Reclaiming Board of Directors’ Lost and Surrendered Accountabilities




As if Boards of Directors do not have enough to worry about. Between concerns over Cyber security, business model disruptions and disruptors, the US dollar and tariffs, Boards’ authorities are now being constantly challenged and undermined by the dominant proxy advisors, and mega public mutual funds. Lost and undermined are the individual investor’s voice, and U.S. public companies’ Boards’ governance duties and authorities, respectively. These fiduciaries are being overridden by two powerful consultants, and by sizeable wholesale investors.

“The proxy advisory firm duopoly is in serious need of reform and SEC attention. The market power of proxy advisory firms’ demands greater accountability for these firms’ actions and the information that they provide institutional investors,” said U.S. House Financial Services Committee Chairman Jeb Hensarling, R-Texas in Pensions & Investments. Equally in need of reform are the unfettered powers of large public mutual funds that vote their individual investors’ ownership shares according to the funds’ managers’ desires with no transparency and accountability. Mr. Hensarling and finally the SEC have directed their attention to the virtual veto powers that proxy advisers such as Glass Lewis and Institutional Shareholder Services (“ISS”) wield. These two firms control 97% of the advisory business, thus carrying a lot of weight with the SEC, and providing a pretext against investors’ lawsuits. According to The Wall Street Journal, “ISS issues recommendations on about 6,000 U.S. companies every year.“ The sheer power of these firms invites group think. Or, perhaps virtually no thinking, and just a follow-the-leader mentality?

Most recently, drug chain Rite Aid and supermarket chain Albertsons called off their prospective merger, after the all-powerful proxy adviser and large public investors nixed their seven-month-old proposed agreement to merge. This is despite compelling business reasons for the combination. Missed by the opponents are severe margin compression; the brutal competitive environment in both the drugstore and supermarket industries, and the entry of Amazon into the drug dispensing business with the acquisition of PillPack, as well as the sale of Targets’ pharmacies to the giant chain CVS. And ISS’s pretext for recommending against the Rite Aid-Albertsons combination was that the transaction would undermine Rite Aid’s share price, and that the deal “would introduce a new set of risks associated with the grocery business, and the combined leverage could limit investment in two evolving business environments, ” said ISS. Seriously? Although the objection to the transaction’s high leverage might be perfectly reasonable and understandable, Rite Aid’s very survivability as a standalone company provides a more pressing reason for the combination, as evidenced by continued losses at that chain and the sustained pressures from PBM companies.

The Rite Aid and Albertsons transaction is just one example of this emerged trend, which has accelerated and grown in the past two decades, all while neutering individual shareholders’ voting power and the very charges, accountabilities and fiduciary authorities Boards of Directors’ were granted by shareholders and regulators. If corporate management and Boards are accountable to shareholders and the SEC, to whom then are the proxy advisers firms with their oligopoly powers accountable to? Better yet, pray tell where is the transparency over the methodology utilized by these firms to make their recommendations?

The good news despite all of this is that last year the SEC started requiring these firms to register their decision-making methodology. Most recently, the SEC “waded into the dispute by rescinding a pair of roughly 15-year-old letters written by its staff. The letters had given mutual-fund managers greater assurance to rely on a consultant’s recommendations about matters up for a vote at a public company’s annual meeting,” said The Wall Street Journal. These staff 2003 and 2004 letters in fact “green lighted” the powerful influence of proxy advisers, and provided the very cover the fund managers needed to ward off potential investors lawsuits, left them vulnerable to outside influence, and relieved them of their responsibilities. Some of the credit for this recent reversal could go to the U.S. Chamber of Commerce, who has “pushed lawmakers and the SEC to quash the letters and more tightly regulate ISS and its main rival, Glass Lewis & Co.”

To the extent that the SEC’s rescission sticks, this may facilitate the expected November debates on regulation of the shareholder voting, and may force fund managers to adopt a more proactive, transparent, and widely accepted decision-making methodology.


Michael Zahaby

Bay Harbor Capital Advisors, LLC

PART III Of III: Community Banks – A Simple Formula for Thriving and Surviving

This is Part III of a three part series. Click here if you missed Part I 

Click here if you missed Part II.


In parts I and II of this three-part white paper, we explored the financial crisis landscape of 2008, and the issues that Community Banks brought on them and those brought to their door steps by all too eager politicians and regulators. [make changes from part 2] Also surveyed was the impact this excessive regulatory environment had on investment in systems and to an already competitive industry grappling with the emergence of “disruptors” such as FinTechs, and with advanced technology that deemphasized “bricks and mortars” service delivery. Part II focused on Organizational Levers, primarily the Board’s role in shaping the bank’s direction; the promotion of a strong Credit and Enterprise Risk Management (“ERM”) cultures, and the shedding of any Bank Holding Company corporate structure. Part III deals with Financial and Operational Levers.

Financial Levers

  • Large Fee Revenue Component, and Stable Deposit Stream

Aggressive loan plans and ergo heavy reliance on Net Interest Income (“NII”) to meet earning plans can only lead the bank into a treacherous territory. It’s no different than overeating. This too leads to a stomachache. By skewing the revenue line as close to an even balance between “sticky” fee income and NII, the bank can afford to say “NO” when it is warranted; and avoid decisions that require “over-stretching.” Fee revenue is also more reliable, predictable, and subscription-like. It helps mitigate economic slowdowns, retrenchment by borrowers, and/or swings in interest rate, and deposit costs. More importantly, a heavily weighted fee component is a cheaper and reserve- free cost of capital.

  • Assets & Liabilities and “Match Funding”

One of the most remarkable difficulties of the 2008 financial crisis is the seizing of money markets. Institutions that relied heavily on bought deposits, “hot” short-term money, commercial paper, etc. saw their funding sources dry up, and made meeting loan commitment difficult to sustain. “Hot money” does not mean illegal money, as much as it means unreliable, short term non-relationship depositors that flit from bank to depository institution seeking the highest short term rates returns. A bank that “gaps” the balance sheet deposit base with short, medium and long term deposit maturities insures a smoother match funding between assets and liabilities. Meaning, loan commitments’ tenors should closely if not identically match with certificates of deposits maturities funding or interest rate risk exposure

  • Razor-Sharp Efficiency Ratios

A bank cost structure is pretty simple. The larger cost is typically personnel and “bricks and mortar” infra-structure. A bank’s efficiency ratio is calculated by dividing its noninterest expenses by the bank’s net income. A low efficiency ratio indicates that the bank is earning more than it is spending. Shareholders and regulators of banks with larger than 50% efficiency ratio should be concerned about the bank’s competitive position, its long term viability and its survivability.

How does a bank maintain a healthy efficiency ratio? A balanced and focused strategy of: (i) a high Relationship to Client ratio; (ii) an ultra-efficient Omni delivery channels; (iii) a low loan loss from a disciplined credit culture as well as a diversified portfolio (CRE and C&I).  And yes, a larger fee income base that affords the bank the luxury of turning down “stretch” loans.

Operational Levers

  • Customer Focused Relationship Philosophy

The old-fashioned term “Relationship Banking” meant not only intimately knowing the customer’s business, but anticipating the client’s requirements in terms of a balanced credit and non-credit products. The relationship also ran deep to the “top of the house.” where the relationship officer made the “elephant dance,” a quaint term that was defined as “delivering the bank.”

Those banks that serviced and anticipated wholesale clients’ needs with up to date non-credit  products and low account officer turnover saw the relationship deepening, the account profitability widening, and a large defensive moat around the client.

  • Cordial Relationship with Regulators

A collaborative and cordial relationship with the regulators serves multiple purposes. First, if you/your bank periodically communicate with the regulators, they will not be surprised in case of an unexpected event. Tapping the resident examiner’s or EIC’s knowledge for valuable industry data and trends is not only valuable to the organization, but also helps avoid issues or surprises during the exam. Additionally, regulators could be helpful when a bank is in an M&A mode, since their sign-off will be required. Regulators also reach out to collaborative and well-run banks when a third institution needs to “rescued.”  Moreover and if need be, they can make accommodations to bring the transaction to a satisfactory close.

  •  Up-to-Date Technology, Systems and Relevant Competitive Product Set

Banks that invested in technology and updated systems’ platforms were generally survivors; were able to fend off competitors; had better efficiency ratios, and higher client satisfaction. And while “brick and mortar” service delivery is still important to certain demographics, millennials and others have migrated to mobile, online and electronic banking services offered by FinTech companies’ platforms and better equipped providers. Clients are looking for Omni product delivery channels. These are equally efficient for providers.

  • Private Label and Outsourcing

Banking is a cyclical industry that faces head winds every ten years or so. Moreover, community banks’ normal business travails is compounded by two additional factors, a regulatory burden that has shackled them with capital requirements, and was brought on by the 2008 financial crisis. Second, natural inefficiency brought on by their sub-optimal size with banks less than $1Bil in assets shouldering the brunt of these two factors.

The much needed investments in product development and systems require the very capital needed to grow assets and balance sheet footings. A way for the bank to offer existing and prospective clients the latest in technology and products offering is to use private label larger non competing institutions products. Institutions like Vanguard, Fidelity, T. Rowe Price  and others are only happy to offer their products to clients in return for non-compete.

Similarly, FiServe, Accenture, IBM offer bank systems outsourcing solutions that not only defrays expensive headcount costs, but heavy CAPEX requirements for state of the arts technology and MIS platforms, to include customer service.

While waiting for regulatory and capital relief, Community Banks’ Boards need to move toward an offensive posture with a process and delivery redesign, and an organizational self-evaluation. Change is unsettling; however, the environment and the ongoing disruption calls for nothing short of “call to action” toward transformational and reenergizing strategies that will ensure the organization will thrive and not merely survive in the face of the current challenges.






PART II: Community Banks – A Simple Formula for Thriving and Surviving

This is Part II of a III-Part white paper. If you missed Part I, read it here. 

In this second part, we explore the financial crisis landscape of 2008 and organizational levers for Community Banks. What issues did Community Banks bring on themselves? What did politicians and regulators lay at their doorsteps? The pendulum clearly swung in the other direction, toward overregulation. We will survey the impact this excessive regulatory environment had on investment in systems and to an already competitive industry grappling with the emergence of “disruptors” such as FinTechs, and with advanced technology that deemphasized “bricks and mortars” service delivery.

Organizational Levers

Organizational levers are the broad framework that drives and defines culture, and direction to executive management and the “troops.” Telegraphed clearly, these levers create the outer boundary of an organization’s ethos. Organizational Levers are:

  • An Insightful and Diversified Board

As a Governance Fellow of the National Association of Corporate Directors (NACD), I have learned that Directors should keep their “noses in and fingers out.” I would amend that as “noses and ears in, and fingers out.” As fiduciaries, Directors are not only the monitors of the organization’s fiscal health, but they are the keepers of the corporate culture. The term “Corporate Culture” means different things to different people. However, the culture must be in tune to the community and all the stakeholders the organization serves, to include shareholders, employees, clients, suppliers, regulators. The poor discharge of these responsibilities creates a loss of credibility, and reputation, inside and outside the organization. And there is very little that’s more precious to a bank than credibility and reputation.

In addition to the above, the emphasis  in today’s corporate boards’ echo system is on Environmental, Sustainability, Governance (“ESG”), and diversity. Environmental and sustainability concerns are impacting communities in different ways, and the organization exhibiting sensitivity to this issue is paramount. Focus on governance dials directly into an organization’s reputation and credibility as expressed earlier. And an organization concerned with governance conducts its affairs and telegraphs its processes in a transparent manner, at arm’s length and with integrity.

  • A Strong Credit and Enterprise Risk Management (“ERM”) Culture

Unlike manufacturing that enjoys Gross Profit Margins (“GPM”) of 35-55%, lending margins are 3-5%. Out of that GPM, an organization has to cover overhead, personnel, losses, regulatory costs and dividends. In addition, banks’ capitalizations are thin by nature, meaning that excessive losses borne out of too many wrong decisions would damage the franchise. This burden translates the need for a prudent credit and overall risk culture. It is not just wrong credit decisions from the “ left hand side” of the balance sheet that negatively impact capitalization, it’s poor systems and/or investment decisions, and fraud from the “right hand side” of the balance sheet too.

One of the costliest mistakes to community banks is a heavy reliance on real estate and contractors’ (a guy with a hammer and truck) loans. These by nature are cyclical businesses that are susceptible to economic cycles that impact the economy and arrive almost every ten years or so.

Aggressive loan plans in the absence of fee revenue should not drive the risk culture, which should be set, regardless of pressures, at the “middle of the fairway.”  Risks need to be understood, and taken from the context of prior experience. Venturing into alien risk territory magnifies the risk profile of an already thin margined and highly competitive business.

  • Shedding Bank Holding Company (“BHC”) Structure

Onerous BHC structures put in place to partially facilitate acquisitions bring with them extra capital, and regulatory and reporting burden, not the least of which being classified as systemically important financial institution (“SIFI”) under Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”), even if it is not a non-financial entity. Under Dodd Frank, BHCs are regulated by the Federal Reserve in addition to their normal federal (“OCC” or “FDIC”) or state oversight. This naturally adds to a Community Bank’s overall costs.

To exit and streamline the BHC structure, Community banks can easily meet the Dodd Frank three-prong test of (1) size of exposures to creditors, counterparties, and investors; (2) their de minimus effects of a rapid liquidation of assets on the markets for those assets, and (3) the extent to which these smaller banks offer critical functions or services to market participants, and for which there are no ready substitutes.


Come back next week for part 3 of this 3-part paper. We will be discussing financial and operational levers.

Community Banks – A Simple Formula for Thriving and Surviving






Bay Harbor Capital Advisors


The financial crisis of 2008 exacted a heavy toll on Community Banks nationwide. Certainly,  a good deal of the damage was self-inflicted, starting with balance sheets heavily skewed toward cyclical commercial and residential real estate assets and contractors’ exposure; insufficient investments in technology and new financial products; lethargic Boards and executive management, sloppy underwriting, coupled with thin capitalization. Congress’s heavy-handed prescription for these grave missteps was to apply a “one size fits all” onerous regulatory, capital and reporting burden on all banks, regardless of size, culpability, and cost. Banks that had no capital markets, no foreign branches, no synthetic hedging or, level III assets, or even foreign exchange activities were then expected to add to capital and reporting requirements, and deemed a systemically important financial institution (SIFI). The standard saying on capitalization requirement became “the old 6 is now the new “8”… or even 10.

The impact on Community Banks has been a wave of small banks’ mergers; disinvestments in products and technology; razor thin profitability that was compounded by the low interest rate environment; and restricted lending standards, since these now require costly reserve requirements. And now that the financial crisis is in the rear-view mirror and the outcry from smaller banks is being heard, the heavy restrictions are being evaluated, and gradually rolled back.

According to the FDIC, there were 5,961 FDIC-insured commercial banks in the United States as of December 31, 2014. That is a far cry from the 8,263 banks recorded to be in existence in the 1st quarter of 2000, and over 12,000 banks in the 1980s. The chart below reflects the dramatic drop in the number of large and small banks.


While Community Banks are regulated institutions that are susceptible to economic cycles, there are concrete and tangible strategies that they can deploy to navigate not only economic downturns, but the current highly charged competitive environment that is not expected to abate. Competition is no longer just from banks and finance companies, but from new disruptors: Well-financed FinTech companies offering financial services through technology platforms and using AI. What then are some of the structural mitigants and basic banking “blocking and tackling” needed to stem this continuous loss of small banks?

This is a three segment white paper that offers tried and true and actionable strategies to reposition a Community Bank toward not only long term survival, but sure-footed profitability. The nine strategies we will present and develop in the next two parts cover a Community Bank’s Organizational, Operational, and Financials levers.

  • Organizational Levers
    • Insightful and Diversified Board
    • Strong Credit and Enterprise Risk Management (“ERM”) Culture
    • Shedding Bank Holding Company Organizational Structure
  • Financial Levers
    • Large Fee Revenue Component, and Stable Deposit Stream
    • Razor-Sharp Efficiency Ratios
    • Assets and Liabilities and “Match Funding”
  • Operations Levers
    • Customer Focused Relationship Philosophy
    • Cordial Relationship with Regulators
    • Up-to-Date Technology, Systems and Relevant Competitive Product Set
    • Private Label and Outsourcing


Stop by next week to read part 2, where we will discuss best practices for board recruitment, ideal efficiency ratios, and more.

Michael Zahaby