Bryan Cave Leighton Paisner was pleased to partner with Bank Director on their first annual Governance Best Practices Survey. In my work with boards of directors over the years I’ve found that the most effective tool can be reference to what other well run companies are doing. Best practices are important in every industry, but of particular importance in the banking industry. I believe the information in this year’s survey results will be very helpful to bank boards across the U.S.
The survey focused on the areas of process, independence, oversight, composition and refreshment. You will find from reading the survey results that there is a range of approach In the banking industry to certain key aspects of board governance. For example, not all bank boards have executive committees and among those which do there is not a uniform approach to the committee’s functioning. There is also divergence of approach in whether the CEO also serves as the board chair. I tend to think that a lack of uniformity of approach in the industry is healthy. I am skeptical of those who advocate for rigid adherence to “best practices” in board governance but I agree that practices which have been effective for others can serve as a guide.
Boards are groups of people, and no two groups of people function in the same way. In my experience, the fundamental building block of an effective board Is careful selection of directors to fill roles within a board. It’s not unlike how the best coaches recruit for talent based on specific needs of the team. Too often I see board rooms with essentially the same director sitting in all of the seats. Differences in business experience, life experience and perspective among directors can greatly benefit the quality of the board’s collective insight and decision making.
In March, I dialed into the first ever “conference call only” meeting of a 14 year old community bank. The main office of the bank is located in Philadelphia and there was growing concern about the rapidly increasing number of Coronavirus cases in New York and New Jersey, and the spread of new cases into eastern Pennsylvania. I recalled that our board had reviewed an updated version of the bank’s pandemic policy in December but I couldn’t remember the details. Suddenly that policy had relevance in a way I could never have imagined. In April, our board held its second conference call only meeting, and we are likely to continue that pattern for several more months.
We are all aware of the circumstances that led to pandemic policies being retrieved from file folders and read with interest for the first time. What we don’t yet know is how severe the resulting economic shock will be, and the degree to which loan portfolios of community banks will be adversely impacted. It is clear, however, that the adverse impact on small to medium sized businesses across the U.S. has been considerable. As the CEO of one of our law firm’s bank clients in the Southwest recently remarked, we are experiencing the first ever government imposed recession.
God willing, the banking industry will remain strong and be a source of support for the nation’s economy as we recover from the onslaught of COVID-19. In that context, the boards of community banks could benefit from recalling some hard learned lessons from the recent Great Recession.
Last week my partner Rob Klingler posted an impassioned plea to the SBA and bank regulators to allow banks with less than 500 employees to be borrowers under the Paycheck Protection Program, or PPP as it has become known. Rob joined a chorus of voices across the country pointing out that community banks are small businesses too, and if the jobs of employees at a community bank can be saved isn’t that as helpful to the economy as any other small business? Unfortunately, the overhang of TARP appears to continue to cloud decisions in Washington and banks were excluded from receiving loans under the PPP. Irony drips from that decision. At the beginning of the last financial crisis, when the business fortunes of some of the largest banks appeared at risk, Washington rushed to their aid with TARP. Now, at the beginning of a financial crisis that is hitting small business hard, community banks are being told they are the only small businesses in America which must soldier on without government financial assistance.
In that context, isn’t it remarkable that small and mid-sized businesses across the country are flocking to community and regional banks for responsive assistance in the PPP process? My practice has always been a mix of corporate finance and advisory work for middle market businesses and consulting and board advisory work for banks. I like the balance and the perspective that mix brings. Over the past two weeks this view into two worlds has revealed to me the true nature of relationship banking, and the absolute commitment to that concept at most community and regional banks. My clients and contacts in the middle market business world have been frequently asking for updates on the roll out of the PPP program. That was understandable and to be expected. What I did not expect was the volume of calls I’ve been receiving for referrals to smaller banks from customers of large banks. Those calls often begin with expressions of frustration at the inability to get anyone from the larger bank on a call or even to respond to an email regarding the PPP process, and that the most frequent communication received is “you need to visit our website for assistance.” In an environment where hundreds of thousands and likely millions of small to medium sized businesses across the country are suddenly struggling, and with no sense of the near term path, it really matters to the persons running those businesses that they receive support, encouragement and, if possible, assistance from their bankers. It is in the difficult times when relationship banking really matters, not the boom times.
Bank merger activity is reducing the number of U.S. banks at a rate of about 5% per year. It’s unclear how long this pace of industry consolidation will continue. Investment bankers, who have an interest in the level of activity continuing, are often quick to counsel bank boards of directors that the merger market may never be better than it is right now. Each year, the boards of hundreds of banks decide to heed the advice of those suggesting it’s time to sell.
A decision to sell a bank is one of the two most important decisions a board addresses (the other being selection of the CEO in a succession process). The strength of a board lies in the manner in which it approaches such a decision. Some boards will have gone through a lengthy process of reaching consensus before exploring potential merger opportunities. Others will find themselves considering unexpected merger offers without first having reached consensus. Vigorous debate can be healthy and productive in the process of a board reaching the best decision for the bank and its shareholders. Regardless of the circumstances in which a potential sale or merger of a bank is being considered, it is critical that all board members have access to the same level of information and be able to provide input throughout the process.
When board members believe they have been kept out of the loop on information flow, or they haven’t been adequately involved in considering a course of action, the strength of a board is undercut. Decision making is often adversely impacted as a result. This is particularly true in connection with consideration of the sale of a bank. Throughout the process of a board investigating options and considering strategic alternatives, the board members should have confidence that they are privy to all communications of importance with both professional advisers and potential merger partners.
We have seen far too many instances in which a director, on his or her own initiative and without authorization from the board as a whole, embarks on private outreach to potential merger partners. These directors usually feel justified in such action as a result of frustration with the pace at which the full board is moving or a sense that the CEO is resistant to the idea of selling the bank. Whatever the driving force, such independent action by a director can result in a breakdown in trust among the board and rarely results in a successful merger transaction.
In this the new era of banking, our clients are continually looking for ways to enhance efficiency and effectiveness at all levels of their organizations. This line of thinking has led to the revolution of the bank branch and the adoption of many new technologies aimed at serving customers and automating or otherwise increasing process efficiency. Perhaps most importantly, however, banks have begun to focus on optimizing their governance structures and practices, particularly at the board level.
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As we discuss this topic with our clients, the conversation quickly turns to the role and function of the bank’s director loan or credit committee, which we refer to herein as the “Loan Committee.” We continue to believe that Loan Committees should move away from the practice of making underwriting decisions on individual credits absent a specific legal requirement, and here we set forth the position that this change should be made in order to enhance Board effectiveness, not just to avoid potential liability.
Ensuring Board Effectiveness
Whenever we advise clients with regard to governance, our fundamental approach is to determine whether a given course of action helps or hinders the Board’s ability to carry out its core functions. Defining the core functions of a Board can be a difficult task. Fortunately, the staff of the Board of Governors of the Federal Reserve System recently outlined its view of the core functions of a bank Board. We agree with the Federal Reserve’s outline of these functions as set forth in its proposed guidance regarding Board Effectiveness applicable to large banks, which was based on a study of the practices of high-performing boards. Based on our experiences, many of the concepts expressed in that proposed guidance constitute board best practices for banks of any asset size. The proposed guidance indicates that a board should:
set clear, aligned, and consistent direction;
actively manage information flow and board discussions;
hold senior management accountable;
support the independence and stature of independent risk management and internal audit; and
maintain a capable board composition and governance structure.
We believe that an evaluation of the board’s oversight role relative to the credit function is a necessary part of the proper, ongoing evaluation of a bank’s governance structure. As it conducts this self-analysis, a board should evaluate whether the practice of underwriting and making credit decisions on a credit-by-credit basis supports its pursuit of the first four functions. We believe that it likely does not.
Considering Individual Credit Decisions May Hinder the Committee’s Ability to Set Overall Direction for the Credit Function.
We have observed time and time again Loan Committee discussions diving “into the weeds” and, in our experience, once they are there they tend to stay there. In most Loan Committee meetings, the presenting officer directs the committee’s attention to an individual credit package and discusses the merits and challenges related to the proposal. Committee members then typically ask detailed questions about the particular financial metrics, borrower, or the intended project, assuming that any discussion occurs at all prior to taking a vote.
While it may sometimes be healthy to quiz officers on their understanding of a credit package, focusing on this level of detail may deprive the Loan Committee of the ability to focus on setting direction for the bank’s overall loan portfolio. In fact, in many of the discussions of individual credits, detailed questions about the individual loan package may in fact distract from the strategic and policy questions that really should be asked at the board level, such as “What is the market able to absorb with regard to projects of this type?” and “What is our overall exposure to this segment of our market?”
In the run up to the Fourth of July holiday, you may have missed that June 27 was the 50th anniversary of the first ATM and June 29 was the 10th anniversary of the first iPhone. I was struck by the coincidence of these two anniversaries occurring in the same week. It also caused me to revisit in my mind a concern that has been growing for some time.
During several recent bank board retreats and strategic planning sessions, I’ve witnessed the challenging dynamics that occur when leaders begin the process of “board refreshment.” Board refreshment is the current euphemism being used by consultants (and by the proxy advisory firms) to refer to the need for a closer match between the strategic goals of banks and the skill sets of board members. This need is especially apparent in the boards of many mid-sized regional and community banks.
We are living in a time of increasing change in the demographics (gender, race and age) of the customer base of banks, coupled with rapid technological developments which impact the ways in which commercial customers conduct their businesses and interact with other businesses, including with their banks. The typical board of a mid-sized regional or community bank, however, consists of men in their mid to upper-sixties who share similar backgrounds and whose perspectives were shaped during a different era for both business and banking. The concern I have is that continued adherence by banks to such board composition will result in competitive disadvantage.
I’ve been practicing law and advising banks for over 30 years, and for most of that period I don’t think it mattered as much how strong the typical community bank board was. What mattered was the strength and competency of the CEO, and it was a bonus if the bank had an energetic and engaged board of directors. I believe there is now an increasing need for stronger boards. Take a moment and consider how well equipped your board is to help guide your bank through the period of rapid change that is on the near term horizon.
In today’s competitive environment, some bank directors may view an acquisition offer from another financial institution as a relief. With directors facing questions of how to gain scale in the face of heightened regulatory scrutiny, increased investor expectations, and general concerns about the future prospects of community banks, a bona fide offer to purchase the bank can change even the most entrenched positions around the board table.
So, how should directors evaluate an offer to sell the bank? A good starting place is to consider the institution’s strategic plan to identify the most meaningful aspects of the offer to the bank’s shareholders. The board can also use the strategic plan to provide a baseline for the institution’s future prospects on an independent basis. With the help of a financial advisor, the board can evaluate the institution’s projected performance should it remain independent and determine what premium to shareholders the purchase offer presents. Not all offers present either the premium or liquidity sought by shareholders, and the board may conclude that continued independent operation will present better opportunities to shareholders.
Once the board has a framework for evaluating the offer, it should consider the financial aspects of the offer. The form of the merger consideration—be it all stock, all cash, or a mix of stock and cash—can dictate the level of due diligence into the business of the buyer that should be conducted by the selling institution.
There has never been a more challenging time to be a bank director. The combination of today’s hugely competitive banking market, increased regulatory burden and rapid technological developments have raised the bar for director oversight and performance. In response, an increasing number of community banks have begun to assess the performance of directors on an annual basis.
Evaluation of board performance is done in many ways, and ranges from an assessment by the board of its performance as a whole to peer-to-peer evaluation of individual directors. Public company boards are increasingly being encouraged by institutional investors and proxy advisory firms to conduct meaningful assessments of individual director performance. The pace of turnover and change on most bank boards is slow, and more often the result of mandatory retirement age limits than focus by the board on individual director performance. This may be untenable, however, as the pace of external change affecting financial institutions often greatly exceeds the pace of changes on the bank’s board.
While some institutions prefer a more ad hoc approach to assessing the strengths and weaknesses of the board and its directors, we suggest that a more formal approach, perhaps in advance of your board’s annual strategic planning sessions, can be a powerful tool. These assessments can improve communication between management and the board, identify new skills that may not be possessed by the current directors, and encourage engagement by all directors. If used correctly, these assessments often provide valuable information that can focus the board’s strategic plan and help shape future conversations on board and management succession.
So what are the key considerations in designing an effective board evaluation process? Let’s look at some points of emphasis:
Think big picture. Ask the board as a whole to consider the skill sets needed for the board to be effective in today’s environment. For example, does the board have a director with a solid understanding of technology and its impact on the financial services industry? Are there any board members with compliance experience in a regulated industry? Does the board have depth in any areas such as financial literacy, in order to provide successors to committee chairs when needed? Do you have any directors who graduated from high school after 1985?
Develop a matrix. Determine the gaps in your board’s needs by first writing down all of the skill sets required for an effective board, and then chart which of those needs are filled by current directors. Then discuss which of the missing attributes are most important to fill first. In particular, consider whether demographic changes in your market will make recruiting a diverse and/or female candidate a priority.
Determine the best approach to assessment. Engaging in an exercise of skills assessment will often focus a board on which gaps must be filled. It can also focus a board on the need to assess individual board member performance. Many boards are not prepared to launch into a full peer evaluation process, and a self-assessment approach can be a good initial step. Prepare a self-assessment form that touches upon the aspects of being an effective director, such as engagement, preparedness, level of contribution and knowledge of the bank’s business and industry. Then, have each director complete the self-assessment, with a follow-up meeting scheduled with the chair of the governance committee and lead independent director for a conversation about board performance. These conversations are often the most impactful part of the assessment process.
Our time is one of rapid technological and social change. The baby boom generation is giving way to a more diverse, technology-focused population of bank customers. In conjunction with the lingering effects of the Great Recession, these changes have worked to disrupt what had been a relatively stable formula for a successful community bank.
Corporate America has looked to improve diversity in the boardroom as a step towards bringing companies closer to their customers. However, even among the largest corporations, diversity in the boardroom is still aspirational. As of 2014, men still compose nearly 82 percent of all directors of S&P 500 companies, and approximately 80 percent of all S&P 500 directors are white. By point of comparison, these figures roughly correspond to the percentages of women and minorities currently serving in Congress. Large financial institutions tend to do a bit better, with Wells Fargo, Bank of America and Citigroup all exceeding 20 percent female board membership as of 2014.
However, among community banks, studies indicate that female board participation continues to lag. Although women currently hold 52 percent of all U.S. professional-level jobs and make 89 percent of all consumer decisions, they composed only 9 percent of all bank directors in 2014. Also of interest, studies by several prominent consulting groups indicate that companies with significant female representation on boards and in senior management positions tend to have stronger financial performance.
FDIC Atlanta Regional Director Tom Dujenski announced this week that he will retire from the FDIC effective May 3, 2014. Tom has held the Atlanta post since 2010 and wraps up a 30-year career with the FDIC. We wish Tom all the best.
FDIC Atlanta Deputy Regional Director Michael Dean has been announced as acting Regional Director, and is the leading candidate to be named as the permanent Regional Director. Mike has served most recently as the Deputy Regional Director for Compliance & CRA Examinations and Enforcement, where we have gotten to know him well. Through out interactions, we have found him to be a solid, experienced banking regulator. He is approachable and candid, and open to listen to problems and even help in fixing those problems in some cases. With his previous service in DC, he is also well positioned to assist the Atlanta region work with the national FDIC office. We look forward to continuing to work with Mike in his new role.
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