Cash on the Barrelhead

Despite a return to profitability across the industry, senior bank executives have mixed views about the desirability of equity in their pay packages, according to Bank Director’s 2014 Compensation Survey, sponsored by Jenkinstown, Pennsylvania-based consulting firm Meyer-Chatfield Compensation Advisors. Bank boards place a high value on equity awards, but that opinion isn’t shared by most executives, including CEOs. The vast majority of bank executives reveal a strong preference for cold, hard cash.

While the board may see equity as an opportunity for the executive to build wealth and align his or her interests with that of the board, bank stock valuations haven’t returned to their pre-crisis levels. Basel III and higher capital requirements have resulted in a lower return on equity (ROE) for the industry, and the days of selling the bank at three to five times book value are a distant memory-translating to a significantly smaller windfall for the executive should the bank sell.

Less than half of CEOs and 40 percent of officers place a high value on equity compensation, revealing a disparity from the 59 percent of board members who believe that executives do value equity as part of their compensation package.

Equity lacks liquidity and can create tax implications, forcing some executives to forgo their cash salary just to pay taxes on their shares. “When you award any kind of equity, whether stock options or restricted shares, you have to think through the exit strategy for the executive,” says Flynt Gallagher, president of Meyer-Chatfield Compensation Advisors. “How are they going to convert those shares to cash when they need it?”

But equity has the added benefit of aligning the executive’s long-term interest with that of the company, so it may be understandable that boards value it more. “No question, I think if you’re in it for the long haul, some type of equity component is very important…because it drives long-term behavior,” says Jim Pope, president and CEO of KeyWorth Bank, a $391-million asset privately-held bank based in Johns Creek, Georgia. The bank offers stock options, but is evaluating the use of stock grants, which typically have a vesting period of three to five years, furthering an executive’s interest in the bank’s long-term performance.

Equity compensation is also part of the executive pay mix at Olympia, Washington-based Heritage Financial Corp., with the company relying on a mix of stock options and restricted stock. Pending shareholder approval, the equity plan will become more flexible, authorizing more varied forms of equity. One-third of respondents indicate that their bank grants restricted stock, and less than 20 percent grant stock options.

Forty-five percent of the respondents indicate that the bank allocates equity grants to executives, compared to two-thirds of public institutions.

Getting the details right is critical for banks that want to attract and retain talented executives, a top challenge for almost half of respondents. When asked about 2013 hires, three-quarters report having made promotions and new hires at the executive level, particularly in lending, compliance and risk management.

WANTED: LENDERS
It’s no secret that good loan officers are in high demand. Strategic growth plans drove many new hires last year, according to 59 percent of respondents, and most banks generate the bulk of their organic growth through lending.

Gallagher says that the environment for commercial lenders is so competitive that the price point for pay packages changes constantly, often in excess of the market. “There’s a real war out there to either attract or retain the lenders [banks] needed to execute their growth plan,” he says.

Lending is not only driving hires; it’s driving board agendas as banks seek more organic growth. Fifty-eight percent report that lending is the issue on which the board is spending the most time. Loan committees are also meeting more often, reporting a median number of meetings of 16 annually, up 33 percent from the previous two years.

Executives with risk management expertise are in greater demand at larger banks, accounting for almost 60 percent of hires at banks with more than $5 billion in assets and outpacing lending hires at larger institutions. Given the heightened regulatory expectations for banks with more than $10 billion in assets, this isn’t a surprise. “Probably the biggest change we’ve seen in the executive management team is the prominence of a chief risk officer. Typically now a chief risk officer reports directly to the board, so I think that’s another reason that you see the board less concerned about risk and compliance,” says Gallagher. The percentage of respondents indicating that risk is an issue on which the board spends the most time dropped from 58 percent in the 2013 survey to 44 percent this year.

The competitive talent landscape makes it crucial for banks to get the details right on compensation. Most survey respondents say that their bank’s executive compensation programs are achieving their objectives. Yet tying compensation to performance remains a top compensation challenge, at 66 percent.

It’s a challenge familiar to Schuyler Sweet, compensation committee chairman at Union Bankshares Inc., a $586-million asset bank holding company based in Morrisville, Vermont. It’s a balancing act, he says, with the board weighing the needs of employees as well as those of the stockholder. “If you’re doing well like we are, it’s almost a fun problem to have.” The company’s stock price has risen 23 percent over the last two years, and boasts a ROE of 15.06 and a return on assets (ROA) of 1.24 as of the 1st quarter 2014, both well above the median for the bank’s peer group. “It would be a lot less fun if things were different,” adds Sweet.

Less than one-third feel that executives value a severance agreement, such as change-in-control, but Sweet says this has been critical to attracting talent to Union’s northern Vermont headquarters, which he admits can be difficult due to its remote location. “To attract an outsider, that’s important,” he says. Change-in-control was just one of the pieces Union focused on when it began restructuring its compensation program in 2011, when the board discovered that while the bank was performing well, the management team was underpaid compared to peer institutions. In addition to change-in-control, the bank implemented a short-term incentive plan which focuses on company benchmarks such as ROE, loan quality and net interest margin. The board plans to implement an equity plan in 2014.

After many banks dropped expensive retirement plans during the economic downturn, the survey reveals that these benefits may now be on the rise, with 64 percent indicating that the bank offers a non-qualified retirement benefit for executives-an increase of 14 percent since 2012. It’s an especially common part of the compensation package for banks with between $1 billion and $5 billion in assets, according to 92 percent of respondents. Gallagher thinks this trend will continue as banks regain profitability. CEOs, at 43 percent, are the most likely to receive this benefit, followed by the bank’s management team, at 38 percent.

Despite the competitive market for talented executives, just 13 percent cite their compensation program as a factor that makes their institution attractive to potential hires. They’re more likely to cite corporate culture, at 69 percent, or the stability of the company, at 53 percent.

“Culture is first and foremost, and you’ve got to really work to develop that,” says Pope. He cites values such as transparency, fairness, a commitment to employee development and integrity of leadership as being key components of the culture at his bank. As a result, Pope says that he has the same executive team in place from the bank’s founding seven years ago, and the organization boasts a high retention rate, at about 93 percent.

CEO PAY
A preference for cash is further reflected in the pay received by bank CEOs. Almost all respondents report that the CEO of their bank receives a cash salary, at a median of $241,600, and the majority either receive or have the potential to receive a cash incentive. The reported median salary ranges from $168,500, for CEOs of banks with less than $250 million in assets, to a high of $565,000, for the top executives of banks with more than $5 billion in assets. This still pales in comparison to the pay packages for the CEOs at the largest U.S. banks: Brian Moynihan of Bank of America Corp. earned a base salary of $1.5 million, forming 11 percent of his total compensation in 2013, and Wells Fargo & Co.’s John Stumpf was paid a base salary of $2.8 million, representing 15 percent of his almost $20 million compensation package. For most banks, the survey indicates that cash salary forms a much larger part of total median compensation for the CEO, at 58 percent.

Heritage Financial, which recently doubled in size to $3.4 billion in assets due to its merger with Washington Banking Co., of Oak Harbor, Washington, offers a mix of components within its executive pay package to attract talent, through a cash salary, and motivates executives to achieve corporate goals, through an annual cash incentive. The CEO, Brian Vance, was paid a salary of $412,008 in 2013, which formed roughly half of his compensation; stock awards valued at $126,697 comprised 16 percent of his pay in 2013. These values are in line with the median CEO compensation for similarly sized banks in 2013, as reported by respondents in this year’s survey.

Vance’s total compensation rose by 44 percent in 2012, in part due to studies which indicated that his pay, as well as that of other key executives, fell below the median for similar institutions. “We have tried to target total compensation at market competitive levels” through the use of data from surveys and peer institutions, says Kimberly Ellwanger, chairman of the compensation committee at Heritage Financial. “That allows us to attract and retain key employees that we think are critical to our business success.”

Vance’s total compensation rose by a more modest 4 percent in 2013, but Heritage Financial’s dramatic increase in size post-merger will likely impact executive compensation for 2014.

Almost half of survey respondents indicate their bank ties CEO pay to the bank’s strategic plan or corporate goals. Seventy-two percent indicate that CEO compensation is tied to performance indicators, the most popular of which are asset quality, ROE and ROA. While private institutions are almost equally as likely as publicly traded ones to use performance metrics, larger banks are much more likely to do so than smaller banks: 47 percent of banks with less than $500 million in assets indicate that they don’t use performance metrics to evaluate CEO pay.

SETTING BOARD PAY
After remaining stagnant-or worse, declining-as banks worked their way out of the financial crisis, hard-working bank directors are reporting an upward trend in their pay, while time spent on board activities remains the same for the fifth year in a row, at a median of 15 hours per month. Thirty-nine percent of respondents indicate that they expect director compensation to increase in 2015, and almost half raised pay in 2013 or 2014. The survey also finds that per-meeting fees received by the bank chairman in fiscal year 2013 rose by 43 percent from the previous year, and annual retainers rose by one-third. For independent directors, meeting fees rose by 20 percent, and annual retainers almost doubled. Gallagher expects fees to continue to rise.

Similar to opinions on executive pay, almost 90 percent of respondents feel that cash compensation is highly valued by board members, but how that pay takes shape is gradually shifting. Eighty percent report per-meeting fees for directors, a decline of 5 percent over the past three years, while 53 percent report that they pay an annual retainer, an increase of 20 percent over the same time period. The prevalence of board meeting fee increases are at smaller institutions, while annual cash retainers are more common at larger institutions.

Because Heritage Financial directors were increasingly expected to be available between meetings, Ellwanger says that a shift to an annual retainer was a matter of fairness. “We found that, as the overall workload has increased for all board members, it became more difficult to define what work [directors are] doing related to meeting,” she says. Many board members must contribute between meetings-reading materials, for instance-and it also became difficult to determine what constituted a board meeting-if the board needed to address an issue by conference call, for example. Committee chairmen at Heritage Financial also receive a retainer, due to more time spent on committee matters between meetings, but committee members still receive fees, as sometimes circumstances require that a committee meet more often than scheduled.

Half of directors place a high value on equity compensation for the board. “We have an equity component to align our interests [as a board] with the shareholders, and that piece increased over the past several years,” says Ellwanger, after the board discovered that the equity compensation allocated to the board was lower than the peer median.

Benefits, like cash compensation, appear to be on the rise as well, reversing a trend noted in previous surveys. “Equity is being devalued and benefits are more valued,” says Gallagher.

Fifty-four percent indicate that the bank offers benefits to outside directors, up 12 percentage points from the previous year. Expenses paid for travel continue to be the most common benefit, but deferred compensation plans are becoming more common, as indicated by more than one-quarter of respondents. Pope says that roughly 40 percent of KeyWorth Bank’s board opts to defer at least a portion of their fees. Not only are the taxes on that income deferred, but “we are also paying a little better than average rate on those dollars,” at about 5 percent, he says.

Unlike bank CEOs, just 4 percent of respondents indicate that the board ties director pay to performance metrics. More than half work with compensation consultants, and as indicated in last year’s survey, the majority rely on compensation studies to determine director pay.

“We try to target board compensation to market. We want to be at the 50th percentile of our peer group or other market data,” says Ellwanger.

Nine percent of respondents say that the CEO has primary responsibility for setting board pay, a practice that most governance experts would frown upon. Gallagher says that this should be under the purview of the board. “For 10 percent of banks, the CEO is still dictating the agenda at the bank. Whatever he says, the board approves,” he says. “It’s a significant amount of liability on the directors and the CEO.”

Eighty-nine percent of respondents indicate that their bank has a compensation committee, and for most the task of setting board pay is allocated to the compensation committee, at 60 percent, an increase of more than 35 percent from the previous two years. Twenty-three percent say that the board as a whole drives their own pay levels.

RETIREMENT A STICKY ISSUE
Whether boards should set a mandatory retirement age remains a divisive issue, though Gallagher thinks more banks will use mandatory retirement to control board size and recruit new directors with needed expertise. Half of respondents report that their board requires retirement, at a median age of 72.

Ellwanger says it can be a thorny issue for bank boards. Heritage Financial implemented a flexible mandatory retirement age policy in 2011, which includes a provision that allows the company to reappoint directors annually if the director is due to retire but has expertise that could leave the board with a critical skill gap. Heritage Financial has seen four directors retire due to the age limit, but has yet to retain any with critical skills. “I think it is an opportunity for boards to be able to refresh themselves,” says Ellwanger.

MOST DIRECTORS SATISFIED
Directors remain largely satisfied with how they are paid, with more than 60 percent of respondents characterizing board compensation as fair. Still, almost one-quarter say that they’re not fairly paid, with the greatest dissatisfaction at banks with less than $500 million in assets. It’s easy to see why: Two-thirds of respondents from institutions of this size expect director compensation to remain the same, compared to 58 percent of banks with more than $500 million in assets. And while median hours spent on board activities remain steady for the industry overall, median board hours for smaller banks have risen by 35 percent since 2013, from 10 to 13.5 hours per month. Given the increase in time, responsibility and liability-combined with the fact that more than 40 percent of banks of this size haven’t seen a raise in board pay levels since at least 2010-these directors are bound to be unhappy.

Of course, the value that good directors bring to the board is beyond measure. “They’re never going to be paid adequately for what they do,” says Gallagher.

ABOUT THE SURVEY
In March and April 2014, 322 senior bank executives and independent directors responded to a survey conducted by Bank Director about director and CEO compensation trends. In addition to respondent data, pay data for the directors of publicly traded banks, including board meeting fees, annual retainers and committee compensation, was collected from the proxy statements of 99 financial institutions, almost one-quarter of the data. The survey was conducted by email. More than half of survey participants serve as an independent director or the board chairman. Response was evenly split between public and private banks. Full summary results of the survey are available in the research section at BankDirector.com.