Don’t Sell the Bank


2-18-15-Al.pngI recently read a report from FIG Partners, an investment bank, that says “M&A pricing is actually much stronger than investors realize given the fact the capital levels are twice—or at least significantly higher—than the past cycle and now price-to-tangible book values are rising.” So if pricing is, in general, improving from a seller’s perspective, it is easy to see why a bank’s board of directors would consider putting the bank up for sale.

But my question is: Why sell now when better times might be ahead?

True, addressing this issue largely depends on how the institution is positioned, geographically, by product line and yes, asset size. Further, I realize a bird in hand is worth two in the bush, and this wait-and-see approach is one that a number of advisers warn boards from taking. However, while the pool of potential buyers is larger than previous years, I don’t see it as aggressive as some would lead you to think.

Still, figuring out when a bank should be a buyer—or a seller—has been on my mind since the Royal Bank of Canada announced a deal for “Hollywood’s bank,” City National Corp., for $5.4 billion. This is the most expensive large U.S. bank deal announced since the financial crisis, based on a price-to-tangible book value of 262 percent. Since that announcement, various media outlets have speculated that buyers will pay a premium for trophy properties like City National. Many anticipate banks that cater to the wealthy will be front and center. But I’m not so sure that institutions with a similar clientele, like San Francisco-based First Republic Bank, should sell, even if approached with a huge multiple.

If you’re not familiar with First Republic, I find the bank’s story fascinating. Jim Herbert founded the bank in 1985, sold it to Merrill in 2007 for 360 percent of book value, took it private through a management-led buyout in July 2010 after Merrill was acquired by Bank of America, then took it public again in December through an initial public offering. A few years ago I sat down with Jim in their New York City offices and came away impressed: not only is the bank solely focused on organic growth, it’s also focused solely on private banking.

So I wonder. Members of First Republic’s board have a fiduciary responsibility to shareholders; however, does a short-term premium trump sustained long-term potential?  For a bank that caters to the wealthy, business executives and owners, I’m sure the U.S. Department of Labor’s announcement that the U.S. economy created 257,000 jobs in January—making this the longest stretch of sustained monthly growth since the early 1990s—was well received. While the unemployment rate ticked back up to 5.7 percent, from 5.6 percent in December, The Wall Street Journal reports that the climb was likely because more Americans said they were looking for jobs, a sign of growing confidence.  As the tide begins to rise, why sell the proverbial boat?

Moreover, a recent report from Deloitte’s Center for Financial Services says that, “the encouraging M&A activity seen in 2014 is likely to continue through 2015, driven by a number of factors: stronger balance sheets, the pursuit of stable deposit franchises, improving loan origination, revenue growth challenges, and limits to cost efficiencies.” However, their 2015 Banking Outlook also acknowledged that “as banks move from a defensive to an offensive position to seek growth and scale, they should view M&A targets with a sharper focus on factors such as efficiencies, growth prospects, funding profile, technology, and compliance.”

So rather than consider an exit, isn’t now the time to double down on your growth efforts?

Performance-Driven Retirement Plans: Are They Right for Your Bank?


1-5-15-Equias.pngBank boards do not like to lose executive talent to competing banking organizations. Developing a compensation plan that is aligned with shareholder interests and retains key executives continues to be an important objective for compensation committees. Compensation committees need to evaluate a variety of compensation strategies to determine which will be the most effective at retaining and recruiting key high performing lenders and executives. While offering competitive salary and performance-based annual bonus amounts are a given, providing additional long-term incentives and/or retirement benefits can be the missing component. Equity plans provide an element of longer-term compensation, but are not available in many privately-held banks and, even where offered, can be complemented by other types of long-term incentive plans.

According to the American Bankers Association 2013 Compensation and Benefits Survey, 64 percent of respondents offered some kind of nonqualified deferred compensation plan for top management (CEO, C-level, executive vice president). (See our article, “Is Your Compensation Plan Generous Enough?”) Choosing the right retirement plan must incorporate the compensation committee’s overall compensation philosophy and bank objectives.

This article will focus on performance-driven retirement plans, a type of defined contribution nonqualified plan. Long-term incentive plans that are performance driven are generally well-received by shareholders. When such plans are properly designed, if the bank’s shareholders do well, so will the executives.

As an example, let’s assume the bank desires to implement a performance-driven retirement plan for a key lender who is 35 years old. Let’s also assume that if the lender meets both department and individual target goals along with the bank-wide net income goal, the lender will receive an annual grant of 10 percent of salary. The bank will cap the grant at 20 percent of salary if maximum performance goals are attained. For this individual, assume the annual contribution is based on a combination of loan growth, deposit growth and bank-wide net income. The goals and the weighting of each goal will vary by officer.

Assuming normal retirement age of 65, and 10 percent of salary contributions each year, the executive is projected to be credited with almost $400,000 in bank contributions. With interest added to the account, the retirement benefit is expected to be almost $80,000 per year for 15 years, a total benefit of $1.2 million. The payments are contingent on the executive not taking a job where he or she competes with the bank after retirement.

This type of arrangement is documented in a legal agreement between the bank and the executive. The agreement must comply with IRC Section 409A and should address various agreement terms and conditions including:

  • Early voluntary termination
  • Disability
  • Change in control
  • Pre-retirement death 
  • Death during payout
  • Non-compete and non-solicitation of customers and employees
  • Holdbacks
  • Qualifiers such as satisfactory performance evaluations and credit quality
  • Form (number of years) and timing (age or date) of benefit distributions

It is critical that bank-wide goals along with department and individual goals be linked to the bank’s budget and overall strategic plan. The goal setting process is typically the most challenging step in designing the plan. Some banks use moving averages (such as the bank’s three-year average net income) and other longer-term measures to determine executive performance and bank contributions.

Rewarding executives with a meaningful compensation package tied to long-term shareholder return is a balancing act. While there is not a one-size-fits-all approach for designing and implementing this type of plan, the facts and circumstances of each bank will dictate the best design after taking into account the bank’s culture and compensation philosophy.

Equias Alliance offers securities through ProEquities, Inc. member FINRA & SIPC. Equias Alliance is independent of ProEquities, Inc.

Why Book Value Isn’t the Only Way to Measure a Bank


11-14-14-Al.jpgA few days ago, I woke up to the announcement that Winston-Salem, North Carolina-based BB&T Corp. has a deal in place to acquire Lititz, Pennsylvania-based Susquehanna Bancshares in a $2.5 billion deal. The purchase price is 70 percent stock and 30 percent cash and includes 0.253 BB&T shares and $4.05 in cash for each Susquehanna share. The implied price of $13.50 per share equates to 169 percent tangible book value, 16.3 times price as a multiple of last-twelve-months earnings per share and a 7.4 percent deposit premium.

While easy to see the deal as being strategically compelling from BB&T’s perspective (the deal makers expect to generate cost savings from the combined institution, targeting $160 million annually or 32 percent of Susquehanna’s non-interest expense), the announcement had me unexpectedly thinking about valuation issues and Warren Buffet.

Yes, Warren Buffet.

Let me explain the correlation between the two. A year ago, Buffet was on CNBC and took a question from a viewer about how he valued banks. In his words, “a bank that earns 1.3 percent or 1.4 percent on assets is going to end up selling above tangible book value. If it’s earning 0.6 percent or 0.5 percent on assets it’s not going to sell. Book value is not key to valuing banks. Earnings are key to valuing banks.

Keep in mind that for many smaller community banks, book value has been the primary determinant of value on a trading basis. As the lion’s share of mergers and acquisitions have involved small community banks over the past few years, talk of book value has been quite prevalent. So the BB&T deal, the second largest so far this year, got me thinking about valuation issues and if an increased focus on price to earnings might be a more appropriate way to value banks.

To get some perspective on this topic, I reached out to Dory Wiley, president and CEO of Commerce Street Holdings. He sees earnings as more important, but was quick to remind me that tangible book value does matter.

John Gorman, a partner in the Washington, D.C.-based law firm of Luse Gorman Pomerenk & Schick, P.C. provided additional context. “Having value driven by earnings is the goal for most publicly traded community banks, and that goal is bearing fruit, but in a discriminating fashion. The market is being selective in terms of which companies it is rewarding with earnings-based valuation on a trading basis. And that reward provides those select companies with a competitive advantage in terms of paying the higher price-to-earnings and price-to-book multiples in the M&A marketplace.”

Andy Gibbs of Mercer Capital opined “it is earnings, after all, that are the source of the capital needed to reinvest in the bank (and grow its value), to pay dividends to shareholders, or to repurchase shares. A well capitalized bank can do those things in the short-run, but without earnings to replenish and expand capital, it’s not sustainable.”

Clearly, a bank that generates greater returns to shareholders is more valuable; thus, the emphasis on earnings and returns rather than book value. To this end, Gorman says: “If a company is a strong earner, and is located in an attractive geographic market, it may be able to obtain a significant M&A premium and thereby realize an earnings-based valuation.”

So investors and buyers will always use book value as a way to measure the worth of banks. But as the market improves and more acquisitions are announced, expect to see more attention to earnings and price to earnings as a way to value banks.

Say-On-Pay Trends at Banks: Proxy Firms Increase “No” Recommendations


What should public bank boards know about proxy firm recommendations? McLagan evaluated Institutional Shareholder Services’ (ISS) recommendation patterns for management say-on-pay (MSOP) votes at bank shareholder meetings this year. ISS’ “no” vote recommendations were up from 2013 to 2014, summarized in the chart below:McLagan_linechart.png

Larger banks receive greater scrutiny from ISS and are more likely to get a negative recommendation. Banks with assets greater than $5 billion received “no” recommendations almost twice as frequently as banks below $5 billion.

Despite the increase in negative recommendations, overall shareholder approval remained high. Nearly 75 percent of banks received greater than 90 percent support for MSOP, and half were above 95 percent approval.

Caution! Receiving a negative recommendation can have a dramatic impact on the level of shareholder approval. McLagan performed an analysis of actual shareholder votes after ISS had made a recommendation on pay practices, either “for” or “against.” The table below shows a distribution of vote results.

MSOP Vote Results
Percentile ISS Recommendation
For Against
25th Percentile 92% 59% 
50th Percentile 96% 75%
75th Percentile 98% 85%

At the median, those banks receiving a “for” vote recommendation from ISS also received a 96 percent approval vote from shareholders. In contrast, a bank receiving a “no” vote recommendation only received a 75 percent approval vote—a drop of 21 percentage points at the median! The drop was even more significant at the 25th percentile, where a “no” vote recommendation resulted in an approval rating of only 59 percent, down 33 percentage points from banks that received a “for” vote recommendation.

Here are the landmines to watch out for that can trigger a “no” vote recommendation.

Top 3 Reasons for ISS “No” Recommendation
Pay for Performance Disconnect
Mega-grants of Equity (e.g. sign-on or retention bonus)
Problematic Pay Practices (e.g. excise tax gross up or re-pricing options)

An example of a pay for performance disconnect is when the CEO is paid above the 75th percentile of ISS’ comparative group, but the bank’s performance as measured by total shareholder return (TSR) is below the 50th percentile. Another example would be an increase in CEO compensation as TSR decreases.

Some banks escaped receiving a “no” recommendation in 2014 even though their pay practices would presumably have merited one. The reason? One example is TSR for a bank may have improved and been relatively strong compared to the comparative group; as a result, some pay practices might be given a pass. But, if TSR slips, these banks may well receive a different recommendation.

In summary, don’t take your MSOP vote results for granted. Be proactive in making appropriate adjustments to executive compensation and watch out for the top 3 reasons for “no” vote recommendations, especially if your bank’s TSR is decreasing. It’s much easier to fix the problems before receiving a failing MSOP vote result.

What to Do When Caught Between Investors and Regulators


hands-tied.jpgIt’s tough to please both regulators and shareholders these days, especially when they want contradictory things. Take the case of executive compensation.

Shareholder groups have been pushing for a greater tie between performance and executive pay. One of the most powerful of these, Institutional Shareholder Services, screens executive pay packages to see how they stack up against peers relative to performance and how the change in CEO pay mirrors change in total shareholder value over five years. ISS recommendations to shareholders on such matters can strongly influence a company’s say-on-pay shareholder advisory vote. Umpqua Holdings Corp. and other banks found this out, as described in a recent story in Bank Director magazine.

But looking at the stock price and shareholder value is exactly what regulators don’t like.

Jim Nelson, a senior vice president of supervision and regulator for the Federal Reserve Bank of Chicago overseeing large banks and savings institutions, is concerned with the use of stock price or return on equity as a measure of performance in making pay determinations. Return on equity doesn’t factor in the risk that executives might be taking to achieve such returns, he said at Bank Director’s Bank Executive & Board Compensation conference recently in Chicago.  There are many factors that can influence the stock price which are outside the realm of management’s control, he said.

“We think most of the people in the firm don’t have a direct impact on the value of the stock price,’’ he said. “We’re looking for a measurement tied to something that that person does control.”

Regulators also explained how they feel about shareholders in their 2010 Guidance on Sound Incentive Compensation Policies, which applies to all banks and thrifts.

The joint regulatory guidance says “shareholders of a banking organization in some cases may be willing to tolerate a degree of risk that is inconsistent with the organization’s safety and soundness.”

So there’s the rub. Do you please shareholders or do you please regulators? But there are ways to combine the concerns of both.

“It’s not the amount [of bonus or incentive pay],’’ Nelson said. “What we’re looking at is the arrangements. You should reward individuals who are producing an attractive risk-adjusted return for you. If they are making more money with low risk, they should be paid more than someone who is making money with high risk. I think that is aligned with what shareholders want and the board wants. There is a lot more free enterprise in this approach than people think.”

He said some big banks are adjusting their profits based on risk metrics before handing out bonuses.

Meanwhile, big banks also are taking into account the needs of shareholders and the recommendations of shareholder advisory groups. Tying short and long-term bonuses, at least in part, to shareholder return is one way to do that.

For example, Buffalo, New York-based First Niagara Financial Corp., one of the nation’s 25 largest bank holding companies with $35 billion in assets, paid out long term incentives to top executives in three ways: stock options, time-vested restricted stock and performance-based restricted stock that vests in three years based on total shareholder return relative to the SNL Mid-Cap Bank Index.

Barbara Jeremiah, a First Niagara director who chairs it compensation committee, said when the bank ran into troubles trying to raise capital for its acquisition last May of HSBC branches in New York and had to cut its dividend in half, the board recognized the hit shareholders took and wasn’t locked into paying short-term bonuses based on earnings per share. The board had made sure it had some level of discretion in determining the bonus, she said.

The board adjusted incentive compensation for CEO John Koelmel to reflect the decline in stock price and reduction of the dividend. Jeremiah encouraged compensation committee members and human resources directors at the Bank Director conference to read and stay abreast of how others viewed executive pay, making note of an article by Gretchen Morgenson of The New York Times entitled  “C.E.O.’s and the Pay-‘Em-or-Lose-‘Em Myth.”

 “We need to keep that outside view,’’ Jeremiah said. “How do our customers and others view us?”

Will Citigroup Shareholders’ “No” Vote Change the Compensation Game?


monopoly.jpgIn its discussion of its pay package this year for Vikram Pandit, Citigroup’s chief executive officer, the company extolled the accomplishments of the man brought in to clean up the mess that was left in the midst of the financial crisis.

Citigroup has been profitable for eight consecutive quarters. It has repaid the government’s Troubled Asset Relief Program money. Pandit had gone two years without drawing a salary in the midst of the company’s trouble, and was rewarded in 2011 with a salary and a bonus. Plus, the company had taken steps to align its incentive pay with future performance: 60 percent of top executives’ bonuses will be deferred over a four-year period based on performance.

None of this was enough to please investors and shareholder advisory groups such as Institutional Shareholder Services (ISS). Investors voted down this week the CEO’s pay by 55 percent in an advisory vote made possible by the Dodd-Frank Act.  ISS claimed Pandit’s compensation was misaligned with total shareholder returns (Citigroup’s stock price was down 23 percent during the past 52-week period and it was down 93 percent during the past five years.) Future bonuses would be “essentially discretionary” based on a variety of factors such as execution of long-term strategic goals and return on capital, according to ISS.

Basically, the pressure is on for Citigroup and other publicly traded companies to tie incentive pay to specific metrics that benefit shareholders, rather than more vague goals that give the board wide discretion.

It didn’t help matters that Citigroup was one of few big banks to fail the federal government’s stress tests this year, meaning it won’t be able to return capital to shareholders in the form of dividends or stock buybacks.

Plus, ISS determined that Pandit would be paid more than his peers at other big financial firms. Although Citigroup reported that his total compensation for fiscal year 2011 was $15 million, ISS determined that future awards could be worth as much as $34 million. A $10 million award is tied to the company earning pre-tax income for a two-year period of at least $12 billion, which “does not appear challenging given that the company’s income from operations exceeded $15 billion in each of the last two fiscal years.”

Citigroup may be scrambling to deal with the bad publicity now from the “no” vote on pay, even if technically, the advisory vote is non-binding. But will other banks scramble to make sure they don’t suffer the same fate?

Maybe not, says Peter Miterko, a managing director in New York City for Pearl Meyers & Partners, a compensation consulting firm.

“It may be a more subtle impact, rather than everyone saying ‘Let’s redo our pay packages,’’’ he says.

Most banks already have sent out their proxy statements for the year, making it hard to revamp any pay practices. But Miterko thinks the publicity will encourage companies to communicate better in the future with shareholders about why they pay what they do.

A typical problem in proxy statements is that it’s not clear to shareholders what performance metrics must be met for an executive to get incentive pay, he says.

“The positive development [with say-on-pay] is that shareholders tend to see a lot more clear connect with how they’re better off,’’ he says. “Shareholders want to know that executives are told in the beginning of the year, ‘This is what you have to do to get your bonus.’ They want to know the goals are stretch goals and the financial improvement will warrant the incentive payment.”

Don Norman, an attorney for Barack Ferrazzano Kirschbaum & Nagelberg LLP in Chicago, who handles compensation issues for community banks, says many banks have already made changes in order to defer a portion of incentive pay for executives and many have tied it to specific performance that benefits shareholders.

Much of that was set in motion following regulatory guidance on incentive pay in the aftermath of the financial crisis and the compensation rules for banks that received Troubled Asset Relief Program money.

But tying pay almost entirely to shareholder returns can place too much emphasis on short-term performance and thereby create undue risk, he says.

“The market doesn’t have a long-term focus,’’ he says. “It’s ‘what have you done for me lately?’”

Instead, he thinks it is not unreasonable for bank boards to maintain some level of discretionary decision-making over bonuses.   This is much easier in the private bank setting.

“If there’s no discretion, why do you need a compensation committee?” he says. “You have an intelligent and educated group of board members for a reason and there should be some level of deference to their judgment. There are management efforts that should be rewarded that are not always reflected in formulas.  Good or bad, this should be part of any pay assessment.”

Banks without a lot of institutional ownership will have less reason to worry about shareholder advisory groups such as ISS. Still, no one wants to find a majority of their shareholders voting down their pay packages.

Last year, 41 firms in the Russell 3000 (or less than 2 percent of the total index) reported that they failed to win majority approval from investors on pay, according to ISS. This year, 175 companies have had proxy votes and the average shareholder vote has been 90.4 percent in favor, ISS says.

So ending up as one of the firms with a no vote doesn’t look so good.

McLagan, another compensation consulting firm, offers some advice to avoid a “no” vote:

  • Analyze the shareholder base to determine the level of ISS or other advisory firm influence.
  • Monitor changes in each of your institutional investor’s proxy voting guidelines.
  • Audit your compensation and governance plans and programs for any potential exposure to guidelines of proxy advisor groups and institutional investors.
  • Track 1-year, 3-year, and 5-year total shareholder return relative to your ISS-established peer group.
  • Use the proxy compensation discussion section to clearly tell the “story” of executive pay and explain pay and governance decisions.
  • Be prepared to engage in meaningful dialog with shareholders.

2011 Shareholder Voting Trends – Preparing for 2012 Say on Pay


vote.jpgStarting with the 2011 proxy season, public companies were required to conduct a non-binding shareholder advisory vote on executive compensation practices at least every three years. Of the more than 3,000 companies disclosing their say-on-pay votes in 2011, only 40 (including one bank) failed to receive majority shareholder support.  While the percentage of failures was not high, we expect that number to increase in 2012 as investors (and advisory firms) have more time and resources to assess pay programs, and in 2013 when smaller reporting companies are required to hold their shareholder vote.

While non-binding, a failed vote can result in negative media attention, pressure on board members and shareholder lawsuits.   Of the 40 companies failing in 2011, seven already face shareholder lawsuits against executives, directors and, in some cases, their consultants.   

2011 Vote Results

While many companies initially recommended votes every three years (triennial), shareholders and advisory firms made clear their preference was for annual votes.  By the end of the 2011 proxy season, shareholders at 76 percent, 1 percent and 22 percent of companies, respectively, voted in favor of annual, biennial and triennial votes.

Many companies’ compensation packages passed when put to a shareholder vote by an overwhelming majority (68 percent passed with more than 90 percent of the vote), while 8 percent of companies received less than 70 percent shareholder support. 

Role of Shareholder Advisory Firms

Shareholder advisory firms such as Institutional Shareholder Services and Glass Lewis & Co. are having a significant impact on proxy vote results.  While these firms have no sanctioned powers, their influence cannot be ignored by boards and companies.  ISS in particular had an impact on 2011 vote results, especially at companies with high institutional ownership.  Overall, companies with an ISS “against” recommendation received an average of 68 percent shareholder support, compared to 92 percent at companies that received ISS support.   Going forward, ISS has indicated they will give extra scrutiny to companies that received less than 70 percent shareholder support in their prior year say-on-pay vote. 

What Factors Influenced the Vote?

Based on our review of ISS and Glass Lewis vote recommendations, a common reason cited for receiving an “against” vote was a pay-for-performance disconnect.  For ISS, this outcome was triggered when a company’s 1- and 3-year Total Shareholder Return (TSR) fell below industry GICS (global industrial classification standard) codes, without a corresponding adjustment in CEO pay.  Poor pay practices such as the use of tax gross-ups and single-triggers on Change in Control benefits also influenced a number of “against” votes.  In some cases, poor disclosure and excessive compensation were cited as contributing factors.

Increasing the Likelihood of  Shareholder Support

Companies can do several things to increase their level of shareholder support for SOP votes in the 2012 proxy season. 

Enhance Proxy Disclosure

The Compensation Discussion and Analysis (CD&A) is the basis of shareholder votes and should be written clearly and presented in an easy-to-read format.  Using tables, graphs and bullets can focus the reader on key points.  While not required, an executive summary allows companies to tell their “story,” reinforce pay-performance alignment and highlight pay practices shareholders will view positively.  The CD&A should plainly discuss incentive plan metrics and payouts, as well as any data, analysis and information considered in the compensation committee’s decisions.  Peer groups will receive increased scrutiny next year, when ISS adds peer data to its vote methodology. 

Understand Shareholder Criticisms

How companies respond to concerns about executive pay programs will be an important factor in future votes.  It is critical to understand the voting policies of major shareholders and any issues raised as concerns, even if they didn’t result in an “against” recommendation.  Compensation committees should discuss these concerns and consider whether to make changes to pay programs.  Companies should provide enhanced disclosure to rationalize  pay programs and decisions in light of investor concerns.

Some changes made by companies include amending employment agreements to eliminate golden parachute tax gross-ups (Disney); adding performance conditions for equity grants (Umpqua, Lockheed Martin, GE); reducing compensation (Key Corp), and changing peer groups (Occidental).

Improve Shareholder Communications

One positive impact of say-on-pay is that it has increased communication between companies and their shareholders. A two-way dialogue with major shareholders throughout the year can increase the likelihood of support for say-on-pay. 

In Summary

Shareholder advisory votes on pay packages were mandated with little notice for the 2011 proxy season, leaving investors and advisory firms with limited resources and time to prepare. As say-on-pay moves into its second year, scrutiny of executive pay practices will continue.  ISS has already changed its methodology for their vote recommendations. Companies that received shareholder support last year are not guaranteed the same result in 2012. 

Overall, monitoring and aligning the pay-for-performance relationship should be an ongoing responsibility and focus of compensation committees.  It is not too late to make well informed decisions, engage shareholders and improve disclosure to increase the likelihood of receiving a positive say-on-pay result in 2012.