The Importance of Competitive Pay

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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.

How to Retain Key Employees: The Benefits of a SERP

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8-16-13-Meyer-Chatfield.pngAre you better off with or without them? That is a question advice columnist Ann Landers asked her readers. The answer is even more relevant when discussing key employees of community banks. As we emerge from the Great Recession, employee retention remains a primary focus. In a recent Bank Director survey, 40 percent of bank boards identified retaining key employees as a significant challenge. In fact, 44 percent of banks nationwide lost key executives or critical employees in the past three years.

What can banks do to retain key employees? Prior to the financial crisis, conventional wisdom accepted equity grants as the best method to retain executives and tie compensation to performance. Then came the economic downturn and those same equity grants looked like a reason for the lax credit policies whose aftermath continues to bedevil banks. Remember, many executives that received those rather large equity grants were approaching retirement age as the first wave of baby boomers. Their opportunity to benefit from equity grants had to be realized in a relatively short period of time, creating pressure for ever increasing earnings and price appreciation. History shows it did not turn out as expected.

Now, let’s reconsider a popular executive compensation benefit that fell out of favor in the wake of media and shareholder outrage. Prior to the economic downturn, many banking executives benefited from a supplemental retirement plan in addition to the company pension plan or 401(k) plan. These Supplemental Executive Retirement Plans (SERPs) were intended to provide benefits to replace the limitations imposed by Internal Revenue Service regulations. As a retention tool, SERPs are extremely effective. Typically SERPs require the executive to stay until retirement age to receive the benefit. For example, a SERP may provide an annual benefit for the executive of 40 percent to 60 percent of salary for up to fifteen years after retirement. In the event the executive leaves to work for a competitor, the SERP is forfeited. The primary objective of all compensation plans—to influence the decision making of the employee—is achieved with a SERP.

Is the expense worth it? Yes. For illustration purposes, let’s assume a bank has a SERP with a benefit of $100,000 per year for 15 years. The total cost to the bank is $1.5 million. Although spread over many years, it is still perceived as expensive. The cost on an after-tax basis is about $900,000 assuming a top tax rate of 40 percent. In an environment of detailed compensation disclosure, this seems excessive. But is it really?

Let’s look at the terms SERPs impose. First, executives must be employed with the bank until retirement. The bank is the guarantor of the benefit, not a third party as in the case of a 401(k) plan or a pension plan. For rank and file employees, if the bank fails, their retirement plan is guaranteed by a third party or the Pension Benefit Guaranty Association. With a SERP, the bank is the guarantor. If the bank fails, there is no one to make the payment and the executive loses the promised retirement benefit. Similarly, if the bank fails after the executive’s retirement, there is no one to make the payments.

One of the responsibilities of any manager is to develop talent to eventually succeed him or her. In this scenario, a 50-year old executive granted a SERP must focus on protecting shareholder value until retirement (age 65) and ensure the successor is capable—and motivated—to do the same. Thirty years is not a bad deal in exchange for a cost of $900,000.

When properly designed, the benefit to the bank and shareholders is greatly in excess of the cost of a SERP. Heidrick & Struggles, an executive search firm, says an incoming executive takes up to 18 months to achieve the level of productivity he or she provided prior to accepting a new position. This cost combined with what is known as the lost opportunity cost of not having a fully effective executive in a critical position makes the cost of a SERP appear minimal.

Top executives drive shareholder performance. If retaining these key employees is important to your bank’s future, then now is the time to make sure your bank doesn’t become one of the 44 percent who lost a key employee.