Measure for Measure

If you want to get really rich as a bank CEO, your best bet is to look for a relatively small, obscure bank, preferably one that recently converted from a thrift.

Take John R. Garbarino, chief executive of Ocean Financial Corp., a $1.5 billion bank holding company based in Toms River, N.J.

Last year Garbarino received $6.69 million in total compensation. Although his salary and bonus were moderate, $325,000 and $103,441 respectively, Garbarino made a killing in two other areas: his long-term incentive plan, which is valued at $2.4 million, and his restricted stock program, which the proxy said would be worth $3.6 million if the stock appreciates at 5%.

That $6 million easily dwarfed the compensation of many highly successful bankers who head far larger, more complex, and more profitable institutions.

Roger L. Fitzsimonds, for example, CEO of the $19.8 billion FirstStar Bank in Milwaukee, received $2.9 million, paltry by comparison with Gabarino’s compensation.

Despite getting more than twice the compensation of Fitzsimonds, Garbarino’s bank didn’t perform nearly as well. While FirstStar earned 18.35% on equity and 153 basis points on assets, Ocean’s returns were 6% on equity and 97 basis points on assets.

Not even Ocean’s stock price beat FirstStar’s. While the 1997 rise in FirstStar’s stock price, at 64%, was well above the average for banks in its peer group, Ocean’s was below the group.

Most banking companies, including Gabarino’s, say the amount they pay their CEOs is in line with the compensation paid to their peers. But there are dramatic differences between the various peer groups and types of institutions.

Running the numbers

Although most of today’s bankers are earning much more than they used to, a somewhat standard approach is evolving, at least at most of the bigger bank holding companies.

Michael Garelik, who heads William F. Mercer’s financial institutions compensation practice and who has just completed a study of compensation trends among the 50 largest banks, says “the majority of large banks have become much more professional in the way they conduct the compensation processu00e2u20ac”the kind of information and analytics that they use and the independence of the compensation committee.”

Attaining a highly professional approach requires “taking the mystery out of the pay-for-performance process,” says Peter T. Chingos, who heads KPMG Peat Marwick’s compensation practice.

Companies “need to establish guiding principles to serve as the foundation of how they are going to pay their executives,” he says. And, like most compensation consultants, Chingos stresses the need to compare the company’s performance with that of others like it. “That takes the mystery out of all these things and reduces the element of surprise.”

Many financial services companies already are following such guidelines, creating a consistency in pay among them. Take FirstStar Corp. and Marshall & Ilsley Corp. Unlike FirstStar, which is a traditional commercial banking business, much of M&I’s income stems from providing data-processing services to other financial institutions. Aside from that, however, they are uncannily similar.

First, they’re both based in Milwaukee. Second, FirstStar’s total assets were $19.8 billion at the end of 1997, only slightly bigger than M&I’s $19.5 billion. And, amazingly, both earned exactly 153 basis points on assets. FirstStar’s ROE was considerably higher than M&I’s, 18.41% versus 16.77%, but this reflects M&I’s higher level of equity.

As one might expect, the total compensation of FirstStar CEO Roger L. Fitzsimonds and M&I CEO J.B. Wigdale were virtually identical. Wigdaleu00e2u20ac”who received a total package valued at $2,836,526u00e2u20ac”nosed out Fitzsimonds by a mere $12,600, equivalent to about a half-percentage point. According to the proxy, Fitzsimonds’ total compensation amounted to $2,823,926.

“Our programs are all formula driven; they’re not subjective, they are driven by relative performance in relation to our peers,” explains Dennis Frederickson, who heads FirstStar’s human resources division. “I think it’s the best way,” he states.

And in fact, it appears that at least in FirstStar’s case, peer comparisons were a leading factor in determining compensation levels. According to the proxy, FirstStar’s consultant on compensation (“an international accounting firm with significant experience in executive compensation matters”) recommended that Fitzsimonds’ compensation be increased to better align it with other banks in its peer group.

Based on the consultant’s advice and on the bank’s own analysis, it was decided that Fitzsimonds, indeed, was underpaid. Says Frederickson, “When we looked at the payouts, we found that the plan was lagging the market.” Thus, the program for determining Fitzsimonds’ compensation was liberalized in line with the consultant’s suggestions at the company’s annual meeting last April and becomes effective this year.

Personal touch

Though comparables are part of the picture, the path taken by FirstStar indicates how compensation programs can be tempered for a particular bank and CEO.

Until last year, FirstStar’s stock price lagged behind its peers despite superior performance by the bank itself. Not surprisingly, senior management’s short-term compensation was based exclusively on return on equity.

In 1996, for example, FirstStar’s total return for shareholders rose 35.6%, a very healthy showing, but still lagged the 41.8% gain of Keefe Bruyette & Woods’ Peer Group 2, composed of banking companies with between $10 billion and $25 billion in assets. Furthermore, FirstStar’s five-year performance registered 188.22 on the KBW peer group index, well below the group’s 227.

But things changed last year. FirstStar’s total return jumped well ahead of its peers, rising 64.7%, compared with only 46.2% for the group. And the sharp rise in FirstStar’s stock price raised its five-year ranking to 310.13, a relatively narrow spread below the peer group’s 332.

Ta da! For 1998, the formula was changed to include any relative rise in the price of the stock as well as FirstStar’s relative standing in terms of ROE.

These changes appear to be fair. FirstStar’s 1997 ROE was a handsome 18.41%. How much farther could it go in relation to other banks, which also are increasing their ROEs?

Across town at M&I, stock price is also a factor. Mike Hapfield, senior vice president and secretary, says the bank’s “compensation committee has tried to take into account a number of factors for base salaries; the bonus is formula-driven, based on the earnings level of the company in any year and how it exceeds plans and/or other basic targets.”

M&I’s long-term incentive program, he says, is a three-year plan driven primarily by performance of the shares in the market relative to the company’s peers.

Disparate views

While it is easy to understand how like-sized and like-minded institutions end up paying their executives similarly, some bank’s pay scales are baffling. For example, although Cincinnati’s $10 billion Star Banc is considerably smaller than, say, Memphis’s $14 billion First Tennessee, Star CEO Jerry A. Grundhofer earned far more than First Tennessee CEO Ralph Horn.

Grundhofer’s total compensation last year stood at $9.6 million ($9,625,972), about seven times higher than Horn’s, which was $1.5 million ($1,477,075), according to the banks’ proxies. Grundhofer’s combined salary and bonus of $1.7 million was twice Horn’s $836,923.

The most dramatic difference was seen within the banks’ long-term incentive plans. Star Banc’s proxy estimates that the options and stock that Grundhofer received were worth $7.9 million ($7,926,210). First Tennessee estimated that for Horn, the amount was a mere $376,544. Why was Horn left in the dust?

Looking at Star Banc’s program for a moment, it’s hard to criticize Grundhofer’s giant package. According to the proxy, “The initial threshold for a bonus award was $1.92 EPS and 15.5% ROE, which would have resulted in record net income for the Corporation. Reported EPS was $2.19 and reported ROE was 22.6%.”

Star Banc was among the three most profitable banking companies both in terms of ROA and ROE on KBW’s most recent ranking of the nation’s 50 largest banking companies.

And that’s only half the story. Star Banc’s stock more than quintupled over the latest five-year period. Compared with the KBW 50 Index, Star Banc’s stock rose to 551.65 versus the Index’s 331.73.

In 1997, Star Banc’s total return amounted to an astounding 90.6%, while the S&P Regional Bank Index was up “only” 50.4%.

But wait a minute. First Tennessee also performed superbly. In fact, with an ROE of 25.11%, it ranked second on KBW’s 50, actually beating Star. And it ranked seventh in terms of ROA, at 166 basis points.

So why did Grundhofer earn seven times more than Horn? When asked whether he thought Horn was terribly underpaid last year, Marty Mosby, who heads investor relations for First Tennessee, quickly agreed.

What gives? “That’s just Mr. Horn’s philosophy,” says Mosby. “He thinks it’s not him and him alone that creates the profitability of the bank. We have everybody scratching to bring in every nickel that they can, and he believes he’s adequately paid.” Horn, according to Mosby, “realizes that in any survey that comes up, he’s the only CEO who’s high performing and underpaid.”

Humble pie, but not for all

Actually there are others with similar philosophies. Among them is 73-year-old Leo W. Seal, Jr., CEO of Hancock Holding Co., a $2.28 billion banking company based in Gulfport, Miss. Unlike the compensation of most CEOs, Seal’s is very easy to decipher. Last year he earned a salary of $100,000u00e2u20ac”pure and simple.

Hancock isn’t the greatest bank in terms of profitability and growth in total return, but it certainly isn’t the worst, either. On the five-year total return index, Hancock scored a 272.56, well below the indices 326.12. Its return on assets was a respectable 125 basis points, and its return on equity was 11.29%.

By no means are those returns earthshaking, and perhaps even below average, but by overall standards, Seal deserved a lot more than $100,000.

Like First Tennessee’s Horn, the relatively low pay reflects Seal’s philosophy, as the proxy explicitly points out:

“For personal reasons, as well as a long-time philosophy of Mr. Seal and his father who served before him, Mr. Seal’s compensation is relatively low in comparison to other chief executive officers of comparable institutions. His compensation is the result of Mr. Seal’s express wishes, and is in no way reflective of his performance, ability as CEO, or his value to the Company.”

Interestingly, while Hancock’s performance was not stellar, it was much better than the performance of other depository institutions that paid their CEOs a lot more. It appears that in some cases, the linear relationship between compensation and performance is anything but straight. And while Seal’s and Horn’s relatively humble compensation is to some degree, self-imposed, they are, by today’s standards, in the minority.

Executives are working hard these days to effect top performance. And though once upon a time shareholders would have been glad just to avoid lawsuits and possible failure, today these same investors are imposing hefty profitability goals for which today’s bank executives must aimu00e2u20ac”and hitu00e2u20ac”to survive. Thus, the majority of bankers are fairly philosophical about the fact that, when you get down to it, money motivates. And for their part, shareholders are willing to bet the bank that a better-paid CEO will be one who stays around and produces profitable returns year in and year out.

Florida’s $1.58 billion First Palm Beach Bancorp, for example, registered a 59 basis-point return on assets and 8.71% on equity in 1997, nothing to write home about. First Palm Beach is a one-bank holding company whose subsidiary is First Bank of Florida.

Stockwise, First Palm Beach did very well. Its total return jumped almost 53% in 1997, and its cumulative increase since 1993 was 365.73%, compared with 353.78 for other thrifts and 284.38 for southeastern commercial banks. First Palm went public in 1993.

While there’s significant interest these days in using stock price as a goal for setting compensation, a fundamental question that compensation committees have to answer in formulating CEO pay is how much weight to give to changes in the stock price and how much weight to give to the bank’s overall profitability. In reality, while a CEO has clear responsibility for the bank’s profitability, he or she has very little control over the stock price, which often swings wildly based on fads and overall market conditions.

In light of its profitability ratios, First Palm seemed to pay CEO Louis O. Davis, Jr. more handsomely than most commercial banks would. Davis received $1.8 million ($1,809,477) in total compensation last year.

Salary and bonus were only a small part of that. Davis takes a salary of $274,000, and his bonus was modest as well, a mere $30,000. But he received options on 80,000 shares of stock that would be worth almost $5 million if the price were to rise by 5%.

R. Randy Guemple, executive vice president and chief operating officer, says the bank uses a formula for salary and bonus, but not for options. “Salary is based on peer-group performance.”

But the level of options is a different matter, he notes. “The number of options given is a board issue and relates to a variety of things, such as success of the company based on past performance. I’m not sure there are any peer comparisons there, because options are approved by shareholders.”

Outrageous fortunes

While CEO compensation at First Palm seems generous, it doesn’t compare with the $6.7 million that John Garbarino received from New Jersey-based Ocean Financial. Despite the huge gap in income, Ocean Financial, with assets of $1.4 billion, is a bit smaller than First Palm Beach.

Like First Palm, its numbers last year weren’t stellar, at least by commercial bank standards. In 1997, Ocean Financial earned 91 basis points on ROA and a 6% return on equity. And although Ocean’s stock price rose last year, even that increase lagged the industry average.

Although the bank’s proxy says it has no obligation to use formulas based on peer groups in setting the CEO’s salary, it also points out that “Garbarino’s base salary remains at the median level as compared to other institutions in the peer group survey.”

The proxy declares that “the Compensation Committee’s recommendations are discretionary and no specific formula is used for decision making; salary increases are aimed at reflecting the overall performance of the Company and the performance of the individual executive officer.” Still, in light of both the bank’s and stock’s performance in 1997 it’s hard to see what Garbarino’s accomplishments were to justify his compensation.

Above all, no specific targets were made for the $6 million in awards under the long-term incentive programs. The stock received vested over a five-year period. For the first two years, Garbarino is automatically vested for the entire amount due that year, with no performance requirements. In the third year, 25% is vested automatically, and in the fourth and fifth years, 50%. But no goals have been set.

Delicate balance

What this example demonstrates is that when it comes to setting the executive’s compensation, much depends on the CEO’s relationship with the board and the degree to which the compensation committee has an arms-length relationship with the chief executive.

“One of the things that is important to look at is the governance process and how strong a compensation committee you have,” says Garelik of William Mercer.

“The balance between the comp committee and management doesn’t get reported in the proxy, but that will have an impact on compensation, perhaps even a pretty significant impact,” he explains.

“If you have a very professional committee, [one] where management and the board have a certain professional respect and professional distance, that results in a compensation process has a different feel and flavor to it,” Garelik continues.

Clearly, broad diversity remains in the way banks determine their executive compensation pay packages. And while the trend appears to be moving toward more financially objective criteria, even the biggest banks have far to go to settle such standards. It seems that for many smaller ones, the journey will be even further.

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