How to Set Performance Metrics that Drive Success


incentive-pay-10-12-15.pngGenerally bank incentive programs reward team members for the achievement of bank-wide financial results. However, important goals which actually build value, such as customer retention, operational improvements and talent management, are often overlooked. Strategy-based compensation marries a bank’s compensation programs with its business strategy, rewarding team players for performance which results in the achievement of strategic objectives. A helpful tool in designing a program that works is a strategic road map, which clearly identifies activities and players needed to achieve results and create value for your organization.

Creating Your Strategic Road Map
The foundation of strategy-based compensation is an understanding at all levels of the organization as to which activities are required to achieve the stated objectives. A road map to execution will identify the focal points—financial/capital requirements, customer consideration, technology needs and the alignment of talent—as well as the value drivers to push success. Laying out your strategy demonstrates team placement and individual responsibilities within the broad scheme. The illustration below is a hypothetical strategic map for a community bank. Efforts in talent management, operation process, and customer satisfaction ultimately drive the desired financial outcome: growth in income and shareholder value.

Incentive Design Considerations
Among banks, executive incentive plans typically measure bank-wide performance across three buckets:

  • Balance sheet goals (e.g. growth in loans and deposits);
  • Earnings (e.g. return on assets and/or equity); and
  • Portfolio quality (e.g. regulatory ratings, non-performing assets, and/or net charge-offs).

As demonstrated in the strategic map above, these financial metrics are outcome-based and generally reflect the results of efforts. Limiting the overall focus of incentive plans to financial objectives potentially limits the program’s ability to reward and motivate the actions required to realize the success of the business strategy. Forward-looking organizations support differentiating their incentive programs beyond the typical financial focus.

From an executive perspective, incentive plans can incorporate value-driving performance metrics such as:

  • Growth in deposits from new accounts;
  • Expansion of lending activities specifically tied to new markets;
  • Identification of acquisitions;
  • Increases in operating efficiencies, new technology platforms;
  • Demonstration of robust succession planning efforts beyond; and
  • Customer satisfaction and usage.

Below the executive level, team members should be rewarded for areas within the strategic map that they can directly impact. For example, branch managers or operation officers are instrumental in increasing efficiencies and improving customer experiences. However, these individuals have limited line of sight and impact on loan growth or capital requirements. Linkage of incentives to particular elements of the strategy map drives towards the stated strategic outcome.

Goal Setting
Equally as important in the incentive design process is setting performance goals. Designing an incentive plan to drive performance beyond the day-to-day requires setting goals with sufficient stretch to push superior market performance. Testing where your target performance goals sit relative to your bank’s and your peers’ past performance, as well as market expectations, demonstrates the rigor of your goals. For example, from a financial perspective, is the achievement of your loan growth target a walk in the park or a more difficult and dramatic home run?

In addition, setting performance goals requires an understanding of the timelines for execution. The strategic map should illustrate the milestones required to execute your objectives and your short- and long-term incentive programs should align accordingly. For example, entry into a new market may require the identification of a branch to acquire or new construction, as well as staffing. The time frame required to complete these activities and their successful deployment is likely to vary and may not be easily compartmentalized in a typical incentive plan performance period of one or three years. The most successful incentive program designs will demonstrate a level of flexibility.

Driving Performance Beyond the Day-to-Day
Incentive programs are powerful tools when designed properly. The program’s design should dovetail with your business objectives, timeframes, and lines of sight among participants. Further, these programs should be frequently monitored, reviewed, and revised as appropriate to ensure they support your bank’s evolving strategic objectives, thereby driving performance beyond the day-to-day.

Taking the Fear out of Phantom Stock


The use of equity compensation has increased in the banking industry in recent years, coinciding with enhanced compensation guidelines from the Securities and Exchange Commission (SEC), bank regulators, and the Dodd-Frank Act. These parties recommend that some executive compensation be deferred and tied to long-term performance. Equity programs typically accomplish both of these goals. A recent study of 177 public banks from Blanchard Consulting Group’s internal database found that the use of equity grants as a percentage of total compensation increased two to three times from 2009 to 2013, depending on the asset size of the bank.

Asset Size 2009 Proportion of Equity to Total Compensation 2013 Proportion of Equity to Total Compensation
Over $1B 15% 26%
$500M to $1B 4% 12%
Under $500M 4% 7%

Most publicly traded banks will use compensation plans tied to the organization’s stock to distribute long-term incentives in the form of stock options or restricted stock. Some private or thinly traded banks will use these types of “real” stock programs; however, many of these banks have limited availability of actual stock. As an alternative, private banks may use synthetic equity, such as phantom stock or stock appreciation rights, which are settled in cash.

Phantom stock programs are modeled to look and feel like restricted stock, where the participant receives the full value of the share plus any appreciation over time. The value of phantom stock is typically linked to the company’s stock price or book value per share. In addition, dividends could be factored into the phantom stock value during the vesting period, typically 3-5 years. Ultimately, the phantom stock awards will be settled in cash.

Advantages to Synthetic Equity
Banks concerned with equity dilution often prefer phantom stock, which provides a value comparable to that of restricted stock, but does not result in actual equity dilution. The value of the phantom stock is paid out in cash upon vesting, so the officer still receives value commensurate with having a real share of stock. Because phantom stock is settled in cash, it does not receive equity-based accounting treatment (value fixed at grant date). Instead, the expense is adjusted over time to reflect changes in the bank’s stock price or book value. The advantage of using phantom stock is the absence of any share dilution.

Stock Appreciation Rights (SARs) are another form of synthetic equity that are settled in cash. Cash SARs work similarly to stock options, as SARs give the participant the right to any appreciation in stock price or book value between the grant date and settlement. The appreciation value is paid in cash and taxed as ordinary income. Similar to phantom stock, cash SARs do not receive equity-based accounting treatment. The SARs are re-valued periodically, and the expense is adjusted to reflect the changes in value throughout the vesting period. This could lead to expensive accruals if the underlying stock price increases dramatically. Similar to phantom stock, there is no share dilution.

Other Considerations
Before implementing any type of equity or long-term incentive plan, a bank should consider a number of factors, such as the following:

  1. Performance-based awards: In today’s environment, equity awards are typically based on the achievement of bank-wide, department and/or individual goals.
  2. Service vesting: We typically see three to five-year vesting schedules within the banking industry. The vesting schedule may vary by grant or employee based on the bank’s retention goals.
  3. Dividends: The board should determine when and if the plan participant will receive value for dividends. This provision can be customized by the bank for each eligible employee.
  4. Termination of employment: If a participant voluntarily terminates employment during the plan term, the employee typically forfeits any unvested awards.
  5. Death or disability: Most banks will accelerate vesting and allow the participant or beneficiary to exercise shares in the event of a disability or executive’s death. All early disbursements will need to comply with Internal Revenue Service (IRS) restrictions (section 409A).
  6. Change-in-control: Shares will typically vest immediately and be paid upon the acquisition or merger of the bank if an employee is terminated as a result, also known as a “double trigger”.
  7. Clawback provision: This allows the bank to recoup incentive compensation payments made to plan participants in error from any unvested phantom stock or SAR grant.

In order to retain and attract talent, private banks need to ensure that they have the compensation tools available to compete with public banks that use real stock compensation. By using phantom stock or SARs settled in cash, private banks can help ensure that they are competitive with the market.

Trends Emerging in Compensation Policies for Bank Executives


Governance policies related to executive compensation are on the rise as a result of increased influence of bank regulators, shareholders and the Securities and Exchange Commission (SEC). These policies are intended to reduce compensation-related risk, encourage a long-term perspective and align executives with shareholder interests.

Meridian’s 2015 proxy research of banks with $10 billion to $400 billion in assets illustrates the prevalence of “standard” and “emerging” practices. Standard practices tend to be common regardless of asset size. Emerging practices are more prevalent at larger banks, but are likely to cascade to community banks over time.

Policies on Risk Adjusting Payoutsrisk-adjustment.PNG
Standard: Clawback Policies
Clawback policies allow the recovery of incentive compensation that has already been paid or vested when there has been a financial restatement and/or significant misconduct. Most banks currently have clawback policies; however, these may need to be revisited once the SEC issues final clawback rules. While many existing policies allow compensation committee discretion to seek recovery, the proposed rules (July 2015) would require a mandatory clawback of “excess” incentive pay in the event of an accounting restatement.

Emerging: Forfeiture Provisions
While clawback policies seek to recover awards already paid, forfeiture provisions provide for the reduction of incentive payouts and/or unvested awards based on negative risk outcomes such as  a lack of compliance with risk policies. While these provisions are standard at large banks that have faced significant regulatory scrutiny, they are only beginning to be used at smaller banks.

Policies on Use of Company Stockcompany-stock.PNG
Standard: Anti-Hedging Policies
Anti-hedging policies prevent executives and directors from participating in transactions that protect against or offset any decrease in the market value of company stock. Such transactions could create misalignment between shareholders and executives since executives would not suffer the same losses as shareholders if the share price drops.

The SEC’s proposed rule (issued February 2015) requires companies to disclose the types of hedging transactions (if any) allowed and the types prohibited for both employees and directors. As seen in our study, most banks already disclose formal anti-hedging policies.

Emerging: Pledging Policies
Pledging policies prevent or limit executives’ and directors’ ability to pledge company shares as collateral for loans. Pledged company stock creates a risk that executives may be forced to sell shares at a depressed stock price in order to raise cash to cover the loan margin, which could further the decline in stock price.

However, some companies allow limited pledging with pre-approval. Pledging enables executives to monetize share holdings without selling company stock. Since 2006, public companies have been required to disclose the amount of company stock pledged by executives and directors. Proxy advisory firms and shareholders typically criticize only significant levels of pledging.

Policies on Retention of Stock AwardsStock-retention.PNG
Standard: Stock Ownership Guidelines
Over 80 percent of banks in our study have stock ownership guidelines that require executives to maintain a minimum level of ownership. Ownership guidelines are typically defined as a multiple of base salary. For CEOs, the most common ownership requirement is five times base salary, while other executives range between one times and three times base salary.

Emerging: Post-Vesting Stock Holding Requirements
Many investors and shareholder advisory firms have started pushing for additional stock holding requirements. Holding requirements restrict executives from selling stock earned from equity awards or option exercises for a period of time after vesting or exercise. Some holding requirements require executives to hold a percentage of shares until ownership guidelines are met. More rigorous policies require executives to hold a percentage of shares for a set period of time (e.g., one year after vesting) or until (or even after) retirement.

Banks have been ahead of many industries in adopting these governance practices as a result of the regulatory scrutiny on compensation programs, and we expect the emerging practices will continue to gain in prevalence across banks of all sizes.

The Current Status of Dodd-Frank Act Compensation Rules


dodd-frank-8-17-15.pngWe have waited for five years since the Dodd-Frank Act became law and we are now seeing consistent movement to finalize several compensation provisions of the law.  

Meetings started in October with President Barack Obama gathering the heads of U.S. financial regulators and urging them to finish the Dodd-Frank rules. To date, we have already adopted Securities and Exchange Commission (SEC) rules that include shareholder votes on executive compensation (Section 951 on say-on-pay and so-called golden parachutes), and on independence of compensation committees (Section 952). Remaining Dodd-Frank provisions, designed to regulate behavior encouraged by compensation structures, are Sections 953, 954, and 956. Already, many institutions have implemented more stringent variable pay plans since 2010, with more compensation tied to longer term performance. The current status of the rules is highlighted below.

Pay Versus Performance Disclosure, Section 953(a)
The proposal for section 953(a) is intended to provide compensation information to augment the say-on-pay vote for public companies. The proposal highlights a new form of realized pay versus reported pay as well as a comparison of the company and peer group total shareholder return (TSR) over several years. The proposed disclosure reflects the SEC’s attempt to help shareholders gain a better understanding of how executive pay compares to company performance by comparing named executive officers’ total compensation as described in the summary compensation table to what the SEC is now defining as compensation actually paid. As an example, the vested value of equity will be incorporated into the actually paid definition versus the value of equity at grant date. Also, the new rule uses total shareholder return (TSR) as the performance measure comparing performance to compensation “actually paid,” and using TSR of a company’s peer group to provide additional context for the company’s performance. In addition, companies will be required to provide a clear description of the relationship between the compensation actually paid and cumulative TSR for each of the last five completed fiscal years.

Current Status of Rulemaking: We expect either a final, or re-proposed rule, by fall, 2015.

Pay Ratio Disclosure, Section 953(b)
The SEC finalized this rule in August, 2015, with implementation deferred to fiscal years beginning on or after January 1, 2017. The rule requires that public companies disclose the ratio of the CEO’s total compensation to the total compensation of all other employees. For example, if the CEO’s compensation was 45 times the median of all other employees, it can be listed as a ratio (1 to 45) or as a narrative. Total compensation for all employees has to be calculated the same way the CEO’s is calculated for the proxy. All employees means all full-time, part-time, temporary and seasonal employees.

Current Status of Rulemaking: The SEC finalized the rule on August 5, 2015. The first disclosure is expected for 2017 fiscal year as shown in proxy statements filed in 2018.

Clawbacks, Section 954
Section 954 is often referred to as the “clawback” provision of Dodd-Frank and applies to all public companies. The proposal requires companies set policies to revoke incentive-based compensation from top executives with a restatement of earnings if the compensation was based on inaccurate financial statements. The company has to take back the amount of compensation above what the executive would have been paid based on the restated financial statements. This rule applies to public company Section 16 officers, generally any executive with policy making powers. Variable compensation that is based upon financial metrics as well as total shareholder return would need to be clawed back, and there is a three year look-back for current and former executives.

Current Status of Rulemaking: Expect final rules in fall, 2015; once final from SEC, stock exchanges will create the listing rule and an effective date (expected late 2016 or early 2017).

Enhanced Compensation Structure Reporting, Section 956
This rule was proposed in April, 2011—more than four years ago. This rule applies to financial institutions, specifically banks greater than $1 billion in assets. The rule is primarily a codification of the principles as found in joint regulatory Guidance on Sound Incentive Compensation Policies, which stated that compensation needs to be:

  • Balanced to both risk and reward over a long-term horizon
  • Compatible with effective controls and risk management, and
  • Supported by strong corporate governance.

In addition, there is an annual reporting requirement and for large banks (greater than $50 billion in assets), there is a mandatory deferral of incentive pay. Given that there have been four years since the original proposal, we are expecting a number of changes as the global regulatory structures have changed greatly since 2011.

Current Status of Rulemaking: Originally proposed in April 2011, changes are expected to be re-proposed in 2015.

BOLI Administration: What Comes Next?



Setting up the right Bank-Owned Life Insurance (BOLI) policy is only part of the story. What happens over the life of the policy is important, too. In this informative video, Jim Calla of Meyer-Chatfield explains how proper maintenance and reporting can make the most of this product.

  • Why is proper BOLI administration an important issue for banks?
  • What are the characteristics of a good BOLI administrator?

Employee Stock Ownership Plans: Another Tool for Family-Owned Banks


ESOP-06-19-15.pngToday’s economy presents numerous challenges to community bank profitability—compressed net interest margins, increased regulation, and management teams fatigued by the crisis. In response to these obstacles, many boards of directors are exploring new ways to reduce expenses, retain qualified management teams, and offer opportunities for liquidity to current shareholders short of a sale or merger of the institution.

For many family-owned banks, their deep roots in the community and a desire to see their banks thrive under continued family ownership into future generations can cause these challenges to be felt even more acutely. In particular, recruiting and retaining the “next generation” of management can be difficult. Cash compensation is often not competitive with the compensatory packages offered by publicly-traded institutions, and equity awards for management officials are unattractive given the limited liquidity of the underlying stock. All the while, these institutions should ensure that their owners have reasonable assurances of liquidity as needs arise or as investment preferences change. In combination, these challenges can often overwhelm a family-owned bank’s desire to remain independent.

Depending on the condition of the institution, implementing an employee stock ownership plan, or ESOP, may help a board address many of these challenges. While the ESOP is first a means of extending stock ownership to the institution’s employees, an ESOP can have other applications for family-owned banks.

Recruitment and Retention
An obvious benefit of an ESOP is to provide management and employees the ability to participate in an increase in the value of the bank, aligning their interests with those of shareholders. An equity interest provides economic incentives to join or stay with the bank and the ownership interest provided by ESOPs to employees has been shown to improve workforce productivity and morale.

Source of Liquidity for Shareholders
Without significant trading activity in their stock, shareholders of a closely-held institution may seek a liquidity event, which can include the sale of their shares to a third party or a merger with another bank. For these institutions, using the ESOP as part of a stock repurchase plan or to buy out selected shareholders can provide a buyer for large blocks of stock at a reasonable price.

For family-owned institutions, the tax benefits associated with a sale of a family’s interest in the institution to management via an ESOP are considerable. Most individual sellers of stock to an ESOP (and some trusts) qualify for a tax-free rollover of the proceeds of that sale into domestic stocks and bonds of U.S. corporations which meet certain limits on passive income. Under certain circumstances, this tax-free rollover opportunity avoids all federal income and capital gain taxes on the sale of shares to an ESOP.

In order to fund large purchases, the ESOP can take on a limited amount of leverage in order to acquire more shares in a particular year than can otherwise be allocated to plan participants. Before taking on this leverage, the bank should carefully consider how much leverage it can actually handle relative to the contributions that are expected to be made to the ESOP.

Special Benefits for S Corporations
ESOPs can also reduce shareholder numbers to facilitate a company’s conversion to an S corporation, which can help significant shareholders avoid the double taxation of dividends that apply to C corporations. Under the Internal Revenue Code, an ESOP counts as only a single shareholder for purposes of S corporation limitations, no matter how many employees have shares allocated to their accounts in the ESOP. Upon a plan participant’s separation from service from the institution, the participant may be entitled to only the cash value of the shares, rather than the shares themselves.

ESOPs also benefit from the S corporation status given their exemption from federal and most state income taxes. Since ESOPs are tax-exempt entities, they do not pay income taxes on their share of the institutions’ income like other shareholders do. When S corporations make distributions to their shareholders, ESOPs can retain that distribution, giving a better return to the ESOP participants. Additionally the cash reserves held in the ESOP from these distributions can be used to pay down ESOP debt incurred to buy shares for the ESOP, fund additional stock purchases by the ESOP, or to fund employee withdrawals from the ESOP.

For a variety of reasons, ESOPs can help family-owned financial institutions better manage the challenges of today’s market by providing a more liquid market for the institution’s shares and an exit strategy for some significant investors short of a sale or merger. ESOPs can also improve employee and senior management engagement and retention at a relatively low cost, which can improve the institution’s bottom line. With careful implementation and board oversight of compliance efforts, ESOPs can be a powerful tool for many community banks.

Will Your Bank Shoot Itself With a Single Trigger?


Here at Bank Director, we encourage readers to contact us with questions about issues they face as independent board members or members of management. We seek answers from experts and publish them for others in our membership program.

Our first question comes from a director of a privately owned Georgia bank:

“I am on the board of a local bank and the discussion involving change of control came up. We currently have a ‘double trigger’ regarding . . . key executives if a bank sale occurs. We have been counseled by our attorneys to change the document to a ‘single trigger’ in order to simplify the transaction and not put our executives in a difficult position of terminating in order to collect two or three times base earnings. What is the most common ‘trigger’ in banks today?”

BrentLongnecker.pngSo let’s retrace what the difference is: A single trigger is payment upon a change in control regardless of any change in employment status. A double trigger is payment upon a change in control followed by an involuntary termination of employment. Tips: Consider what constitutes a change in control, and consider the likelihood of the executive surviving the change in control. Consider position, age and the cost of severance to the deal. The trend today is double triggers; single triggers are out of favor.

Also, if this is a private bank, a single trigger may be worth considering IF it can get sound and enforceable non-compete and non-solicitation language signed by the departing executives. There is nothing worse than to give out a nice payment to executives—on behalf of the bank and its shareholders—only to see them set up shop “across the street” and begin competing and taking your people. Change-in-control monies have seeded more competition than most people would imagine, especially with banks!

—Brent M. Longnecker, chairman and CEO, Longnecker & Associates

DoreenLilienfield.pngChange-of-control protections can both ensure that executives provide an impartial consideration of strategic alternatives for a company without focusing on their own potential job loss, and serve as an effective retention tool for executives during uncertain times surrounding a potential transaction.

Executives are often eligible to receive enhanced severance benefits (typically a multiple of base salary and bonus) if their employment is involuntarily terminated (e.g., for cause or good reason) within a specified period following a transaction. In today’s market, there is minimal use of single trigger cash change in control payments, as they can undermine rather than foster the purposes noted above. Due to shareholder and shareholder advisor pressures, the use of single triggers for most types of change-in- control benefits has become fairly uncommon; however, notwithstanding plan design, equity awards may often accelerate at the time of a transaction, particularly in cash deals.

Some companies may elect to provide cash retention bonuses in lieu of, or in addition to, change-of- control severance benefits. Retention bonuses incentivize key individuals to remain with the company through the closing date or a specified milestone thereafter, and are also typically paid out on an involuntary termination prior to the payment date. The amount of any severance and other change-in- control benefits should be taken into consideration when determining retention bonuses.

—Doreen E. Lilienfeld, partner, executive compensation and employee benefits, Shearman & Sterling LLP

The Changing Landscape for Incentive Pay


10-25-13-Blanchard.pngHistorically, bank employees have enjoyed a culture where employees had a feeling of entitlement to generous annual salary increases and profit-sharing bonuses merely for continuing to work for the bank. That is changing. Performance based cultures that reward shareholders and employees and allow transparent communication of expectations and results are becoming more prevalent.

Creating compensation plans that provide a transparent link between actual organizational performance and executive pay is now the rule rather than the exception. Several aspects of the Dodd-Frank Act encourage pay for performance, including mandatory clawbacks of unearned compensation, transparency of incentive compensation agreements and shareholder say-on-pay advisory votes. The increasing influence of shareholder advisory groups (primarily Institutional Shareholder Services and Glass-Lewis) have driven public banks to change executive compensation practices to reflect pay for performance.

Private banks also are shifting executive compensation practices as their regulators look for best practices in executive compensation. Blanchard Consulting Group’s 2012 Executive Benefits Survey showed that 59 percent of banks said regulators reviewed executive compensation plans and practices during the exam. Blanchard Consulting Group’s 2013 Compensation Trends survey found that 63 percent of banks have modified executive compensation incentive plans in at least one of the last three years based on the changing bank regulations.

Compensation transparency at the executive level as well as emphasis on cost containment (salary and benefits costs are generally the largest budget expenditure for a bank) are supporting a larger overall bank cultural shift away from “pay for loyalty.”

Creating a Performance Based Culture

What can your bank do to start to support a sales and performance based culture? Creating a bank-wide annual incentive plan (AIP) with individual employee goals that “roll-up” to the executive AIP goals is one alternative. For example, in the lending department, all the loan officers’ portfolio loan growth goals at target performance levels should add up to the overall bank target loan growth goal. Your bank can also affect change with strategic use of the annual salary increase budget. For example, your bank may target a 3 percent salary increase for all employees. Instead of just giving all employees a 3 percent increase, many banks are now using position on a salary range and performance reviews to give more of a salary increase to high performing employees or those that are meeting performance expectations and are low on the salary range. There is an opportunity for strategic salary budget use, especially with the recent economic hardship that certainly broke down employee entitlement thinking around salary increases. Many banks froze salary increases or bonuses or both during 2008 to 2010. This practice as well as bank failures, mergers and acquisition activity, reduction in force, and hiring freezes gave employees a clearer sense of how their pay and job security is affected by overall bank performance.

Impact on Executive Officer, Producer and Staff Level Incentive Plans

Both executive and non-executive incentive plans are being structured to meet several different planning objectives including the following:

  • Earning opportunities under executive officer incentive plans should be reasonable and capped, as cash incentive plans with unreasonably high payout opportunities may motivate executives to take excessive risks or manipulate earnings.
  • Incentive plans that relied historically on profitability or income goals are adding strategic and/or asset quality goals that focus on long-term viability.
  • Many banks with producer plans that pay out frequently are moving to annual payouts and considering holding back/deferring a portion of the incentive payout until it can be determined that a loan will not become problematic.
  • Mortgage lender compensation restrictions by the Federal Reserve and Dodd-Frank prohibit banks from paying mortgage lenders incentives that are based on fees.
  • Many banks are now including a long-term incentive component in executive pay-for-performance programs to help mitigate regulatory concerns that executives focus exclusively on short-term goals.
  • Today, the most common form of long-term incentive for publicly traded banks is restricted stock, which is viewed more favorably by the new regulations and guidelines. Restricted stock typically provides a stronger retention device than stock options and typically provides lower stock dilution rates.
  • Many private banks will use phantom stock and/or performance-based deferred compensation programs when real stock is not available.
  • Stock ownership guidelines and holding requirements (especially in public banks) are viewed favorably by regulators and shareholders.

Incentive compensation programs have experienced increased scrutiny in recent years. However, performance based compensation seems to be more useful than ever. Banks need to be more strategic and many are trying to drive a performance turnaround. To that end, identifying, quantifying, and driving the right performance plan can play a critical role and can differentiate your bank and your high performing employees from the competition.

How to Retain Key Employees: The Benefits of a SERP


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.

The Compensation Puzzle: Results of the 2013 Compensation Survey


5-17-13_Comp_Research_Report.pngHow should bank boards properly compensate executives, under the watchful eye of regulators and the media, while still retaining key talent? That’s the question with which directors and chief executive officers continue to struggle.  Despite this, there is perhaps a touch of newfound optimism in the banking industry regarding the management and fairness of compensation programs.

Last March, more than 300 directors and senior executives of financial institutions across the U.S. responded to the 2013 Compensation Survey, conducted via email by Bank Director and sponsored by Compensation Advisors by Meyer-Chatfield. Almost half of the respondents were independent directors.  Response was almost evenly split from respondents representing privately-held and publicly-traded institutions.

Key Findings:

  • Bank boards continue to struggle with how to effectively tie compensation to performance.  Sixty-nine percent of respondents cited this as their top compensation challenge for 2013. Boards continue to struggle with regulatory compliance—41 percent indicated that this is a key concern. Rounding out the top three, retaining key people was selected by 40 percent of respondents as a top challenge.  
  • Talent retention could increasingly prove to be a concern for the industry. Forty-four percent of respondents reported the departure of a key executive within the last three years. Very few reported that these departures are due to promotional moves, for a better pay or position, or even lateral moves to other banks. Of those reporting an executive departure, 23 percent indicated that the officer left the banking industry. With increased scrutiny on the industry coupled with the departures of retiring baby boomer executives, could the banking industry find itself in the midst of a talent drain?
  • Thirty-five percent of directors expect to see a pay increase in 2014. Just two percent expect pay to decrease. Moreover, the majority, at 62 percent, believe that they are fairly compensated. Respondents also reported that the amount of time spent on bank board activities remains the same, at a median of 15 hours per month.  
  • The mood is a little lighter. Respondents indicating a positive or neutral feeling in the management of executive compensation rose 17 points from last year’s survey, to 92 percent. When it comes to management of director compensation, those indicating a positive or neutral feeling rose 10 points, to 90 percent.
  • Banks are increasingly tying executive compensation to performance metrics or strategic goals. Still, nearly one-third, or 32 percent of respondents, said they don’t tie executive pay to a strategic plan. 
  • Show me the money. Cash rules as the most valued form of compensation for executives, in the form of salary, and directors, in the form of annual retainer and meeting fees. Benefits for boards, such as retirement or health insurance plans, continue to decline, with 58 percent indicating that they receive no benefits at all as compensation for board service. This represents a drop of 19 percentage points since 2011. 

Download the summary results in PDF format.