The Year Ahead for Compensation

As bank CEOs, compensation committee members, and other key bank executives gathered several weeks ago for the annual Bank Executive and Board Compensation Conference at the Dallas Four Seasons Resort, conversations were buzzing about financial reform legislation and changes in regulatory oversight of compensation practices. Not since the SEC’s revamping of disclosure requirements three years ago have compensation committee members had so much to worry and wonder about. Subsequent to this year’s conference, even more attention was brought to bear on compensation practices with the SEC’s mid-December release of final proxy disclosure rules, which broadly cover director qualification, risk review, and compensation disclosure, among other things. Thus, while bank compensation committee members experienced several jolts in 2009, from all counts it looks as if 2010 should prove just as interesting. As one director at the conference wryly quipped, “Why couldn’t I have been on the audit committee instead?”


Attendees at this year’s event had plenty of general and breakout sessions from which to choose, on issues surrounding both regulatory and practical considerations for the year ahead. Among the most pertinent topics were how bank executives and directors can ascertain whether current compensation plans are competitive, how regulatory changes are likely to affect their plans, how TARP has changed the political landscape for compensation, and how to undertake a comprehensive risk assessment. Looking ahead for the next 12 to 18 months, it is certain bank executives and directors will be watching to see what effects the new SEC guidelines will have, how changes in national economic trends will influence compensation plan designs, and which metrics can safely be used to successfully motivate high performance without raising concerns about risk.

The changing landscape

To kick off the conference program, audience members listened to an overview of the new world of the compensation committee moderated by Amalfi Consulting president and founder Todd A. Leone and featuring discussion by three experienced compensation committee chairs: Amador S. Bustos, American River Bankshares; Janice E. Halladay, Cascade Financial Corp.; and Susan D. Goff, Sandy Spring Bancorp. This session delved into the challenges community banks face in today’s economy and featured a discussion surrounding the multitude of rules and guidelines promulgated in recent months.

To set the stage for the sessions that followed, Leone briefly outlined the more than 300 pages of regulatory guidance recently released:

Federal Reserve regulatory guidance-On Oct. 22, the Federal Reserve released guidance that affects more than 7,000 banking organizations and focuses on incentive compensation for both TARP and nonTARP institutions, a watershed event for the industry.

TARP guidelines-Last June, the Treasury published 120 pages of regulation that applies to all TARP organizations, outlining what they can and cannot do with compensation programs.

SEC proxy disclosure rules-Featuring comprehensive instructions on how to report compensation data for the proxy, these rules also include changes regarding the reporting of equities as well as require a risk review for all public companies. [Although the rules were still in proposal form at the time of the conference, final rules have now been released.] The overaching impact of all these events, according to Leone: months of work ahead, as public companies begin preparing for the2010 proxy season.

Later that day, Leone also led a nuts-and-bolts session featuring a customized compensation packet that analyzed the competitiveness of each attendee’s bank’s compensation plan. The current focus, according to Leone, is toward variable pay plans, using capital and credit metrics, and with performance measured both annually and over the longer term. He also noted that many institutions are revising their peer groups and modifying their existing executive plans to bring their bank more in line with what is expected, as well as looking to recruit new executives from other organizations in the months ahead.

Industry performance analysis

To further set the stage for the conference sessions that followed, attendees welcomed the well-respected John G. Duffy, chairman and CEO of investment banking firm, Keefe, Bruyette & Woods. Duffy outlined the areas of challenge for bankers in 2010 and explained how the current economic environment would likely affect industry performance in the next 12 months. Prefacing his remarks by stating, “While I am not here to tell you how to structure your pay plans, I am here to show you why comp was down last year… and why it is likely to stay down next year,” Duffy explained that having a good understanding of performance fundamentals creates a practical underpinning for making sound decisions on bank compensation plans.

While many 2009 trend lines were less than optimistic, Duffy’s presentation demonstrated that the industry had actually experienced a rebound from the stock values experienced in March, yet he noted the market “clearly is favoring large-cap banks in this rally.” Even so, he said, it’s still not a great banking environment, especially where liquidity is lacking.

“Investors are fearful of going into small-cap names where there is limited liquidity. So even if a price looks cheap on the surface, given the fundamentals, there is a reluctance to jump in where liquidity is in question.”

With regard to lending, the delinquency trend line is still rising, said Duffy, which indicates more difficult days ahead. So with credit card chargeoffs high, commercial real estate weakening, and the unemployment rate still near 10%, “it’s hard to get optimistic about these trend lines reversing themselves” anytime soon, he noted. Clearly for bankers, the days of hunkering down are not yet over.

Regulatory developments and compliance

Following the industry analysis, a session on understanding the current climate’s regulatory impact on public and private institutions gave attendees a wealth of information on the latest developments. Panelists included Bob Walsh, manager of planning and program development, division of supervision, FDIC; Donald L. Norman Jr., partner, Barack Ferrazzano; and Susan C. O’Donnell, managing director, Pearl Meyer & Partners. Among issues covered were the massive Federal Reserve proposal and an overview on which compensation rules apply to TARP institutions as well as to those that declined the government capital infusion.

In many ways, panelists agreed, compensation issues today have become more political and less strategic, making it more difficult for banks to chart their own course. This brings up many questions for the future, they noted, such as whether more public companies will consider going private and whether banks will be able to find ways to reward for performance without raising regulators’ ire.

“We need to find balance in the middle,” O’Donnell said, adding that while the Fed proposal looks to eliminate risk, bankers are still being told they ought to base compensation on performance-two extremes that might be considered at odds with each other. Without careful balance, “we may look back on this in three to five years and say ‘I am not sure we really got out of this what we wanted,’” O’Donnell noted. “Do we really want to drive out pay for performance?” Barack Ferrazzano’s Norman shared his concern that the regulatory and political reaction to what he characterized as “the sins of the few” were, in reality, overblown.

“They are drafting legislation to cure this terrible ‘wrong,’ but it’s unfortunate that it’s a blanket that covers everyone-even though the problems were not derived from Main Street America. In fact, they stemmed from Wall Street.”

In addition to such philosophical issues, this valuable session also featured many questions from the audience and offered guidance on the future of severance, change-in-control benefits, and golden parachutes, all of which, the panelists explained, are in a state of regulatory flux.

The duty to manage risk

By the end of the conference, one theme was central: Compensation today is all about risk management. To better address this critical point, Eric S. Kracov, partner, Kilpatrick and Stockton LLP, and J. Henry Oehmann III, national director, Compensation Services, Grant Thornton LLP, focused on how to understand and assess risk in incentive plans for public banks. A separate session on risk assessment for private banks was led by Michael Blanchard, partner, Blanchard Chase & Associates, and Laura G. Thatcher, partner, Alston & Bird LLP.

In the public bank session, Kracov pointed out that although the central regulatory focus has always been on safety and soundness, today much of the supervisory emphasis has shifted toward whether there is an element of risk in the compensation program that is causing behavior to change. In other words, said Kracov, “Does the program itself, on its own terms, create risk for the organization?” Along those lines, he pointed to two emerging trends. The first trend involves the evolving role of the compensation committee within the governance structure, as it becomes a focal point of risk analysis. The second trend involves the manner in which regulators are delving into the ranks of the organization to analyze compensation-related risk, rather than simply considering pay plans for top officers or the most highly paid individuals.

To conclude, Kracov summarized four primary items that will create a higher level of regulatory scrutiny in 2010. First, he said, is TARP. “[The management of] any bank that took TARP now has to sit down on a semi-annual basis and evaluate whether their compensation program contains elements that are creating risk within the organization.” Second is the SEC’s requirement to include the results of the risk analysis in the CD&A. Third is the House bill that applies to banks $1 billion and above that requires each banking agency to release a regulation that outlines how compensation committees should consider risk in their compensation plans. Fourth, and most significant, is the Federal Reserve regulation that outlines how banks must review risk as they look across their organizations.

Though the collective onslaught of all these regulatory guidelines can be overwhelming, Grant Thornton’s Oehmann offered that, in reality, the process comes down to sound enterprise risk management-which means good strategic planning. “If you are doing good risk management,” he said, “you are really going to have a lay up in terms of enterprise risk management.” But, he noted, these two ideologies have heretofore not been seen as one. In that respect, “we anticipate a sea change, in that risk management will be factored into compensation, but also, I suspect, into all areas of business.” Thus in every aspect of business, Oehmann concluded, “companies are going to have to identify how much risk they are willing to take.”

Looking ahead for 2010

At the end of the information-packed, two-day conference, attendees of the 2009 Bank Executive and Board Compensation conference received a wealth of information on the critical developments banks are facing in the months ahead. In addition to the comprehensive session presentations, they enjoyed another key ingredient to Bank Director‘s conferences-plenty of time to network and collaborate with peers and the opportunity to meet one-on-one with leading experts in compensation today.

Bank Director would like to thank its sponsors and attendees for a successful 2009 event and is already planning its 2010 conference. Watch for the 2010 Bank Executive and Board Compensation Conference to take place in Chicago in November-details and registration information will be announced soon on www.bankdirector.com.

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