Fifth Third Bank and Banks and Irwin Financial and Banking & Finance and Government & Economic Development and Government

Bank directors feeling greater scrutiny

October 15, 2011

It used to be hard to turn down an offer to join the board of directors for a community bank in Indiana.

The post offered the chance for community service, local recognition and some compensation, even if a modest amount.

But these days—in an age of bank failures and heavy regulation—the job also brings sizable risk and duties. And that, banking experts say, is starting to make it tough for local banks to recruit board members, particularly those with the talent and commitment to help guide them through trying economic times.

“It used to be an honor to be on the [bank’s] board—it used to be prestigious,” said John Reed, a longtime banking expert who leads the Indianapolis office of Chicago-based investment banking firm David A. Noyes & Co. “Offsetting that is the realization that there’s quite a bit of responsibility with it. Everyone is going to look over their shoulders to see if they messed up in not catching a problem bank.”

Responsibility implies liability. The Federal Deposit Insurance Corp., which provides insurance to cover banks’ losses in the event of failures, has the right to sue bank officers and directors if FDIC officials deem they played a role in a bank failure.

That can sap board members’ wealth. And while banks have insurance to protect directors in such cases, that insurance is becoming tougher to get as bank failures become increasingly common.

All that is leading potential board members to become more skittish about making the commitment to join.

Joe DeHaven, president of the Indiana Bankers Association, said in recent weeks he’s heard a few leaders of Indiana-based banks express concern about recruiting qualified board members. But many are reluctant to talk about the challenge, given the confidential—and sometimes competitive—nature of the director-selection process.

Seven banks contacted by IBJ to discuss the topic did not return calls. However, area banks including Franklin-based Heartland Community Bank and Martinsville-based Home Bank, said they haven’t struggled to recruit directors.

Leaders such as DeHaven, however, say it’s an area of growing concern.

“It’s a problem, and it will be more of a problem going forward,” DeHaven said, citing increasing regulations brought on by laws such as Dodd-Frank. “All of those things are creating an atmosphere where it’s more difficult to find qualified community leaders who are willing to accept that level of potential liability for relatively small compensation.”

Lawsuits lead to fear

It’s hard to say how many lawsuits the FDIC will file as a result of the recent wave of bank failures. Between 2008 and August this year, 386 U.S. banks have failed, including two in Indiana, according to a Wall Street Journal database.

Between 2008 and mid-September, the FDIC authorized suits in 32 bank failures against 294 individuals, with damage claims of $7.2 billion, according to the FDIC’s website. That figure includes 14 suits naming 103 former directors and officers.

A suit filed recently by a federal bankruptcy trustee overseeing the liquidation of Columbus-headquartered Irwin Union Financial Corp. addresses three executives of the defunct bank, but not the directors. That’s because the directors received an inaccurate picture of the institution’s condition, the suit said.

But the number of lawsuits doesn’t provide the full picture, since the agency has six years to file certain claims, and longer if the state allows.

From 1985 to 1992, the FDIC brought claims against officers and directors in 24 percent of bank failures.

At that time, which encompassed the period of massive bank failures called the savings-and-loan crisis, litigation numbers translated into fear about joining boards, said David Baris, executive director of the American Association of Bank Directors.

His group surveyed about 500 banks to determine how many had lost directors or director candidates because of liability concerns. Some 20 percent said they did.

Baris’ group is preparing to launch a similar survey and he predicts, based on anecdotal feedback, that the numbers again will be high.

Baris, also a lawyer in Washington, D.C., law firm Buckley Sander LLP, said he receives a few calls per week from members concerned about liability. Part of the fear stems from the tendency of lawsuits to center on directors’ approval of individual loans.

“The more troubled a bank is, the more difficult it is to find directors, because they’re that much closer to possible insolvency,” Baris said.

Mike Alley can attest to that.

Alley, who led Fifth Third Bancorp’s central Indiana operations from 1989 to 2002, said liability was among his concerns when he was approached in 2008 by leaders at Evansville-based Integra Bank to join the board.

He initially declined, but then was heartened after the bank got money from the Troubled Asset Relief Program—a sign, he thought, that Integra could make it.

The bank, which Alley eventually took over as CEO, failed in July. So far, neither Alley nor former Integra board members have been sued.

He said the Lehman Brothers collapse in 2008 created new dynamics around joining bank boards—not only because the risk of failure is greater, but also because the level of involvement demanded of members has increased.

“In the past, the dynamic was that board members focused on a very high level and didn’t have to engage deeply in the business itself,” Alley said. Now, “there’s a higher standard and degree of engagement expected from board members.”

Deeper ‘community’ impact?

Those in the industry disagree over whether the impacts of director fear are more or less acute for community banks.

Some, such as Baris, say community banks are more hurt. Their pockets aren’t as deep as big players such as Chase, so they’re less able to offer solid compensation for their service and insurance in case of a lawsuit.

Others believe community banks have an easier time because they tend to be located in smaller towns where potential members have a deeper sense of responsibility about serving—and in some cases receive a bigger ownership interest in the bank.

And for some Indiana-based banks, the board-member conundrum simply hasn’t been an issue, either because financial performance is strong or because board members have a long history with the bank.

Community Bank of Noblesville directors have been with the bank since it was started in 1991, and President Chuck Crow said he isn’t worried about finding new ones because he doesn’t anticipate his directors stepping down any time soon.

Still, he says he wouldn’t want to undertake a search in the current environment.

“When times are good, everybody wants to be a director,” Crow said. “When times are bad and difficult, everybody rethinks that.”

While there are a number of banks such as Crow’s out there, experts such as Reed say they are the exception.

That’s a problem now, Reed said, because qualified directors prepare banks to withstand scrutiny.

“A lot of banks want good, strong, probing directors,” he said.

The fear among them is that those directors will be in shorter supply in years to come.•

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