Rules the Day at Community Banks
Since the enactment of the Sarbanes-Oxley Act (SOX) on July 30, 2002, which applies to publicly held companies, there has been steady discussion on the applicability of selected provisions of the law to all insured depository institutions. Many of the SOX provisions mirror the annual audit and reporting requirements of Section 36 of the Federal Deposit Insurance Act that is applicable to insured institutions with $500 million or more in assets.
According to Grant Thornton’s Twelfth Annual Survey of Community Bank Executives, just over half (52 percent) of all community bank executives indicate that corporate governance is important to their bank’s success.
But what of the costs associated with enhanced corporate governance? Two-thirds (67 percent) of the bankers surveyed report that the cost of documenting internal controls has increased this year over last year and eight in 10 (83 percent) of the bankers reported an increase in general audit fees in the past year. All of the community bankers interviewed for this story can attest to that.
“We have seen an increase in the cost of corporate governance at our bank,” says Robert Marling Jr., chief executive officer of Woodforest National Bank in The Woodlands, Texas. “The increase wasn’t drastic because we are a FDICIA bank. Most of the increase we are seeing is in legal fees and audit fees, as well as board and management time.”
Woodforest is a private subchapter S bank with $1.8 billion in assets (considered a “large” bank in terms of the survey) and 162 branches, including 131 branches inside retail stores, such as Wal-Mart.
“We were a week away from going public last year, but decided against becoming a public company,” says Marling. “I wouldn’t say that SOX was the deciding factor, but it was a factor.”
For 1st Century Bank, a public bank in Century City, Calif., with assets of more than $100 million (considered a “small” bank in terms of the survey) and one branch, the increase was huge.
“We are a brand new bank, only one year old,” says Dick Cupp, 1st Century’s CEO, “so being new we didn’t know what to expect. And, the increase wasn’t just in the dollar cost, but in heightened attention by all levels of management.”
“It’s a time investment for people, particularly for a new bank that doesn’t have the functionality in place,” continues Cupp, who reports that the cost of internal controls was the highest at his bank.
“We’ve all had to become compliance junkies. While we don’t have to comply until 2006, we have definitely learned a lot from those banks that have already gone through the process.”
“We have absolutely seen an increase,” says Anne Arvia, CEO and president of ShoreBank, a C corporation bank located in Chicago. “While the FDICIA requirements haven’t changed, the costs certainly have. It is all due to the increased scrutiny of regulators and the media.”
ShoreBank, which has $1.5 billion in assets (considered a “large” bank in terms of the survey), while not required to comply with SOX, does so as a best practice.
“So even though we aren’t required to meet the terms of SOX or 404, we now have more documentation and testing of our internal controls. This is also the area where we saw the biggest increase in costs this year.”
Business Success Factors
What are the issues bankers view as important for community banks’ future success? Retaining employees is once again a top priority with 93 percent of bankers saying it is important to their bank’s success, tying this year with the first-time survey option of retaining deposits.
At 1st Century Bank, it is hiring key employees that took the top spot with developing new sources of revenue in the number two spot. “I believe that the solutions to both are related,” says Cupp. “To find new sources of revenue, you need to have good people.
“As a new bank, we don’t make wide use of executive search firms. We know what we want and we send our people out to find individuals with those talents we need. We’re managing to bring in good people through our current employees, clients and investors.”
“Retaining our key employees is definitely the top priority for ShoreBank,” says Arvia. “One of the things we have done to address this is implemented a formal human capital strategic plan. We must also survey our people annually to make sure that we are addressing their concerns.”
Another benefit that ShoreBank introduced for its employees is “CEO of your Career,” which gives every employee $500 to use at their discretion to further their career. “We have people taking accounting classes and Spanish language classes,” says Arvia.
“However, the employees don’t have to use the money to work on furthering their banking jobs. They can use the money towards nursing classes or teaching classes. We figure even if they don’t want to stay in the industry, we still want them to be happy while they’re with us.”
The programs appear to be paying off for the bank, with Arvia reporting a retention rate of 97 percent for their high-performing employees. The bank’s satisfaction scores from the annual survey are very high compared to the market, and they focus on improving those areas where they fall below the industry average. This past year, the focus was on reducing employee stress, so the bank offered free chair massages to its employees. “It was a huge hit,” reports Arvia. “Our employees know we listen to their complaints and try to address them,” she says, “so they know we care about them. Employee retention is one of those areas where you have to stay constantly vigilant.”
Similar to 1st Century and ShoreBank, Woodforest is primarily interested in retaining key employees, as well as acquiring new ones; however, for different reasons. “It’s our rapid growth that prompts the hiring,” says Marling. “We got to have good, productive people.”
One way the bank does that is by offering its employees a stock ownership program. “We’ve aligned our employees as both customers and owners. In doing this, the employees in each of our branches have a business owner mentality.”
Woodforest is also a big believer in using technology to enhance the bank’s productivity. Out of those banks surveyed, 88 percent of large banks also said that enhancing the use of technology to improve productivity was important to their bank’s continued success, compared to 77 percent of medium banks and 78 percent of small banks.
Marling adds, “We believe that some of the technology is too important to rely on third-party vendors. Therefore, we have written certain systems to make us more productive. One example is our teller system, which gives us the ability to color code our customers’ profiles – yellow screens indicate more caution; green indicates lower risk – making it easier for our tellers to assist our customers.”
Operational Success Factors
In the operational arena, 92 percent of bankers are concerned about protecting their customers’ privacy. While bankers are obviously concerned about issues of corporate governance, they also think it is important to their bank’s operational success, with 87 percent of them citing the importance of assuring the quality of their financial reporting and almost two-thirds (65 percent) saying that developing appropriate written business procedures is important. Almost nine in 10 (86 percent) bankers say that complying with government regulations (such as the Gramm-Leach-Bliley Act of 1999, the Bank Secrecy Act and the USA Patriot Act) is important to success.
At ShoreBank, verifying system operations was ranked number one, with protecting customers’ privacy as a close second. “In regards to our systems, we have a very strong risk management process in place and the board is delighted that we have taken this issue so seriously,” says Arvia.
Verifying systems operations and technology risks was also ranked as the most important operation issue for continued success by Woodforest National Bank. “We have to do everything right, every day and every night,” says Marling. “We do this every day to ensure quality customer service. The service quality needs to be perfect. Our customers expect that!”
Nine in 10 (91 percent) bankers at large banks think that verifying systems operations and technology risks is important for their bank’s success, compared to 81 percent of bankers at small banks.
Confidence in third-party service providers is most important to 1st Century. “Just because we outsource to third parties doesn’t mean we abdicate the responsibility,” says Cupp. “We have a person monitoring the situation with all our vendors. It has become an important issue because of SOX and internal controls requirements.”
Cupp ranked protecting customers’ privacy as the next most important issue. “Everyone here is also very interested in protecting our customers’ privacy. However, since we’re a new bank, we have all new systems in place with the latest technology. We totally rely on third-party vendors.”
Reprinted, with permission, from Grant Thornton’s Summer 2005 issue of Currency. © 2005 Grant Thornton LLP.