Is Your Backup Ready? CEO and the Backup Quarterback

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The 2023 NFL postseason gave us a clear example of what it looks like when a team doesn’t have a backup. Dallas Cowboys continued to use kicker Brett Maher in games, even though he missed not one or two extra points, but a total of four extra points in the Cowboys’ wild card game against the Tampa Bay Buccaneers.

If your financial institution doesn’t have a strong CEO succession plan, it could wind up feeling like the Dallas Cowboys with no options to move forward. There are many parallels between a backup quarterback who is ready and a strong CEO successor.

Recruit Next-Generation Talent
Championship teams recruit talented players for each position. In addition, they recruit the next generation of players. The quarterback knows that there is someone ready to take over his position when he graduates or becomes unexpectedly injured. The backup trains his skills with the expectation that he will one day surpass the current quarterback.

Create Opportunities to Practice Leadership
Backup players are trained, mentored and given the opportunity to practice their skills and leadership. When a team with a talented depth chart fails to designate the backup quarterback, the team is not ready to follow when one of the backups steps in. Talent is not enough. Practice is not enough. The team needs to be ready to follow the next leader. Teams can absolutely have more than one candidate for the backup position, but at some point before the season, they need to make a decision on the depth chart.

Work Together for the Greatness of the Team
The relationship between the quarterback and the backup is strong. They work together for the success of the team. Backup preparation, coupled with clear communication, prepares the entire team for the next generation of leadership — whether that time comes in three years or in an instant.

Three Steps to Cultivate Backup Readiness
1. Timeline.
The backup needs to be ready now, while having the confidence to wait for graduation or retirement. When a team extends a transition timeline in college football, we see players jumping in the transfer portal and playing for a competitor. The same is often true in CEO succession planning. Holding to your timeline helps retain your backup.

2. Position Profile.
Look at your organization chart for your institution today and understand what is needed for each position in the next five years. Create a position profile that combines a job description with what the business will look like at the point of succession. Make sure your bank’s backup options have, or are building, the skills and experiences they will need to align with where the business will be at the point of succession.

3. Assess Your Talent
Much like a wide receiver can move to play safety, your institution needs to find strong talent to fill key position to lead into the future. Use a comprehensive assessment that profiles leadership potential and identifies development opportunities that allows for your “best athletes” to move into a range of roles.

When your bank needs a succession plan or depth chart, follow the example of championship football teams. Understand the timeline, then match the skills of your players with the demands of your organizational chart. A third party can be useful in helping to assess and plan for the future team.

Survey Results: Crisis Reinforces Need for Talent

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Throughout the Covid-19 pandemic, banks have relied on their employees to counsel customers and process billions of dollars of Paycheck Protection Program loans — not to mention working behind the scenes as they adapt to a virtual work environment.

The crisis reinforces the old adage that good talent is hard to find. “Hire right,” investor Ray Dalio once wrote. “The penalties of hiring wrong are huge.”

Bank Director’s 2020 Compensation Survey, sponsored by Compensation Advisors, confirms that talent can be difficult to find in key areas. More than 70% of directors, CEOs, human resources officers and other senior executives responding to the survey point to skills that are particularly difficult to hire and retain, such as information security, technology, lending and risk.

But hiring less-skilled staff also proves challenging: Half indicate that it’s “somewhat” or “very” difficult to attract and retain entry-level employees who fit into the organization’s culture. What’s more, concerns around recruiting younger talent have risen slightly in the past three years: 30% cite this as a top-three challenge this year, compared to 21% in 2017.

Yet, 79% believe their bank offers an effective compensation package that helps attract and retain top talent.

This apparent disconnect could stem from the generation gap between bank leadership and younger staff. Two-thirds of survey respondents are over 55, while more than half of their bank’s workforce is 45 or younger. One can infer that these employees, mostly Gen Z and millennials, primarily occupy entry and mid-level positions.

The survey was distributed in March and April, as the coronavirus forced banks to rapidly shift operations to work-from-home arrangements and adjust branch procedures. Ninety-two percent of respondents indicate their bank instituted or expanded remote work, and 80% introduced or expanded flexible scheduling in response to Covid-19. As the industry emerges from this crisis, how will this impact corporate culture moving forward, as well as expectations from prospective employees?

Key Findings

Covid-19 Response
In addition to adapting to remote and flexible work arrangements, more than half expanded paid leave to encourage staff to stay home if they showed symptoms of the virus. In addition, 81% have limited service to drive-thru only, and 78% limited in-person meetings to appointment only, in order to keep customers and staff safe.

Top Compensation Challenges
The top two compensation challenges that respondents identify remain the same compared to last year: tying compensation to performance (48%), and managing compensation and benefit costs (44%).

Few Measure D&I Progress
Stakeholders have increasingly paid attention to corporate efforts around diversity & inclusion. However, 42% of respondents say their bank lacks a formal D&I program, and doesn’t track progress toward hiring and promoting women, minorities, veterans or individuals with disabilities. Of the metrics most frequently tracked by banks, 58% look at the percentage of women at different levels of the bank, and 51% at the percentage of minorities. Less than half track the gender pay gap, participation of women or minorities in development programs, or participation by employees in D&I-focused education and training.

CEO Retirement
More than 20% expect their CEO to step down within the next three years; an additional 7% are unsure whether their CEO will retire. This metric is, naturally, age dependent: For CEOs over the age of 65, more than half are expected to retire.

CEO, Board Pay Increased
Median total CEO compensation increased in fiscal year 2019, to $649,227. Pay ranged from a median of $251,000 for banks under $250 million to $3.6 million for banks above $10 billion. More than 70% measure CEO performance against the bank’s strategic plan and corporate goals.

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

Generational Shift Complicates Shareholder Succession

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A challenge facing many community banks this new decade has nothing to do with public policy, the yield curve, regulation or technology.

A growing number of banks face an aging shareholder base, concentrated ownership and limited liquidity. This can lead to shareholder succession impositions when large shareholders want to exit their ownership position or an estate settlement creates a liquidity need.

Community banks have always been owned by local centers of influence, passed down through generations and thought of as both a financial investment and philanthropic participation in the community. But the societal aspect of bank ownership is not the same as the current ownership cedes to the younger generation, many of whom have moved away from home and see banking as an increasingly more digital experience.

Banking and securities regulations do not make the situation easier. There are parameters around a bank’s ability to issue stock in the local community to attract new shareholders. Banks are cautious of giving unknown investors a seat at the table, particularly institutional or activist owners, as they may only hold the stock for a defined, shorter period before seeking liquidity themselves. The bank itself can sometimes be a source of liquidity to repurchase stock from shareholders, but regulatory capital ratios may limit that capacity. Some advice for banks struggling with these issues includes the following:

Treat shareholder succession as a business initiative: Identifying issues before they occur, or a capital need before it becomes urgent, increases a bank’s flexibility. Boards should discuss shareholder liquidity issues, as some large owners may be sitting around the board table.

Investor relations is not just for large and liquid banks: Local banks are often owned by members of the local community. The legacy of family ownership is emotional, and large owners often do not want to “upset the apple cart” and force the bank to sell. Many may not realize that how they treat their position could impact the bank’s future. Some may not be open to discussing the issue, but others might appreciate the opportunity.

Address long-term liquidity in strategic planning: Under what conditions would the bank consider listing on a more liquid exchange, commencing a traditional public offering, or raising subordinated debt as a way to address shareholder succession? The owners of many closely held banks are wary of incurring dilution to their ownership stake but want to remain independent, which limits their options. For smaller banks, even upgrading to a slightly more liquid trading medium such as OTC Market Group’s OTCQX Banks market, may open the doors to investors that understand smaller, less-liquid situations and have capital to put to work.

Plan for shareholder liquidity as you would for balance sheet liquidity: It is helpful that directors and executives understand the bank’s capacity to repurchase shares, as the bank itself is often the first line of defense for an immediate liquidity need. Small bank holding company regulation gives community banks flexibility to leverage their capital structure by issuing debt at the holding company, which can be injected into the bank subsidiary as common equity. Creating an employee stock ownership plan or dividend reinvestment plan may help to manage and retain capital and dividend policy can also be critical.

The right answer is usually a combination of all of the above: There is no silver bullet for addressing shareholder liquidity in a smaller, more closely held bank; all of the discussed initiatives will play a part. Many banks get caught flat-footed after the fact, either faced with an estate settlement or a family with a large position seeking liquidity. Dealing with an urgent liquidity need, often in tight timing, limits the bank’s flexibility and options.

If a merger or sale is the right alternative, control that dialog: Some shareholders looking to exit may find the premium in a sale attractive relative to the desire of others for independence. It’s a worthwhile exercise for boards and executives to understand the bank’s value in a sale, as well as likely partners, even if a sale is only a remote possibility. This allows your bank to identify preferred partners and ascertain their ability to pay a competitive valuation independent of any urging from shareholders. Highlight those strategic alternatives to the board on a regular basis. If an urgent shareholder need forces the bank to seek a partner, your bank has already begun addressing these issues and building those relationships.

Shareholder succession issues can drive change and create uncertainty, risk and opportunity at community banks. Careful analysis and planning can help lead to a desired outcome for all involved.

How To Manage Talent in a Parfait Organization

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talent-11-7-18.pngThe banking industry sits at an interesting crossroads from a talent management perspective. Demographically, many banks are layered like a parfait, with as many as four distinct generations working in the organization, each with its own set of personality traits, likes and dislikes.

The oldest generation—the baby boomer generation, now running the bank for several years—is beginning to retire in increasing numbers. The Generation X cohort, which follows the boomers, is moving into senior management, the best and brightest among them soon to rise to the CEO and CFO level, if they haven’t already.

Generation Y, otherwise known as millennials, are now far enough along in their careers to have gained some meaningful experience, and the really talented ones are identifiable to the bank. Most members of the final and largest cohort, Generation Z, are still in high school and college, although the oldest ones are entering the workforce. At 26 percent of the population, Gen Z will be a force for the next several decades.

This dramatic generational shift is forcing banks to become more proactive in how they manage their talent, particularly millennials, who will comprise a significant part of the industry’s workforce in the near future. The importance of creating opportunities for those individuals was a significant theme in day two of Bank Director’s 2018 Bank Compensation and Talent Conference, held at the Four Seasons Resort and Club at Las Colinas in Dallas, Texas.

In a session on talent management, Beth Bauman, an executive vice president and head of human resources at the Bank of Butterfield, a NYSE-listed $11 billion asset bank domiciled in Bermuda, described the situation at the bank when she joined it in 2015. Butterfield had frozen salaries and done relatively little hiring for several years as it struggled to recover from the financial crisis. So Bauman, along with senior management, has worked to bring in new talent so the bank can continue to grow.

A key element of that hiring effort has been to create a talent management program so Butterfield’s younger employees can have their careers guided, with the most talented groomed for higher positions within the bank.

Bauman sees this as a key to successfully managing the generational change occurring now throughout the industry. “Regardless of the size of your bank, you can have an effective talent management program,” she says.

Talent management has been very much on the minds of the conference attendees. In an audience survey that polled the 300-plus people who were there, 45 percent said it has become both more difficult and costly to attract and retain talented staff—a result not surprising in an economy where the unemployment rate is just 3.7 percent. Banking also has the disadvantage of not being perceived as an exciting employment opportunity for many job seekers, particularly millennials.

Sixty-one percent of the survey respondents said their bank is actively and intentionally recruiting younger employees like millennials and Gen Z’ers.

Similarly, more than 70 percent said in the last two years their bank has expanded its internal training programs to develop younger leaders within the organization.

As increasing numbers of baby boomers approach retirement (the youngest boomers are in their mid-50’s), and Gen X’ers take their place in the management hierarchy, it will create an opportunity for millennials to move up as well. Gen X’ers are the smallest of the four demographic groups at just 20 percent of the population, so the banking industry will be forced to rely disproportionately on millennials as this generational shift occurs.

This is why training programs that focus on talented younger employees in the organization are so important.

We’ve all heard the jibes about millennials’ self-absorption, or their refusal to return voicemail messages, but the fact is the oldest among them are already buying homes and raising families, and when the day comes to run the bank, they’ll need to be ready.

Are Your Retirement Vesting Provisions Motivating the Wrong Behaviors?

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incentive-1-4-16.pngAs more executives near retirement age, many banks are realizing their equity vesting provisions may be motivating unintended behaviors. Do your bank’s retirement provisions encourage executives to:

  1. Provide advance notice of retirement to facilitate planned succession?
  2. Assist in their transition?
  3. Remain engaged and motivated through the last day on the job?
  4. Remain interested in the bank’s success following retirement?

Unfortunately, many retirement provisions don’t consider these important objectives and in some cases motivate the opposite behaviors.

Current and Emerging Retirement Provisions

Forfeit
Forfeiting all unvested equity may be used as a means to retain executives, but this practice can unintentionally encourage executives to wait around for equity to vest when the executive is no longer fully engaged.

Fully Accelerate
Accelerating unvested equity upon retirement allows executives to announce and retire whenever they want without losing any equity. However, if an executive communicates an intention to retire two months before an equity award, does the company make the award? Not doing so could impede the executive’s motivation to provide advance notice of pending retirement. However, full acceleration can limit the retention value of awards once the executive reaches (early) retirement eligibility.

Prorate
Proration provides executives with a portion of unvested equity based on the amount of time the executive has worked during the vesting period, regardless of when the grant was made. The bank may be uncomfortable with executives receiving value from recent grants, while executives may feel that they are forfeiting earned compensation. Below are three potential solutions to this concern which combine proration with acceleration:

  1. Holding Period. Participant must have received the grant at least 6-12 months prior to retirement in order for vesting to accelerate or performance awards to vest.
  2. Prorated 12 Month Period. The amount of award that accelerates or vests is based on the portion of time worked during the first year after grant. If a participant works for six months following a grant, he/she would receive value of half the award. This alternative is more generous and does not create as much of a cliff timeline.
  3. Most Recent Grant Pro Rata. Equity accelerates in full except for the most recent grant (made in the last 12 months) which would vest pro rata based on the full vesting period of the award (e.g., if stock options vest ratably over 4 years, a participant who works for six months during year one would receive one-eighth of the award).

Continue Vesting
Continued vesting is an emerging practice with benefits for the executive and the bank. Continued vesting allows the executive to retire without forfeiting all or a portion of outstanding awards. Instead, the awards continue to vest on the original schedule. This also encourages the executive to leave the bank in sound condition and facilitate transition. Another benefit for the bank is that continued vesting helps reinforce non-compete or non-solicit agreements because the bank can cease vesting if the executive violates the restrictive covenant.

Committee Discretion
Some committees want the discretion to determine retirement treatment on a case by case base. This treatment acknowledges that each executive is different and each retirement situation is unique. However, this approach puts a significant pressure on the committee and may be perceived unfair by executives if the discretion is not applied consistently.

Other Considerations

Retirement Definition
Banks should also review the retirement definition to ensure it remains appropriate. If a bank’s retirement age is 65, what is the treatment if an executive is hired at age 64? Some banks define an age plus service definition such as age 65 and 5 years’ service or an age and service definition to recognize early retirement (e.g. 55 age plus 10 years’ service or age plus service equals 75). For these definitions, banks may want to consider including a “retire from the industry” requirement in their retirement definition.

Performance Awards
Should performance award payout be based on target or actual performance? Awards paid based on actual performance at the end of the performance period could encourage the retiring executive to leave the bank in sound condition.

Vesting Schedule
Finally, the vesting schedule may also impact which type of retirement provision a bank chooses. For example, if time-vested restricted stock vests ratably over three years (i.e. 1/3 per year), a forfeiture provision would not be as detrimental to the executive as if the award was cliff vested.

Choosing the right retirement treatment is a more strategic decision than ever before. Banks should review their long-term incentive plans to ensure they are meeting desired objectives.

Ownership Succession for Family-Owned Banks: Building the Right Estate Plan

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4-15-15-BryanCave.pngFor a number of community banks, the management and ownership of the institution is truly a family affair. For banks that are primarily controlled by a single investor or family, these concentrated ownership structures can also bring about significant bank regulatory issues upon a transfer of shares to the next generation.

Unfortunately, these regulatory issues do not just apply to families or individuals that own more than 50 percent of a financial institution or its parent holding company. Due to certain presumptions under the Bank Holding Company Act and the Change in Bank Control Act, estate plans relating to the ownership of as little as 5 percent of the voting stock of a financial institution may be subject to regulatory scrutiny under certain circumstances. Under these statutes, “control” of a financial institution is deemed to occur if an individual or family group owns or votes 25 percent or more of the institution’s outstanding shares. These statutes also provide that a “presumption of control” may arise from the ownership of as little as 5 percent to 10 percent of the outstanding shares of a financial institution, which could also give rise to regulatory filings and approvals.

Upon a transfer of shares, regulators can require a number of actions, depending on the facts and circumstances surrounding the transfer. For transfers between individuals, regulatory notice of the change in ownership is typically required, and, depending on the size of the ownership position, the regulators may also conduct a thorough background check and vetting process for those receiving shares. In circumstances where trusts or other entities are used, regulators will consider whether the entities will be considered bank holding companies, which can involve a review of related entities that also own the institution’s stock. For some family-owned institutions, not considering these regulatory matters as part of the estate plan has forced survivors to pursue a rapid sale of a portion of their controlling interest or the bank as a whole following the death of a significant shareholder.

To preserve the institution’s value, significant shareholders should consider the regulatory and tax consequences associated with their estate plans. Here are some issues to consider:

  • Combined family ownership interests. A significant shareholder should consider not only her own stock ownership, but also that of her immediate family, when determining if any bank regulatory issues may apply. For purposes of the various statutory thresholds for determining control, ownership of immediate family members, including grandparents, siblings, and children, can be aggregated, leading to unexpected presumptions of control.
  • Types of estate planning entities. For many larger estates, a variety of estate planning vehicles can be involved, including revocable and irrevocable trusts, testamentary trusts, family partnerships, charitable trusts and other charitable entities, such as private foundations. However, federal regulations only provide a narrow “safe harbor” from the requirements of the Bank Holding Company Act, which has led to a number of estate planning structures being unexpectedly classified as bank holding companies.
  • Impacts to S corporations. Many family-controlled banks have elected to be taxed as S corporations in order to allow the institution’s earnings to be distributed to shareholders more directly. Estate planners should consider any barriers to transfer under an applicable shareholders’ agreement, especially if the owner contemplates transferring stock to an entity that is an ineligible shareholder under S corporation rules.
  • Corporate governance issues. Individuals that own a controlling interest in a financial institution should consider the impact of his or her death on the governance of the institution until the estate is settled and the shares transferred to new owners. If the controlling shares are unable to be voted due to an estate or trust dispute, governance tasks for the bank, such as holding an annual meeting or approving a merger, can be held in limbo. As a result, the appointment of capable and responsible executors and trustees is a critical step in any estate plan.
  • Strategic planning. Significant shareholders should consider the desires of the next generations when formulating an ownership succession plan. While some family members may have a desire to manage the bank in the future, others may simply desire liquidity or have other investment goals. Considering these desires and determining how an estate plan may affect the strategic plan of the institution can preserve value for the controlling family, the institution, and minority shareholders.

Family-owned financial institutions are built over a lifetime and the regulatory and tax issues associated with an ownership transfer can be mitigated with careful planning. Regardless of whether a family intends to transition active management to the next generation or to simply pass down the full value of their shares to their relatives, constructing a plan that considers the family’s goals, in addition to regulatory and tax matters, is essential.