Team Lift-Outs: Compensation to Entice and Integrate Revenue Producers


A “lift-out” is often used to describe the hiring of a group of individuals from the same company who have worked well with each other and can make an immediate and long-term contribution. A successful lift-out can create financial gain or provide competitive advantage such as replacing or crowding out a competitor. It can help expand the bank’s geographic markets or solidify its existing footprint.

Lift-outs, however, are not without risk. Management that becomes too enamored with a team can overlook essential steps required to determine whether it would be accretive. Inadequate due diligence or simply “paying up” on compensation without having a reasonable understanding of the expected results can cause a myriad of issues. In order to mitigate the risk, bankers should follow a standardized process, as outlined below:

Stages of a Successful Lift-Out

Initial Conversation Due Diligence Team Transfer Cultural Integration
Bank and team leader discuss potential market opportunities and competitive advantages. Team leader gauges interest of other members, develops market projections and business plan for the bank’s review. Both sides investigate reputation, culture, resources and viability of a union. Team joins bank and transfers client relationships in accordance with any contractual agreements. The bank plans for and announces the acquisition of the team internally and externally. The team, which is now on the bank’s operational platform, becomes fully integrated and establishes relationships with other groups within the bank.

The compensation structure for the lift-out team should also support the four stages:

During the Initial Conversation stage, discuss high-level compensation expectations. Often, these conversations provide insight into the team’s current compensation levels and programs. It can help the bank determine whether the team can easily fit into the current compensation structure or whether additional compensation is required to entice the team to come onboard. If additional compensation is required, it is important to determine (i) how much?, (ii) in what form?, (iii) for how long?, and (iv) whether it will create any internal equity or pay compression issues for existing talent.

During the Due Diligence stage, the bank must determine compensation levels that are commensurate with the economic value of the lift-out. Understanding the amount and the timing of each team member’s individual production is essential. It can also help the bank make the determination about which team members are essential and truly accretive. Determining the expected production streams can help determine who needs a compensation package outside of the current structure and who within the team could readily be integrated into the current structure.

It may be helpful to create a program where the additional pay phases out over a period of time or is only paid if the individual (or team) meets the production expectations agreed on at the time of the lift-out. For example:

  • Special equity awards could vest based on the achievement certain levels of production within a specified period of time or could cliff vest (e.g., after 3 years) providing time to assess talent prior to vesting
  • Special bonuses could be paid if certain levels of production are achieved.

During the Team Transfer stage, care should be taken to address any internal equity concerns and ensure that non-competition/non-solicitation commitments are upheld.

Possible rationales for accepting differing levels of compensation among like positions could include the limited nature or timing of the differences or the financial impact of the additional revenue stream.

Revenue producing roles are increasingly subject to non-competition and non-solicitation agreements. To avoid litigation, it is extremely important to ask lift out team members for any documents that involve their interaction with clients or the solicitation of former employees. The bank should review these and seek the advice of legal counsel.

During the Cultural Integration Stage, the Bank should assess whether pay differences should (a) remain given the structure and/or economics of the team or (b) be discontinued.

Maintaining pay differences makes sense if the team continues to outperform or if the group is highly-sought after by other institutions. However, if the results are commensurate with those in similar roles, it may become increasingly divisive to maintain special programs. Integration into the existing pay programs is a more natural choice.

In summary, team lift-outs provide a way for banks to accelerate growth by acquiring, rather than developing, proven revenue producers. Thoughtful management of compensation during the stages of a lift-out ensures that individuals are enticed to move and are motivated to produce for the bank.

Clawbacks Are Coming. Are You Ready?


clawbacks-8-1-16.pngFive years after the passage of Section 954 of Dodd-Frank adding new provisions on clawbacks, we expect the Securities and Exchange Commission (SEC) to make some minor adjustments to its proposal and adopt a final rule before summer’s end.

The proposal, which would amend Section 10D of the Securities Exchange Act of 1934, shifts responsibility for recouping excess compensation from the SEC to the registrant, creates a non-fault standard as opposed to the Sarbanes-Oxley “misconduct” standard, extends the clawback period to three years and significantly expands the number of executives subject to its reach. Almost all issuers publicly registered with the SEC, including smaller reporting companies and current or former executive officers, are covered. Small and emerging companies, which previously were exempt under Reg SK from making detailed compensation disclosures, will shoulder a disproportionate burden.

Which Officers Are Subject to Section 10D Clawback?
Unlike Sarbanes-Oxley, which only applies to the CEO and CFO, the proposal uses the definition of executive officer from Rule 240.16a-1. It includes principal officers as well as any vice president in charge of a principal business unit, division or function and any other persons who perform similar policy-making functions for the registrant.

What Triggers a Clawback?
The law requires that the company recoup excess compensation received during the three-year period prior to the date the issuer is required to prepare an accounting restatement. Again, unlike Sarbanes-Oxley, no misconduct or error on the part of the executive need be shown. The accounting restatement is the triggering event.

What Type of Compensation Is Subject to the Rule?
The proposed rule applies to all “incentive-based compensation,” which is defined as any compensation that is granted earned or vested based wholly or in part upon the attainment of any “financial reporting measure.” A financial reporting measure is defined to mean any measure derived wholly or in part from financial information presented in the company’s financial statements, stock price or total shareholder return. This is an expansion of the language of Dodd-Frank which states that the law applies to incentive-based compensation that is based on financial information required to be reported under the securities laws. The proposed rule excludes by its terms salaries, discretionary bonus plans, time-based equity awards or other payments not based on financial reporting measures, including strategic or operational metrics.

What Is Excess Compensation?
Excess compensation is defined to be erroneously awarded compensation that the officer receives based on erroneous information in excess of what would have been received under the accounting restatement. Examples include unexercised options, exercised options with unsold underlying shares still held and exercised options with underlying shares already sold. Similarly, all excess stock appreciation rights and restricted stock units awarded must be forfeited and if already sold, any proceeds returned to the company. The clawback would also apply to bonus pools and retirement plans based on the attainment of financial metrics. What should be emphasized is the law and proposed rule leave almost no discretion to the company. Clawback is mandatory except in cases where the pursuit of recovery would be futile or counterproductive.

What Is the Tax Consequence of a Clawback?
What is particularly troublesome is the tax complications. The most common problem is likely to be that the employee will be taxed fully on the original income. When income is paid back in a different tax year, it will be treated most likely as a miscellaneous itemized deduction and its full deductibility will be subject to whether the taxpayer has sufficient deductions to equal or exceed the 2 percent threshold of adjusted gross income. A clawback could have the effect of penalizing the employee through no fault of his own beyond the amount received.

How Should a SEC Registered Bank Adjust Its Compensation Approach?
Banks which may qualify to deregister should consider it. For companies that desire to remain registered or who have no alternative, then executives should consider purchasing insurance products with their personal funds to hedge against an unexpected loss of income already earned and spent. The SEC rule does not permit the issuer to indemnify or purchase insurance for the executive to cover clawbacks. What is unfortunate is that onerous rules governing circumstances out of the control of most executives only makes performance-based incentive compensation less desirable.

The Elements of a Compensation Plan: What a Board Needs to Know


5-25-15-BCC.pngReviewing compensation within an organization is an integral part of the board’s duties, but it can be challenging to get right. There are a number of reasons for this.

Philosophy
Compensation committees need to determine the bank’s philosophy regarding compensation. Will it be a zero-sum equation where paying more compensation creates fewer dollars for management and/or the shareholders, or an abundance mentality where paying for performance generates shareholder value? Having tension between the two is healthy for setting compensation practices correctly while maintaining balance.

Regulatory
One facet that overlays any compensation structure is regulatory constraints. Over the last decade, there have been three major regulatory pronouncements affecting how banks can structure compensation.

The first is the adoption of the Internal Revenue Code Section 409A, which prohibits the acceleration of payment of deferred compensation.

The second major regulation originates from the Dodd-Frank Act. Essentially, mortgage compensation incentives can only be paid based upon: (i) the dollar volume of the mortgage loans made; or, (ii) the transaction volume generated by the mortgage lender. However, the incentives can vary as to how much is paid to each lender on either method.

The third regulation adopted is the Interagency Guidance on Sound Incentive Compensation Policies effective June 25, 2010. In the guidance, policy steps are set forth that require incentive compensation to be structured to balance the risk to the institution of such incentives, and the guidance dictates that boards are responsible for reviewing this.

Delivery
In what form will your bank deliver compensation? The following are some major ways that banks pay their executives.

Non-statutory stock options
Non-statutory options (NSOs) can be granted to just about anyone. It is not unusual for a participant to fail to realize that not only must they have sufficient funds to purchase the stock, but that there will be ordinary taxation on the gain in stock value from the exercise price for the shares compared to the fair market value of the shares at exercise. In addition, the participant will also owe Social Security and Medicare taxes on the gain.

Incentive stock options
Incentive Stock Options (ISOs) have the benefit of being taxed as capital gains upon the sale of the purchased shares for the gain over the exercise price. However, there can be one surprise in the way of alternative minimum tax (AMT).

Restricted stock
Restricted stock has become more popular as a delivered component of compensation since restrictions come with the grant of the shares. Unlike options, which do not have restrictions once the options become exercisable, restricted shares often carry a restriction as to when they can be sold. This avoids the potential of a quick sale that can occur with options, leading to volatility in the stock price and negative news when investors and others learn of executive sales of stock.

Deferred compensation
Many banks will use nonqualified deferred compensation to recruit, reward and retain key executives in various formats because plan design can be very flexible, structured as defined contribution or defined benefit plans. With closely-held organizations, the shareholders are not subjected to dilution of ownership with deferred compensation as it is accrues through the financial statements. Also, unlike the equity components previously mentioned, shareholder approval is not required. Programs of deferred compensation require board approval. There are various types of deferred compensation programs including, but not limited to, Supplemental Executive Retirement Plans (SERPs), deferred incentives, deferred grants, phantom stock, stock appreciation rights and elective deferrals.

BOLI
While it might appear that deferred compensation is expensive because the entire value of any program generates expense to the bank, often bank-owned life insurance (BOLI) is utilized as an asset to offset or recover the cost incurred by the deferred compensation. This happens in two ways. First, the interest earned while the BOLI contracts are owned informally counterbalance the expense of a deferred compensation program. Second, if the participant meets an untimely death, the death benefit the bank receives in addition to the return on its investment is available to offset the additional expense to complete the accrual of the deferred compensation benefit, so that such benefit can be paid in full to the employee’s beneficiaries.

While the components of compensation are numerous, banks can use the various components for certain tiers of executives within the organization. Further, no single component discussed is superior to the other. Each has its advantages and disadvantages, and can be tailored to the bank’s needs.

When Your CEO Becomes a Million Dollar Baby


5-20-15-Pearl.pngCEO compensation at community banks is often approaching $1 million or greater as bank profits and stock prices improve, and as merger and acquisition activity increases. Compensation committees are finding they must now address the cumbersome and confusing $1 million pay cap limitation under Internal Revenue Code (IRC) Section 162(m) in order to preserve the bank’s tax deduction for certain compensation payments. Understanding the regulation and how it applies to the bank’s compensation programs is the first step in developing an effective process for maintaining compliance. 

What is IRC Section 162(m)?

Public companies are prohibited from receiving a corporate tax deduction for compensation over $1 million paid to a covered employee (i.e., proxy-reported executive).  Under the code, compensation is based on the executive’s realized taxable wages in any given year, including actual incentives paid and the value of any vested shares and exercised stock options.  

However, Section 162(m) provides an exception for “qualified performance-based compensation” and this exception is widely used to exempt annual incentive plan payments and equity compensation from the $1 million limit. The requirements to qualify compensation as performance-based are summarized below.

Understanding How IRC Section 162(m) Applies

In general, the following types of compensation can qualify for the performance-based exception if Section 162(m) requirements are met:

  • Short-term incentive compensation with specific performance goals.  Discretionary components can be managed by creating a process that funds the plan at a maximum level using specific goals and exercising negative discretion to reduce the payouts.
  • Performance-based stock or stock units.  Goals need to be specified at the beginning of the performance period and generally should not include discretionary elements.
  • Stock option and stock appreciation rights.
  • Certain deferred compensation as long as the contribution is funded using specified performance goals.

What makes Section 162(m) confusing to many directors is that compensation must be qualified as performance-based at the time of award, even though realization of the compensation and its deductibility may be several years in the future.  In thinking through whether 162(m) may apply, directors need to foresee the level of compensation likely to be provided in the future. The future may include growing to an asset size where market-based compensation above $1 million is a reality for the CEO and other proxy-named executives.

Creating an Effective 162(m) Process

The first step in the process is to determine whether the bank is likely to be affected by 162(m). Target compensation provided to CEOs at banks with assets exceeding $1 billion generally begins to approach the $1 million level. Therefore, it is usually wise for public banks growing to that size during the time period in which a compensation program is paying out to proactively plan for compliance. The following suggestions can aid compensation committees in ensuring an effective process:

  • Incorporate all 162(m) language into an omnibus incentive plan. Having one plan in which annual incentives and equity compensation may be awarded keeps shareholder approval simple and eliminates the need to track multiple plans.
  • Add the process to qualify compensation as performance-based per 162(m) to the compensation committee’s calendar, keeping in mind the timing requirements for approval.
  • Develop a reminder system to ensure performance measures are approved by shareholders every five years as required by 162(m).
  • Obtain expert guidance whenever the committee is contemplating modifications to goals, accelerations and vestings. Individual modifications can disqualify awards from the performance-based exception for all covered employees.

Compensation committees have a responsibility to ensure that the bank preserves the tax deductibility of performance-based compensation. In doing so, compensation committees need to consider the bank’s future growth and how it relates to the compensation of their executive officers. Proper planning and development of a well-defined 162(m) process now can ensure the future deductibility of compensation expenses.

The key performance-based compensation requirements under the law:

  • The compensation terms (or plan) and performance measures are approved by shareholders within five years of the award date
  • Plan includes the maximum amount payable to any one covered employee
  • Performance goals are substantially uncertain at the time the goal is established
  • Compensation is awarded by a committee of at least two independent directors
  • Performance goals are established by the compensation committee within the lesser of 90 days or 25 percent of the performance period
  • Performance achievement is certified in writing by the compensation committee.

Report on the Market: BOLI Assets Continue To Have Strong Growth


4-29-15-Equias.pngBank-owned life insurance (BOLI) experienced another year of steady growth, with $149.6 billion in total assets in 2014, a 4 percent increase from the year before, according to the latest research from the Equias Alliance/Michael White Bank-Owned Life Insurance (BOLI) Holdings Report. For banks with less than $10 billion in assets, the growth rate was a robust 7.1 percent.

Of the 6,509 banking institutions in the U.S. operating at the end of last year, 3,803 (58.4 percent) held BOLI assets. BOLI was popular among all types of banks, with more than 50 percent of banks of all charter types holding BOLI assets. Leading the way were savings banks with 76.0 percent of the 367 banks in this category owning BOLI and Federal Reserve-member banks with 67.4 percent of the 858 banks in the category owning BOLI.

One of the reasons that bank-owned life insurance (BOLI) continued to experience significant growth in 2014 is that existing policyholders often chose to make additional BOLI purchases. This is not uncommon and is a testament to the satisfaction that many BOLI clients have with both the short and long-term performance of their BOLI policies. BOLI remains popular with banks because:

  • It provides tax advantaged investment income not available with traditional bank investments, as well as attractive yields compared to alternative investments of a similar risk and duration.
  • The growth in the cash value of the BOLI policies generates income for the bank and its shareholders.
  • The bank receives the life insurance proceeds tax-free upon the death of an insured employee who elected to participate in the plan.
  • The bank may, at its discretion, enhance the benefits it provides to the insured employees.

Thus, each year, an increasing percentage of U.S. banks hold BOLI assets and use the income to help offset and recover employee benefit expenses such as healthcare and retirement.

With BOLI currently providing a net yield ranging from 2.50 percent to 4.00 percent, depending upon the carrier and product, it is not difficult to understand why BOLI remains so appealing to banks. For a bank in the 38 percent tax bracket, this translates into a tax equivalent yield of 4.03 percent to 6.45 percent.

Hybrid and Variable Separate Account Plans
Hybrid separate account plans have continued to grow rapidly the past several years. The number of banks using hybrid separate account has increased by 47.7 percent from 862 at the end of 2011 to 1,273 at the end of 2014 and the amount of hybrid assets reported has increased by 53.2 percent from $10.36 billion to $15.87 billion over the same time period.

Hybrid separate account policies have been attractive to banks because they combine features of both general and separate account insurance products. Hybrid separate account policies operate like general account policies in that the price risk and default risk of individual securities within the portfolio remain with the carrier. In addition, the carrier guarantees a minimum crediting rate of 1.00 percent to 2.00 percent. The enhancement that many banks find attractive is that if the carrier ever becomes insolvent, the assets in the separate account are segregated from the general creditors of the carrier. Essentially, the assets in the separate account serve as collateral for the cash value of the policies. Hybrids have only been available in to BOLI marketplace for approximately 13 years compared to 33 years for general account products, so the total asset value is lower, but the growth rate is greater.

The largest portion of BOLI assets continues to be held in variable separate account policies (47.6 percent of total BOLI assets). However, only 1.1 percent of this total was held by banks with less than $1 billion of assets. Like hybrid separate account products, the assets in a variable separate account are segregated from general creditors in the event of the carrier’s insolvency. However, gains and losses of the underlying investment portfolio are passed through directly to the policyholders. While most banks that have purchased variable separate accounts policies utilize “stable value” wrappers to reduce the accounting volatility, the complexity of the product has made it more suitable to larger banks than to smaller banks.

It is also interesting to note that median BOLI assets rose from 7.6 percent to $3.98 million in 2014 from $3.70 million in 2013, and that the median ratio of bank BOLI assets to Tier 1 Capital increased from 17.46 percent of capital in 2013 to 17.67 percent of capital in 2014.

New Policies in 2014
In 2015, IBIS Associates, Inc., an independent market research firm, published a report analyzing BOLI purchases last year based on information obtained from carriers that market BOLI products. According to that report:

  • Life insurance companies reported placing 1,175 BOLI cases in 2014 representing about $3.21 billion in premium. The 1,175 cases included banks purchasing BOLI for the first time as well as additional purchases by banks that already owned BOLI.
  • Of the $3.21 billion in new premium, $2.48 billion (77.2 percent) was put into general account; $698.4 million (21.7 percent) into hybrid separate account; and $35.6 million (1.1 percent) into variable separate account.
  • Of the 1,175 cases placed, 494 (42.0 percent) were under $1 million in premium; 341 (29.0 percent) were between $1 million and $2 million; 242 (20.6 percent) were between $2 million and $5 million; 75 (6.4 percent) were between $5 million and $15 million; and 23 (2.0 percent) were over $15 million.

The Market’s Future
The near term trend in the marketplace is for higher general account and hybrid separate account purchases and relatively few variable separate account purchases. Finally, the amount of BOLI assets held by U.S. banks is expected to increase annually by 3 percent to 4 percent based on recent results.

Additional Equias articles on BOLI:
BOLI is Becoming an Increasingly Attractive Option for Banks
What Do Bank Boards Need to Know About BOLI

Equias Alliance offers securities through ProEquities, Inc. member FINRA & SIPC. Equias Alliance is independent of ProEquities, Inc.

Assessing Your Say-on-Pay Vote


As banks prepare for their annual shareholder meetings, most will have a say-on-pay vote where shareholders indicate whether they support the executive compensation program. This process has pressured companies to improve their compensation disclosures and clearly explain their pay practices and decisions. Today’s bank boards should engage with shareholders to understand their evolving perspectives on compensation and governance practices.

Meridian Compensation Partners’ Susan O’Donnell and Daniel Rodda discuss how to interpret your say-on-pay results and how to prepare for next year’s vote.

What do directors need to understand about the results of their 2015 say-on-pay vote?
Directors should know what percentage of their shareholders voted in favor of their executive compensation programs, and how that level of support compared to prior years. Receiving majority support isn’t enough. Over 70 percent of banks last proxy season received a favorable shareholder vote on their programs of 90 percent or more, so any result below that level suggests potential concerns. If your bank receives less than 70 percent support, shareholders and advisory firms such as Institutional Shareholder Services (ISS) will expect to hear specific details on how the company responded to feedback, and they will conduct a more rigorous assessment the following year. Strong shareholder support one year does not guarantee future success. We have seen the result change swiftly when not monitored.

How can directors understand what drove the results of their say-on-pay vote?
Directors should understand the makeup of their shareholder base, as there are differences in what drives the voting patterns of retail and institutional investors. Many institutional shareholders are influenced by ISS and another prominent shareholder advisory firm, Glass Lewis, so it is valuable to review their vote reports. Other institutional shareholders, like Blackrock and Vanguard, follow their own voting guidelines. While pay outcomes are more easily controlled, say-on-pay also reflects how shareholders view performance, primarily based on total shareholder return (both relative to peers and on an absolute basis). Directors need to take an objective look at how shareholders will view the relationship between executive pay and the bank’s performance.

How can banks improve the results of their say-on-pay vote?
Ensuring a significant portion of your total pay program is variable and that actual pay outcomes vary based on performance are the best ways to gain shareholder support. It is also important to maintain and disclose policies and practices that reinforce sound governance, such as stock ownership requirements, clawback policies, minimal perquisites and elimination of any tax gross-ups. The Compensation Discussion and Analysis (CD&A) section of your company’s annual proxy must effectively communicate the context and rationale for pay decisions, as well as how the programs ensure alignment between pay and performance. Investors want to understand the “how and why” of compensation decisions, including why performance measures were chosen, how pay decisions were made, and how the compensation program is aligned with shareholder value. If the say-on-pay vote receives less than 90 percent support, banks should consider reaching out to large shareholders to understand any concerns they may have. Additionally, banks that received negative recommendations from ISS and Glass Lewis should reach out to these advisory firms to discuss what led to their recommendation and what might address their concerns.

When should banks begin preparing for the following year’s say-on-pay vote?
Directors should already be thinking ahead to next year’s vote. The board has likely already made pay decisions in 2015 that will be evaluated as part of the 2016 say-on-pay vote. Typically, salary increases and equity awards are made in the first quarter of the year, but shareholders will be evaluating those decisions through the lens of performance through the end of the year. This can at times lead to an unfortunate disconnect. As a result, it is never too early to consider decisions in light of shareholder perspectives and the potential impact on the say-on-pay vote. In addition, ongoing shareholder outreach is viewed positively by investors and can proactively surface potential issues while there is still time to make changes. Being proactive and considering pay in the broader context of bank performance and shareholder perspectives should be an ongoing process.

You’ve Selected a Good Compensation Peer Group…But Are You Getting the Most Out of It?


1-21-15-Pearl.pngMany community and regional banks have invested the time and energy to establish a peer group of comparable banks to benchmark their executive compensation practices. The selection of the peer group is important work, but its full potential benefits often are not realized. Here are four key uses of peer group information to advance your business and leadership strategies.

  1. Test your bank’s relative pay-performance alignment. How does your bank pay relative to your peers, and how does it perform relative to your peers? Such an assessment of relative pay-performance alignment requires definitions of “pay” and “performance,” as well as a determination of the appropriate time period over which to measure pay and performance against peers.

    In general, the closer the bank’s percentile ranking of pay to the percentile ranking of performance, the better the relative pay-performance alignment over the selected time period. A significant difference in those percentile rankings may indicate a need for adjustments to the pay opportunity structure, especially if the difference persists over multiple periods. The peer group is very useful when conducting this type of analysis for the bank’s executive pay program.

  2. Challenge your bank’s short-term incentive (STI) design practices. The proxy disclosures of your peer group will provide varying levels of clarity about their STI arrangements. However, design elements such as threshold, target and maximum payout opportunities, performance measures and their respective weights, as well as how discretion is exercised in determining actual payouts are often discussed in proxy disclosures. Understanding how your peer group approaches these key design elements can bring greater clarity to your bank’s decisions.
  3. Inform future decisions regarding long-term incentive (LTI) strategy. Bank boards are increasingly shifting business strategy discussions from the near-term to a longer-term time horizon, particularly as they return to financial stability and cleaner balance sheets. The shift has created new energy in boardroom conversations about the best way to support the long-term business strategy with LTI compensation arrangements, particularly equity-based pay. There are no silver bullets on this front, but good ideas are being tested in the marketplace on a regular basis. Your leadership and advisors can study the LTI design practices disclosed by the peer group to add valuable context to the bank’s deliberations in this area.
  4. Understand the total compensation picture. Executive compensation consists of more than just salary, bonus and equity awards, as the banking industry continues to make significant use of supplemental retirement arrangements for senior executives. For this reason, it is critical for compensation committees to understand the value of compensation delivered in the marketplace by such arrangements. The best source of information related to retirement and perquisite compensation is the proxy disclosures of your peer group. Interpreting this data and incorporating it into a holistic competitive pay analysis takes some work, but is worth the extra effort. Take advantage of this available information so your board and senior management team make pay decisions based on full, not partial, information.

Your bank’s peer group provides useful information to help determine competitive pay levels for your senior executives. It is extra work, but there is significant additional information to be gained which will elevate the exercise to a more strategic level and support the creation of long-term value for all stakeholders.

The Importance of Competitive Pay


1-14-15-Kaplan.pngIn the midst of the Great Recession, a number of community banks found themselves the beneficiary of an unexpected inflow of talent. In particular, veteran bankers and commercial lenders who were stuck in dead or dying institutions jumped ship to a safe port during this major storm. Obviously, this was highly beneficial to those institutions seeking new senior leaders or major producers, but in some cases it also created a false sense of “talent security”—the idea that a stream of good bankers would continually find their way to the bank.

While there are indeed some high performing community and regional banks that have become “destinations” for top talent, this remains the exception to the rule. Furthermore, given the demand for talented bankers and lenders in excess of the supply (in both rural and urban markets), compensation has returned as an important factor in bankers’ consideration of where to deploy their talents.

This is not to say that an executive’s primary motivation to pursue new opportunities is financial: all of the data affirms that this is not the case. We have observed, however, several evolving dynamics regarding executive compensation, which have significantly impacted the market for senior banking talent over the past several years:

  • Banks are increasingly locking in their high performers and senior leaders with tools such as equity grants that vest over time, phantom shares for private banks or deferred compensation. In this still uncertain economic climate, few executive level candidates are willing to walk away from real dollars for the privilege of joining another institution. Candidates are usually reticent to leave money on the table, and thus these retention tools designed to “handcuff” executives are working in many cases.
  • Career moves that are financially lateral are becoming increasingly rare. As institutional and regulatory risks remain uncertain—often impacting an executive’s willingness to consider a career move—the “change premium” needed to attract new senior talent has increased. In addition, the due diligence conducted by senior bankers on potential career destinations has never been more thorough. This often complicates negotiations, impacts offer terms, and in some cases even results in a banker’s decision to pass on a superior opportunity due to a bank’s regulatory status or cloudy future.
  • Institutions that do not have the liquid currency of equity to work into the compensation mix—including privately held banks, mutuals, institutions whose equity plans have expired and those under some form of regulatory agreement—often face a greater challenge in structuring an appropriate compensation package when in heavy recruiting mode. Making up for lost equity, pending bonus payments, and deferred compensation may be especially challenging when the sole or primary compensation tool available is cash.

As evidence of this shift in executive recruiting economics, nearly every CEO search assignment we have been involved with over the past five years has also involved the bank’s compensation consultant. We have partnered with our clients’ compensation advisor—firms such as Pearl Meyer, Meridian and McLagan—in order to ensure not only that the proper financial package can be designed, but that the structure of such packages is appropriate and defensible.

Talent is so important, that one of the prime reasons some banks sell to another bank is the lack of a succession plan or the limited availability of talent.  At the end of the day, talent drives the execution of strategy, and people are always the variable in a bank’s ability to execute that plan. Thus, banks that want to survive and thrive must have the strongest possible executive leadership, as well as a cadre of good lenders. Of course, “A” players always have the most options, while “B” players are more plentiful.  However, it is always the “A” players who move the needle in terms of performance, while also commanding market compensation. “B” players may be less expensive but rarely move the needle, and the savings in hiring a B player will never make up for the lower performance.

Compensation is always a sensitive issue in banking, particularly for publicly traded institutions. And yes, it often feels that the competition is always driving up the cost of talent, impacting the bank’s bottom line. In reality though, the two most vital ingredients for banks to succeed in this environment are capital and talent. In banking as in most businesses, you do get what you pay for most of the time. Banks that are willing to invest in competitive compensation packages will be better poised to attract the best talent, and win the never-ending battles in the marketplace.

Performance-Driven Retirement Plans: Are They Right for Your Bank?


1-5-15-Equias.pngBank boards do not like to lose executive talent to competing banking organizations. Developing a compensation plan that is aligned with shareholder interests and retains key executives continues to be an important objective for compensation committees. Compensation committees need to evaluate a variety of compensation strategies to determine which will be the most effective at retaining and recruiting key high performing lenders and executives. While offering competitive salary and performance-based annual bonus amounts are a given, providing additional long-term incentives and/or retirement benefits can be the missing component. Equity plans provide an element of longer-term compensation, but are not available in many privately-held banks and, even where offered, can be complemented by other types of long-term incentive plans.

According to the American Bankers Association 2013 Compensation and Benefits Survey, 64 percent of respondents offered some kind of nonqualified deferred compensation plan for top management (CEO, C-level, executive vice president). (See our article, “Is Your Compensation Plan Generous Enough?”) Choosing the right retirement plan must incorporate the compensation committee’s overall compensation philosophy and bank objectives.

This article will focus on performance-driven retirement plans, a type of defined contribution nonqualified plan. Long-term incentive plans that are performance driven are generally well-received by shareholders. When such plans are properly designed, if the bank’s shareholders do well, so will the executives.

As an example, let’s assume the bank desires to implement a performance-driven retirement plan for a key lender who is 35 years old. Let’s also assume that if the lender meets both department and individual target goals along with the bank-wide net income goal, the lender will receive an annual grant of 10 percent of salary. The bank will cap the grant at 20 percent of salary if maximum performance goals are attained. For this individual, assume the annual contribution is based on a combination of loan growth, deposit growth and bank-wide net income. The goals and the weighting of each goal will vary by officer.

Assuming normal retirement age of 65, and 10 percent of salary contributions each year, the executive is projected to be credited with almost $400,000 in bank contributions. With interest added to the account, the retirement benefit is expected to be almost $80,000 per year for 15 years, a total benefit of $1.2 million. The payments are contingent on the executive not taking a job where he or she competes with the bank after retirement.

This type of arrangement is documented in a legal agreement between the bank and the executive. The agreement must comply with IRC Section 409A and should address various agreement terms and conditions including:

  • Early voluntary termination
  • Disability
  • Change in control
  • Pre-retirement death 
  • Death during payout
  • Non-compete and non-solicitation of customers and employees
  • Holdbacks
  • Qualifiers such as satisfactory performance evaluations and credit quality
  • Form (number of years) and timing (age or date) of benefit distributions

It is critical that bank-wide goals along with department and individual goals be linked to the bank’s budget and overall strategic plan. The goal setting process is typically the most challenging step in designing the plan. Some banks use moving averages (such as the bank’s three-year average net income) and other longer-term measures to determine executive performance and bank contributions.

Rewarding executives with a meaningful compensation package tied to long-term shareholder return is a balancing act. While there is not a one-size-fits-all approach for designing and implementing this type of plan, the facts and circumstances of each bank will dictate the best design after taking into account the bank’s culture and compensation philosophy.

Equias Alliance offers securities through ProEquities, Inc. member FINRA & SIPC. Equias Alliance is independent of ProEquities, Inc.

Higher Salaries, Tougher Performance Metrics Mark Pay Trends for 2015


12-19-14-Pearl.pngAs banks look ahead to 2015, compensation committees are entrusted with the task of determining executive pay for the upcoming year. The goal is to ensure an optimal balance between providing fair compensation for the job and motivation to meet and exceed business objectives.

Based on Pearl Meyer & Partners’ recent survey, Looking Ahead to Executive Pay Practices in 2015 – Banking Edition, there are five trends that compensation committees should consider as they make decisions for the upcoming year.

Banks of all sizes are facing the same pay challenges.
Regardless of size, the study indicates that banks are facing the same top three pressing issues:

  1. Alignment of incentives with business strategy and objectives;
  2. Assuring compensation plans ultimately result in pay/performance alignment; and
  3. Attraction and retention of key executives.

Implications: The ongoing quest to align pay programs with business strategies requires specificity. Boards should define “what is success?” in enough detail that incentive plan metrics can be chosen that have a direct linkage to realizing that success.

Compensation committees should also consider the definition of pay being used as they analyze pay-for-performance. Pay realized or realizable by the executive may offer the best insight into the relationship between compensation and financial results.

More banks are increasing CEO and direct report base salaries.
The overall number of institutions in 2015 that expect to increase CEO base pay between 2 percent and 4 percent is 41 percent, up from 26 percent in 2014. Increases in the 4 percent to 6 percent range are also on the rise versus the previous year.

CEO direct report base salaries are also rising modestly with 59 percent of banks anticipating increases between 2 percent and 4 percent, an improvement of 9 percentage points over the previous year.

Implications: As banks return to profitability, more are reinstituting modest base salary increases. Significant gains in executive compensation are more likely to come through incentive compensation and in particular, long-term awards as compensation committees seek to strengthen the pay-for-performance relationship.

Annual incentive program payout levels are expected to be strong.
Thirty-three percent of banks anticipate that bonuses will be somewhat higher for 2014 performance, with 32 percent expecting bonuses to exceed 100 percent of target. In particular, larger banks with more than $3 billion in assets expect strong payouts, with 47 percent indicating bonuses above 100 percent of target. Another 33 percent expect bonus payouts similar to the prior year.

Implications: Annual incentive plan payouts are an indication that many banks have recovered from the worst of the financial crisis. Compensation committees should align payout levels with strengthening bank financials and the economy as our next trend suggests.

Incentive program performance goals are expected to get tougher.
Perhaps as a sign of continued economic recovery and greater scrutiny on pay-for-performance, 48 percent of banks are planning to increase the difficulty of their performance goals in 2015. This again is most pronounced among institutions with more than $3 billion in assets, where 67 percent expect to increase goal difficulty.

Implications: Goal difficulty should be tested using both internal and external benchmarks to ensure performance levels employ an appropriate level of stretch goals while being realistic and achievable. Comparisons to historical performance, budget, analyst forecasts and peer group performance may prove useful.

Long-term incentive values are steady and growing. Performance shares are gaining in prevalence.
As banks consider shareholder alignment and regulator encouragement to link rewards to the time horizon for risk, 44 percent of banks predict equity award values will remain at current levels, while 38 percent of all respondents are expecting either somewhat or considerably higher value in 2015.

Banks continue to adopt performance shares, which are prevalent in other industries. Currently, only 18 percent of banks use performance-based vesting versus 33 percent in other industries; however, more than 15 percent of bank participants are planning to use performance-based awards for the first time in 2015.

Implications: The data indicates that banks may be shifting the executive compensation mix to be more long-term through the use of equity awards. As stock option usage declines and there is greater pressure to link pay and financial performance, banks often are adding performance vesting to restricted stock (or restricted stock units) in order to achieve the objectives of shareholder alignment, stock ownership and executive retention.

Conclusion
As banks address the same pay challenges across asset sizes, compensation committees are seeking ways in which to improve the pay-for-performance relationship. Based on the results of the study, boards are doing this by increasing the difficulty of annual incentive plan goals, placing emphasis on long-term incentive compensation and granting performance-based equity. Combining these actions with a review of performance to realized/realizable pay and testing incentive plan goal difficulty can assist the committee in making appropriate compensations decisions for 2015.