Executive Benefit Plans in 2016: Emerging Trends

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benefit-plan-1-27-16.pngSince the credit crisis, most community banks have been able to grow and improve their financial condition. According to the Federal Deposit Insurance Corp. (FDIC), almost 60 percent of community banks reported higher year-over-year earnings for the period ending in the third quarter of 2015. In addition, community banks have increased assets by 5.6 percent and total loans and leases by 8.5 percent for the same period adjusted for mergers. While these growth numbers do not represent the pre-credit crisis years, the industry is showing an improvement. The percentage of unprofitable community banks are at the lowest level in many years. Community banks are defined by the FDIC Community Bank Study, December 2012, and one of the criteria is that these banks are “likely to be owned privately or have public shares that are not widely traded.”

What do improving conditions mean to banks and their compensation plans? Some banks have seen challenges in retaining key officers given increased competition for top talent, while other bankers believe they are now in a position to invest in additional key talent to grow their organization. For banks that have implemented various types of compensation plans, it may mean including an additional key officer in these plans. Attractive executive compensation plans include market-based salary, annual bonus based on performance, stock options or restricted stock (where applicable), reasonable contributions to a 401(k) or other qualified retirement plan, medical care and other standard benefits, change- in-control agreement and a custom-tailored nonqualified retirement plan.

Another important trend is the disruption created in many markets by mergers. The purchasing bank wants to retain the top lenders and others revenue generators, but the change in ownership can cause those individuals to consider other options. Competing banks that have developed a game plan for such situations will be positioned to hire some of these talented individuals. A nonqualified plan (customized for each executive) can play a vital role in attracting and retaining these individuals.

Another trend that has been taking place is an increase in the number of community banks that previously only offered salary and annual bonus plans, but are now providing more comprehensive compensation packages for key executives. This is a result of increased competition for executives as well as improved earnings.

Nonqualified plans need to be tailored to meet the needs of the individual. For example, a younger officer in his or her 30s may not see the value of a retirement benefit targeted at age 67, but would see value in a plan that allows for earlier cash distributions to pay for a child’s college education or that allows for early retirement at age 55. Many organizations use a combination of plans and approaches to attract and retain their key people. Here are some examples of situations and challenges bankers have faced when contemplating compensation plans:

  1. You have an executive in his mid-50s who has contributed to leading and growing the organization but has not yet been rewarded for his efforts. This executive’s compensation focus is now being more directed at retirement and wealth building rather than solely increases in current cash compensation. Consider a supplemental executive retirement plan (SERP) plan and perhaps a long-term incentive plan. He may also be interested in deferring current salary.
  2. You have young officers in their 30s and 40s who are high producers and need to be compensated for their efforts with more than just base salary and annual bonus amounts. Consider a performance-based nonqualified benefit plan or a combination of a SERP and performance-based nonqualified plan. It is important to tie these individuals to your bank if you remain independent, but it can also enhance the sales price if these individuals stay with the purchasing bank in the event your bank is sold. Properly designed nonqualified plans can substantially increase the probability they will stay in either scenario.
  3. For closely held banks that would like their management team to think like owners, consider nonqualified plans using a phantom stock or stock appreciation rights approach or, if another type of deferred compensation plan is adopted, consider linking the interest credited to the executive’s account to the bank’s return on equity.

Summary
With an improving economy and asset growth of community banks, along with a higher than normal level of merger activity, banks have been adding officers to existing long term incentive and nonqualified benefit plans or developing and implementing new plans to compete with other banks for talent. Utilizing more than one compensation strategy or plan can be an important element in attracting and retaining talent. The bank’s franchise value is dependent on its level of success in attracting and retaining key executives.

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Stock Bonus Plans for Community Banks

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nest-egg.jpgCompanies are cutting employee benefits to conserve cash. There is another approach. Banks can sponsor retirement plans which provide deductible employee benefits in the form of stock, not cash, and reward the folks who build value over time.

How Does a Stock Bonus Plan Work?

It is a retirement program that works much like a profit-sharing plan, permitting the sponsoring company to make tax-deductible contributions in cash or stock to participant accounts. The limit is 25 percent of eligible compensation aggregated for all qualified plans.  

So, if a community bank with a payroll of $2 million makes a $50,000 match on the 401(k) plan, the deduction limit for an additional stock bonus contribution would be $50,000 less than 25 percent of $2 million, or $450,000. While most banks would typically contribute a much smaller percentage of compensation, the key is to understand the limits. 

Who Benefits from a Stock Bonus Plan?

In the above example, the bank had 49 employees with seven employees making more than $100,000 annually; these seven received 47 percent of the total compensation.  Since the allocations to participant accounts were made in proportion to pay, the 10 percent of payroll ($200,000) contributed meant that the key group received $94,000 in stock. The non-discriminatory plan meant that the non-highly compensated group received the balance of the shares in the plan.

Curiously, these plans sometimes better suit smaller banks specifically because of the need to reward key players and the ability of some stock bonus designs to skew benefits to them. Large plans with hundreds of participants can spread ownership more broadly.

The bank holding company sponsoring the plan received a tax deduction for the $200,000 non-cash expense and a resulting cash flow improvement (analogous to the tax effect of depreciation). This would not be possible if you contributed cash instead of stock to a retirement plan. The end result is more cash saved on the balance sheet. The table below illustrates this in a hypothetical example.

Three retirement plan options were considered: A) cash contribution; B) no contribution; C) stock contribution.  

ccrv-stock-chart.png

What Are Five Must Dos for Stock Bonus Plans? 

  1. Use an independent stock valuation for the share value, if the corporation is closely held or thinly traded.
  2. Coordinate the capitalization and shareholder (dilution) effects with a comprehensive benefit strategy for both the highly and non-highly compensated employees.
  3. Base the cost/benefit analysis on the ongoing plan operating costs, cash savings and the long-term obligation to repurchase shares from former plan participants when they retire. 
  4. Maximize the benefit of employee ownership by communicating the plan clearly to the participants.
  5. Consider using the more versatile Employee Stock Ownership Plan (a sub-class of stock bonus plans), if the intent is for the plan to purchase shares rather than operate as a simple contributory plan. A stock bonus plan cannot purchase stock from shareholders, while an ESOP can; the ESOP can even borrow money to buy the shares; both types of plans hold the majority of their assets in company stock.

What Are Three Things Not to Do?

  1. Implement a stock plan where the organization’s operating profits (<$500K) or numbers of employees (<30) do not warrant the cost.
  2. Convert the 401(k) plan of a closely-held sponsor to any of the forms of stock bonus arrangements and use employee money to purchase shares or otherwise have stock in employee-directed accounts.
  3. Consider stock compensation in troubled banks with problematic “going concern” valuations or questions about viability. 

Conclusion

Successful banks may be tempted to curtail employee benefits in a difficult economic environment, but may in fact be better served in terms of employee motivation and operating results by a restructuring of the benefit program. There are many other rules and variations on the stock bonus theme; a decision should be narrowed to the main pros and cons through a review with skilled designers.