2007 Bank Director Compensation Review

This yearu00e2u20acu2122s survey of directors of U.S. financial institutions crystallizes the notion that director pay is slowly increasing, while maintaining a reasonably fair balance between reward and responsibility. in fact, Most of the 894 directors responding to the survey believe their banks are doing a good job of aligning interests and responding to shareholdersu00e2u20acu2122 concerns about compensation practices and policies.

Moreover, in the aftermath of the sweeping disclosures required in 2007 of public companiesu00e2u20acu2122 compensation data, banks seem to have come through the procedure relatively unscathed. Though Clark Consultingu00e2u20acu2122s managing director Todd A. Leone cautions that there u00e2u20acu0153are a few pitfallsu00e2u20ac the SEC has yet to work out, by and large, directors among banking institutions we surveyed seem to feel the situation is under control. For most of them, the upshot is that the proxy disclosures, while creating a mountain of work for compensation committees, have not had a significant impact on pay levels or practices.

Other topics relevant to this yearu00e2u20acu2122s director compensation landscape include refining the types of equity pay offered and transitioning to better means of aligning ownership interests with those of board members. Specifically, there is a greater push toward structuring equity pay in the form of restricted stock, rather than stock options. The article that follows details the survey findings, including peer comparisons on board and committee compensation, as well as benefits and practices for benchmarking, review, and evaluation.

Compensation survey overview

Overall, compensation remained fairly steady this year, with 68% of directors reporting no change in their board income. About a third of our respondents did experience a rise in pay for 2006, with most receiving a 10% increase. Accordingly, only 2% said their compensation decreased in 2006.

Despite differences in size, culture, and philosophy, weu00e2u20acu2122ve found that most banks structure their compensation packages similarly, breaking down director pay into four basic components: annual retainer, board and committee meeting fees, equity income, and benefits. To design their plans, our survey found that 45% of boards depend on a compensation committee, while 35% leave that job with the full board. About 10% said the CEO sets director pay and 7% said the chairman has that responsibility. Nearly 65% of these decision makers perform peer review analysis to assess compensation, although consultant reports are also fairly popular, particularly at larger institutions. More than 20% noted that trade association reports are considered, and 27% refer to the results of this annual survey.

From an asset-size perspective, we found that the full board is more likely to set fee levels at community banks, while compensation committees are used more frequently at larger institutions. Regionally, compensation committees are heavily favored in the Northeast (71%), while responses from those in other regions were more equally split between using a compensation committee and assigning the job to the full board.

As to how often banks undertake this process, nearly two-thirds of our respondents (65%) reported having their compensation reviewed in the last 12 monthsu00e2u20ac”approximately half of those said it had been done in the last six months, with the greatest percentage of those responses coming from banks in the $1.1 billionu00e2u20ac”$5 billion asset size. However, 14% noted it had been more than two years since director pay was last reviewed at their institution. When asked how often they think their compensation should be evaluated, 57% said annually, while 31% said every two years is adequate, and 12% believe every three years is enough.

Structure of director pay

In most cases, the annual retainer and board meeting feesu00e2u20ac”along with committee fees, which are detailed belowu00e2u20ac”comprise the bulk of a directoru00e2u20acu2122s pay package. To assist in making fair comparisons, weu00e2u20acu2122ve broken out compensation levels at both holding companies and lead banks, as well as figures specifically for de novo banks (Figure 1).

Overall, the median annual cash retainer for directors in 2006 was $9,600 for all responding boards, an increase of 14% over 2005. That figure rose to $11,000 for directors at holding company boards (a 10% increase over 2005) and came to $7,000 for directors on lead bank boards (a 5% decrease from 2005). The overall median board meeting fee was $600, with a $700 median board meeting fee for holding company directors and a $500 median board meeting fee for lead bank board members.

When analyzed by asset size (Figure 2), annual retainers and board fees generally increase proportionately, with the median annual retainer for directors at banks greater than $5 billion in assets more than five times that of the annual retainer for directors at banks under $100 million in assets. Similarly, the median board meeting fee for directors at the largest banks is three times greater than that for directors at the smallest banks in our survey.

By comparison, the median time spent on director duties varies less dramatically, holding steady at about 10 hours per month for banks with assets $250 million and under, stepping up to 12 hours a month for those in the $251 millionu00e2u20ac”$1 billion range, and increasing to about 15 hours per month for those at banks greater than $1 billion in assets (Figure 3). In all, 74% of directors surveyed believe they are fairly compensated for the time required by their board position. Furthermore, nearly 60% of respondents report having enough informationu00e2u20ac”and specifically useful informationu00e2u20ac”to prepare for board meetings, and 54% say materials are sent out early enough for adequate preparation. Forty-three percent agree that agenda items are covered in the time allotted, and 52% say there is constructive discussion among board members on these topics.

Equity

A review of equity compensation drawn from a proxy study conducted by Clark Consulting (Figure 4) shows the median values for both stock awards and option awards at various asset sizes. For more on trends and issues related to director equity pay, see the sidebar on page 58.

Committee work

Much of the boardu00e2u20acu2122s work is done in committee. The top three committees on which our respondents serve are loan (55%), audit (53%, 16% are chairmen), and compensation (50%, 13% are chairman). To get a better idea of how much directors are paid for these duties, weu00e2u20acu2122ve isolated fees for the major committees at both holding companies and lead banks (Figure 5).

According to our data, on a per-meeting basis, audit committee members receive as much as, and in some cases more than, other committee members and are at least twice as likely as other committee members to receive annual retainers for their committee work. Furthermore, audit committee chairmen at holding companies are the highest paid, receiving annual fees that are at least two-thirds higher than those for chairmen of other committees. So when we asked our respondents who most deserves additional compensation, it came as no surprise that the audit committee chairman was far and away the most popular choice (named by 48%); other positions named include lead director (24%), compensation committee chair (23%), and loan committee chair (20%). It should be noted that 39% of respondents did not feel additional compensation for these board positions is necessary.

With regard to time spent in committee, our survey found that loan committee members meet most often, an average of 16 times a year at holding companies and 23 times annually at lead banks, followed by executive committee members, who meet an average of eight times a year at holding companies and nine times annually at lead banks.

Benefits and training

In addition to cash and equity income, most directors are offered benefits to round out their compensation package. Accordingly, more than two-thirds of our respondents reported receiving such extras in 2006, with the top three being education and training (38%), travel expenses (33%), and deferred compensation (24%). Rounding out the list: life and medical insurance, retirement plans, and charitable contributions, among others mentioned. The popularity of education and training follows a trend from recent surveys and is understandable given the increasing complexity of director duties. In general, directors these days are expected to attend at least some form of training annually. Perhaps as a result, 81% of those surveyed believe their compensation committee has the skills and training necessary to perform its job. However, it is of concern that nearly 20% believe more instruction is needed.

One fairly new tool being used to address the issue of board competency is gaining in popularity, according to our survey. Forty-seven percent of directors indicated they took part in performance evaluations in 2006: nearly 30% of our respondents reported participating in full board, in-house evaluations, up from 25% in 2005, and 22% said their bank conducts individual, in-house evaluations, also a slight increase over the previous year. Of those participating in such reviews, more than 50% believe they are fair and promote a stronger board.

Risk vs. reward

In many ways, establishing a fair director compensation plan requires a bit of a balancing act. Not only must the board or its compensation committee try to equate the rate of pay with the work required, time commitment, and what the bank can afford to pay, another factor it must consider is the risk involved in serving as a director. Our society as a whole has grown increasingly litigiousu00e2u20ac”one has only to scan the daily headlines to find another corporation under fire. And though the financial arena has long dealt with regulatory oversight, here, too, the rules have tightened and the bar has been raised for personal accountability. It is hardly shocking then that more than half of our respondents (52%) do not feel they are fairly compensated for the risks they assume as directors; furthermore, 48% believe their risk of liability increased in the past year. Only 3% believe their risk level decreased, with the remainder indicating no change in the amount of risk they faced.

As to their greatest personal risk, nearly 60% are most concerned about the risk of litigation, much more so than financial loss (17%) or loss of reputation (14%), though concern over financial loss is greater for directors at smaller banks, and worry over loss of reputation is greater for those at the largest banks (Figure 6). Meanwhile, personal/career growth and respect from their peers and the community (both at 27%) top the list for greatest rewards for board service.

With regard to liability specifically associated with compensation, most of our survey respondents appear to be more worried about the structure of executive pay and incentives than their own. More than 60% of those surveyed pointed to executive pay as a chief concern of their compensation committee in the last year, with executive bonuses at 47% and executive benefits at 25%. Equity compensation (24%) and employment agreements (19%) rounded out the top concerns. Board compensation was sixth on the list at 15%. Of course, this fixation with executive compensation may also stem from a concern over liability, given the high-profile settlements of late and the number of suits filed against boards of directors in the last few years. However, when we asked what affect SEC proxy rules requiring additional disclosure of director and executive compensation would have on public institutions (nearly two-thirds of our respondents sit on boards at public companies), only 19% of those surveyed felt the rules would create more risk of liability. Furthermore, 60% of our respondents believe the rules will have no effect on pay levels at U.S. companies, and nearly 40% believe that the rules will, in fact, help establish better metrics for compensation programs.

To this end, one director pointed out, u00e2u20acu0153Senior management must be watched carefully. Unsuspecting board members have difficulty in identifying financial incentives done incrementally that have negative consequences for shareholders.u00e2u20ac But on a more positive note, another director chimed in: u00e2u20acu0153One thing I know for sure, if the board can get a talented and gifted CEO and keep his or her interests and those of shareholders aligned, a directoru00e2u20acu2122s challenges and risks are greatly diminished!u00e2u20ac

Yet another potential risk of liability for the board is in the area of compliance, and again this year we received several pointed comments on this issue. As one director noted, u00e2u20acu0153Business and banking are becoming increasingly complex. Compliance issues stemming from the Patriot Act, GLB (Gramm-Leach-Bliley Act), Bank Secrecy Act (BSA), etc. are becoming more important from a regulatory standpoint than credit and risk management.u00e2u20ac A second commented, u00e2u20acu0153Many of the new SEC requirements are nitpicking and their cost far outweighs their purpose.u00e2u20ac Another noted an interference with board productivity, stating, u00e2u20acu0153Regulators have made board meetings less productive with overemphasis on BSA and regulatory matters having little to do with effective management of the institution.u00e2u20ac And another said simply, u00e2u20acu0153Itu00e2u20acu2122s an awesome responsibility and the examiners are constantly prying.u00e2u20ac

However, one director had a different take: u00e2u20acu0153I donu00e2u20acu2122t think there is as much risk as everyone likes to act like there is. As a business owner you know if management is stepping over the line, and if you are afraid to say something, you shouldnu00e2u20acu2122t be on the board.u00e2u20ac

Performance incentives

We asked directors two new questions this year related to the types of compensation available. When asked which methods of compensation provide the greatest level of positive incentive for directors, our survey respondents most often chose pre-established cash retainers and fees (47%), followed by equity grants (34%), performance-based pay (25%), and deferred compensation (17%). Numbers for the types of compensation that provide the greatest level of independence followed the same order, though weighted more heavily toward pre-established cash retainers and fees at 64%, followed by equity grants (20%), performance-based pay (18%), and deferred compensation (12%) (Figure 7).

As one director noted, u00e2u20acu0153Independence seems to me to be a matter of integrity and courage. Where compensation is a significant part of an individual directoru00e2u20acu2122s income, it may not be reasonable to expect total independence.u00e2u20ac

In short, as one of our respondents so aptly put it: u00e2u20acu0153Being a director is about maintaining a community bank. A strong, independent bank is a great asset to the community. Who doesnu00e2u20acu2122t want big money, but at the end of the day, Iu00e2u20acu2122m reasonably compensated for my work.u00e2u20ac

While fair and reasonable compensation is the number one goal of most director compensation programs, there are many nuances that lead to complexity in this arena and myriad questions and issues for individual boards. Each board has unique dynamics, and while peer comparisons are a useful tool, the board must also look inward and determine pay and benefits as best fits its own situation.

Bank Director hopes the information and analysis within this annual report is a useful tool for all directors, and we thank all board members who generously responded and helped make this report a success. We also are grateful for the assistance of Clark Consulting in serving as a cosponsor of this annual project.