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Embracing a Broader Mandate in Bank Compensation

June 3rd, 2011 |

New federal requirements for the compensation of employees helped draw a record crowd to Bank Director’s 6th annual Bank Executive & Board Compensation conference, which took place November 11-12, 2010 at the InterContinental Hotel in Chicago. Passage of the landmark Dodd-Frank Act, combined with new rules on compensation practices at banks and thrifts issued by the Federal Reserve Board, brought compensation committee chairs and members from around the country to the Windy City looking for answers.

On an unseasonably warm day in Chicago, over 270 bankers and advisers gathered in the InterContinential’s ornate ballroom for the conference’s opening session of the “Future of Performance Compensation Plans.” Moderated by Todd Leone, a principal at McLagan, a Stamford, Connecticut-based consulting firm, the panel addressed the challenging issue of how to design compensation programs that deliver a competitive edge while still rewarding the CEO and balancing the needs of the company and shareholders.

In addition to Leone, the participants included Paul R. Barber, senior vice president and human resources manager at $1.6-billion-asset Graystone Tower Bank in Harrisburg, Pennsylvania; Sam Borek, chairman of the board at Opti-mum Bank in Ft. Lauderdale, Florida; and Gregory V. Ostergren, chairman of the compensation committee at Guaranty Federal Bancshares, a $732-million-asset institution in Springfield, Missouri.

Leone started the session with a review of the four regulatory factors that have changed the responsibilities of compensation committees–making their role one of the most challenging on the board:

  • Compensation committees are now being held accountable for performance-driven compensation plans across the entire organization, including the lowest paid employees.
  • Clawbacks are predicated upon restatement of earnings, and performance bonuses will need to be re-paid if a loan goes bad.
  • Committee members will be instrumental in reviewing the risk of compensation plans and should have an audit process in place.
  • Members will need to look beyond the fiscal year to ensure that the team is focused on long-term goals as well as short-term ones.

Analyzing Compensation Risk

The new Federal Reserve rules on compensation require that banks perform a risk analysis of their compensation practices to make sure they are not structuring plans for senior managers–or other key employees like loan officers–that raise the institution’s risk profile to an unacceptably high level. Ostergren at Guaranty Federal said in response to the new regulations, his institution hired a chief risk officer to help manage regulations, review compensation plans and to help the bank stay ahead of the curve. The panelists also recommended that at smaller community banks with limited resources, the compensation committee might consider taking on the duties of risk oversight. In some cases, the human resources or internal auditing team can take on this role of giving a more objective viewpoint.

Given the generally poor performance of bank stocks in recent years, most institutions have had a difficult time structuring effective incentive compensation plans for their key employees because stock options—which have long been a staple of most plans—have not been an effective tool. One approach suggested by the panelists would be to develop a mixed ratio plan that accounts for performance metrics, company culture and business development. Bar-ber at Graystone Tower Bank said that 50 percent of that institution’s incentive compensation is based on credit quality.

With all the regulations coming down the pike, attracting top talent to a troubled bank can be a challenge. One cre-ative solution is to bring new recruits on as consultants before submitting them to the Federal Deposit Insurance Corp. for approval as management. Borek at OptimumBank reminded the group that while the FDIC doesn’t approve of signing bonuses, it does approve of so-called staying bonuses, which can aid in the recruiting of top management talent.

While several points were discussed among the panel, the overall recommendation was to consider what works best for each individual bank based on its region, business goals and staff needs. And as Borek put it, his company’s number one stakeholder group is the employees, as happy employees create happy customers who make for happy shareholders who ultimately make for happy communities. Everything else falls in line behind that key mission.

New Regulations Drive Change

Not surprisingly, regulatory issues dominated much of the discussion at this year’s conference, including a second panel discussion titled “How Regulation is Shaping Compensation?” The participants were Michael Blanchard, partner at the consulting firm Blanchard Chase in Atlanta; Thomas Hutton, a partner at the Atlanta-based law firm Kilpatrick Stockton; and Charles Tharp, executive vice president for policy at the Center on Executive Compensation in Washington. The session was moderated by Jack Milligan, editor of Bank Director magazine.

With increased government intervention courtesy of the Dodd-Frank Act, here are five key insights on the level of impact facing today’s compensation committee shared by the panel.

  • Be proactive. Committee members could find themselves in the position of having to actually educate the regula-tors on the guidelines.
  • It’s not about the what but the how. New regulation isn’t about shaping compensation but rather changing the pro-cess of designing performance based plans.
  • An emerging trend among many banks is to have an independent compensation consultant attend the committee meetings. While there are no hard stats on file to date, this process may be looked at more favorably by shareholders.
  • Before developing compensation plans, the committee should do its homework by researching what institutions in their peer group are doing with their incentive packages.
  • Private banks under $1 billion are more at an advantage than disadvantage with regulatory requirements, but every institution should be prepared for regulatory reviews.


It was clear throughout this session that being prepared and ready to tell your story was the best approach when dealing with the new regulations. Knowledge is power and having the right team on the board and in management will go a long way towards staying ahead of the curve.

Everyone knows that the U.S. banking industry has been bloodied by the worst economic downturn since the Great Depression of the 1930s. During a comprehensive overview of the industry, Ben Plotkin, executive vice president and vice chairman at the investment banking firm of Stifel Nicolaus Weisel in St. Louis, explained that the industry’s profitability plummeted from a high-water mark of $128.2 billion in 2006, to $97.6 billion in 2007–to just $15.3 billion in 2008.

Industry’s Fundamental are Improving

But there is a light at the end of the tunnel for most banks, and it’s not necessarily a freight train hurtling towards them. Based on Plotkin’s numbers, it would seem that the industry’s asset quality problems have finally peaked. After rising sharply from 2006 through 2009, non-performing loans have finally leveled out and even declined slightly to about 3.2 percent in November 2010. Healthy banks with strong balance sheets (including better than average asset quality) have also been able to raise capital from institutional investors.

The industry’s net interest margin (which is essentially the difference between the interest rate on a loan and all the costs associated with getting that loan) has also shown recent improvement. Through the first two quarters of 2010 the margin was approximately 3.85 percent–compared to 3.39 percent in 2006 and 3.35 percent in 2007, when the industry was much more profitable than it is today.

M&A Poised for a Rebound?

Why would the big pension and mutual funds be willing to invest capital in a troubled industry? Perhaps because they anticipate a predatory environment in which the strong and the swift will devour the weak and the weary. “Many of the catalysts for renewal of the traditional M&A market are beginning to take shape,” Plotkin told the audience. Asset quality is slowly beginning to improve, signaling potential acquirers that the worst is over. Strong banks have access to capital, so they can afford to acquire. And banks with diminished earnings power and little or no access to institutional sources of capital may find that selling out to a more highly valued competitor is their only viable strategy to reward their long suffering owners.

One of the most important responsibilities of the compensation committee is to review the CEO’s compensation, take the lead in conducting board evaluations and be the focal point in managing the board/CEO relationship. These core duties were the focus of a panel discussion on “Handling Situations Most Compensation Committees Want to Avoid,” moderated by T.K. Kerstetter, president of Corporate Board Member and formerly the president of Bank Director. The other participants were Susan O’Donnell, managing director of Pearly Meyers & Partners in New York; J. Henry Oehmann III, director of National Executive Compensation Services at Grant Thornton in Chicago; and Alice Cho, senior principal at Promontory Financial Group LLC in Washington.

How to Handle Sticky Situations

O’Donnell kicked off the discussion by outlining the following scenarios that many board members all too often find themselves struggling with:

  • The compensation committee has designed the entire plan with no input from the management team and thus is experiencing an unexpected backlash that is costing the company time and money.
  • The bank is being led by a dominant, yet high-performing CEO who is driving most of compensation planning process, and therefore board members essentially have become lame ducks who rely too much on CEO.
  • The CEO is best buddies with a few directors and as a result the board has lost all sense of objectivity.
    The panelists all agreed that the following approaches will go a long way in setting the board up for success:
  • Set expectations with the CEO early on in the relationship.
  • Use outside advisers to help evaluate compensation plans, especially the CEO’s.
  • Rely on the chair, lead director or compensation adviser to help with the tough discussions.
  • Don’t be afraid to think independently as healthy debates are important.
  • Know the compensation plans even for audit and risk team members.
  • Use board evaluations to hold each other accountable.


Clearly, the goal is to avoid dissension between the management team and the board while keeping the bank’s CEO happy and cooperative. Building these positive relationships starts by setting expectations and staying objec-tive despite having differing opinions.

One of the ramifications of the new regulatory framework for compensation is that the compensation committee has to take a much broader view of pay practices throughout the organization. The conference’s final panel discus-sion–“Past the CEO: Compensation Down the Ranks”–focused on the role the committee should take when planning competitive yet acceptable compensation plans for employees below the CEO.

Panel participants included Gayle Applebaum, a principal at McLagan; Donald Norman, partner at the Chicago-based law firm of Barack Ferrazzano; and Kimberly Ellwanger, chairman of the compensation committee at Heritage Financial Corp. in Olympia, Washington. The discussion was moderated by Milligan.

Embracing a More Holistic Role

To start, the panelists addressed the compensation committee’s newly expanded role when it comes to employ-ees below the senior management team. One conclusion was that the committee needs to take a more holistic ap-proach than in the past. As Applebaum pointed out, the responsibility of the board is not to micromanage each plan, but rather to be aware of how they are designed. Compensation committees should actively review and evaluate the structure of all plans from the executive team down to the teller staff.

While this sounds like an overwhelming task, the panelists agreed that the burden should not rest on the compen-sation committee alone, and that committee members should work in conjunction with the management team. While the board is ultimately responsible for oversight, they will most surely need input from the CEO and other senior team members.

The concern of some audience members was how to determine who was objective and well versed enough in the requirements to help the board evaluate these plans thoroughly. Ellwanger noted that Heritage Financial Corp. had appointed a chief risk officer whose responsibilities included sharing the list of all compensation plans semi-annually with the board for review.

For those banks with limited resources, personnel who should be able to help committee members analyze the plans on a regular basis include the chief risk officer, the senior human resources executive, the CEO and his or her management team, the bank’s general counsel and its outside compensation adviser.

Different Metrics for Different Employees

Of course, assembling a qualified team of people to review and oversee all significant compensation plans at an institution is only part of the equation. Designing plans that are attractive to top talent is a critical piece of the puzzle. The panel encouraged smaller banks to not be hasty by cutting out bonuses and raising salaries as this would cer-tainly result in the loss of key employees.

Instead, banks should consider varying the levels of performance in their incentive plans by employee rank and then base those on individual and/or company-wide goals. Ellwanger explained it this way: with the senior manage-ment team, metrics are usually driven by corporate performance, while for lower level employees the metrics are driven by bank and individual performance.

As it turns out, regulators tend to lean more towards global metrics used in compensation plans as these are deemed less risky than behavioral based incentive plans.

Norman suggested that boards conduct at least a semi-annual risk analysis to evaluate the risks, goals and met-rics developed. Throughout those sessions, it’s important to document thoroughly including meeting minutes and anything that speaks to the thought process behind the plans. A constant theme heard throughout the two-day con-ference was again reiterated in this session–be prepared to tell your story.

Bank Director Staff Writer