Regulators Revive Efforts to Pass Dormant Compensation Rules

Written by

When it comes to incentive compensation, everything old is new again.

Financial regulators are expected to revive rulemaking on a number of compensation provisions that never went into effect but were mandated by the Dodd-Frank Act of 2010.

Some of the issues that bank and securities regulators could consider in the coming quarters include measures that will gauge executive pay against their performance, as well as mandate clawback provisions and enhanced reporting around incentive compensation structures, said Todd Leone, a partner and global head of compensation at consulting firm McLagan. He was speaking during Bank Director’s 2021 Bank Compensation & Talent Conference, held Nov. 8 to Nov. 10 in Dallas.

All banks with more than $1 billion in assets would need to comply with the final version of the enhanced incentive compensation requirements. Public companies, including banks, would need to comply with any final rules around clawbacks and pay versus performance. If the topics sound familiar, Leone reminded the crowd, it was because they were debated when the banking reform bill initially passed in 2010. Regulators considered rulemaking several years later. But the move to finally pass those rules could catch banks off-guard, especially when considering that rulemaking was essentially paused under the administration of President Donald Trump. Below is Leone’s overview of the proposed rules.

Clawbacks
Clawback provisions, or a company’s ability to take back previously awarded pay or bonuses after a triggering event such as a restatement of earnings, were a hotly debated topic of the post-crisis financial reform bill more than a decade ago. They also came into focus in the bank space after news broke about the Wells Fargo & Co. fake account scandal in late 2016. In 2017, the bank’s board announced it would seek $75 million in previously awarded compensation from two of the senior executives that it held accountable for the scandal. In response, a number of banks created clawback policies of their own.

In October 2021, the U.S. Securities and Exchange Commission, under Chair Gary Gensler, reopened the comment period for the clawback provision, or Section 954 of the act. Leone pointed out that the proposed rule defines a triggering event as an accounting restatement for a material error. A company has up to three years to claw back incentive pay linked to the financial information that is restated; potentially impacted employees include current or former executive officers. Leone expected a final rule by the second half of 2022 but recommended that audience members stand pat until something is published.

“Don’t touch existing policies, since it’s in flux,” he recommended for banks that created their own policies.

Pay For Performance
Pay for performance, or Section 953(a), is a proposed disclosure requirement for public companies, including banks, that would most likely appear as a table in the proxy statement. The disclosure compares total shareholder return for a company against a company-selected peer group, along with compensation figures of a company’s top executives. The company would need to state the principal executive’s reported total compensation for the current year and past four years, along with the average reported total compensation for other named executive officers over the current year and past four years.

Like the clawback proposal, this provision was first debated by the SEC in 2015; it is in “final rule stage,” according to the agency, and Leone believed it could go into effect in the second half of 2022. The rule could create a “fair bit more work” for companies to comply with, he said. But he believed it will have a similar impact on the industry as the CEO pay ratio disclosure, which compares the pay of the CEO to that of the company’s median employee and has yet to lead to significant changes in pay for either group.

Incentive Compensation Rules
Similar to the other two proposals, the enhanced incentive compensation rule, or Section 956, has come up again. The SEC included it as a proposed rule in its agency rules list for spring 2021. Leone joked that he had used the same presentation slide on the enhanced incentive compensation rule a decade ago. The rule has been proposed by regulators twice since the passage of Dodd-Frank: It was 70 pages when it was first proposed in 2011 but had grown to 700 pages when it was re-proposed in 2016, he said.

Leone believed this rule will come up again in the spring of 2022, and that rulemaking will take some time because a number of regulators will need to collaborate on it. It would apply to all banks with more than $1 billion in assets, along with other financial institutions such as credit unions and broker dealers. The requirements would vary based on asset size, with the biggest firms facing the most stringent rules around their incentive compensation agreements. Under previous iterations of the rule, financial institutions would need to include provisions to adjust incentive compensation downward under certain circumstances, outline when deferred incentive compensation could be forfeited and build in a clawback period of seven years.

In the end, Leone recommends banks be proactive when it comes to changing compensation rules.

“Expect more, not less regulation,” he said.

Unlocking Meaningful Compensation to Keep Essential Talent

Written by

Banks are no strangers to using nonqualified deferred compensation plans to attract, retain and motivate their employees and strengthen their succession plans.

According to the American Bankers Association’s 2019 Compensation & Benefits Survey, nearly 65% of banks report utilizing deferred compensation plans. These plans can include supplemental executive retirement plans, or SERPs, which are typically designed for the seasoned bank executive talent. Unlike a 401(k) plan, a SERP has no contribution limit or rules that mandate that all employees must be able to participate. They are purposely designed for highly compensated executives and key employees for whom the 401(k) contribution limits act as a form of “reverse discrimination” toward retirement. These limits can cause a whole host of problems if not addressed by the introduction of a SERP.

Meaningful, thoughtful compensation will be essential for banks interested in motivating and retaining key executives and talent as they continue navigating through these unprecedented times. Guaranty Bancshares’s CFO Cappy Payne called the SERP a “cornerstone” of the Addison, Texas-based bank’s compensation approach.

“[W]e have a wide variety of executive compensation and benefit plans for our senior level management,” he says. “We purposely diversify their compensation such that it increases our ability to attract, retain and motivate the talent we need to differentiate in this incredibly tough economic environment.”

SERPs are often offered alongside several other types of long-term incentive compensation vehicles. Long-term plans can include stock options, stock appreciation rights, phantom stock, restricted stock, restricted units, performance shares of units and combinations of two or three plans. All of these programs are also a form of deferred compensation, like a SERP, but don’t offer as much customization as a SERP. Additionally, most institutions use bank owned life insurance as an indirect funding approach.

A bank may design the SERP so the executive receives a benefit at a later date — like retirement or after 15 years of service. The benefit of the SERP may be issued as a lump sum, a series of payments or combination thereof. It can also have performance criteria added as a motivational incentive. And because there are no contribution limits, this ability to customize and design around one executive team generates a significant ROI. Payne says Guaranty “strongly believes” in the customization of its long-term compensation plans.

“We find customization increases the appreciation of our efforts. In addition, when used with other plans like the annual incentive plan, and other stock-based long-term incentives, we believe we are able to sustain bank leadership that creates a successful banking atmosphere,” he says.

But SERPs aren’t perfect; just like any other executive compensation and benefit plan, it’s critical that bank executives and boards understand their disadvantages. One disadvantage is the funds that accumulate for a SERP are not protected from bankruptcy and creditor claims in the event of insolvency. SERP participants become general creditors of the bank. Still, the plans offer significant advantages and can be incredibly attractive to banks as employers.

  1. They are easy to implement.
  2. The don’t require IRS approval.
  3. They can be customized to the executive team and included as a retirement benefit.
  4. Banks can use BOLI to help recover their costs and offer a split-dollar life insurance benefit while employed.

All of these advantages combined make for a powerful compensation cocktail that, when used in conjunction with other plans and communicated appropriately, is dynamite.

Banks are under more pressure than ever before to succeed. The pandemic, low interest rates and political uncertainty all contribute to questions and uncertainty in the workplace — including among top executives. SERPs can be a powerful tool in the hands of visionary banks. The flexibility afforded in a SERP is second to none. Finally, it’s just smart business to make sure banks can differentiate themselves while being sustainable by attracting, retaining and motivating the best talent possible.

Compensating Employees in a Crisis

Written by

It’s an old conflict with new, pandemic-created urgency: How to compensate employees during a crisis.

Compensation is one of the biggest variable expenses a bank has, and many incentive compensation plans may have components or goals that are no longer realistic at this state of the business cycle. At the same time, bank employees have served as first-responders to the economic crisis created by the coronavirus pandemic, putting in long hours to modify or originate loans. Boards are figuring out how to reward employees for these efforts while keeping a lid on expenses overall, balancing the bank’s growth and safety against the short-term operating environment.

The Paycheck Protection Program from the Small Business Administration creates an interesting compensation opportunity for banks, says Flynt Gallagher, president of Compensation Advisors. Many banks had employees who pulled all-nighters while working remotely to fulfill demand for these unsolicited loans. Some institutions may choose to exercise discretion by issuing spot awards, which reward employees for a specific behavior over a limited period of time, to bankers who worked overtime to help customers. Gallagher believes these may be larger than a typical award, citing one client that is setting aside $100,000 of PPP profits to distribute to employees who pitched in.

The pandemic created challenges for Civista Bancshares’ commercial lenders and their incentive compensation program, though it presented opportunities as well. Processing PPP applications took time that the Sandusky, Ohio-based bank’s commercial team may have spent monitoring and administrating their existing portfolios or prospecting for new customers. But after the $2.6 billion bank satiated demand from current customers, it opened its doors for new customers, says Civista Bancshares CEO Dennis Shaffer. Some new customers transferred their accounts and service needs as a result, which counts toward deposit goals that retail bank staff have.

Banks with plans featuring objectives or goals that may no longer be reasonable or prudent may be able to exercise discretion under their plans’ “extraordinary events” clause, Gallagher says. The clause applies to events that materially affect profitability, like selling a branch or implementing a new operating system. Banks electing that approach, he says, will also need to quantify the impact that Covid-19 has had on their performance.

At Civista, goals tend to be set in the first quarter, and Shaffer says that changing course on an incentive plan midstream could compromise its integrity. Gallagher adds that public companies like Civista may face scrutiny from proxy advisory firms if they make changes to a current plan or exercise too much description.

But boards have some options as they evaluate their current incentive compensation plans. Some may break their compensation plans into shorter plan periods. Gallagher predicts that banks may decide to shift or roll up individual goals into team or department objectives to reward the broad efforts of groups that may have gone beyond the four corners of their job descriptions.

“I don’t think you’re going to see any general methodology adopted. It’s going to be all over the board, based on the institution,” he says.

Walden Savings Bank is comparing its compensation plan, which uses a scorecard of 12 metrics evaluated monthly, to its expected financial performance, says Stephen Burger, who has chaired the Montgomery, New York-based bank’s compensation committee for 16 years. He says there is already “no way” to achieve at least four of those metrics, reducing the incentive accrual by 25%. The board and CEO of the $603 million bank also decided to cut their pay, but so far no employees have been laid off or furloughed.

“The scorecard is just a guideline,” he says. “We do have latitude to look at other opportunities and reward or cut in certain areas.”

The bank is already trying to keep a tight lid on expenses. They stayed local for their strategic planning weekend instead of going out of town, implemented a hiring freeze, paused a branch transformation project and are mulling alternations to certain benefits or staff reductions.

“We will find a way to reward our employees,” Burger says. “At the same time, if earnings aren’t there, we’ll also do a very effective job of making sure that they recognize that it’s a unique type of year.”

Gallagher cautions against banks making short-term cuts in employment or not rewarding producers. Good employees need to be retained in anticipation of better operating periods. And some banks may actually look to hire new employees right now, given that mass unemployment has flooded the marketplace with talent.

“One banker [I spoke to] said he doesn’t think he is overstaffed, he just doesn’t think he has people in the right places,” Gallagher says. “Companies that are forward-thinking will go hard on people while they’re available, even if they don’t need them. You’ll figure out how to use them to the best of their ability later. Get the talent right now.”

The High Cost of Good Talent and the Value of Retention

Written by

How would your bank fare if your top-performing lenders left tomorrow?

A bank succeeds because of its employees who grow the bank and keep it safe. The departure of these employees can impose massive costs to a bank in lost relationships and the effort to find new personnel. Has management at your bank adequately assessed the financial cost and risk of losing its key employees? What would be the financial impact to the bottom line and shareholder value if a key employee is not retained?

The direct cost of replacing a high-performing employee is up to 213% of the annual salary associated with the position, according to research by the Society for Human Resource Management. Total costs can rise to as much as 400% when considering indirect expenses. Direct costs include screening, interviewing, acquisition cost, onboarding and training, while indirect costs include lost productivity, short-staffing, coverage cost and reduced morale.

The following are hypothetical examples that help illustrate both the costs and risks associated with replacing a key employee at a bank:

Example 1: A lender in their early 40s who maintains a $40 million loan portfolio with a 4% margin joins a competitor bank. The estimated earnings on the lender’s portfolio were $1.6 million. If 30% of the portfolio moves to the competing bank, that would create an annual impact of $480,000. The bank stands to lose $1.4 million in three years. Assuming this lender generates $10 million in new loans annually, that adds another $400,000 in additional lost income. Losing this one lender results in lost annual revenue of almost $900,000.

Now imagine the bank has seven lenders with similar portfolios and margins. If the entire team left, the lost revenue potential could be over $6 million annually.

Example 2: A bank loses its compliance officer. In addition to the direct financial costs of replacing the officer, this could cause both short- and long-term regulatory and financial risks and challenges. If the officer had a salary of $90,000, the cost to replace them is between $191,700 and $360,000, using the 213% and 400% of base salary replacement cost assumptions. There could also be additional costs associated with potential outsourcing the compliance services until the bank can hire a new compliance officer.

Fortunately, in both of these examples, management preemptively responded by strategically designing compensation programs to retain the officers. Quantifying the lost revenue and costs to replace the employees demonstrated the substantial risks to the bank, and convinced executives of the  inadequacies of the compensation plan in place.

It is critical that banks design and implement competitive compensation plans that provide meaningful benefits. Some compensation committees believe a salary and an annual performance bonus are adequate to retain key employees. But based on our experience, banks with higher retention rates offer two to four types of compensation plans, in addition to salary and bonus. Examples include employee stock ownership plans, stock options, restrictive stock, phantom stock, profit sharing, salary continuation plans and deferred compensation plans. These plans provide for payments either at retirement or while employed, or a combination of pre- and post-retirement payments. Banks can strategically design and customize these plans in ways that incentivize strong performance but fit the demographics and needs of the key personnel. There is no one-size-fits-all plan.

Additionally, nonqualified executive benefit programs such as supplemental executive retirement plans (SERPs) and deferred compensation plans (DCPs) can help your key employees accumulate supplemental funds for retirement. Their flexibility allows them to be used alongside other forms of compensation to enhance your bank’s overall executive benefit program by offering additional incentives and incorporating special features intended to retain top performers who may not be focused on retirement. For example, a deferred compensation plan with payments timed to when the officer’s children are college age can be highly valued by an officer fitting that demographic.

The significant potential financial impact when your bank loses key employees quantifies and underlines the value and importance of retention, so it is paramount that executives meaningfully and competitively compensate these employees. Banks without a strong corporate culture and a competitive compensation plan in place are at a higher risk of losing key employees and may have an emerging potential retention problem.

Use Compensation Plans to Tackle a Talent Shortage

Written by


Can you believe it’s been 10 years since the global financial crisis? As you’ll no doubt recall, what was originally a localized mortgage crisis spiraled into a full-blown liquidity crisis and economic recession. As a result, Congress passed unprecedented regulatory reform, largely in the form of the Dodd-Frank Act, the impact of which is still being felt today.

Significant executive compensation and corporate governance regulatory requirements now require the full attention of senior management and directors. At the same time, shareholders continue to apply pressure on management to deliver strong financial performance. These challenges often seem overwhelming, while the industry also faces a shortage of the talent needed to deliver higher performance. As members of the Baby Boomer generation retire over the coming years, banks are challenged to fill key positions.

Today, many banks are just trading people, particularly among lenders with sizable portfolios. Many would argue the war for talent is more intense than ever. According to Bank Director’s 2017 Compensation Survey, retaining key talent is a top concern.

surey-chart.png

To address this challenge, many banks have expanded their compensation program to include nonqualified benefit plans as well as link a significant portion of total compensation to the achievement of the bank’s strategic goals. Boards are focusing more on strategy, and providing incentives to satisfy both the bank’s year-to-year budget and its long-term strategic plan.

For example, if the strategic plan indicates an expectation that the bank will significantly increase its market share over a three-year period, compared to competition, then executive compensation should be based in part upon achieving that goal.

Achieving Strategic Goals
There are other compensation programs available to help a bank retain talented employees.

According to Federal Deposit Insurance Corp. call report data and internal company research, nonqualified plans, such as supplemental executive retirement plans (SERPs) and deferred compensation plans, are widely used and are particularly important in community banks, where equity or equity-related plans such as stock options, restricted stock, phantom stock and stock appreciation plans are typically not used. These plans can enhance retirement benefits, and can be powerful tools to attract and retain key employees. “Forfeiture” provisions (also called “golden handcuffs”) encourage employees to stay with their present bank instead of leaving to work for a competitor.

SERPs
SERPs can restore benefits lost under qualified plans because of Internal Revenue Code limits. Regulatory rules restrict the amount that can be contributed to tax-deferred plans, like a 401(k). A common rule of thumb is that retirees will need 70 to 80 percent of their final pre-retirement income to maintain their standard of living during retirement. Highly compensated employees may only be able to replace 30 to 50 percent of their salary with qualified plans, creating a retirement income gap.

retirement-income-gap.png

To offset this gap, banks often pay annual benefits for 10 to 20 years after the individual retires, with 15 years being the most common. SERPs can have lengthy vesting schedules, particularly where the bank wishes to reinforce retention of executive talent.

Deferred Compensation Plans
We have also seen an increasing number of banks implement performance-based deferred compensation plans in lieu of stock plans. Defined as either a specific dollar amount or percentage of salary, bank contributions may be based on the achievement of measurable results such as loan growth, increased profitability and reduced problem assets. Typically, the annual contributions vest over 3 to 5 years, but could be longer.

While deferred compensation plans have historically been linked to retirement benefits, we see younger officers are often finding more value in cash distributions that occur before retirement age.

To attract and retain millennials in particular, more employers are expanding their benefit programs by offering a resource to help employees pay off their student loans. According to a survey commissioned by the communications firm Padilla, more than 63 percent of millennials have $10,000 or more in student debt. Deferred compensation plans can also be extended to millennials to help pay for a child’s college tuition or purchase a home. Because these shorter-term deferred compensation plans do not pay out if the officer leaves the bank, it provides a strong incentive for the officer to stay longer term.

Banks must compete with all types of organizations for talent, and future success depends on their ability to attract and retain key executives. The use of nonqualified plans, when properly chosen and correctly designed, can make a major impact on enhancing long-term shareholder value.

Insurance services provided by Equias Alliance, LLC, a subsidiary of NFP Corp. (NFP). Services offered through Kestra Investment Services, LLC (Kestra IS), member of FINRA/SIPC. Kestra IS is not affiliated with Equias Alliance, LLC or NFP.

BOLI Market to Remain Steady in 2018

Written by


BOLI-12-6-17.pngAs 2017 comes to a close, bank-owned life insurance (BOLI) continues to be an attractive investment alternative for banks, based on the increasing percentage of banks holding BOLI assets and the high retention rate of existing BOLI plans. Through the first half of 2017, BOLI carriers reported receiving almost $1.4 billion in new BOLI premiums, according to the market research firm IBIS Associates. Assuming an annualized production level of $2.8 billion, this is only slightly behind the actual full-year new premium results of $3.2 billion received in 2016.

In 2016, 91 percent of new premiums were invested in general account products, and through mid-year 2017, the results were very similar, with 84 percent of new BOLI premiums going to that product type. Cash surrender value of BOLI policies held by banks stood at $164.5 billion as of June 30, 2017, reflecting a 3.5 percent increase from $159 billion as of June 30, 2016, according to the Equias Alliance/Michael White Bank-Owned Life Insurance (BOLI) Holdings Report™. Further, the percentage of banks holding BOLI assets increased in that time period, from 61.3 percent to 62.8 percent. With that in mind, what can we expect of the BOLI market in 2018, given today’s economic and legislative landscape?

Impact of the Economy on BOLI in 2018
Overall, the economy generated some very positive results in 2017. Unemployment declined to just over 4 percent, the stock market hit several new highs, and wage growth increased, albeit slightly. However, banks and other financial institutions continue to operate in a low interest rate environment with no significant market change expected in 2018, based on a November 2017 informal survey that Equias conducted of major BOLI carriers.

To understand the impact of continued low interest rates on BOLI carriers offering fixed-income products, it is important to understand the carriers’ investment philosophies and portfolio compositions. The investment objective of most carriers is to build a diversified portfolio of securities with a long-term orientation that optimizes yield within a defined set of risk parameters. The portfolio strategy often targets investment-grade securities. Corporate bonds are usually the largest holding in the portfolio, along with commercial mortgages and mortgage backed securities, private placements, government and municipal bonds, a small percentage of junk bonds, and other holdings. Some of the carriers in our informal survey stressed they will be allocating more of the portfolio to higher quality bonds in 2018 to guard against any potential downturn in the economy in 2019 or 2020.

Continued low market interest rates will somewhat affect the credited interest rates offered by carriers on both new BOLI sales as well as existing BOLI policies. Credited interest rates and net yields (defined as the credited interest rate less the cost of insurance charges) on new BOLI purchases are currently expected to remain stable in 2018. As a result, new BOLI purchases are, once again, expected to be in the $3 billion to $3.5 billion range in 2018. We also anticipate that approximately 80 to 90 percent of new premiums will be directed to general accounts with higher interest rates.

For existing general account and hybrid separate account BOLI policies, credited interest rates are likely to remain level or decrease slightly, unless market interest rates begin to rise at a faster clip than we have seen in recent years.

Impact of Federal Legislation on BOLI in 2018
One of the key proposals under the Tax Cuts and Jobs Act, passed recently by both houses of Congress, is to reduce the corporate tax rate from 35 to 20 percent. If this were to occur, the taxable equivalent yields on BOLI policies would be slightly lower. For instance, if the net yield on a new BOLI policy was 3.5 percent, then the taxable equivalent yield on that policy would be 5.38 percent at the current federal tax rate of 35 percent, due to the favorable tax treatment that life insurance policies receive.

With the lower federal corporate tax rate under the proposed legislation, the tax equivalent yield for a 3.5 percent net yield BOLI policy would be reduced to a still attractive 4.38 percent. If the corporate tax rate ends up at 25 percent, as some predict, the tax equivalent yield would be 4.67 percent.

Looking ahead to 2018, the continuation of low interest rates and a possible reduction in the corporate tax rate may have some minor impact on BOLI sales and existing BOLI policies, but neither should result in any material impact on the BOLI market.

Compensation Strategies to Attract, Retain and Motivate Millennials

Written by


compensation-9-18-17.pngDistinguishing between retirement plans for a bank’s older executives and other key high performers and shorter-term incentives for its younger millennials, who are the bank leaders of the future, continues to be an important strategy for boards of directors. Compensation committees are willing to provide some type of mid-term incentive plan as a retention strategy focused on their younger workers. Boards also want to have both short- and long-term, performance-driven plans in place that are aligned with shareholder interests and retaining their key officers.

As with most employees, effective compensation plans and performance management programs can help attract, retain and motivate millennials. Providing a competitive base salary may not be at the top of their priority list, but certainly being rewarded for performance is important.

The next generation of leaders have been impacted by the recession, both from watching their relatives endure job loss and financial stress and from experiencing the post-recession economy directly. They are also the largest group carrying student loan debt. As a result, money is very important to them and while they may not be worrying about retirement, they are focusing on shorter term financial needs.

While millennials have essentially the same financial needs as the generations preceding them, their time horizon to retirement can be 30-plus years or more, which is too far into the future for them to focus on when faced with immediate financial planning decisions, like retiring student debt, purchasing a home and providing for their children’s education.

Nonqualified benefit plans including deferred compensation plans can be an effective tool for attracting and retaining most key bank performers—both those focused on retirement as well as more interim financial needs—because of their design flexibility. According to the American Bankers Association (ABA) 2016 Compensation and Benefits Survey, 64.5 percent of respondents offered some type of nonqualified deferred compensation plan for top management (chief executive officer, C-Level, executive vice president).

For this next generation of leaders, boards should consider a type of plan that allows for in-service distributions timed to coincide with events such as a child entering college. Plan payments made to the participant while still employed can be made at some future point such as three, five or 10 years.

These plans could be used in lieu of stock plans with a similar time duration and are important to younger leaders looking to shorter, more mid-term financial needs in a long-term incentive plan. Plans with provisions linking plan benefits to the long-term success of the bank can help increase bank performance and shareholder value as well as to reward key employees for longer-term performance. Defined as either a specific dollar amount or percentage of salary, bank contributions are discretionary or dependent on meeting budget or other performance goals. Interest can be credited to the account balance with a rate tied to either an external index or an internal index such as bank return on equity.

The plan can also include a provision that the account balance, or a portion thereof, is forfeited if the key employee goes to a competitor. In addition, it is typical to see events such as a change in control or disability accelerate vesting to 100 percent.

Let’s look at two examples, one for a retirement-based plan and the other for an in-service distribution to help pay for college expenses.

Assume that the bank contributes 8 percent of a $125,000 salary for a 37-year-old employee each year until age 65. At age 65, the participant will have $1,370,000 in total benefits, assuming a crediting rate equal to the bank’s return on assets, with an annual payment of $130,000 per year for 15 years. This same participant could also have had part of the benefit paid for out via in-service distributions to accommodate college expenses for two children. Assume there are two children ages three and seven and a desire to have $25,000 per year distributed for four years, for each child. Thus, these annual $25,000 distributions would be paid out when the employee was between the ages of 49 and 56. The remaining portion available for retirement would be an annual benefit of $78,000 for 15 years beginning at age 65.

Regardless of the participant’s distribution timing goals, both types of defined contribution plans can be tied to performance goals. The bank contribution percentage to each participant’s account could be based on some defined performance goal. Again, the ABA’s 2016 Compensation and Benefits Survey results showed that bonus amounts were based on several factors including: 85.6 percent bank; 74.9 percent individual; and 26 percent department/group. Aligning the bank’s strategic plan goals with the participant’s incentive plan provides a better outcome for both shareholder and participant.

In addition, many banks have implemented defined benefit type supplemental retirement plans as a way to retain and reward key executives. These plans can also be structured as performance based plans.

Regardless of a participant’s time horizon, it is important to reward both your older and younger leaders with compensation that is meaningful to them and will help them accomplish their personal financial objectives, while balancing the long-term interests of shareholders.

Managing Today’s Compensation Risk

Written by



Regulatory attention on incentive compensation is heightened following the Wells Fargo scandal, posing a greater burden to boards and management teams. Todd Leone and Gayle Appelbaum of McLagan, part of Aon plc, explain what tools banks should use to mitigate compensation risk and the questions boards should be asking about incentive compensation arrangements.

  • Increased Scrutiny on Compensation Plans
  • Tools to Mitigate Compensation Risk
  • Questions to Ask About Incentive Compensation
  • Balancing Compensation Risk with Attracting Talent

Dangling the Carrot: How Banks Can Approach Incentive Compensation

Written by


incentive-5-24-17.pngWith the dearth of talent at many community banks, particularly in the executive suite, it has become increasing important to make sure that key employees stay put and not pack their bags for the competitor down the street. It is one thing to tie up these executives with non-competition and non-solicitation restrictions, but finding that delicate balance between appropriately protecting the bank’s interests and over-reaching, thereby running the risk of unenforceability, can often be tricky. In addition, adopting a carefully drafted incentive compensation plan can have the benefit of not only improving executive loyalty, but also encouraging revenue-enhancing or other desirable behaviors.

Cash or Equity?
Each employee may be motivated by different things, so it is often difficult to gauge what will have the biggest impact from an incentive perspective. There a few things, however, that should be kept in mind in evaluating this decision:

  • Cash has the advantage of immediate gratification. Equity awards are often subject to vesting requirements and can be difficult to monetize due to the virtually non-existent markets for most community banks’ stock.
  • Because of the vesting requirement of equity, such awards have the advantage of providing a longer-term benefit to the bank, in that executives will be loath to leave while they hold unvested equity awards.
  • It can be difficult for both the bank and the executive to value equity awards, given the lack of an efficient market for the shares.
  • Any time stock is issued by a bank holding company, it must be issued pursuant to a registration statement with the Securities and Exchange Commission, or an appropriate exemption must be available. The most common exemption for equity incentive awards is Rule 701, which requires awards to be issued, among other things, pursuant to written compensatory plans.

Appropriate Triggers
There are endlessly creative ways that community banks and their compensation consultants use to determine incentive compensation awards. So much of this is driven by the types of behaviors that the bank desires to encourage. However, there are a few things to keep in mind as you decide how to design your particular plan:

  • Beware of the Wells Fargo effect. While it is not uncommon to tie awards to achieving certain revenue and sales metrics, it is important to have appropriate controls and/or claw back policies in place to recoup pay and discourage overly aggressive sales practices.
  • Avoid tying incentives to confidential supervisory information. Many banks want to tie incentive compensation to achieving certain examination findings or CAMELS ratings. However, regulators have consistently stated this is inappropriate on a number of levels, not the least of which is that they do not appreciate being one of the deciding factors in whether an executive gets a bonus or not.

Other Do’s and Don’ts

  • Revisit plans that have been in place for a while to ensure that they are Section 409A compliant. Section 409A of the Internal Revenue Code sets forth certain rules regarding the timing of deferrals and distributions with which non-qualified deferred compensation must comply. Non-compliance could have significant negative tax consequences on the employee and, potentially, the bank.
  • The worst time to adopt a new incentive compensation plan, particularly one that contains change-in-control provisions, is right before the board decides to put the bank up for sale. Doing so may be perceived by shareholders as a breach of the board’s fiduciary duties.
  • If any of the bank’s mortgage loan originators are included in the pool of executives entitled to participate in the executive compensation plan, additional attention will need to be given to ensure that any awards granted under the plan do not run afoul of the loan original compensation restrictions set forth in Regulation Z.

While it is certainly a good idea to make sure your most valuable assets—your executives—are protected, there are a lot of variables to consider in putting together incentive compensation plans, which should be carefully crafted to achieve the bank’s objectives while avoiding unintended consequences.

Surging Stock Prices and Your Long-Term Incentive Strategy

Written by


incentive-3-6-17.pngWith the Trump administration, investors are anticipating an easing in banking regulations and modest increases in interest rates. Accordingly, the market response to Trump’s election sent bank stock prices surging. From election to year-end, the Keefe, Bruyette & Woods NASDAQ Banking Index, which is made up of money center banks, as well as regional banks and thrifts, was up 22 percent, alongside a very strong 7 percent increase in the S&P 500. Full year returns were even better, and they were better for many smaller banks as well. For example, banks with total assets between $1 billion and $10 billion saw returns of 20 percent to 65 percent.

In our experience, large swings in stock prices trigger important design considerations for long-term incentive grant strategies and grant policies.

Long-term Incentive Strategies—Target Value Versus Fixed Share
Long-term incentive strategies among banks typically incorporate the use of full-value awards, such as restricted stock or performance shares, or stock options.

There are two common approaches used to determine the number of shares granted under equity awards—a target value approach and a fixed share approach.

  • Target value approach: The bank targets a specific award “fair value.” Thus, as stock prices surge, the number of shares granted is reduced to deliver the same grant value. Conversely, when stock prices decline, more shares are granted. This is the most common method for determining the number of shares awarded.
  • Fixed share approach: The bank targets a specified number of shares. Thus, as stock prices surge, the fair value of the award also increases. The volatility in grant value is one of the reasons this approach is less common.

No matter the approach used, sudden surges in stock prices will result in significant changes in either the number of shares granted or the fair value of the award, assuming no adjustments are made to the grant strategies. For example, the increase in stock prices over the past year for banks with assets between $1 billion and $10 billion will likely result in a 16 to 40 percent decline in shares delivered through a target value approach or a 20 to 65 percent increase in fair values at banks utilizing a fixed share approach.

The advantages in delivering equity through a target value approach include providing tighter controls over the accounting expense of long-term incentive programs, a clearer understanding of the award value to the participant, greater consistency in disclosed compensation values for proxy-reported officers, and maintaining alignment with competitive market compensation levels. However, when stock prices surge, no matter the cause, the resulting reduction in shares under a target value approach may be perceived as a so-called performance penalty by participants. Your participants in the plan might wonder, “The stock price went up and you cut my shares?”

Alternatively, under the fixed share approach the increase in the fair value of the award may result in higher compensation expense, greater variability of disclosed compensation, and compensation levels that are positioned higher relative to the market than the bank’s stated compensation philosophy.

Considerations
In light of the potential variability in grant values or the number of shares issued, banks should thoroughly review the impact of recent stock price changes on their long-term incentive grant strategies to avoid unintended consequences.

Target value programs can be adjusted through an increase in the value delivered or revisions to the approach used to determine shares, or a combination of these two approaches. Generally, an increase in the value delivered would not correspond directly with the increase in stock price, for example award values would increase 20 to 30 percent of the gain in stock price. In adjusting the approach used to determine the number of shares issued, banks can use an average stock price (for example, 90 to 150 days) rather than the price on the date of grant.

Conversely, fixed share programs would be adjusted to reduce the grant value through a reduction in the number of shares issued. For example, shares granted would be reduced by 10 percent to 15 percent of the gain in share price.

In all cases, the impact of adjustments to long-term incentive strategies on total compensation should be evaluated against market compensation and share utilization levels as well as the bank’s stated compensation philosophy. Further, the rationale for adjusting long-term incentive strategies should be communicated clearly to program participants.