Bean Counters Sound Off: Community Bank Chief Financial Officers Face Challenges No One Expected Ten Years Ago. Relations with outside Auditors Continue to Be Itchy, and Real Estate Regs Are a Concern

By Cocheo, Steve | ABA Banking Journal, June 2006 | Go to article overview

Bean Counters Sound Off: Community Bank Chief Financial Officers Face Challenges No One Expected Ten Years Ago. Relations with outside Auditors Continue to Be Itchy, and Real Estate Regs Are a Concern


Cocheo, Steve, ABA Banking Journal


The scrapes and cuts of the early implementation of the Sarbanes-Oxley Act have begun to heal. But scars will remain. And there s no returning to the way things used to be. Relations with his bank's outside auditing firm "deteriorated dramatically in 2004 and that was because there was limited guidance out there," says J. Kimbrough "Kim" Davis, CFO at Capital City Bank Group, Tallahassee, Fla. "We had this massive task list of testing and controls ahead of us. The accounting firms didn't know what they were supposed to do. We didn't know what we were supposed to do."

The exasperation factor for accelerated tilers, like Davis, was high.

"Things improved in 2005, as more guidance has come out," the CFO says. "But the relationship can't touch where it was in years past, and I think that day's gone forever."

Davis was one of six community bank CFOs who met in a recent face-to-face roundtable during ABA's National Conference for Community Bankers. Even for those banks not directly affected by SOX, the unpopular law has affected their work.

Davis says compliance and administrative costs associated with SOX will come down a little, but the audit is still much more expensive.

"Our audit costs went from a little less than $250,000 to over $800,000 from 2003-2004," says Davis. While the total bill for 2005 was expected to be somewhat lower than for 2004, Davis says it was not likely going to be as low as management would have liked.

And there are other, less obvious, costs. Davis says the bank's internal auditor now concentrates almost exclusively on SOX Section 404 (broadly, internal controls), leaving other chores to be handled by others. Davis believes 404 will require a three-year learning period.

"Now, it's kind of baked in," says Davis. "It's become part of the corporate culture, so, increasingly, everybody knows what we are supposed to do. But though it's baked in, the problem is you've embedded this new cost in the permanent cost structure. We may trim around the edges once we've got it all down, but the tendency of this kind of thing, over time, is to grow."

Things have started settling down for Texas banker Bob Scott. "It got pretty strained there for a while, but we're back on track," says Scott of relations with his outside firm. It cost $335,000 for outside consultants, attorneys, and other accountants to help his company, Summit Bancshares, sort things out.

Other members of the roundtable, not directly affected by SOX, have still seem some changes.

State Bank of Countryside, Ill., is a Sub S community bank, which has a "strong relationship with our auditors," according to CFO John Laherty. Nevertheless, the bank's accounting firm began applying some SOX steps as best practices even though they weren't supposed to apply under similar, but not identical, FDICIA rules.

"They were holding us to what I'll call a higher standard of a public company," says Laherty. "So we had a little bit of a hurdle there, some banter back and forth."

Other members of the roundtable lament a SOX casualty in the accounting firm relationship: the easy availability of advice.

"That was a perk of having an accounting firm with knowledge, which you could draw from," says Bruce Williams, CFO of Hardin County Bank, Tenn. "Now they are quicker to point you to other bankers who have lived through the question you are asking, so that you'll call them, than to answer you directly."

What Keeps CFOs Busy Today

Are you busier because top management wants more analytical work? Or is it regulatory demands? John Laherty It's a mix. We do look at the broader picture and help drive the company strategically because by its very nature financial reporting cuts across the whole company. This puts us in a rare position that gets to see all the dynamics of the bank. Our board sees the importance of risk management and the importance of strategic direction. Not that they don't see the value of financial and accounting information, but they want to know that risk management is going the way that is being represented to them. Then there are things like the Bank Secrecy Act, but there are also possible challenges like the proposed commercial real estate lending guidance that will have a big impact. [Discussed in more detail further on.]

Bob Scott Following on your point, boards are becoming more forward-looking. They ask for more forward-looking information and for more market information, that is, indicators of how we are doing versus rivals. That's because community banking is growing more and more competitive. They are interested in the history, what was the bank's ROE last month, but they really want to focus on what's going to be.

Craig Kremser When I first started at the bank, the board was elderly, and all the directors cared about was the bottom line. Since then those directors have retired, and the younger ones coming on ask all those questions we've been bringing up. They want to know what's in the market, what's going on, where are we heading, "what if this?" and "what if that?" That was never the case before.

Keith Bouchey I was just at a conference where they talked about directors' responsibilities and that they should spend 30% or more of their board meeting time talking about strategic direction. The speaker stressed that it's management's responsibility to have the financial numbers properly recorded and accounted for.

Bob Scott Historically, bankers thought safety and soundness was the exam.

Today, with the function of risk management being stressed so much, I think the compliance exam may be the key exam.

Kim Davis SOX 404 clearly sensitized our board. The board took on a whole different persona. It made the directors better understand what their responsibility and accountability was. I spend a lot more time now at the board and committee meetings, making sure they have all the information they need. The audit committee meets nearly every month now--its members get a book that's thicker than the full board's book.

Growth and the CFO function

How has the growth of your institution affected your function? Bruce Williams We've added staff. I have an assistant now, and if she had not come along I probably would have even less hair than I do now. Today's generation of employees embraces technology better than people from my generation. [Williams has been in banking for 20 years.] My assistant has taught me some efficiencies in using technology, especially in importing data from our core system into spreadsheet and database programs, for deeper analysis.

Scott We've had pretty rapid growth over the last several years and as a result we've been adding support staff in the financial and accounting area. We're seeing rapid growth in the compliance area, too. We've got a full-timer in there now, and outsourced the compliance audit. Over time, compliance will probably be two or three people. We'll need that just to keep up with the Bank Secrecy Act and related issues.

Laherty We're very lean, so employees wear a lot of hats. I worked for KPMG Peat Marwick for ten years as an auditor and, when I first came to the bank, I was a transaction person. But we've had significant growth, so we brought on an assistant controller. That person focuses on more of the detail level matters, such as transactional types of items and asset-liability management modeling, in order to free up me for risk management, strategy, and things of that nature.

Kremser I have the help of half a person, so the majority of whatever goes on comes to me. But we've grown 20% last year, 15% the year before, so our growth is showing, and we are looking at adding additional people.

Davis Prior to 1995, my company consisted of ten separate bank charters, but in that year we combined them all into one. And then we realized that while we had a CFO we really didn't have a controller, so we added one in 1997. That's evolved because of growth to today's accounting and financial reporting department, which has ten associates in it, and a separate treasury area with a staff of four.

In the area of straight, traditional consumer compliance we're doing fine there, but we've beefed up BSA/AML. Not too long ago we didn't have a BSA officer, and now we have a BSA department and it's growing. We're adding investigators and managing high-risk accounts, and bolstering it with purchased software.

A lot of what we're doing today just simply would not be possible without technology, which has reduced the number of people that you would have needed, but at the same time SOX 404, BSA, and more, are all adding pressure to have the appropriate number of people.

Bouchey You can outsource compliance to try to keep up with the ongoing evolution--not just the regulations--but then you also have to get the internal staff. We've had a full-time compliance person who then utilizes people from other areas of the banks, plus someone responsible in each branch from an operational stand-point, who keeps the bank functioning on the front line.

Vendors and the CFO

Are you satisfied with the tools that the vendor community makes available? Bouchey Something I find very helpful, and would like to see more of, is vendor-sponsored user conferences. It's very handy being able to get together with other bankers who use the same products and systems. Often we have similar questions, things that other users may have figured out already, say, how to read a certain report or advice on what you can gain from the reporting system that you didn't have before.

Laherty Sharing your information that way prevents mistakes from happening over and over at different banks and that's why user groups are so effective.

Davis We're still getting our feet on the ground with what's out there--there's a great deal that's available in asset-liability management software, profitability software, and more. Much of what's available consists of very sophisticated, complex models. These are very helpful, and add a lot to our ability to manage our businesses, now and 12 months down the road.

Kremser There's so much out there, and so much choice, the hard thing is finding which pieces meet our needs. A bank our size doesn't need everything in the vendors' packages. The biggest issue that I have is that talking to vendors is supposed to be how your pick out what you need and want. But they'll sell you everything.

Laherty Along those lines, my biggest issue is making sure the vendor is really our partner. Vendors could do a better job in really understanding our business. I don't want them to just come in and sell me a product because they need to make quota. Often I feel like we at the bank must make sure that we're asking the right questions in order to get the right answers before we make a key purchase.

Scott That's a good, strong point that you make. In fact, it's a pet peeve of mine. Quite often I get calls from vendors who really haven't done their homework. They don't have a clue as to what my bank's business is, how the company is structured, and what our book of business overall is. I spend time educating them about what we are, so they can then sit down and figure out what we need.

There is so much information about banks available now, through the FDIC website and other accessible sources, that vendors should be able to come and make an educated presentation for us--not just paint the company with the same brush as all the other banks. To be blunt, nowadays, if a vendor arrives not knowing exactly what we are, it's going to be a very short conversation.

Davis We're spending more and more time on due diligence. And it's nice if we can call another bank or two and ask: Is the company a partner? Does the software really work, and smoothly? In fact, going back to the user conferences, now we try to get to one before we make a purchase. That way, you can really hear what is going on with that package, before you put all the dollars into it.

Williams Something that spoke volumes to me when I was doing due diligence was another banker who said, "That's a great product--but we don't have the manpower to use it to its full functionality."

This was coming from a $500 million bank, and, at the time, we were a $200 million bank. His comment told me that the product had too much horsepower for a smaller bank, that it hadn't been designed with the lower tier of banks in mind, and wouldn't work for us.

Is "too much horsepower" a common problem for community banks?

The panelists had different views based, somewhat, on their size.

For example, Craig Kremser, noted that one modeling program that his bank uses requires the dedication of an entire employee. Other members of the panel said that their staffing situations would never permit dedication of an employee. Indeed, one banker said his bank had purchased a package that was so sophisticated that it was several years before enough staff time could be allocated to it to make it useful to the bank. In some cases, the need for extensive training before a package can be used is a barrier to utility.

And in some cases, the packages that are out there are like some of the standard desktop computer programs that have features that 90% of users never know about, let alone use.

"It's no different from a calculator," one banker observed. "There's all these functions, and generally you use it to add, subtract, multiply, divide, and that's it."

Views on real estate proposal What kind of cost impact are you expecting, if the regulators' commercial real estate proposal goes through? Davis It is going to require some programming to generate the portfolio stratifications. But I don't see it as being a major expense.

The real concern with these guidelines, particularly from the viewpoint of a Florida-based bank, where we do so much real estate development lending, is what it potentially can do to the economics. Will the additional capital requirements for highly exposed commercial real estate lenders cause many bankers to reduce this type of lending? If so, what will it do to the Florida economy?

Laherty With about 85% of our portfolio in commercial real estate and just coming off an FDIC safety and soundness exam, our view is a little bit different.

The comments we received in our exam that were related to our real estate concentration mirrored the prospective guidelines, so we've actually been working under those proposals for three to four months. We've found the internal cost far exceeded what we thought it would be. But so far it hasn't had an impact on our pricing, which was a relief because we were afraid that falling under the guidance early would hurt us competitively.

The [troubling] thing about these requirements and the regulators' proposal is that these aren't unsecured loans--we can visit these properties. That's the lending we're expert in and comfortable with.

Bouchey Could this actually have been a service to the industry, driving out speculators from banks and sending them to other borrowing alternatives?

Davis That's probably the end game. But what bankers will have to do in the meantime is convince the regulators that we've got our arms around the risks and know how to mitigate any losses.

Does the timing surprise anybody? The regulators have been warning about commercial real estate for a couple of years. Isn't anyone who's going to be in trouble already in it?

Davis Not necessarily. We haven't seen the down cycle in commercial real estate lending yet. In Florida, land value has escalated so rapidly that a lender could make a lot of bad loans and be bailed out by rising values. Some banks lend heavily to speculators, what we call "flippers." That's somebody who buys property and six months later sells it for a quick game. But that game will come to end and the problem is that there are not enough end users, so a lot of people are going to get hurt. The regulators clearly hope to catch it early enough so they can do something before the cycle turns.

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Bean Counters Sound Off: Community Bank Chief Financial Officers Face Challenges No One Expected Ten Years Ago. Relations with outside Auditors Continue to Be Itchy, and Real Estate Regs Are a Concern
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