The Synovus case: directors and the oversight of credit

This is a companion to a blog by Jeff Gerrish, community banking blogger, which addresses the Synovus case from a corporate governance standpoint.  

A few weeks ago Synovus Financial, a $27 billion regional bank holding company headquartered in Georgia, announced the partial settlement of issues involved in a large lawsuit relating to credit accommodations it extended to the developer of Sea Island, Ga., a luxury resort located off the coast of Georgia just north of Florida.

The borrower filed for bankruptcy in 2010 as a consequence of the severe contraction of tourism and high end second-home demand during the recent recession. The company's lead bank and the developer had reciprocal board relationships and enjoyed close business and personal contacts through their executive managers. The credit accommodations at their high point aggregated approximately $200 million.

Looking at the case

In a way, this suit and its related issues appear to be a somewhat predictable consequence of a large real estate deal gone sour in the face of a severe and unanticipated economic downturn. This type of story and the related legal proceedings are familiar to many lenders in recent years as banks and their borrowers have struggled with a very difficult economic environment.

What seems truly remarkable in this case are the specific remedies that the court imposed on the bank. Press reports emphasized that the bank's board of directors will be precluded from approving loans. Apparently the press reports exaggerated the court's conclusion, as Jeff Gerrish explains in the companion blog. Everyone understands that banking law and generations of legal precedent charge the directors with the responsibility for the proper oversight of their institutions. However, the publicity associated with this case gives us an opportunity to remind ourselves what those credit-related responsibilities that directors need to emphasize.

The bank was accused of approving loans to the developer based on a "golf course handshake" between borrower's and bank's executives. There were also a number of securities-type claims whereby allegedly misleading information was provided to Synovus shareholders. As an expert witness in financial litigation, I have seen firsthand how allegations involving sloppy risk management practices are standard fare in such proceedings. What is subject to frequent litigation is the extent to which the bank and the borrower are culpable in such activities for the resulting losses.

It's always hazardous for non-lawyers like me to sound like experts in the law. Rather, my experience is useful in understanding the behaviors of the banks and their officers and agents in the facts and circumstances of the actual administration of a borrowing relationship. What this case clearly reflects is just how boards of directors continue to be under fire for the consequences of risk management systems instituted and implemented by the bank.

Directors and the credit function

The extension of credit is one of the principal functional areas of any bank and one that has historically been associated with a significant degree of potential risk. Boards of directors are considered responsible for the appropriate "governance" of the institution including sound and appropriate risk identification and management functions and practices.

I think the first question to ask is whether directors typically have the requisite training and expertise to undertake the normal and full range of tasks involved in the underwriting of credit. Said simply, "Should the board be making credit decisions?"  I've always had a bias toward leaving the specifics of credit underwriting to those who are trained and specifically authorized to conduct this aspect of the banking business.

If one agrees with me on this point, then the question becomes one of identifying the appropriate role of directors in the oversight of the lending function--those activities of a governance nature rather than the day-to-day implementation of the normal range of lending activity. Governance implies the existence of systems and policies and the knowledge through testing and observation that they work harmoniously and effectively.

If the directors in the Synovus situation failed to implement and enforce appropriate risk management systems--and we don't know anything about that from the public record--then this suggests remediation that's unrelated to the day-to-day extension of credit. It also points to an actual or partial failure in some of these internal systems to curtail and manage risk.

It's always a good idea to periodically review and reinforce the expectations of the appropriate respective roles of boards of directors and credit executives. In fact this has been going on throughout the industry in recent years as bankers and supervisory authorities wrestle with the principles of earnings risk management.

The supervisory authorities turned their considerable influence to the objective of formalizing credit policies over 30 years ago. Next came a deliberate push to strengthen banks' loan review capabilities and the resulting discipline has been in place for nearly as many years.

Since that time, but more recently in the wake of the severe business contraction of the recent recession, attention is being paid to both the identification of risk and its management. This is the systems side of credit risk management and we are frequently reminded that it is as equally important as the specific provisions of the loan policy.

The best credit policy in the world means very little if it's not monitored with a degree of vigor and determination. If, for example, a bank permits risk to magnify by permitting concentrations of credit to accumulate within the loan portfolio, then the job of risk management is probably dangerously incomplete.

Directors and risk management

Risk management oversight is the appropriate role for the board of directors and a role for which they truly earn their compensation.

Credit people apply their discipline in an orderly process but the board can be an independent source of perspective on whether the right questions get asked and the right rocks get overturned.

Unfortunately, at many banking companies today, much risk management practice is confined within the functional silos of credit, liquidity, and operational risks.

Yet all risks are ultimately interrelated and all eventually have the potential to impact, positively or negatively, the earning power and solvency of the enterprise.

We need a more holistic approach to risk management, as an industry. But that also demands an independent and fully comprehensive assessment within each of the institution's functional areas.

If the Synovus case contains elements of issues applicable to the overall current discussions of banking risk management it lies in the affirmation that bank directors have a unique and irreplaceable role to play. They should govern in ways and within structures that assure a certain independence of judgment and oversight that they uniquely exercise and the appropriate focus of skills and experience where each is needed for a long term successful outcome.