How Fintechs Are Impacting Conventional Pay Practices

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Traditional banks are facing unprecedented talent market pressures to retain key people, while also needing to attract talent from the financial technology industry to execute their own business transformations at an accelerating rate.

As the pressure on traditional banks increases, the question of “how much?” is no longer the only relevant question to be answered. Equally important is understanding how compensation opportunities should be structured and potentially delivered to ensure offers remain competitive.

PitchBook, a Morningstar company, has tracked over 820 companies in their fintech industry database as of October 2021. A third of these companies are less than five years old and well-funded by venture capital investors looking to capitalize on the industry’s explosive growth. Growth requires highly skilled, experienced talent to drive it. The fintech revolution has many traditional banks evolving their business models to remain relevant in this highly competitive market.

Seven Notable Pay Practice Trends from the Fintech Industry
The following seven pay practice trends are common across the fintech industry and essential for banks to understand. Financial institutions are likely to encounter several of these practices when competing for talent, and should consider which may work well within their programs to bolster competitiveness.

  1. Highly Competitive Salaries. Many fintech companies were established in high-cost cities, and the pay levels established in Silicon Valley often ripple through their national pay structures. Market-leading base salaries establish a firm offer upfront for prospective candidates.
  2. More Equity Compensation. High company valuations support granting equity more broadly in the organization; candidates coming from that environment will expect an equity grant.
  3. Equity Grants at Hire. It is common in high-tech markets to make an upfront equity grant at the time of hire between two and four times annual target levels to establish a foundational level of ownership.
  4. Shorter Equity Vesting Periods. The age-old belief that longer vesting periods promotes retention is being challenged by some high-profile tech firms. These companies are opting for monthly vesting over a multi-year time frame. Some even opt for full vesting within a year.
  5. Specialized Incentive Plans. The bank’s “corporate plan” may not fit the needs of a developing Banking-as-a-Service venture or fintech business unit. As such, a customized incentive geared towards growth or achieving strategic objectives may better support these businesses in the critical early stages.
  6. Retention Awards for In-Demand, Specialized Skills. Candidates with anti-money laundering, cryptocurrency and treasury function experience are highly sought after by firms and are experiencing large jumps in pay when they change employers. “Lock-in” retention equity awards are one way that companies are attempting to retain their employees.
  7. Flexible Work Arrangements. All industries are encountering this, but this is old hat for fintech companies that have historically emphasized this style work. Flexible work arrangements have become an expectation for most employees with in-demand skills.

For traditional banks, the realities of the broader competitive labor market are further complicated by the increased talent crunch in the fintech industry. Amid these unprecedented labor market pressures, traditional banks would do well to ensure relevant stakeholders are well informed about the realities of the broader competitive labor market and the need for a nimble talent strategy. Understanding both the “how” and “how much” of pay will prepare organizations to respond proactively to these market realities and provide an advantage when competing in the marketplace for talent.

Focus on Survival

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Comp-WP-Report.pngThe pressures brought to bear upon the banking industry as a result of Covid-19 and the related economic downturn promise to exacerbate two long-term challenges facing bank boards and management teams: tying compensation to performance, and managing compensation and benefits costs.

In early July, the U.S. remained “knee deep in the first wave” of the Covid‑19 pandemic, according to Dr. Anthony Fauci, director of the National Institute of Allergy and Infectious Diseases. States paused or began rolling back their efforts to reopen businesses and public areas. Tens of millions of Americans were unemployed. By September, newly reported cases remained above infection levels in March and April nationally. Many states were experimenting with school reopenings, and case counts were rising in the U.S.

“I’m really concerned about it,” said William Demchak, chairman and CEO of PNC Financial Services Group, who warned of an impending wave of loan defaults in a July interview. “I don’t know that it’s going to devastate us, but I think it’s going to put us into a period of really slow growth.”

Bank Director’s 2020 Compensation Survey, sponsored by Compensation Advisors, was conducted in March and April, just as Covid-19’s broad reach became clear, leading banks to embrace remote work and respond to the monumental task of issuing Paycheck Protection Program loans.

The survey highlights key concerns for bankers in this unusual environment, which will be explored in this white paper. How will bank boards evaluate CEO pay? What about director compensation and efforts to refresh the board? Finally, will banks be prepared for the impending turnover in the C-suite once baby boomers retire?

Forward-looking banks could emerge stronger from this crisis, says Flynt Gallagher, president of Compensation Advisors. “This environment is an opportunity for them, because it gives them the ability to make the changes they’ve been wanting to make,” he says. With so many Americans unemployed, more high-quality talent is available, and he believes institutions should find a way to bring them into the organization — even if a position isn’t open.

“You never go wrong when you get good people,” Gallagher says.

To read more about addressing board and CEO pay challenges, read the white paper.

To view the full results to the survey, click here.

The Evolution of Strategic Business Objectives in Annual Incentive Plans

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incentive-8-19-19.pngBoards are increasingly looking for ways to appropriately align pay and performance for bankers in the face of the disruptive changes in the industry.

Post-financial crisis, many bank boards shifted to a scorecard approach as a way to improve their compensation governance and accountability. However, industry disruption has sparked an evolution of the scorecard itself.

Before the financial crisis, determining annual bonus payouts at banks was a singular, annual event. The compensation committee and the CEO compared the bank’s current financial results to the prior year, assessed the operating environment, considered last year’s bonus pool and adjusted bonus accruals accordingly. Higher performers got a little more than prior year; poor performers looked for new jobs.

Following the financial crisis, a search for improved compensation governance and accountability ushered in a movement to construct incentive plans with payouts specifically tied to financial outcomes. This resulted in the popular financial scorecard approach used by many banks today.

Most scorecards include “hardwired” financial goals (usually earnings per share, net income and return on equity), banking-specific metrics (deposits, credit quality metrics and expense management) and a component that reflects “individual” or “discretionary” evaluations of performance.

Scorecards have served the industry well and addressed concerns that the lack of transparency into banking incentive plans resulted in shareholders being unclear of exactly what performance they were rewarding. The industry is now in the midst of a new phase of disruption that has banks reexamining their business models and entering a period of significant transformation.

In response, boards are increasingly enhancing the qualitative component of their scorecards to add balance and encompass the progress executives have made against clearly articulated strategic business objectives (SBOs). These strategic components balance the “backward-looking” nature of financial metrics with a “forward-looking” assessment that focuses on improving future financial performance.

Trends in Strategic Business Objectives
An SBO is a goal or metric that generally supports a key business priority and can be measured and objectively evaluated. For many boards, delivering against SBOs is critical to ensuring sustainability of their franchise. While growing earnings per share is a proven measure of current business success, achieving other critical outcomes is essential to creating long-term value for shareholders.

Detailed SBOs are specific to each bank and reflect where the bank is in its life cycle or period of transformation. Recently, we have observed banks incorporating the following eight categories into their SBOs for bank bonus plans:

  1. Executing the Digital Strategy: Depending on the bank’s current digital state, this category evaluates the success of critical milestones, such as percentage of paperless customers, “app” rollout and usage rates and expansion of service offerings through the digital interface.
  2. Technology Enhancements: This can include initiatives such as cybersecurity upgrades, automated fraud detection and general infrastructure enhancements like enterprise resource planning rollout.
  3. Corporate Development: This objective centers on the bank’s execution of its M&A strategy. It reflects the board’s evaluation of acquisitions, divestitures and integrations throughout the year. Banks often set goals based on quality, rather than quantity, to avoid incentivizing “bad deals.”
  4. Branch Strategy: This rewards the expansion, contraction or footprint-specific goals tied to the bank’s strategy for brick-and-mortar branch presence.
  5. Fee-Income Initiatives: Boards want to compensate for successful growing non-interest income from existing products, new products and complimentary service offerings.
  6. Customer Metrics: This can be measured through various means, such as net promoter score, internal customer satisfaction ratings, call center resolution rates and client retention statistics.
  7. Compliance: This generally focuses on the performance against anti-money laundering (AML) objectives and other regulator-specific compliance priorities.
  8. Risk Management: Boards define this SBO by evaluating process-related rollouts, infrastructure enhancements and talent upgrades across the risk function.

Banks are looking to drive their key initiatives during this time of significant transition in the industry. To do so, they are increasingly using SBOs to underpin the strategic drivers of future value creation in their business. Linking these initiatives to annual incentive compensation can communicate the importance of the strategies to the organization, and align compensation to the successful execution of these strategies.

Managing Today’s Compensation Risk

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

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

Is Your Bank Ready for the CEO Pay Ratio Disclosure?

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ceo-pay-ratio-1-4-17.pngStarting with the 2018 proxy statement (covering fiscal year 2017), most public companies will be required to start reporting their CEO pay ratio, that is, the ratio of the CEO’s pay to the median of all other employees’ pay. While it is questionable whether the CEO pay ratio disclosure will be a truly meaningful or useful figure to aid shareholders understanding of a company’s compensation practices, the new disclosure is likely to be a focus of both the media and shareholder activists. Directors and management should be aware of how their CEO pay ratio compares to peers and how it may change from year to year. The good news is that banks are expected to produce lower CEO pay ratios compared to companies in other industries. However, as with any new process, this will require time and planning.

Here are some questions to ask to see if your bank is ready.

1. Do you know how your CEO pay ratio will compare to the market?
To avoid surprises, know where your CEO pay ratio fits in with similar sized banks. McLagan’s research shows that the estimated CEO pay ratio ranges from 10 to 67, depending on asset size for banks under $30 billion in assets. Business focus also matters. Retail-focused banks tend to have a higher ratio as compared to non-retail focused banks as a result of lower median employee compensation (about 20 percent lower on average). Start planning your communications strategy to proactively consider employee concerns and press coverage. You’ll also need to evaluate the need for supplemental disclosure in the proxy statement if your CEO pay ratio is outside the norm.

Bank CEO Pay Ratio Information
CEO Pay Ratio Chart.PNG

2. Does the CEO pay ratio apply to my bank?
If you are a smaller reporting or an emerging growth company, you do not need to report the CEO pay ratio. However, even if you are not required to disclose the ratio publicly, your board may want to know how your CEO compares to the market.

3. How do I determine who is included in my employee population?
Employees are identified based upon any date within the last three months of the year. It must include all full-time, part-time, seasonal and temporary employees (including subsidiary employees and potentially, independent contractors). While the date flexibility is less of a benefit for banks, this may simplify the process for some companies, such as those in the retail industry who have significant seasonal employees.

4. Is there flexibility in the methodology used to calculate the median employee?
Yes, W2 data, cash compensation, or some other consistently applied compensation measure can be used. In addition, the time period for measuring compensation does not have to include the date on which the employee population is determined. Keep in mind that decisions regarding specific methodologies may affect the resulting median and may require additional disclosure.

5. Can I use estimates?
Yes, reasonable estimates and sampling can be used; however, the methodology and assumptions must be disclosed. Regardless of the method used, ensure that your process is reliable, repeatable and able to be explained in the proxy. This is not likely a benefit for wholly owned U.S.-based banks with centralized human resource information or payroll systems.

6. How often is the disclosure required?
Annually; however, the median employee may be updated every three years, provided the employee population has not changed significantly. Banks on an acquisition path may need to update the median employee each year.

7. Can all my data providers supply the information I will need and on time?
Do your due diligence now to determine your data requests from payroll vendors, stock reporting systems, benefits providers, actuaries for retirement plan accruals, etc. The time and resources to comply could be substantial and working through the various decisions and establishing a methodology ahead of time will make for a smoother process in 2018.

In summary, don’t assume your CEO pay ratio calculation will be quick and easy. Getting started now will allow time to provide education and manage expectations. Be proactive to ensure your methodology is well tested to be ready for implementation in your 2018 proxy statement.

Clawbacks Are Coming. Are You Ready?

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

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

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

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

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

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

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

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

New Incentive Compensation Rules Will Impact Banks and Their Boards

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incentive-compensation-6-27-16.pngRecently, four of six regulators issued an inter-agency proposal for new rules on incentive compensation under §956 of the Dodd-Frank Act. The new rules replace the joint rules proposed in 2011, which never went into effect. Banks boards must approve incentive compensation plans for senior executives and “risk takers” under the framework of the law.

Four Key Differences
While some of the re-proposal is the same, there are important differences between the new rules and the 2011 rules. Here we touch on four key differences, and one important similarity.

1. The regulators have been “getting smart” on incentive compensation. While the 2011 rules seemed to have been proposed in a vacuum, the regulators have indicated that the new rules are based on their collective supervisory experiences gained over the last several years. The new rules incorporate practices that institutions and foreign regulators have adopted to address compensation practices that may have contributed to the financial crisis.

2. The new rules try to lessen the burden on smaller institutions by further dividing banks into categories based on assets and by scaling the requirements. The new rules recognize three categories each of which will be subject to varying levels of oversight:

  • Level 1 (greater than or equal to $250 billion);
  • Level 2 (greater than or equal to $50 billion and less than $250 billion); and
  • Level 3 (greater than or equal to $1 billion and less than $50 billion).

Institutions with average total consolidated assets of less than $1 billion will be subject only to the “safety and soundness” aspects described below. In most cases, the new rules apply the most stringent aspects only to Levels 1 and 2, while Level 3 just has primarily governance and recordkeeping obligations. However, regulators do have the discretion to subject Level 3 institutions to the rules applicable to Level 1 and 2 institutions.

3. The new rules get more specific about troublesome compensation designs. An incentive compensation arrangement will not be considered to appropriately balance risk and reward unless it:

  • Includes financial and non-financial measures of performance;
  • Is designed to allow non-financial measures of performance to override financial measures of performance, when appropriate; and
  • Is subject to adjustment to reflect actual losses, inappropriate risks taken, compliance deficiencies, or other measures or aspects of financial and non-financial performance.

4. The new rules extend mandatory deferral and clawback periods for Level 1 and 2 institutions. At their most restrictive, the new rules will require deferral for at least four years of at least 60 percent of senior executive officers’ incentive compensation and at least 50 percent of significant risk-takers’ incentive compensation. In addition, the new rules will require clawback provisions that, at a minimum, allow the institution to recover incentive compensation from the same individuals for seven years following the date on which the compensation vests, if the institution determines that the individual engaged in misconduct, fraud or intentional misrepresentation of information.

One Similarity
In addition to the foregoing key differences from the 2011 proposal, one important aspect remains the same. Similar to the 2011 rules, the new rules will prohibit all institutions from establishing or maintaining incentive compensation plans that encourage inappropriate risk by providing excessive compensation, fees, or benefits or that could lead to material financial loss to the covered institution. In this regard, the new rules continue to rely on the bank regulators’ “safety and soundness” guidelines respecting all compensation arrangements. In particular, in assessing the balance of risk and reward with respect to any compensation arrangement, institutions should consider all relevant factors including:

  • The combined value of all compensation, fees, or benefits provided to a covered person;
  • The compensation history of the covered person and other individuals with comparable expertise at the covered institution;
  • The financial condition of the covered institution;
  • Compensation practices at comparable institutions, based upon such factors as asset size, geographic location, and the complexity of the covered institution’s operations and assets;
  • For post-employment benefits, the projected total cost and benefit to the covered institution; and
  • Any connection between the covered person and any fraudulent act or omission, breach of trust or fiduciary duty, or insider abuse with regard to the covered institution.

Effective Date and Transition
It is expected that the last two regulators will publish their version of the new rules in the coming weeks. Variation between versions is not expected. A comment period will follow publication by each of the regulators. The new rules will become effective approximately 18 months after being published in final form. The new rules will not apply to any incentive compensation plan with a performance period that begins before the final rules are effective.

The Four Habits of Successful Bank Compensation Committees

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compensation-committee-6-17-16.pngCompensation committees are responsible for setting the foundation of a bank’s compensation program, subsequently impacting the bank’s underlying culture. The banking industry is more competitive than ever, so attracting and retaining top talent should be the number one priority. With a compensation committee that is educated on industry trends and modern-day compensation best practices, your bank will be on its way to developing programs that attract and retain top talent. Here are the top four best practices a bank’s compensation committee should consider.

1. Committee Members Should Take Steps to Stay Educated
Your committee members are responsible for staying aware of compensation trends. They need to always be in-the-know of complications, IRS penalties, and other factors with unintended consequences or expenses that can impact both the bank and the executives. Committee members should regularly review market trends in executive compensation; staying aware of banking trends as well as trends in other industries will better position the bank for success in recruiting, rewarding, and retaining talent. Your board should also be educated by the committee regarding your compensation philosophy and how the committee functions.

A few areas the compensation committee has direction over include equity grants, incentive structure, benefits, qualified plans, board compensation and other aspects of compensation. The directors should have a full understanding of structuring compensation plans, and if not, the committee should consult an adviser.

2. Establish the Duties and Responsibilities of Each Committee Member
In addition to staying educated, members of the compensation committee must have a framework for their efforts. This involves establishing the duties and responsibilities of each member, but before you begin, you’ll need to develop a compensation philosophy if you don’t already have one. Without an established compensation philosophy, your compensation committee will lack direction, clarity, and consistency regarding compensation practices. In addition to putting your philosophy in print, you should ensure that everyone on your committee understands it and is able to relay its message. The philosophy should be comprehensive as well as consistent with the culture of your bank, the interests of your shareholders and market trends.

3. Review the Committee’s Performance Quarterly
Quarterly, you should hold a meeting to assess the success of your committee. Check on what’s working and what isn’t with regards to committee function, meeting processes and other aspects. It’s important to look at whether you’re hitting benchmarks—and whether you’re attracting and retaining the talent you need to hit those benchmarks. There’s always room for improvement, so discuss what the committee may need to change in order for your bank to be more successful with recruiting and retention.

4. Engage Expert Consultants When Necessary
There’s a delicate balance that must be struck with compensation; it needs to be competitive enough to retain executives but as efficient as possible to drive shareholder value. With the increasing competition for talent and the rising costs of benefits like health care plans, many banks have been pre-funding benefits through plans such as bank-owned life insurance (BOLI). Choosing the best insurance carriers and structuring pre-funding plans is something that requires outside help from qualified consultants.

Professionals can help you determine competitive compensation packages and discern what investments will bring you the greatest return for the lowest risk.

If you don’t feel your compensation committee is hitting the mark, it’s time for something to change. Rewarding talent and funding those rewards is a complicated topic, so outside help from a compensation consultant who specializes in banking may be helpful to bring direction to your committee. If your committee follows these four best practices, you’ll be on a path to success applying your finest approach to compensation and benefits plans.

Mega-Acquirers: Compensation Practices That Make a Difference

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As football coach Lou Holtz famously stated, “In this world you’re either growing or you’re dying, so get in motion…” In the past two years, 545 banks have been acquired—the highest level of activity since 2006 to 2007. During this busy cycle, the regional public banks between $5 billion and $50 billion have enjoyed greater profitability than either their smaller or larger counterparts.

With improving financial markets, increasing regulatory requirements, and decreasing margins, some of these regional banks have been executing an acquisition growth strategy for several years. Pearl Meyer identified 22 “mega-acquirers,” banks in the top quartile of regional banks ranked by three-year asset growth. These mega-acquirers have averaged a three-year asset growth rate of over 30 percent, compared to just over 7 percent for other regionals. Not only do they outperform in asset growth, but also on a number of other key financial metrics.

Median Financial Performance of Mega-Acquirers Versus Other Regionals (as of 12/31/2015)

  3-yr Asset CAGR (%) Price/Tangible Book (%) TSR CAGR (%) Diluted EPS after Extraordinary Items CAGR (%)
1-Yr 3-Yr 5-Yr 1-Yr 3-Yr 5-Yr
Mega Acquirers (n=22) 31.58 171.48 21.63 21.56 16.55 25.56 20.12 9.82
Other Regionals (n=89) 7.30 158.87 7.62 15.19 9.97 3.39 6.85 5.29

CAGR: Compound Annual Growth Rate
TSR: Total shareholder return defined as stock price appreciation plus dividends Source: S&P Global Market Intelligence

Pay Differences
While there are many factors that can influence financial success, we looked specifically at whether or not mega-acquirers structure executive compensation differently. The answer is yes and no. The median pay of CEOs for the mega-acquirers and other regionals aren’t markedly different. The mix between base salary, annual incentives, and long-term incentives for CEOs also were generally consistent for all regionals. There were, however, three key differences.

  • Mega-acquirers manage to results. Fewer mega-acquirers have an annual incentive plan with a discretionary component (33 percent versus 46 percent for other regionals), potentially inferring that mega-acquirer executives are accountable for achieving financial goals regardless of the external environment.
  • Mega-acquirers focus on both revenues and cost. While all regionals use net income as a metric equally, mega-acquirers are more likely to include an efficiency ratio in their annual plans (27 percent versus 17 percent for other regionals).
  • Mega-acquirers tend to use more time-vested restricted stock and fewer performance shares. Curiously, mega-acquirers are getting good financial results without the use of performance-based equity. Eighty-two percent (82 percent) of mega-acquirers provide time-based equity awards to their CEOs versus 73 percent for other regionals. Prevalence of performance-based shares is 36 percent for mega-acquirers versus 51 percent for other regionals.

While we can only speculate why there is a greater preference for restricted stock rather than performance shares, there are a couple possibilities. First, performance shares often vest based on achieving operational metrics. The argument may be that future operational performance is a function of what is acquired and this can be hard to pin down even if it is measured on a relative basis. Second, while median stock ownership for mega-acquirer CEOs is similar to other regionals, it is more than twice that of regional CEOs at the 75th percentile. There may be a strong desire by some of the mega-acquirers to ensure that the CEO has meaningful share ownership and is willing to achieve this through time-based vesting. In our experience, actual share ownership is what drives behavioral shifts and creates shareholder alignment.

Considerations
These pay differences are subtle. However, when you combine strategy, financial results, and pay practices together, the implications provide for compelling discussion in the boardroom.

Has the use of discretion in incentive plans gone too far? Discretionary components are inappropriately used if they are a way of explaining away poor performance on the defined metrics. Discretion is best used when it is a qualitative assessment of non-financial results or where it is difficult to determine financial outcomes due to acquisition or other factors. Establishing what will be evaluated qualitatively at the beginning of the year, rather than at year-end also fosters discipline in using appropriate discretion.

If there aren’t meaningful differences in CEO compensation values, are you getting what you are paying for? Holding CEOs and their executive teams accountable for strategy deployment and financial results is a primary board responsibility. Open and honest feedback coupled with active oversight can ensure the bank is getting value from its compensation dollars.

Are you evaluating the CEO on the right things? Simply focusing the CEO’s evaluation on whether the bank made its numbers that year is insufficient. A more holistic view of the role using seven characteristics should be considered:

  1. Strategy and Vision
  2. Leadership
  3. Innovation/Technology
  4. Operating Metrics
  5. Risk Management
  6. People Management
  7. External Relationships

Conclusion
Compared to both smaller and larger banking organizations, regional banks have enjoyed relatively strong performance despite a challenging operating environment—and mega-acquirer performance has been even stronger. Has executive pay design played a role in the success of mega-acquirers? The differences in design are small, but potentially impactful—a tighter link to performance, a stronger focus on operational effectiveness, and for some, a higher level of long-term equity ownership.

Executive Benefit Plans in 2016: Emerging Trends

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benefit-plan-1-27-16.pngSince the credit crisis, most community banks have been able to grow and improve their financial condition. According to the Federal Deposit Insurance Corp. (FDIC), almost 60 percent of community banks reported higher year-over-year earnings for the period ending in the third quarter of 2015. In addition, community banks have increased assets by 5.6 percent and total loans and leases by 8.5 percent for the same period adjusted for mergers. While these growth numbers do not represent the pre-credit crisis years, the industry is showing an improvement. The percentage of unprofitable community banks are at the lowest level in many years. Community banks are defined by the FDIC Community Bank Study, December 2012, and one of the criteria is that these banks are “likely to be owned privately or have public shares that are not widely traded.”

What do improving conditions mean to banks and their compensation plans? Some banks have seen challenges in retaining key officers given increased competition for top talent, while other bankers believe they are now in a position to invest in additional key talent to grow their organization. For banks that have implemented various types of compensation plans, it may mean including an additional key officer in these plans. Attractive executive compensation plans include market-based salary, annual bonus based on performance, stock options or restricted stock (where applicable), reasonable contributions to a 401(k) or other qualified retirement plan, medical care and other standard benefits, change- in-control agreement and a custom-tailored nonqualified retirement plan.

Another important trend is the disruption created in many markets by mergers. The purchasing bank wants to retain the top lenders and others revenue generators, but the change in ownership can cause those individuals to consider other options. Competing banks that have developed a game plan for such situations will be positioned to hire some of these talented individuals. A nonqualified plan (customized for each executive) can play a vital role in attracting and retaining these individuals.

Another trend that has been taking place is an increase in the number of community banks that previously only offered salary and annual bonus plans, but are now providing more comprehensive compensation packages for key executives. This is a result of increased competition for executives as well as improved earnings.

Nonqualified plans need to be tailored to meet the needs of the individual. For example, a younger officer in his or her 30s may not see the value of a retirement benefit targeted at age 67, but would see value in a plan that allows for earlier cash distributions to pay for a child’s college education or that allows for early retirement at age 55. Many organizations use a combination of plans and approaches to attract and retain their key people. Here are some examples of situations and challenges bankers have faced when contemplating compensation plans:

  1. You have an executive in his mid-50s who has contributed to leading and growing the organization but has not yet been rewarded for his efforts. This executive’s compensation focus is now being more directed at retirement and wealth building rather than solely increases in current cash compensation. Consider a supplemental executive retirement plan (SERP) plan and perhaps a long-term incentive plan. He may also be interested in deferring current salary.
  2. You have young officers in their 30s and 40s who are high producers and need to be compensated for their efforts with more than just base salary and annual bonus amounts. Consider a performance-based nonqualified benefit plan or a combination of a SERP and performance-based nonqualified plan. It is important to tie these individuals to your bank if you remain independent, but it can also enhance the sales price if these individuals stay with the purchasing bank in the event your bank is sold. Properly designed nonqualified plans can substantially increase the probability they will stay in either scenario.
  3. For closely held banks that would like their management team to think like owners, consider nonqualified plans using a phantom stock or stock appreciation rights approach or, if another type of deferred compensation plan is adopted, consider linking the interest credited to the executive’s account to the bank’s return on equity.

Summary
With an improving economy and asset growth of community banks, along with a higher than normal level of merger activity, banks have been adding officers to existing long term incentive and nonqualified benefit plans or developing and implementing new plans to compete with other banks for talent. Utilizing more than one compensation strategy or plan can be an important element in attracting and retaining talent. The bank’s franchise value is dependent on its level of success in attracting and retaining key executives.

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