How We Pay the CEO: A Board Member’s View

For Banker, By Banker Video Series
Designing a fair and effective compensation plan for the bank’s CEO is a challenge for most compensation committees.  In this short video, Kimberly Ellwanger, compensation committee chairman for Heritage Financial Corporation, shares her board’s approach to structuring and measuring the CEO’s incentive pay plan.

Getting Shareholders to Say “Yes” to Your Pay Plan

12-11-13-Naomi.jpgHonolulu-based Territorial Bancorp’s Vice Chairman Vernon Hirata has a piece of advice for other bank boards: communicate with shareholders about potentially sensitive compensation related matters. Or else.

Territorial received a 74 percent approval rating from shareholders in its annual “say on pay” advisory vote in 2012. Sure, it was a passing vote, but too close for comfort, said Todd Leone, a partner at McLagan, the bank’s compensation advisor.

“We called McLagan and said, ‘Houston, we have a problem,’’’ said Hirata, who spoke at Bank Director’s recent Bank Executive and Board Compensation Conference in Chicago.

As Hirata remembers it, the $1.6-billion asset company approved a new equity incentive plan for top management in 2010 after an initial public offering of bank stock in 2009. The company spent lots of time with investor groups explaining the compensation plan, and passed its first shareholder advisory vote with no sweat. But the next year, in 2012, there was almost no communication with shareholders about the incentive plan, aside from a written description in the proxy.

And that was unfortunate because the proxy statement’s summary compensation table that year had some high numbers in it. Most notably, chairman, president and chief executive officer Allan Kitagawa had been paid almost $6.8 million in 2010, more than double his pay in 2009 or 2011. Other executives saw similar jumps that year.

Hirata said the executives were paid stock awards that year that vested over a six-year period, but the company had to report the amounts as a one-time grant, per rules from the Securities and Exchange Commission. Apparently, shareholders were not pleased. “Soon after our proxy was distributed, we got a call from our proxy distributor and said a proxy firm was deciding to recommend a ‘no’ vote,’’ Hirata said.

It was a little late to do anything, as the shareholder meeting was right around the corner. But this year, the bank reached out to shareholders and explained the equity plan better, he said. The bank was rewarded with a 91 percent approval vote this time around.

Shareholder advisory firms, which recommend votes to the large institutional investors who are their clients, don’t like big equity payouts when they don’t seem to be linked to performance, said Chris Fischer, a partner at Aon Hewitt consulting, which owns McLagan. Institutional shareholders owned about 55 percent of Territorial Bancorp’s stock, which meant the bank had to pay attention to the advisory groups.

Other compensation practices that draw the ire of shareholder advisory groups include tax gross ups, where the company agrees to pay an executive’s taxes when a change-in-control would trigger a “golden parachute” and additional taxes under the Internal Revenue Code. Also, shareholder groups don’t like it when companies tell the market one set of goals for the institution’s financial performance, while benchmarking their executives to a lower standard for bonuses.

Another red flag for shareholder advisory groups is when companies compare their compensation to a peer group with other companies that are much larger. Instead, companies typically set up peer groups with similar-sized companies in the range of half to 2.5 times the bank’s asset size, Fischer said. Communication with shareholders is important to winning a say on pay vote, he said.

“It’s better on an annual basis to reach out to your institutional investors about what concerns them with your pay package,’’ he said.

Leone agreed.“You are generating some good will with them, and most important, in your next proxy, you get to say you went out and talked to your investors,’’ he said.

As for Hirata, he had his own lessons learned from the crisis at his bank.

“Do the hard work now,’’ he said. “You don’t want to have that call and scramble at the last minute. You need to do the work before your proxy gets out there.”

How Mergers Can Impact Deferred Compensation Plans: Part II

12-9-13-Equias.jpgSome compensation arrangements can cause headaches during a merger or acquisition or even derail a deal if they trigger the golden parachute rule under the Internal Revenue Code and possibly related excise taxes. So how do you know if your bank has such arrangements? It’s best to review compensation plans well ahead of striking a deal with another bank to plan for the possibility of the application of the golden parachute rules, otherwise known as exceeding the §280G limit. This is the second in a two-part series about what constitutes a golden parachute payment and what a bank can do about it. Check out the first article to see what constitutes a parachute payment.

Is there anything the bank can do to avoid the creation of parachute payments in a change of control?

Yes. There are several potential options:

  1. Accelerate vesting prior to the change in control (CIC). The bank can accelerate vesting of a Supplemental Executive Retirement Plan (SERP) or some other non-qualified deferred compensation arrangement at least 12 months in advance of the change in control to avoid triggering the “golden parachute” excise taxes. The downside is that the bank would have to accrue a liability for the increase in the vested benefit. In addition, if the executive terminated employment, the bank would be obligated to pay the executive the increased benefit. (This is a positive to the executive but may be a negative to the bank.)
  2. Classify payments as part of a non-compete. If the executive’s separation agreement provides that the executive cannot compete with the company for a period of time, then a portion of the payments may be attributable to the non-compete and therefore excludable from the parachute payment amount. There is no bright line test for how much can be excluded as it is based on facts and circumstances. The excludable amount will vary by bank and by individual within a bank. Any amount paid that does not represent reasonable value for the non-compete will be part of the parachute payment.
  3. Provide a retention agreement. The buying bank could enter into retention agreements with one or more executives. There is value to the buying bank in retaining key executives for some period of time after the merger to protect its investment. The amount paid to the executive for retention (including salary, bonuses, stock options or other) must represent reasonable compensation for the services rendered or it will be considered a parachute payment.
  4. Accelerate income. If it is anticipated that the bank may experience a CIC in the foreseeable future, it could take steps to increase the executive’s base amount by accelerating income (through bonuses or the exercise of stock options). In addition, the executive may want to discontinue deferrals under any voluntary deferred compensation plans. Lastly, it may be possible to increase the base amount by terminating the bank’s non-qualified deferred compensation arrangements and distributing the proceeds (being careful to follow the guidance under IRC section 409A).

What are the bank’s alternatives, when designing a plan, to address §280G?

There are three basic strategies:

  1. Cutback. The agreement provides that if the total parachute payments exceed the §280G limit, they will be reduced so as not to trigger an excise tax.
  2. Gross up. The executive is to receive the total payments and the bank will pay the executive additional compensation to cover his excise taxes.
  3. Neither cutback nor gross up. The executive receives his payments, even if they trigger an excise tax, but the bank does not cover his excise taxes. This one should include a filter that would cutback the parachute payments if the excise taxes cause the executive to receive less on a net after tax basis.

Do we have to apply the same strategy for all covered executives?

No. As with other nonqualified benefit plans, you can have different CIC provisions for each executive.

What happens after the CIC is completed?

Typically the timing and amount due the executive is paid pursuant to the CIC provisions in the plan agreement. However, Section 409A of the Internal Revenue Code allows the buying bank to terminate the plan and pay a lump sum to each executive in the plan. The buying bank may only do so if it follows the specific criteria detailed in §409A. Boards and executives should take this into consideration in designing or updating their plan.

Equias Alliance offers securities through ProEquities, Inc. member FINRA & SIPC. Equias Alliance is independent of ProEquities, Inc.). IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, we advise you that any tax advice contained in this communication is not intended to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code.

The Well Written Compensation Philosophy

12-2-13-Blanchard.pngTaking tests would certainly be easier if you had the answers beforehand. What if you also had the ability to determine those answers? Well, that is exactly what compensation committees and bank executives should be thinking when they develop a written compensation philosophy. Put in the effort up front, so when the tough decisions have to be made, you already have the answer key developed. A well thought out and well documented compensation philosophy makes life easier. So where do you start?

Strategic Discussions

If you don’t have a written compensation philosophy, I suggest you start discussions with the compensation committee and the CEO (add other key executives if appropriate) to get the ball rolling. Talk about the organization’s beliefs surrounding compensation and how you want to strategically position your compensation programs to help achieve your goals. And remember, there is no right or wrong compensation philosophy. You get to decide your unique answer.

Focus on Total Compensation

The philosophy should focus on the total compensation package. That means base salaries, incentives (cash and equity if available), benefits and perquisites. It should cover what programs you have, who qualifies for those programs, and where you want to be positioned compared to market. Ask yourself some critical questions, such as:

  1. What are we trying to accomplish with our compensation programs?
  2. Do we believe in pay for performance?
  3. Should certain employee levels qualify for certain compensation programs?
  4. Where do we want to be positioned compared to market?
  5. What can we afford? (Don’t forget this one.)

These questions will help get you started down the road that is right for you.

Put it on Paper

Once you have determined the answers to some key questions you can start to draft a philosophy statement. Be sure you cover all compensation components from a high level and discuss how they fit into the complete picture. For example, if you start with base salaries and think they should be positioned at market competitive levels for fully functioning employees, then you need to take the next step and determine your market and your job expectations. Often, specific percentile positions (i.e. 50th percentile) will be mentioned in philosophies and other times ranges may be utilized. Be as specific as possible (at least internally). Some organizations will choose to lead or lag the market for specific purposes. As an example, a very performance-driven company may choose to slightly lag the market on salary, but provide high incentive opportunities based on performance that would allow the employees to potentially earn a total compensation package that is above market. This will likely attract a certain type of employee and should be communicated at the time of recruitment.

Test Your Philosophy vs. Current Reality

Once you have drafted your philosophy, you should test your goals against reality. Start by asking yourself: Are we currently practicing what we just wrote down? Or will this require a cultural shift? Some organizations incorporate a reality philosophy and an aspiring philosophy. For example, maybe you want to target salaries between the 50th and 60th percentiles of the market, but you realize you are currently paying closer to the 40th. You can’t afford to make huge adjustments all at once, so you develop a plan to get there during a period of time. This has been very common in recent years where performance challenges in the banking industry created the need for a re-set button for a lot of compensation philosophies.

Communicate Your Philosophy

Once you feel you have developed a philosophy that works for your organization, you need to communicate this philosophy. Your human resources department and managers will be critical in helping with this phase. Every employee should understand your compensation philosophy and where their specific position fits. For example, if you have determined that certain levels of employees (i.e. senior vice presidents and above) qualify for participation in a long-term incentive plan, then use this as a motivator and performance driver for those employees at the vice president level or below to aspire to that level and be rewarded for that achievement.

Put it Into Practice, Revisit and Revise

Once the philosophy is developed, written, tested and communicated, you need to keep it current and use it to make life easier. Those making decisions around hiring, annual salary increases, incentive program payouts and executive benefits should annually go back to the compensation philosophy and be sure their decisions are consistent with the stated philosophy. Each year, the compensation committee, CEO, and human resources department should review the philosophy and determine if externally or internally things have changed significantly enough to require a strategic change. It is OK to revise the philosophy for strategic purposes from time to time, but it should generally be looked at as a document of guiding principles that provides more answers than questions.

A Banker’s Story: What are Your Values?

BEBC13-Postcard-article2.pngThere is hardly a more transformative story than the one that occurred at Huntington Bank during the past several years. In 2009, Stephen Steinour was brought in to right the struggling, Columbus, Ohio-based bank in the wake of the financial crisis. The bank lost $3.1 billion that year and had bad credit issues. It raised capital and went through extensive layoffs.

“It was a tough year for us,’’ Steinour said at Bank Director’s recent Bank Executive and Board Compensation conference. “We had to shift gears.”

One of the things the $56-bilion asset Huntington Bancshares did was rebrand Huntington Bank, capitalizing on the bad name banks got during the financial crisis. While other banks were criticized for making substantial sums in overdraft fees, Huntington rolled out a 24-hour grace period on overdraft. If a customer overdraws an account, that customer gets a notification and 24 hours to put the money in the account with no fees. It was an extremely difficult year in which to introduce the plan. The bank was losing money, and the new program cost $36 million that first year.

“It was a huge step by our board and boy are we glad we did it,” Steinour said.

On the tail of the program’s success in bringing in new business and cementing loyalty, Huntington introduced asterisk free checking on the recommendation of employees. The checking account has no minimum balance requirements or terms.

“Our colleagues loved it because they asked for it,’’ Steinour said. “It put them in an empowered position with our customers.”

Huntington Bank began marketing itself as a “fair play” bank that would “do the right thing.” A training and recruitment video for the bank portrays the bank as a contrast to Wall Street, featuring a guy smoking a roll of dollar bills as if it were a cigar.

“We want to give customers an advantage rather than taking advantage of them,’’ the video says.

The transformation of the bank seems to have worked. Branding was by no means the only way the bank has improved profitability, but it helped.

In Bank Director’s 2013 Bank Performance Scorecard, Huntington was the top performing bank above $50 billion in assets, beating out giants such as Wells Fargo & Co. and Capital One Financial Corp., on measurements such as profitability, asset quality and capital levels. Huntington’s core return on average equity was 11.95 percent in 2012 and its core return on average assets was 1.22 percent, compared to a median of 9.70 and .98, respectively, for banks above $50 billion in assets.

Nowadays, Steinour is also focused on recruiting employees, with a particular emphasis on attracting the millennial generation into banking. It’s a challenge heightened by a public perception of the industry as one that takes advantage of people and has benefited from government “bailouts.”

Steinour says young people expect advances in technology and they are outspoken about their career objectives. Getting them to stay more than a few years is a challenge, as they generally don’t plan to work for the same employer for their entire careers.

“You have to respond to that,’’ he said. “That’s the workforce we’re getting.”

In order to address the concerns of its millennial employees, Huntington has laid out explicit career pathways and expanded its internship program. In response to questions from prospective employees about diversity, the bank has started groups for particular ethnicities and persuasions, including a lesbian, gay and transgender group.

“The things I assumed from my era of banking are no longer valid,’’ Steinour said.

Some good business practices, however, are timeless.

“We are in a people business,’’ Steinour said. “It is critical to us to engender engagement and continue to build upon colleague satisfaction. Their enthusiasm every day translates into great customer service.”

Banks Pay Higher Salaries, But There is More Turnover

9-27-13-Crowe.pngEvery year Crowe conducts a compensation and benefits survey of financial institutions. The results of the 2013 Financial Institutions Compensation Survey are now in, and our analysis of the trends indicates some interesting patterns.

Pay is rising. Inflation expectations and market conditions appear to be strengthening as indicated by banks making larger upward adjustments to their salary structures.

2013 was not a banner year for CEO compensation growth. Slow compensation growth for CEOs in 2013 appears to indicate that bank financial performance has improved only modestly.

Hiring and retaining the right employees continue to be the highest-priority human resource concerns. While banks have several important priorities related to human resources, their most highly rated concerns appear to be finding and retaining the right employees.

Annual salary increases continue to average 2.70 percent. The market has settled into a stable range of annual salary increases.

Employee turnover is increasing. Employees appear to be more comfortable with their job prospects as turnover has returned to pre-recession levels.

Compensation growth varies widely by job position. Some job positions have experienced significant growth in compensation over the past four years while others have lagged. For example, compensation for chief credit officers is up 23 percent over the past four years, while branch manager II compensation is up only 9 percent.

Benefit costs continue to grow. Benefit costs as a percentage of salary continue to increase, with health benefits being the primary source of increased costs.

Benefit cost-containment efforts are a major focus. More than half of the banks surveyed are trying to contain costs by using a variety of techniques to shift a portion of benefit costs to employees.

This year, our analysis identified some differences between small banks (those with less than $1 billion in assets) and their larger brethren.

An above-market compensation strategy is more common at larger banks. A higher proportion of larger banks than smaller banks indicated they are consciously paying above-market compensation.

Smaller banks are doing a better job of differentiating pay for above-average performers. Smaller banks had a higher differential of pay increases between above-average performers and average performers.

Larger banks pay a higher proportion of incentives. Incentives as a percentage of salary are typically higher at larger banks, although the difference and amount vary from year to year.

Banks with more than $1 billion in assets are expecting more growth. A higher proportion of larger banks expect their number of employees to grow compared with their smaller counterparts.

View a full summary of the results of the survey for more detailed findings.

Changing the Way We Pay

Rewarding performance without increasing risk or running into problems with regulators or shareholder advisory groups has been a tough job for bank boards in recent years. Many have made changes to their long-term and short-term incentive plans and metrics. Bank Director asked some board member and management speakers at its upcoming Bank Executive and Board Compensation Conference in Chicago Nov. 4-5 to address what changes they have made recently.

Has your bank implemented any changes to compensation or to the compensation committee during the last year that you would view as an improvement? If so, please describe.

Samuels-Ron.pngAvenue Bank introduced a long-term incentive plan in 2012 for executives, key officers and directors. This is a performance-based plan. Based on achievement of annual goals, equity awards in the form of restricted stock will be granted at threshold, target or maximum and vested evenly over a four-year period. Objectives included the ability to attract and retain key employees in a highly competitive talent market; encourage ownership; provide a portion of total compensation in deferred compensation; minimize accounting expense and provide the most efficient long-term incentive vehicle.

— Ron Samuels, chairman & CEO, Avenue Bank, Nashville, Tennessee

Stephens-Barbara.pngFirst Business Financial Services, Inc., has undertaken two major projects over the past year to align compensation and performance.  CEO performance is now evaluated using a robust process, which incorporates both business results and excellence in leadership.  In addition, we have developed a new peer group that best reflects our business model, size and markets.  This peer group will be used in evaluating both our performance and our compensation.  When combining these tools with engaged directors, we believe we provide a solid foundation for both the art and the science of compensation.

— Barbara Stephens, compensation committee chairman, First Business Financial Services, Inc., Madison, Wisconsin

Holschbach-Leon.pngOur annual compensation review considers key factors such as: talent acquisition and retention needs, long term strategy of the bank, changes in competitive landscape, and the complexity of our growing company. In 2013, we continued the practice, established a few years ago, of shifting from options as our single, long-term incentive to a combination of options and restricted shares. Going deeper into our company with options has also allowed us to recognize the hard work and commitment of our management team as well as rewarding our promising young employees that have the potential to assume leadership roles in the future.

— Leon Holschbach, president and CEO, Midland States Bancorp, Effingham, Illinois

Sorrentino-Frank.pngAt ConnectOne Bank, we have recently focused on an alignment strategy for compensation. This was accomplished by creating both an annual cash incentive plan and a formal long-term incentive plan. The dynamic tension between these two different plans motivates and rewards short-term actions while making sure that those decisions also drive long-term value creation. For a high-growth, risk-compliant organization such as ours, retaining and rewarding our top talent has become a priority for our compensation committee. This balanced approach between short and long-term incentive aligns our employees’ goals with those of our shareholders, while also building leaders who reinforce our client-centric, sense of urgency culture. The result: good decision-making, added shareholder value and strategic focus.

— Frank Sorrentino III, chairman/CEO, ConnectOne Bank, Englewood Cliffs, New Jersey 

Hirata-Vernon.pngLast year, we changed one of the executive non-equity incentive plan performance measures from strategic/nonfinancial goals to a financial goal of measuring the holding company/bank’s nonperforming assets ratio against the company’s peer group. In discussions with some of our institutional investors and after reviewing some of our past proxies, we found that this previous goal was not easily explained and not clearly an objective performance measure.  As such, the old measurement might not clearly qualify for 162(m) treatment; which, if disqualified, would mean that part of the compensation awarded would not be tax-deductible by the company.

— Vernon Hirata, vice chairman, co-chief operating officer and general counsel, Territorial Bancorp Inc., Honolulu, Hawaii

Stumped on How to Pay the CEO?

Tying compensation to performance is the top compensation challenge for bank boards, according to a survey of more than 300 bank directors and executives conducted by Bank Director in March. Some banks are approaching this challenge in unique ways. Bank Director asked upcoming speakers at its Bank Executive & Board Compensation Conference in Chicago Nov. 4-5 to share the most innovative compensation package they have seen.

What’s the most innovative CEO or employee compensation package you have seen?

Rodda-Daniel.jpgA privately-held bank was seeking to reduce its use of equity awards while maintaining a program that motivated executives and aligned their compensation with shareholder returns. The company replaced some equity grants with a new long-term cash plan tied to three-year return-on-equity goals, which reduced the equity grant rate while retaining alignment with the return provided to shareholders. The company continued to grant stock options, including some with a premium exercise price, to reinforce the link to value creation for shareholders. The long-term program also includes potential reductions in payouts if performance on credit and risk measures fails to meet expectations during the vesting period. While this program may not be appropriate for many banks, for this bank it aligned with their business objectives while maintaining a balance between risk and reward.

—Daniel Rodda, lead consultant, Meridian Compensation Partners, LLC  

Gustafson-Dennis.jpgIt’s not a bank, but the most interesting one I have seen is for the chairman and CEO of GAMCO Investors. He does not receive salary, bonuses, or stock options, but is paid a management fee of $69 million.

—Dennis Gustafson, senior vice president and financial institutions practice leader, AHT Insurance

Gallagher-William-Flynt.jpgA large financial institution wanted solutions to unintended consequences surrounding officer compensation plans. The bank annually awarded significant equity grants to all officers in the form of options or restricted shares. A deferred compensation plan also allowed officers to defer a portion of salary, annual incentive and/or equity grants in various funds, with disbursements made in company stock upon retirement. The bank officers were concerned regarding the concentration of compensation in the form of bank stock and the lack of diversification upon distribution from the deferred plan. We swapped existing equity grants in a value-for-value exchange for cash-settled restricted stock units, which were then deferred into a new fund using our patent-pending LINQS+TM design. The end result was a significantly reduced shareholder dilution, diversification for the officers, and a lifetime retirement benefit.

—W. Flynt Gallagher, president, Meyer Chatfield Compensation Advisors, LLC

ODonnell-Susan.jpgA bank I know focused its CEO pay on the success of its business strategy (driving profitable, risk- appropriate growth through acquisition). Base salary and annual cash incentives were minimized with stock based compensation representing the majority of his compensation. A modest portion of the grant consisted of restricted stock that would cliff vest after three years to provide retention and ownership perspective. The majority of shares would vest only if a balanced scorecard of measures were achieved (profitability, shareholder return, efficiency and asset quality). This encouraged the CEO to focus on long rather than short-term results. Ownership and holding policies, along with the CEO purchasing shares outside the program illustrated his “skin in the game” and alignment with shareholders. The business plan was exceeded, share value increased and the CEO was rewarded accordingly.

—Susan O’Donnell, lead consultant, Meridian Compensation Partners LLC

Swanson-Greg.jpgPearl Meyer & Partners worked with a compensation committee that, on the heels of the financial crisis, needed a more rigorous set of annual incentive goals. The committee members elected to remove some of the usual guess work in establishing annual incentive plan goals by taking a new approach to the concept of plan funding triggers. Rather than the common approach of using a single earnings-based trigger to determine whether the entire plan gets funded, they revised their plan to include “gatekeepers” based on performance relative to a peer group for each of the plan’s four corporate financial goals. Meeting the gatekeeper for a specific metric would then trigger a potential incentive payout if the bank also meets its budgeted goal for that metric. This approach promotes a more balanced assessment of performance relative to peers as well as to the bank’s budget. The result: a higher level of confidence by directors and investors that pay will be directly aligned with performance.

—Greg Swanson, vice president, Pearl Meyer & Partners

Is Your Compensation Plan Generous Enough?

6-24-13_Equias.pngWhile banks continue to have challenges with low interest rates and slow loan growth, two issues are always critical: (1) the need to attract, retain and reward executive talent and (2) the need to consistently optimize earnings.

Many bankers put compensation and retirement discussions on the back burner for the past four or five years, but are showing a renewed interest in these programs as the crisis has eased. While salary, annual performance bonuses and equity plans are important elements to consider in a compensation plan, many banks have been offering nonqualified plans to help balance the total compensation plan for key executives.

If a bank upgrades its executive compensation and benefits to compete for outstanding talent, won’t the additional cost reduce earnings? Not really. When you are able to attract and retain key officers, the bank can expect to be rewarded with superior performance and increased earnings. Additionally, banks can generally offset these unfunded benefit liabilities with the tax-advantaged earnings from bank-owned life insurance (BOLI).

There are several types of nonqualified benefit plans and unlimited benefit and contribution formulas as well as performance-based strategies that can be incorporated to meet board approval. Where do you begin?

Begin by Understanding Your Shortfall
By design, qualified plans regulated by ERISA (the Employee Retirement Income Security Act) do not provide top executives with sufficient retirement benefits and do not reflect the shareholder value they create. Salary caps, the virtual elimination of defined benefit pension plans and the relatively low level of 401(k) matching contributions typically limit executives’ retirement benefits to 30 to 50 percent of final pay. Knowing the extent of your shortfall (amount needed at retirement compared to estimated amount available) is vital to the design of an effective nonqualified plan.

Regulatory guidance says that the overall compensation package must be reasonable; therefore, SERPs and other nonqualified plans should take into consideration other compensation being provided.

Prevalence of Nonqualified Plans
Such plans are common in the banking industry. According to the American Bankers Association’s 2012 Compensation and Benefits Survey, 68 percent offer some kind of a nonqualified deferred compensation plan for top management (CEO,C-Level, EVP), and 43 percent of respondents offer a SERP.

Nonqualified Plan Basics

  • Supplemental executive retirement plans (SERPs) can be designed to address an executive’s shortfall. Generally, under the terms of a SERP, an institution will promise to pay a future retirement benefit to an executive, separate from any company-sponsored qualified retirement plan.
  • Deferred compensation plans (DCPs) minimize taxation on base salary and bonuses by allowing executives to make elective deferrals into a tax-deferred asset. The bank can also make contributions to the executive’s account using a matching or performance- based methodology.
  • Performance-driven benefit plans tie the bank’s overall objectives to an executive’s measurable performance. As these plans are based on reasonable performance benchmarks critical to the bank’s success, they address corporate governance concerns by increasing compensation only when objectives are met. Part or all of the distributions are made on a deferred basis for a variety of reasons.
  • Split-dollar plans allow the bank and the insured officer to share the benefits of a specific BOLI policy or policies upon the death of the insured. The agreement may state that the benefit terminates at separation from service or it may allow the officer to retain the life insurance benefit after retirement if certain vesting requirements are met.
  • Survivor-income plans/death benefit-only plans specify that the bank will pay a benefit to the officer’s survivor (beneficiary) upon his or her death. Typically, the bank will purchase BOLI to provide death proceeds to the bank as a hedge against the obligation the bank has to the beneficiaries. The benefits are paid directly from the general assets of the bank.

How Banks Use BOLI to Offset the Benefit Expense
The cost of each of the above plans varies by type and design. BOLI is a tax-advantaged asset whereby every $1 of premium equates to $1 of cash value on the bank’s balance sheet. Basically, BOLI is an investment asset that generates a return currently in the range of 3.00 percent to 3.50 percent after all expenses are deducted, which translates into a tax equivalent yield of 4.84 percent to 5.65 percent (assuming a 38 percent tax bracket). From an income statement standpoint, the cash surrender value (CSV) is expected to grow every month. Increases in the CSV are booked as non-interest income on a tax preferred basis. From a cash flow perspective, BOLI is a long-term accrual asset that will return cash flow to the bank upon the death of the respective insured(s).

As an example, let’s assume a 50-year-old executive will be provided a $100,000 per year nonqualified benefit payment for 15 years at age 65. The annual pre-retirement after-tax cost averages $47,000 per year. The bank could invest $2 million into BOLI to fully offset the annual after tax benefit cost.

While bank challenges still remain, providing a balanced and affordable compensation plan that includes nonqualified benefit plans can help make a difference for growing shareholder value.

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

Expect CEO Pay to Rise in 2013

6-21-13_Moss_Adams.pngWestern bank CEOs and their direct-report executives should expect average salary increases in the 3 to 5 percent range during 2013, according to a survey by assurance, consulting and tax firm Moss Adams LLP. Also, the industry should expect a nearly 50 percent reduction compared to 2012 in the number of institutions that continue to subject their executive officers to a salary freeze.

According to the 2012 Community Bank Compensation Survey conducted with Western Independent Bankers, the executive compensation banks are providing continues to show a strong correlation with the institution’s operating performance. The survey found compensation strategies continue to favor incentive-based compensation over salaries in order to place a greater emphasis on variable costs for the retention of key executive officers. However, as the economic recession gives way to recovery and many more banks return to profitability, we’re beginning to see more focus and attention given to executive compensation programs, particularly with respect to incentive pay components.

We also found that operating performance objectives, return measures and top-line growth continue to be primary considerations in establishing annual incentive compensation levels, while executive retention strategies are becoming more of a factor. While these compensation-related measures remain consistent from previous years and from bank to bank, nearly 50 percent expect to raise performance hurdles for measuring overall incentive compensation available in 2013. Long-term incentive award levels are also trending up modestly in 2013, with the award packages still relying heavily on time-vested restricted stock but increasingly including performance-vested stock awards.

In addition to these salary and incentive-based compensation expectations, the survey identified a number of emerging trends.

Increased Incentive Pay
Executive compensation is increasingly being delivered through incentive pay. It’s evident that there is a greater alignment of pay and performance, and incentive pay programs have a greater focus on long-term performance and risk outcomes. Equity-based incentives that defer compensation through multiyear vesting and mitigate compensation risk appear to be gaining favor.

More Performance Factors
Boards of directors and their compensation committees are taking a broader view of relevant performance factors in setting incentive-based compensation. An entirely discretionary approach to incentive compensation payouts is giving way to a formulaic approach dependent, in many cases, on multiple measures. Earnings measures remain the prominent factor, although returns on equity, capital levels, credit quality, and asset growth represent alternative metrics that are also considered.

Increased Documentation
When discretionary measures are used as the primary determinant for executive incentive compensation payouts, increased rigor and documentation is expected. We expect regulators to be more probing about the structure surrounding discretionary payouts to ensure decisions are justified and consistent. We expect compensation committees to refine their approach to discretionary payouts through the use of scorecards that will reflect absolute goals moderated by some subjective judgment tied indirectly to specific metrics or goals. Clawback provisions for incentive-compensation payments continue to be limited in application and complicated to enforce.

More Long-Term Incentive Strategies
Multiple long-term incentive strategies are expected to emerge with an increased use of performance-based vesting and increased responsiveness to shareholder interests and market trends. While performance-based incentive programs increase in application, time-based awards are expected to remain, balancing the mix if poor risk outcomes materialize prior to vesting.

More Transparency
More transparency in compensation reporting will become the norm, as say-on-pay provisions and public company advisory votes on executive compensation have raised reporting expectations. Proxy disclosures related to how compensation decisions are made, how performance criteria were established and how performance results led to incentive payments are expected to improve reporting clarity.

As boards of directors and their compensation committees continue to explore business planning strategies, risk tolerance measures, executive goal setting and the use of defined metrics in performance measurement, they will be better equipped to make even more meaningful connections between expected business performance and executive compensation in the future.

The Moss Adams annual survey was conducted in 2012 with Western Independent Bankers. The compensation report includes responses from 123 institutions that range in size from less than $50 million in total assets to over $2 billion across the western United States.