Mega-Acquirers: Compensation Practices That Make a Difference

Written by


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.

Avoiding the Excess Parachute Payments Trap in M&A Deals

Written by


parachute-payment-11-27-15.pngIn the normal course of M&A events, compliance with Section 280G of the Internal Revenue Code to be an eleventh hour thing. In very general terms, 280G applies to compensation paid to an employee in connection with the employer’s change in control. It’s not that the merger partners don’t care at all about this provision in the tax code, it’s just that there are a lot of other issues—like the merger agreement itself—that need to be settled first. However, waiting until the last minute can have adverse financial implications for the selling bank and its employees, so here are a few ideas for 280G planning.

Specifically, 280G makes “excess parachute payments” nondeductible to the employer and subject to a 20 percent excise tax payable by the employee if the aggregate payments equal or exceed three times the employee’s base compensation. An employee’s “base amount” is the average of W-2 compensation for the five years before the year of the transaction. To avoid 280G’s negative consequences, an employee’s change in control payments must be no more than one dollar less than three times the base amount.

For example, if we assume Employee A has a base amount (i.e., five-year average) of $200,000, the maximum change in control payment she could receive without triggering 280G is $599,999 (i.e., $1 less than $200,000 times three. If payments to Employee A equal or exceed $600,000, then any amount in excess of $200,000 (i.e., the base amount) will be nondeductible and subject to the excise tax.

Cutbacks and gross ups are the most common form of 280G planning. A cutback provision in a contract ensures that no amount will be paid in excess of the 280G threshold. In contrast, a gross up provision ensures that the employee will be made whole for any excise tax.

Another 280G planning method is managing the base amount. The more advance managing that can be done, the better. Still, some planning can be done even in the calendar year prior to a transaction. Any increase in the base amount will serve to also increase the threshold amount. As such, employers can consider (1) increasing base salary payable in the year (or years) preceding the year of a transaction; (2) accelerating calendar year bonuses, which are typically paid in the spring of the following calendar year, to December of the current calendar year; or (3) encouraging an employee to exercise vested stock options in the year prior to the transaction. Any of these three could have an impact on the base amount.

A little more complex approach would be an employer’s affirmative action to accelerate the vesting of restricted stock or accelerate the settlement of restricted stock units to the year before the year of a transaction. Also, keep in mind that payments with respect to certain restrictive covenants can have value that is not counted as a change in control payment.

Finally, employers should note that in certain circumstances, 280G provides for a “cleansing” shareholder vote. If at least 75 percent of shareholders agree to the change in control payments, regardless of amount, they will not be subject to 280G’s bad consequences.

If selling the bank is one of the strategic options you are considering, you should give some thought to these planning opportunities in an effort to avoid 280G problems.

2015 Compensation Survey: What Executives and Board Members Want

Written by


5-20-15-Compensation.pngFor a moment, forget about the talk about the death of traditional banking: Executives with particular sets of skills are in demand at U.S. financial institutions. Sixty-one percent of the senior executives and directors responding to Bank Director’s 2015 Compensation Survey, sponsored by Compensation Advisors, report that their bank hired or promoted new executives last year. One-third lost executive personnel.

At the board level, 15 percent say they brought on new directors in 2014, with many seeking board members with particular expertise, or adding those that can help grow their institution.

Lenders continue to be in high demand, particularly at banks with less than $5 billion in assets. Technology/information security, risk management and compliance were other top areas for hires and departures in 2014. Banks aren’t training up the next generation of bankers like they used to, so given a limited (and aging) talent pool, offering the right compensation package is an important strategy for ensuring the bank’s long term sustainability.

The 2015 Compensation Survey tracks what bank chief executive officers and boards were paid in fiscal year 2014, what benefits are currently awarded to executives and directors, and how bank leaders want to be compensated by their organizations. Responses were collected online from 281 directors and senior executives of U.S. banks, including CEOs and human resources officers, beginning March 18 and ending April 7, 2015. Information on board and CEO pay was supplemented using data from 90 bank proxy statements, collected March 16 through March 20.

Key Findings:

  • Executives responding to the survey say that in addition to a cash salary and bonus, what they want most is a retirement benefit, at 72 percent. Just half desire equity as part of their own compensation. Even the executives of publicly traded banks place less emphasis in holding equity: Just 58 percent indicate it’s of high value.
  • Seventy percent report that their bank offers a non-qualified retirement benefit. Half offer it to the bank’s CEO, and 39 percent to the entire management team as well.
  • Less than half of all respondents, and two-thirds from publicly traded banks, allocate equity to executives annually. Thirty-one percent offer restricted stock, while 21 percent grant stock options. Just 5 percent give their executives synthetic equity.
  • The median salary for a bank CEO was $382,205 in FY 2014, but how much the CEO earns varies widely depending on the size of the bank.
  • Twenty-eight percent of respondents plan to increase director compensation in 2015, and more than half increased pay in 2013 or 2014. However, 28 percent report their board hasn’t seen a raise in pay since at least 2010.
  • While most bank boards are earning more, directors are also spending more time on bank board activities. The median hours per month devoted to meetings, business development, education and other board obligations rose to 20 hours, up 33 percent from 2014.
  • Boards continue to shift from board meeting fees to awarding an annual retainer. The percentage of directors receiving board meeting fees declined 7 points from the 2012 survey, to 77 percent. Directors receiving annual retainers grew 17 points, to 61 percent.
  • The median board meeting fee for an independent director was $1,000 in FY 2014, an increase of one-third from FY 2013. The median annual retainer remained level in 2014, at $20,000.

Download the summary results in PDF format.

Trends in CEO Pay: Work Now, Get Paid Later

Written by


The financial crisis has had a huge impact on the way banks pay their executives and even their loan officers, but CEO pay is definitely creeping back upward. The smallest community banks to the international mega-banks have all made changes in the last few years to reduce the likelihood that employees will take big risks that threaten the long-term health of their financial institutions.

Many banks are moving away from short-term incentives, paying smaller amounts in cash bonuses for meeting short-term performance goals, and paying equity gradually over a longer period of time in the form of restricted stock based on performance goals.

One of those banks is First Commonwealth Financial Corp. in Indiana, Pennsylvania, a $6 billion-asset institution with 112 offices.

Bob Ventura, chairman of the board’s compensation and human resources committee, said at Bank Director’s Bank Executive & Board Compensation conference in Chicago recently that the bank has moved from paying a roughly 75 percent/25 percent ratio of compensation in short/long term pay to now using a 65/35 ratio.

Even more changes have been made from a risk standpoint among loan officers.

“We have gotten away from volume goals and put some profitability goals in there,’’ he said, adding that there’s an 18-month time period to get paid the full incentive package.

Even though the bank is not a recipient of Troubled Asset Relief Program money from the federal government, it still follows TARP compensation guidelines. The bank conducts third-party annual reviews of its compensation plans, and has created a position for a chief risk officer who reviews compensation plans and makes recommendations to the risk committee of the board.

 “We have evolved from plans that were primarily paid in cash,’’ he said.

Todd Leone, a principal at McLagan compensation consultants in Minneapolis and a speaker at the conference, laid out some general trends, including:

  • The use of full value equity plans (such as restricted stock) continues to increase.
  • Most banks don’t use stock options as a form of equity compensation, no matter what the bank size is.
  • The larger the bank, the more frequent the use of equity compensation.
  • Banks are increasingly using credit quality measures in performance plans.

Bank CEO pay increased last year as the economy strengthened and bank balance sheets improved, although most of the increases were tied to cash and equity incentives, Leone said. The biggest pay increases were for CEOs at the largest banks, who saw their paychecks drop substantially in 2008 and 2009 following the financial crisis. The median cash compensation for big bank CEOs is now roughly what it was in 2006, $2.3 million, according to McLagan’s analysis of 717 publicly traded bank proxy statements, 41 of them banks with more than $15 billion in assets.

The following table shows the breakdown in CEO pay last year:

Median 2010 CEO Compensation

comp-mclagan.png

*Cash compensation is salary plus all other cash incentives, like bonuses. Direct comp is  cash compensation plus equity. Total compensation adds direct compensation, retiree benefits and all other compensation.

Source: McLagan