Five Factors Directors Should Consider Before Granting Equity Awards


8-7-13-Pearl-Meyer.jpgThe three-year average total shareholder return of the KBW Regional Banking Index was greater than 13 percent as of June 30, 2013. Banking stocks are recovering, creating renewed interest in programs that reward executives appropriately for continued growth in share price and dividend yield.

Options provide the most direct reward for creating shareholder value. If the stock price goes up, executives and shareholders alike share in the upside. The counter argument is that options are far too subject to market whims and since an executive receives more “return” with options as the stock price increases, this could motivate the very behaviors that started the financial crisis. 

Restricted stock may seem like a safer alternative, but without some type of performance element, the awards may just serve as an incentive for executives to stay put, at least until their awards vest. 

In this environment, how do directors design equity awards that will provide a meaningful link back to shareholder value? 

There are five questions that directors can ask to gain clarity and create an effective equity grant strategy:

1. Who should receive an award?

There is often a consensus that senior management should receive equity as a normal part of the pay program. The subject of debate is typically who should receive awards below that level. Competitive practice, dilution and financial impact all play a role in determining how deep equity awards are granted within a bank. In our experience, the answer truly depends on the culture of the organization and what messages the bank wants to send regarding the behaviors that are most valued. If individual performance is important, defining and rewarding a pool of top performers can be highly effective. If revenue production is king, granting equity to top producers in areas such as commercial lending may aid in the retention of key rainmakers.

2. Is the goal of granting equity awards to reward performance or to retain executive talent?

In a recent survey conducted by Pearl Meyer & Partners, reward and retention tied at 89 percent as the top long-term incentive objectives for banks. Such multiple strategic objectives may call for granting both time- and performance-based awards. For example, a bank may decide to grant part of the award in time-vested restricted stock that is subject to holding requirements and provide the remainder as performance-based restricted stock.

3. Should performance-based awards strictly reward total shareholder return or operational performance that may result in a higher stock price?

In the same survey, nearly 70 percent of banks said they evaluate their long-term incentive programs on the basis of positive operational performance, versus 42.7 percent who focus on gains in total shareholder return. Members of management who believe that vagaries in the stock market are not under their control generally would prefer measures that correlate to increased shareholder value such as earnings per share, tangible book value, return on assets and return on equity as the key metrics for granting stock or vesting stock. 

4. Once an award is exercised or vested, what is the executive’s obligation?

One of the primary reasons for granting equity awards is to promote executive stock ownership, since tying a significant portion of an executive’s wealth to share price puts that executive on the same side as shareholders. The counterargument, however, is that long-term incentives are just that—incentives—and if performance is achieved, the executive should be able to reap the reward. Defining retention requirements and/or ownership requirements upfront can address these issues by establishing reasonable expectations around the executive’s obligation and what may be received as a reward.

5. How do we handle competing goals in our equity grant strategy?

Often, bank boards and management teams want to achieve multiple goals in their equity strategy. Being deliberate in the mix of equity types, the selection of eligible employees and the achievable retention/ownership guidelines will provide a balanced approach. 

Drivers of Bank Valuation, Part III: Size and Diversification


6-5-13_Commerce.pngA critical function of any bank’s board of directors is to regularly assess whether their activities and those of the bank’s management are driving value. This may be defined as value for shareholders, value for the community and the perception of strength among the bank’s customers and regulators. 

In the last two installments of this series, we explored the concept of tangible book value (TBV) and its relationship with bank valuation. We also looked at internal steps, such as promoting efficiency and growing loans, which boards could take to drive more revenue to the bottom line and drive bank value. 

In this final installment, we’ll look at two additional factors that drive value in both earnings production and market perception. 

Size

The first of these is size. A bank’s size has a direct bearing on its value. The data show clearly that larger banks are perceived to be more valuable, according to the tangible indicators of open market trades of bank stocks and in bank merger pricing. In 2012, for example, there was a clear disparity in the public markets between banks with less than $1 billion in total assets (which traded below tangible book value on average) and those above $1 billion (which traded, on average, at a substantial premium to TBV). Regarding whole bank sales in 2012, banks with more than $500 million in assets sold  at a higher valuation, as a function of price to TBV, than banks smaller than $500 million in total assets (122.3 percent of TBV versus 113.6 percent). Likewise, banks with more than $1 billion in total assets sold at 129.3 percent of TBV versus 113.1 percent of TBV for banks below $1 billion in assets.

There are a number of reasons for this. Certainly greater scale means greater efficiencies, the ability to expand the customer base through a higher legal lending limit, the ability to spread the cost of carrying regulatory compliance over more assets, and the ability to offer products that smaller banks cannot afford to offer. 

A key consideration for a bank’s board should be a regular assessment of the institution’s size relative to market and the steps needed to achieve a critical mass that drives value. Small banks can achieve scale through raising capital and expanding the balance sheet organically—or pursuing mergers with compatible institutions. Either approach allows banks to grow in size, improve efficiency and grow value.

Diversification

Another approach to growing value is to diversify the balance sheet and the income statement. The data shows that more diversified banks earn more and grow TBV faster. In 2012, banks with a real estate concentration of less than 60 percent earned as much as 90 basis points more on assets than peers more concentrated in real estate. 

Community banks, in particular, are more heavily concentrated in real estate by their very nature. The recent crisis points out the limits to this business philosophy, however, and should prompt some soul searching at the board level on how to avoid putting all the bank’s eggs in lower margin baskets. Commercial and industrial loans along with consumer lending have risks, to be sure, but prudent diversification into these areas offer opportunities for higher margins, more fee business, and more low cost deposits, all of which increase a bank’s overall valuation.

The Role of the Board

Driving shareholder value, whether on an ongoing basis or in a sale, is the key rationale for running the bank in the first place. Boards should aggressively work on all fronts to drive earnings, drive efficiency, drive margin and drive value. This is hard work and not without risks. But managing risk is central to a bank board’s obligations. Setting limits and managing tradeoffs within the market environment should be active rather than passive board activity. 

This work is hard and requires careful planning and execution. But the benefits to boards, management and—importantly—shareholders, of such efforts are considerable. 

Lee’s comments are strictly his views and opinions and do not constitute investment advice.

M&A Case Study: How Selling For Less Created More Value



Selling for a premium is not the only strategy. Kevin Hanigan, CEO of ViewPoint Financial, and C.K. Lee, managing director at Commerce Street Capital, describe the creative strategy behind their 2012 M&A transaction in Texas that solved a management succession problem at ViewPoint and provided liquidity for Highlands shareholders.

Video Length: 45 minutes

Highlights include: 

  • The problem facing the board at Highlands Bancshares Inc.
  • Thinking outside the box – three growth options to weigh
  • Key lessons learned from the deal

About The Presenters:

Kevin Hanigan is president and CEO of ViewPoint Financial Group, Inc. and ViewPoint Bank, positions he has held since completion of the merger of Highlands Banchares, Inc. Prior to ViewPoint, Mr. Hanigan was the chairman and CEO of Highlands Bancshares. His experience in Texas banking spans three decades and includes numerous leadership and management roles.

C. K. Lee is a managing director in the financial institutions group, capital markets division of Commerce Street Capital, LLC. In that capacity, Mr. Lee assists financial institution clients with M&A, capital raising, balance sheet restructuring, business plan development and regulatory matters. In addition, he provides regulatory advisory support to the private equity fund management team. Prior to joining Commerce Street in June 2010, Mr. Lee was regional director for Office of Thrift Supervision’s (OTS) Western region headquartered in Dallas, with offices in Seattle, San Francisco and Los Angeles.

How a Texas CEO Made a Difficult Sale Work for His Shareholders, His Bank and Himself


2-18-13_ViewPoint_Financial.pngHow do you raise money from investors at $10 per share and then turn around a year and a half later and ask them to approve a sale of your bank at $7 per share?

That’s exactly what Kevin Hanigan did. The scrappy CEO of a $508-million asset bank in Texas made himself the CEO of a $3.2-billion asset bank by selling his bank to a larger institution, and persuading his shareholders that taking less is more, at least in the long haul. It seemed to work out not just for Hanigan, but the shareholders, too.

Background

Highlands Bancshares Inc. was a three-year-old institution in Dallas, Texas, when it brought in Kevin Hanagan as its CEO in 2010. It had been doing business as Highlands Bank and at the time of Hanagan’s hiring was struggling under the dead weight of bad construction loans. Its ratio of non-performing assets to total assets was north of 3 percent.

Prior to Hanigan’s arrival, the bank had embarked on a clean-up and recapitalization scheme where it sold $17 million worth of bad assets for about $10 million. That resulted in a $7 million hit to capital, which it replaced with new equity from about 10 families in the summer of 2010, who bought stock at $10 per share. Highland then tried to make a few acquisitions of other banks, but lost the bidding each time. By the end of 2011, the bank’s tangible book value was just $7.12 per share.

“We as a board were struggling with what to do next,” Hanigan says, who spoke at Bank Director’s recent Acquired or Be Acquired conference in Scottsdale, Arizona. “As a bank with less than $1 billion in assets in a metro market, size was important to us.”

He and financial advisor C.K. Lee, a managing director of Commerce Street Capital LLC, saw an opportunity when ViewPoint Financial Group Inc. of Plano, Texas, announced that its CEO, Garold Base, would retire at the end of 2011.

They decided to propose something risky. ViewPoint, a publicly traded holding company for ViewPoint Bank, would buy Highlands, a privately owned company, and install Highlands CEO Hanigan as the chief executive officer of the newly combined company. Luckily, Both Hanigan and Lee knew the chairman of ViewPoint, James McCarley, and they thought that connection could help.

“You really can’t do a deal as difficult as this one without having the ability to talk as closely with people as we did,” Lee says.

The ViewPoint board brought Hanigan in for interviews in September to replace the retiring CEO, along with other candidates.

Problem

It turned out that ViewPoint’s board wanted Hanigan as its CEO but didn’t want his bank. So Hanigan and C.K. Lee went back to the drawing board. They decided to analyze Highlands’ options in three different scenarios: grow organically, acquire multiple other banks or merge with ViewPoint.

Given the low loan demand in Highland’s market, it could take a long time to grow organically and become a more than $3 billion asset bank, as the merger with ViewPoint offered. Highland was interested in acquiring larger clients but Dallas was a competitive market and it would be tough for such a relatively small bank to put bigger loans on its balance sheet without bumping up against its legal lending limit.

2-18-13_ViewPoint_Financial_2.pngMultiple acquisitions also would take a long time with significant execution risk. Banks that Highland considered to be attractive takeover candidates would have commanded a purchase price of at least 1.75 times book value, as the Texas market was doing better than other parts of the country. That would have resulted in significant dilution for Highland shareholders. Lee’s modeling showed better returns for shareholders with the ViewPoint stock-for-stock merger, even if the bank sold at just 100 percent tangible book value. But would shareholders, especially those who had just paid $10 per share, agree to sell at the equivalent of roughly $7 per share, the current value of the Highlands’ franchise?

Solution

The benefit to shareholders was that a sale to ViewPoint—even at book value—would drive value much quicker than Highlands’ other options. Selling for a lower price could help make the deal successful in the long run. The combined pro forma bank would be diversified in both commercial banking and real estate, and each bank complemented the other in terms of strategy. Merging with a publicly traded company provided liquidity for Highland shareholders. The deal seemed to make sense, but would shareholders agree?

Not to worry. Ninety-five percent of Highlands shareholders voted and their support for the deal was unanimous. Most of the shareholders were Dallas families. The stock price of ViewPoint is now up more than 60 percent from when the deal was announced in December of 2011. The efficiency ratio of ViewPoint has dropped from 67 percent to 55 percent, and core return on equity has climbed from 5.8 percent to 8.6 percent.

“You can sometimes drive greater shareholder value by accepting the lower price,’’ Lee says. “It sounds like an oxymoron. “If you put yourself in a position to drive shareholder value, it can make sense.”

Hanigan says too many boards get hung up on the price the day of closing, in part because of fear of future lawsuits. But choosing a merger partner wisely can make all the difference.

“Fortunately we were really aligned from day one on where we wanted the bank to be on both sides,’’ he said.

Banking Panel: Top Challenges in 2013


Everybody in banking knows this by now. Banks have been hit with an onslaught of new regulations right when low interest rates are continuing to erode profitability. But what will happen in 2013? Experts who will speak at Bank Director’s upcoming April Bank Chairman/CEO Peer Exchange say what they think boards will be dealing with next year.

 “What is the top strategic challenge facing bank CEOs, chairmen and their boards in 2013?”

Brown_Scott.jpgThe greatest challenge to CEOs, chairmen and their boards will be how to generate acceptable returns to shareholders in the face of ever-growing compliance concerns and a continued sluggish economy with high unemployment and historically low interest rates.  Without an administration change, 2013 promises to continue increasing and more stringent banking supervision and additional regulation, including consumer compliance initiatives and aggressive enforcement from the Consumer Financial Protection Bureau and new capital requirements from Basel III.  This will not only impact decisions on day-to-day operations and planning but also shape thinking on mergers and acquisitions  activity and the raising of capital.  Specifically, if new capital rules are adopted, boards will need to explore the availability of capital, and whether capital can be raised at satisfactory pricing levels.

— Scott Brown, Kilpatrick Townsend & Stockton LLP

Boehmer_David.jpgTalent. There is a shifting environment of constant change that is the new normal for how all businesses operate. Pressure is intensifying—from regulators to creative innovators who are bucking the traditional banking models trying to influence change.  Bottom line, CEOs need to have the right talent in place to lead effectively—not only to confront the current challenges, but to create an organization with a connected culture to be the bank of the future.

— David Boehmer, Heidrick & Struggles

Plotkin_Ben.jpgThe top challenge is that banks cannot earn their cost of capital in today’s environment.  The combination of higher capital requirements, margin pressure due to extraordinarily low rates, slow economic growth and cost pressures associated with regulation translates into inadequate returns for shareholders.  A CEO’s job is to outperform peers in this environment while making investors realize that these challenges will not last forever.  In the event that a bank can’t operate more effectively than its peers, it is the CEO’s responsibility to his/her board to face that reality and proactively explore exit opportunities.

— Ben A. Plotkin,Stifel, Nicolaus & Company and Stifel Financial Corporation

Bronstein_Gary.jpgNotwithstanding the difficult business climate and the continuing economic challenges facing the banking industry today, the regulatory burden is the top strategic challenge facing bank management and boards today. While the reelection of Obama results in some certainty that the barrage of new regulations will continue, there continues to be considerable uncertainty. For example, what will the creation of the CFPB mean for community banks not directly regulated by the CFPB? What will happen with Basell III? Regulatory costs are also a significant factor when considering the optimal asset size to best leverage today’s cost of doing business.  

— Gary Bronstein, Kilpatrick Townsend & Stockton LLP

Balance the Challenge: Executive Compensation & Shareholder Value


Are your institution’s compensation plans structured to benefit or hurt your shareholders? In this five-minute video, William Flynt Gallagher, president of Meyer-Chatfield Compensation Advisors, offers insight and advice on strategies the compensation committee can use to maximize benefits and structure executive agreements to actually enhance shareholder value. 

Highlights includes:

  • Compensation challenges facing publicly traded banks today
  • Which compensation structures you should avoid
  • Ways to benefit both executives and shareholders

Click the arrow below to start the video.