Shareholders Give Banks a Thumbs-Up on Pay

6-26-13_Semler.pngBank directors can take heart from the results of say-on-pay votes during the past three years. Since the 2010 Dodd Frank Act gave shareholders of public companies the right to an advisory vote on executive compensation practices, banks have, on average, slightly outperformed all other companies in affirmative votes.

Although say-on-pay voting is ostensibly about pay only, it is one of the few mechanisms shareholders can use to directly send a message about their overall satisfaction with the company. Since the 2008 recession, banks have been subjected to intense scrutiny and an avalanche of negative publicity for their perceived role in precipitating the financial crisis. Nevertheless, if bank shareholders are unhappy, it hasn’t shown up in their say-on-pay votes.

From Semler Brossy’s say-on-pay database, we looked at the 2013 voting results through May 27th for all banks in the Russell 3000 index and compared them to the results for all other companies in the Russell 3000. We found that banks averaged a positive say-on-pay approval vote of 92.9 percent. The average for all other Russell 3000 companies is 91.1 percent. Banks not only outperformed other companies on the average approval rate but also in terms of variance: 83 percent of banks passed with more than 90 percent approval for executive pay compared to 77 percent for companies overall. Interestingly, no banks have as yet failed say-on-pay this year, while 2.2 percent of other companies recorded less than 50 percent shareholder approval, basically a failure.

These results have held remarkably steady since say-on-pay was instituted in 2011. In 2011, banks averaged 92.6 percent approval versus other companies at 90.7 percent. In 2012, banks averaged 91.7 percent approval versus other companies at 89.7 percent. Also, banks have failed say-on-pay at a slightly lower rate than companies in general, with failure rates of 0.5 percent in 2011 and 1.6 percent in 2012, versus general industry numbers of 1.5 percent in 2011 and 2.7 percent in 2012.

What about the results for big banks versus small banks? After all, it was the big banks that bore the brunt of negative publicity about executive pay and government bailouts after 2008, while small and regional banks were largely unscathed. But when we looked at the 2013 results for the 30 largest banks by assets compared to all other banks, we found little difference. The large banks averaged 93.1 percent approval and the other banks averaged 92.5 percent, with similar results holding for 2012 and 2011.

These positive results may stem from a combination of factors. Shareholders are likely evaluating the compensation practices of their banks separately and distinctly from broad public or other concerns. Also, bank boards are likely taking the time to carefully design compensation programs and also clearly explaining this linkage of pay and performance in the proxy materials. In any case, no negative messages here. Move along.

Dimon, JPMorgan Board Face Investor Judgment

5-13-13_Jacks_Blog.pngJPMorgan Chase & Co.’s May 21st annual meeting in Tampa should be a doozy for Chairman and CEO Jamie Dimon and the company’s 11-member board. The country’s largest bank has come in for some withering criticism ever since it lost a reported $6 billion last year on a disastrous credit derivatives trading strategy. Early comments by Dimon that the loss was only $2 billion and the bank had the situation under control—only to see the loss estimates continue to escalate—most certainly hurt his credibility with banking regulators (who later ordered the board to improve JPM’s risk management processes) and Congress (where Dimon was summoned to testify about what went wrong.)

Now the bank’s large institutional shareholders—including the likes of BlackRock Inc., Vanguard Group Inc. and Fidelity Investments, which collectively own 12 percent of JPM’s outstanding shares—get to have their say. One measure that is up for a shareholder vote calls on the bank to divide the chairman and CEO titles between two different people. The vote is nonbinding but would be an embarrassment for Dimon and the board since the company has argued publicly and strenuously that he should continue as chairman.

Two influential shareholder advisory firms—Institutional Shareholder Services (ISS) and Glass Lewis—have recommended that JPM shareholders vote for the measure. Citing their dissatisfaction with the board’s risk governance performance, both ISS and Glass Lewis also recommend that three JPM directors who currently serve on the risk policy committee not be re-selected. Glass Lewis went even further and also recommended that three members of the audit committee not be re-elected as well, arguing that the trading loss revealed shortcomings in the bank’s auditing practices.

Taken together, the two advisory firms have come out against the re-election of over half of JPM’s board (there is no overlap between the audit and risk policy committees), and would strip Dimon of his chairmanship. If that’s not a stinging rebuke of the governance performance of JPM’s board, I don’t know what is.

Shareholders are voting on the proposals now and the results will be announced at the May 21st meeting.

Would separating the jobs of chairman and CEO really make a difference at JPM? It could, if the board brought in a new person to serve as the non-executive chairman—which no doubt is what ISS and Glass Lewis would prefer. The board does have a “presiding director” (essentially the same thing as a lead director), retired Exxon Mobil Corp. CEO Lee R. Raymond, but would Raymond be able to ride herd on a strong-willed CEO like Jamie Dimon as effectively as someone new from the outside? ISS says it met with Raymond after the trading debacle to express its concerns about the performance of the risk policy committee, but later concluded that any changes made to JPM’s risk management practices after the big loss were initiated by management and not the board—hardly an endorsement for his leadership.

I can think of two reasons why Dimon wants to hold on the chairmanship at JPM. One, he probably believes he deserves to. The bank has reported a profit for 12 consecutive quarters, its stock has been trading within a couple of bucks of its 52-week high, and unlike two other megabanks that are in many of the same businesses—Bank of America Corp. and Citigroup Inc.—JPM came through the 2008-2009 global financial crisis largely unscathed. Just two years ago, Dimon was hailed as something of an American (or at least a Wall Street) hero for how he managed the bank during that frightening time. While the trading loss was an embarrassment and revealed some serious flaws in JPM’s risk management practices, Dimon has enjoyed a long and successful career. Getting fired as chairman would be humiliating for this very proud man, especially when he has made relatively few mistakes.

But there’s probably another reason Dimon doesn’t want an outsider coming in as his new boss. In March 2012, Michael E. O’Neill, a former Bank of Hawaii Corp. CEO who was widely praised for turning that troubled company around some years ago, replaced Richard Parsons at the non-executive chairman at Citigroup. By October of last year, Citi’s CEO—Vikram Pandit, who had steered the bank through the 2008-2009 financial crisis when it required massive government support to survive—was forced to resign after O’Neill engineered his dismissal. It didn’t take long for O’Neill to turn Citigroup’s board against Pandit even though he had stabilized the company after the crisis and was gradually returning it to financial health.

Here’s why Glass Lewis believes the chairman and CEO roles should be separated: “Research suggests that combining the positions…may hinder a board’s decision to dismiss an ineffective CEO.”

I’m sure Pandit would agree—and no doubt Dimon would, too. Dimon might not be “ineffective,” but he could still be dismissed.

Winning Over Shareholders with a Well-Constructed Merger

Jefferies_1-23-13.pngSince the financial crisis, investors have looked at falling stock prices following a merger and not been pleased.

While the mixed results of M&A transactions in general have long fueled investor skepticism, banks have fared worse than buyers in other industries since the financial crises.

There are many reasons for the negative reactions that we have seen.  For instance, investors remain focused on tangible book value and have imposed harsh penalties on those acquirers that cannot illustrate the ability to rapidly earn back dilution.  In general, investors have a low level of confidence in the earnings power of the industry and thus have a low tolerance for acquisition-related risks.

The current operating environment, characterized by declining net interest margins and increasing operating expenses, is causing bank boards and bank stock investors to re-evaluate M&A for a number of reasons:

  • Cost savings from merger transactions are one of the few ways to grow earnings in the current rate environment.
  • Credit related purchase accounting adjustments are gradually decreasing.
  • The rally in bank stocks since post-crises lows has made stock buybacks less attractive versus reasonably priced M&A.
  • Earnings per share accretion can help to maintain dividend levels. 
  • The demise of the serial acquirer has reduced seller options.

While circumstances are right for investors to view bank M&A in an improved light, we do not expect to see widespread investor acceptance of high market premiums.  As a result, boards need to study the potential benefits of stock-for-stock mergers that are reasonably priced and often include various nonfinancial aspects.

Banks should not use the “merger of equals” or “strategic merger” labels. The MOE label has been used to describe transactions with a wide variety of financial and governance characteristics causing much confusion in the market.  Using the MOE label will make it more difficult to explain a transaction to the market. Similarly, we think using the word “strategic” can imply that the financial merits of the transaction are lacking and can create ammunition for investor criticism.  

By their nature, stock-for-stock mergers are based on the potential long-term value created by the combined company and do not constitute a change of control as defined by relevant case law.  As long as a board has gone through an appropriate process to evaluate the benefits of a merger transaction versus other options there is no need to further define the transaction as anything other than a merger to shareholders. 

Boards should study past merger deals (no matter what they were called) to gain an understanding of the many ways to balance financial and governance considerations. However, the presentation of the deal to the public must be sensitive to investor expectations that are shaped by the current operating environment and not just what has worked in the past.

The following suggestions can assist the board in structuring a merger that will win over shareholders:

  • The exchange ratio must produce financial benefits to both sides.  
  • Cost savings estimates should be simple to explain and understand.  An acceptable estimate of merger-related savings will be in a range of 5 percent to 15 percent of combined expenses.
  • Be prepared to explain why the merger is better financially than simply buying back stock or increasing the dividend.
  • Proactively explain the impact of purchase accounting adjustments on pro forma financial estimates. 
  • Evaluate the risk of the transaction being “jumped” by an interloper when negotiating the financial and governance deal terms. Investors will be more demanding regarding the financial benefits if they perceive that a materially higher initial premium is available.
  • The exchange ratio may in fact result in a market premium to one side. However, the perceived buyer cannot be seen as paying a full premium while also granting significant governance concessions and the perceived seller can’t be seen as accepting a lower price in order to save management jobs.
  • Governance issues such as board splits, CEO succession and senior management roster must be conducive to a smooth integration. Investors will criticize complicated power-sharing arrangements that can hinder post-transaction performance.
  • Minimize the jargon around the strategic benefit. 
  • Keep in mind that many of the best banks in the country based on long-term shareholder returns have gone through at least one significant and successful merger in their history.  
  • Be careful not to create a written record that can be used against the bank. Avoid exchanging term sheets as a means of negotiating.

This material has been prepared by Jefferies & Company, Inc., a U.S.-registered broker-dealer, employing appropriate expertise, and in the belief that it is fair and not misleading. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified, therefore, we do not guarantee its accuracy. This is not an offer or solicitation of an offer to buy or sell any security or investment. Any opinion or estimates constitute our best judgment as of this date, and are subject to change without notice.  Jefferies & Company, Inc. and Jefferies International Limited and their affiliates and their respective directors, officers and employees may buy or sell securities mentioned herein as agent or principal for their own account.

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