business line. Further, there should be frequent, objective follow-up on actual versus planned results.”

In writing about strategic risk, the Atlanta Federal Reserve’s supervision and regulation division said that “a sound strategic planning process is important for institutions of all sizes, although the nature of the process will vary by size and complexity.” The article noted that the process “should not result in a rigid, never-changing plan but should be nimble, regularly updated (at least annually) and capable of responding to risks and changing market conditions.”

Given economic changes and increased market competition, community banks must understand how to conduct effective strategic planning. This is more important now than ever, says Invictus Consulting Group Chairman Kamal Mustafa.

The smartest banks are using new analytics to develop their strategic plans— not because of regulatory pressure, but because it gives them an edge in the marketplace and a view of their banks they cannot otherwise see, Mustafa said.

Strategic planning is useless without incorporating capital planning. The most effective capital planning is built from the results of stress testing. These critical functions—strategic planning, capital planning and stress testing—must be integrated if a bank truly wants to understand its future,” he said.

He advises banks to use the same fundamental methodology for both capital planning and strategic planning, or else they will run the risk of getting misleading results. This strategy is also crucial in analyzing mergers and acquisitions.

OCC Deputy Comptroller for Supervision Risk Management Darrin Benhart also advises community banks to use stress testing to determine if the bank has enough capital. “Boards also need to make sure the institution has adequate capital relative to all of its risks, and stress testing can help,” he said in a February speech. “We also talk about the need to conduct stress testing to assess and inform those limits as bank management and the board make strategic decisions.”

Why Your Bank Should Have a Capital Plan


strategic-planning-7-24-15.pngThree significant events have altered expectations for capital plans. First, as of January 1, 2015, banks need to comply with the new BASEL III capital requirements, including the new “capital conservation buffer.” Second, regulatory authorities now view strategic planning and capital planning as risk appetite and risk mitigation documents, respectively. Finally, the demise of the market for trust preferred securities has reduced the ability to raise just–in–time capital, which was a prevalent concept from 2005 to 2009.

Every board should ask the hard question of whether or not the depository institution has sufficient capital to (1) address BASEL III regulatory requirements, (2) navigate the current economic environment, and (3) implement the desired strategic plan for the depository institution. If the answer is no, management should focus on how much capital is needed, and the board and management should determine the sources for funding those needs.

Even if you currently have a capital plan, it may not “chin the bar” with the regulators. Traditional two–page or five–page capital plans are falling short of what regulators expect to see in capital plans. Such plans are now becoming much more robust and are truly a management planning tool rather than simply something that is “nice to have.” A strong capital plan is a critical document, as it ensures that there is enough fuel to drive the bank’s strategic plan and ensures that there is adequate insurance against the bank’s risk profile. Every depository institution, even healthy depository institutions, should have a comprehensive capital plan that dovetails with its strategic plan and its enterprise risk management plan.

The regulatory agencies are clearly steering institutions away from the concept of just–in–time capital that resulted in many depository institutions finding trouble in 2008 and 2009. Some regulators have even hinted that a comprehensive capital plan may soon be an integral part of the safety and soundness examination process, perhaps showing up as an element in the capital or management component of the CAMELS–rating system. Some of our clients have already received questions in this regard in light of upcoming regulatory examinations, so it is likely a trend that will only continue to become more frequent and ultimately a requirement.

The breadth and depth of a comprehensive capital plan will, of course, depend on the risk profile of the depository institution. While there is no magic outline for a capital plan, almost all capital plans should have a few critical components: (a) background on the depository institution’s strategic plan, operations, economic environment and current capital situation, (b) tolerances and triggers, (c) alternatives for available capital, (d) perhaps a dividend policy and (e) financial projections.

The tolerances and triggers may be the most important part of the capital plan, as this is how the institution will avoid needing just–in–time capital. The identification of tolerances and triggers operate as an early warning system to alert management that capital may become stressed in the near future. Careful planning should take place when considering what the tolerances and triggers will be, as these are the key drivers in making the capital plan a true planning tool.

In summary, capital planning is an important, if not necessary, tool for any depository institution, regardless of condition. There is a growing sea change in how the regulators view the necessity of a capital plan, and a growing expectation that every depository institution have a viable capital plan. It is important to note, however, that there is no one–size–fits–all capital plan that can be pulled off of a shelf as a form document. Instead, the plan should be carefully considered and evaluated, either as part of the institution’s strategic plan or as a separate plan working in tandem with the strategic plan. Finally, after it is prepared, the capital plan cannot simply sit on the shelf, but should instead be treated as a living, breathing document that will need to be revised as the economic and regulatory environment, risk profile, strategic direction and capital resources available to the institution change over time.

Ownership Succession for Family-Owned Banks: Building the Right Estate Plan


4-15-15-BryanCave.pngFor a number of community banks, the management and ownership of the institution is truly a family affair. For banks that are primarily controlled by a single investor or family, these concentrated ownership structures can also bring about significant bank regulatory issues upon a transfer of shares to the next generation.

Unfortunately, these regulatory issues do not just apply to families or individuals that own more than 50 percent of a financial institution or its parent holding company. Due to certain presumptions under the Bank Holding Company Act and the Change in Bank Control Act, estate plans relating to the ownership of as little as 5 percent of the voting stock of a financial institution may be subject to regulatory scrutiny under certain circumstances. Under these statutes, “control” of a financial institution is deemed to occur if an individual or family group owns or votes 25 percent or more of the institution’s outstanding shares. These statutes also provide that a “presumption of control” may arise from the ownership of as little as 5 percent to 10 percent of the outstanding shares of a financial institution, which could also give rise to regulatory filings and approvals.

Upon a transfer of shares, regulators can require a number of actions, depending on the facts and circumstances surrounding the transfer. For transfers between individuals, regulatory notice of the change in ownership is typically required, and, depending on the size of the ownership position, the regulators may also conduct a thorough background check and vetting process for those receiving shares. In circumstances where trusts or other entities are used, regulators will consider whether the entities will be considered bank holding companies, which can involve a review of related entities that also own the institution’s stock. For some family-owned institutions, not considering these regulatory matters as part of the estate plan has forced survivors to pursue a rapid sale of a portion of their controlling interest or the bank as a whole following the death of a significant shareholder.

To preserve the institution’s value, significant shareholders should consider the regulatory and tax consequences associated with their estate plans. Here are some issues to consider:

  • Combined family ownership interests. A significant shareholder should consider not only her own stock ownership, but also that of her immediate family, when determining if any bank regulatory issues may apply. For purposes of the various statutory thresholds for determining control, ownership of immediate family members, including grandparents, siblings, and children, can be aggregated, leading to unexpected presumptions of control.
  • Types of estate planning entities. For many larger estates, a variety of estate planning vehicles can be involved, including revocable and irrevocable trusts, testamentary trusts, family partnerships, charitable trusts and other charitable entities, such as private foundations. However, federal regulations only provide a narrow “safe harbor” from the requirements of the Bank Holding Company Act, which has led to a number of estate planning structures being unexpectedly classified as bank holding companies.
  • Impacts to S corporations. Many family-controlled banks have elected to be taxed as S corporations in order to allow the institution’s earnings to be distributed to shareholders more directly. Estate planners should consider any barriers to transfer under an applicable shareholders’ agreement, especially if the owner contemplates transferring stock to an entity that is an ineligible shareholder under S corporation rules.
  • Corporate governance issues. Individuals that own a controlling interest in a financial institution should consider the impact of his or her death on the governance of the institution until the estate is settled and the shares transferred to new owners. If the controlling shares are unable to be voted due to an estate or trust dispute, governance tasks for the bank, such as holding an annual meeting or approving a merger, can be held in limbo. As a result, the appointment of capable and responsible executors and trustees is a critical step in any estate plan.
  • Strategic planning. Significant shareholders should consider the desires of the next generations when formulating an ownership succession plan. While some family members may have a desire to manage the bank in the future, others may simply desire liquidity or have other investment goals. Considering these desires and determining how an estate plan may affect the strategic plan of the institution can preserve value for the controlling family, the institution, and minority shareholders.

Family-owned financial institutions are built over a lifetime and the regulatory and tax issues associated with an ownership transfer can be mitigated with careful planning. Regardless of whether a family intends to transition active management to the next generation or to simply pass down the full value of their shares to their relatives, constructing a plan that considers the family’s goals, in addition to regulatory and tax matters, is essential.

How Not to Waste Your Time in Strategic Planning


1-28-15-Naomi.pngBank boards are starting to take strategic planning seriously. The industry has returned to a modest level of profitability, and the boards at many small banks are wondering what the future holds for their institutions in an age of low interest rates and high levels of government regulation.

For many, the 4 percent or 6 percent return on equity that their bank promises to earn is not enough. Or perhaps the board managed to survive the financial crisis and many members are now ready to cash in their shares. Whatever the cause, more boards are asking about the value of remaining an independent entity versus selling or acquiring another bank, said investment bank Austin Associates Managing Director Craig Mancinotti, a speaker at Bank Director’s Acquire or Be Acquired Conference Tuesday in Scottsdale, Arizona. More than 800 people attended the three-day conference at The Phoenician hotel.

One of those who attended the conference is Arthur Johnson, chairman and chief executive officer at United Bank of Michigan in Grand Rapids, Michigan. Johnson is interested in starting a formal strategic process, with an independent moderator and an in-depth assessment of what the board’s goals are, now that many members of the closely-held bank board are over the age of 60. Most of the bank’s ownership lies with one family.

“I think the process has to become a little more formal than it has been in the past,’’ Johnson said. “I have a way of taking over meetings. Everybody knows my opinion counts but I have a hard time not letting my views come out first.”

When Austin Associates moderates a strategic planning retreat, each member of the board fills out in advance a brief S.W.O.T. analysis of the bank, which stands for strengths, weaknesses, opportunities and threats. Each member also lists the critical strategic issues facing the bank. To find out exactly what the board thinks and wants, Mancinotti recommends that management be excluded from the strategic planning sessions. Management’s input is still sought outside the sessions, but a director-only strategic planning session “is the best way to have unfiltered opinions,’’ he said.

As an introduction to the strategic planning retreat, Mancinotti gives a 30-minute to 45-minute overview of the economic and M&A environment, and he compares the bank’s performance to peers. That’s important so everyone is on the same page as to how the bank is performing. The board strategic planning session usually lasts six to eight hours, with a focus on developing key strategic priorities that management can then turn into a detailed action plan. The bank might need only two or three action items under each strategic priority, and all the different department heads should be involved in developing the action plan.

In order to make the goals a reality, the board should provide direction to management on how often, and when, management should report back to the board with progress toward the action items. It might be several times per year. “We are a big believer in reviewing [your strategic plan],’’ said Richard Maroney, Jr., managing director at Austin Associates in Toledo, Ohio. “You shouldn’t come up with a three-year plan and not look at it again for three years.” 

The bank’s M&A strategy should be a part of the strategic plan, and regulators should be informed in advance of the bank’s strategy. Regulators, just like shareholders, don’t like to be surprised. That should make the M&A approval process smoother.

If an acquisition is your goal, an investment banker can help the board identify a list of potential targets. Not all banks use an outside advisor for help with strategic planning, fearing that the advisor’s views will color the outcome. But regardless, the chief executive officer, not an investment banker, should make the first contact with potential targets and begin informal discussions. In fact, the board should understand that its role in the M&A process is to guide strategy, not initiate negotiations outside the board room.

Another good practice is to conduct a training session for the board to prepare for M&A. Is your board ready if it got an offer tomorrow? What if your number one target suddenly becomes available? An investment banker should be able to walk you through a hypothetical scenario. 

“You could waste a week just figuring out who has the authority to start the discussion,” Maroney said. “The first thing you should ask is: Are we ready to do M&A? What holes do we need to fill to be successful?” 

In the end, strategic planning can be a useful and productive exercise, as long as there is follow up and management knows to take the planning document seriously. 

Strategic Thinking: It Has Never Been More Critical


5-19-14-wipfli.pngStrategic planning has never been more critical to the continued success of any financial institution. After all, the financial services environment continues to be extremely challenging, and these are no ordinary times. Many institutions are thinking about a rebirth in strategy as they get back to the basics and focus on their core business model. As you approach your forthcoming strategic planning initiatives, you will need to focus on several external and internal themes that demand attention and require ongoing, fluid strategic solutions.

Key External Themes to Keep in Mind

  1. A “wave of consolidation” is expected to accelerate. If your financial institution is going to be a survivor, how will you compete successfully? What does that portend for strategy?
  2. The core business model should be examined to decide what strategies will maximize shareholder value and ensure a return on investment. There is a limit to how far expense reduction and recapturing loan-loss provisions can boost industry earnings. At some point, profitability must come from the ability to grow revenue. Margin is not likely to come roaring back, efficiency ratios have remained relatively flat and the increasing regulatory burden and new delivery channels have added to expense. The supposed lower cost of electronic/mobile delivery has not hit the bottom line.
  3. The ultimate challenge is to identify the source of tomorrow’s profitable growth. What markets are growing? Which niches within those markets should the bank target? What are the habits of your customers? What role should technology play?
  4. Regulatory reform has changed the game. At the end of the day, it’s still about our ability to manage risk within a complicated, complex web of regulation.
  5. A distinctive competitive advantage needs to be ensured. Simply put: Why do customers choose your bank?
  6. The key to success is to focus and to prioritize. Reaffirm what your institution does really well and build the strategic direction on core foundational strengths and on the most significant opportunities. Motivated execution of strategic priorities equates to sustained bottom line performance. Implementation and execution of a well-developed strategic plan will significantly enhance earnings.

Key Internal Themes to Keep in Mind

  1. Strategic planning should result in sustained bottom line performance and should be the highest yielding annual investment a financial institution makes.
  2. The planning process has a defined purpose: To help an organization focus its energy on clearly aligned goals and to assess and adjust strategic direction as appropriate in a dynamic, rapidly changing environment.
  3. The process must be customized to meet the unique needs of each organization. A “cookie cutter” process or “glorified budgeting” meeting will not produce forward-looking strategies, nor will it maximize shareholder value.
  4. Strategic planning requires discipline and a focused, productive planning meeting where questions can be raised and assumptions tested. The leadership challenge is always about making choices. As we frequently say, “If you emerge from a planning session ‘exhausted…but invigorated,” you have likely had a successful session that propelled needed action and a renewed commitment to aligned results.
  5. Organizational structure needs review. Look forward, not backward. Pretend you are starting from scratch. Reaffirm what works and what does not work for your organization.
  6. Leadership does matter. In fact, it is all about the “M.” The quality of management is probably the single most important element in the successful operation of a financial institution. Proactively assess the talent within your organization. Develop a deeper culture of accountability that rewards implementation, execution and sustainable high performance.
  7. Board governance has never been more important. It has never been more challenging to find competent, qualified directors willing to assume the personal risk associated with being on a board.

The Outlook

All components of your strategic plan should align with the strategies the bank needs. Even if you have a well-crafted strategic plan, that is not enough. All critical issues must be addressed in an executable plan implemented within a well-led culture of accountability.

Difficult times can be an opportunity in disguise. On the other side of most challenges lie great opportunities. To survive and flourish, financial institutions must exploit the current opportunities—carefully, deliberately, and thoughtfully.

Making Outsourcing Work for Your Bank


With increased regulatory compliance demands, many financial institutions are looking to relieve the pressure by outsourcing their non-core functionality. In this video, Beth Merle of Sutherland Global Services provides insight into which services can be outsourced, how much banks can save and the best way to hold providers accountable.


Strategic Planning for Bank Boards: Proactive Governance in the New Regulatory Environment


planning.jpgSweeping new regulations and unprecedented scrutiny of the banking industry have combined to place a greater emphasis on the role of boards of directors in the leadership of banks. Although the board’s primary responsibilities have not changed—to maximize shareholder value and to hire, compensate and supervise qualified management—there is now a greater need to address these responsibilities within the context of a well considered strategic plan.

Many bank boards primarily employ a month-to-month approach to the oversight of their institutions, which can result in heavy reliance on bank management to chart the strategic course of the bank. It is valuable for a board occasionally to set time aside to take stock of the bank’s strengths, weaknesses and opportunities, and then proactively engage in a process of determining the strategic goals and direction for the bank. This gives the board a frame of reference within which to measure the performance of the bank going forward, and it will give management a clearer sense of the goals to be pursued and how aggressively to pursue them.

In our experience, directors can be skeptical of the benefits of strategic planning sessions – their enthusiasm dampened by visions of a day spent listening to consultants equipped with PowerPoint decks and sharing the latest buzz words. Too often, such sessions focus on tactical, not true strategic, issues. We recommend that board members be included in preparation for the planning session, in an effort to make the session more relevant to them and to foster a sense of ownership of the process. One approach is to seek input from the directors through short questionnaires in which they can describe their vision for the bank’s future, share their thoughts and analysis regarding the bank’s performance and its strengths and weaknesses, and indicate their preference of strategy for maximizing value to the bank’s shareholders. Such questionnaires are valuable in sharpening the focus of the strategic planning session.

A well crafted strategic plan is only as good as the people who will implement it. Since it involves future plans, the board should consider the depth, quality and enthusiasm of the bank’s senior management team. The question to be asked is do we have the right people to accomplish our goals, and are they in the management roles which are best suited for their skill sets, personalities, and energy levels? The board’s analysis should not be limited to senior management, but should also include the board members themselves. There has never been a more demanding time to be a bank director. Gone are the days when three or four members of a ten-person board can, or should, be expected to fill the gaps created by inattentive or non-involved board members. Good strategic planning will result in goals and objectives for the key people as well as for the organization.

A detailed description of best practices for a strategic planning session is beyond the scope of this brief article, but we have two suggestions for topics to begin the planning session and to lay the foundation for a productive strategic discussion:

  • Orienting the Board to the “New Normal.”  In order to formulate a viable strategic plan, it is helpful for the board members to have an informed appreciation of the overall environment in which the bank is operating. This should include an overview of the developing regulatory environment, a description of how the bank’s local and regional market areas are performing, and a description of how the bank is performing relative to its peers. Consider bringing in a trusted professional to provide this information, as the impact on the board can often be greater from an outside assessment. Providing this baseline information should also lessen the chance that anecdotal or speculative information shared by a board member will take the planning discussion off track. Such a presentation might also include information on the lower expectations for stock price and acquisition multiples in today’s market, which may come as a surprise to some board members.
  • The Threshold Question. The threshold question to be addressed in strategic planning is the board’s general vision for the bank’s future. Does the board think the bank should “buy, sell or hold” in the near to intermediate term? The answer to this threshold question can drive the direction of the discussion, and lead to more fruitful and specific conversation in the planning session. For example, if the board believes the bank should be positioned for sale, management will need to be careful about entering into new long-term contracts or commitments. If, on the other hand, the board believes the institution should position itself as an acquirer, steps will need to be taken to ensure sufficient capital. Care should be taken in this threshold discussion to engage the full board in the conversation. Almost everyone will have an opinion on this topic, and they should be encouraged to share it with the group.

In our experience, there is no magic formula for successful strategic planning. Each bank board is different because it consists of a unique collection of individuals. We suggest that you tailor your board’s strategic planning session to the needs of your bank and the desires of the board. The important part, as in beginning an exercise program, is to take the first step.  Schedule a strategic planning meeting, get input in advance from board members, and make sure you address the most important issues facing your bank. Be proactive in planning for your bank’s future and for securing a worthwhile return for its shareholders.

The Board’s IT Check-Up


tech-health.jpgAt the conclusion of Bank Director’s recent board compensation survey co-sponsored with Meyer-Chatfield Compensation Advisors, we followed up with some of our respondents who reported being overwhelmed by information technology concerns. Directors have the responsibility of ensuring their banks are keeping up with IT threats and safeguards, but for some, keeping on top of IT to the satisfaction of regulators is becoming increasingly frustrating and time-consuming. 

Paul Schaus, president of CCG Catalyst, a consulting firm that works with banks in regulatory compliance and technology planning, spoke with Bank Director about what directors should be considering when handling IT at their bank.

BD: What is changing about the board’s IT responsibility?

Boards are in some aspects in a transition phase. Now the regulators want them to have more oversight and know more what’s going on because they are legally responsible.  Just having a community member on the board isn’t the only requirement.  Having somebody with expertise to bring to the table is becoming more of a factor in banking.

So what you are seeing is more diversification of knowledge because directors are responsible for that oversight. You’ve seen the change in the larger banks.  It’s slowly working its way down.

The board has to do what is reasonable based on its size, where it’s located, and its infrastructure. The problem is that the regulations are written in more of a vacuum. Regulators get under pressure like anybody else. 

BD: What are some steps boards can take to address this change?

It’s healthy for a board to evaluate itself, to say, ‘Do we have the right people and do we need to bring some more people on the board?’  If a director can’t add anything to the board, and you can’t train him because he’s not a finance guy or a tech guy, a regulator could look at that as the board having poor judgment. 

So do your due diligence, listen to the experts, and when you don’t know, go get outside advice.  There is nothing wrong with saying, ‘we don’t know and we need outside help.’  Make sure what you are doing is not putting too much stress or risk on the bank itself, including the directors personally.

If I was sitting on the board of a bank, from my perspective, I would look at my personal risk.  That’s how you have to look at things. If a board member doesn’t feel comfortable about something, his view should be voiced.  The last thing you want is to have a regulator come in and talk to your board and the regulator makes a comment, ‘you do understand?’ and someone says, ‘no, I don’t.’  The regulator knows you didn’t know what you were doing when you approved something in the first place.

BD: What should boards be cautious of when taking a more proactive role in IT?

Some boards really go beyond what the rules require, and they create subcommittees that are technology oriented.  The [chief information officer] will work with that subcommittee heavily. There’s nothing wrong with banks that are getting more involved; it’s just that it can lead to some micromanagement issues.  There is a line. If the directors are going to start micromanaging the bankers, then do they have the right people in the right positions?

The board has to rely upon the expertise of the people that are working at the bank, and if that expertise is not there, then they have to question if they have the right people.  That’s the board’s responsibility. 

BD: Could you leave us with some questions directors need to be asking about IT?

Yes. Here they are:

  1. Are we confident we have a clear and viable IT strategy that supports our business strategy?
  2. Are we making capital investment decisions about technology proactively or reactively?
  3. Is our technology strategy customer-centric?
  4. Are we making measurable and sustainable progress toward integrating our IT at the enterprise level, or are we still predominantly a silo-focused organization?
  5. Is our technology usage moving us measurably and sustainably toward greater operating efficiency?