Trends in Executive Compensation and Loan Officer Incentive Arrangements OBA HR Committee February 12, 2014
What We ll Be Covering Today Executive Compensation Trends Before, During, and After the Crisis Emerging Trends and Issues Impacting Loan Officer Incentives Commercial Lenders Mortgage Lenders 1
Executive Compensation Trends 2
Bank Performance in the Pacific NW Though significantly improved since 2009, median ROAA has returned to only slightly better than half of pre-crisis levels 2.0% 1.5% 1.0% 0.5% 0.0% -0.5% -1.0% -1.5% -2.0% Return on Average Assets (ROAA)* 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 25th Percentile Median 75th Percentile There is still a long way to go in order to return asset quality to pre-crisis levels * Data source: SNL Financial regulated depositories in OR & WA 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 3 Non-Performing Assets as % of Total Assets* 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 25th Percentile Median 75th Percentile
Salary Increases Reflecting the challenges in the heart of the crisis, annual increases for NW bank executives were subdued 2009 2011; the last three years have seen average annual increases between 3.0% and 3.5% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Average Increase in Base Salary* 2009 2010 2011 2012 2013 2014 Executive Exempt Nonexempt * Data source: Milliman NW Financial Industry Salary Survey (all commercial bank participants) Pre-crisis, average annual salary increases for NW bank executives were often in the 6% - 8% range 4
CEO Bonuses While NW bank CEO bonuses continue to be modest relative to precrisis levels, the percentage of CEOs receiving bonuses has been increasing each year 60% 50% Average Increase in Base Salary* 40% 30% 20% % of CEOs Receiving a Bonus Average Bonus as a % of Salary 10% 0% 2009 2010 2011 2012 * Data source: Milliman NW Financial Industry Salary Survey (all commercial bank participants) 2012 was the first year since 2007 that more than half of the bank CEOs in the NW earned a bonus 5
#1 LTI Equity Grant Trends at Smaller Banks % of CEOs Receiving Equity Grants* 80% 70% 60% Restricted Stock Options 50% 40% 30% 20% 10% 0% 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 * Based on proxy disclosures of public banks in the Western U.S. with assets $200m - $1b. 6
#1 LTI Equity Grant Trends at Smaller Banks Median Size of CEO Equity Grants as % of Salary* 30% 25% 20% 15% 10% 5% 0% 2006 2007 2008 2009 2010 2011 2012 * Includes only those CEOs that received an equity grant in the respective year. Based on proxy disclosures of public banks in the Western U.S. with total assets $200m - $1b. 7
CEO Total Compensation Mix at Smaller Banks* The change in mix of CEO total compensation over time reflects the health of the banking industry Options 7% R-Stk 3% SERP 11% Bonus 21% 2006 2009 2012 Other 6% Salary 52% SERP 11% Options 1% R-Stk 2% Bonus 2% Other 8% If bank performance continues to improve, we would expect CEO total compensation mix at smaller banks to shift closer to the 2006 mix Relative weighting between restricted stock and options will likely stay closer to 2012 (2 to 1, restricted stock to options) Salary 76% SERP 10% Options 2% R-Stk 4% Bonus 10% Other 5% Salary 69% * Based on proxy disclosures of public banks in the Western U.S. with assets $200m - $1b. 8
Hot Topics for Bank Boards and HR Professionals Short-term incentives Defining and measuring performance; there is greater demand than ever to demonstrate pay-performance alignment Managing risks; at the same time shareholders are demanding that more pay be delivered through performance-based arrangements, regulators insist that incentive plan design and operation be consistent with sound risk management principles Long-term incentive strategy How much equity compensation is appropriate? What are the right vehicles (e.g. options, restricted stock, performance shares, combination) and mix? Is our current shareholder-approved equity plan sufficient to carry out our LTI strategy? Employment / Change-in-Control (CIC) Agreements All of the M&A activity has unearthed many surprises related to inadequate planning in this area (especially if there s a SERP involved) 9
Emerging Trends and Issues Impacting Loan Officer Incentives 10
Commercial Lenders 11
Current Commercial Lending Marketplace Hot! Hot! Hot! Many banks are entering the market place, particularly Commercial & Industrial (C&I) lending Banks of all sizes are competing with each other - banks are looking for experienced lenders with relationships/portfolios they would like to have at their bank Pay levels are moving faster than the compensation surveys Pay influenced by region rather than bank size Market is tight many banks are facing difficulties filling openings Long term incentives playing a key role in retaining star lenders 12
Commercial Lender Incentives Current Trends in Design Majority of incentive plans make annual payouts and utilize a scorecard approach rather than commission framework Reward lenders for individual or team performance related to: Business development / loan volume Relationship management Portfolio profitability Timely and accurate assignment of asset quality ratings (AQR) Lender portfolio asset quality Policy exceptions and variances Include corporate performance component (i.e. net income) into incentive framework we re all in this together Important to provide appropriate upside opportunity 13
Commercial Lender Incentives How Can Loan Quality Be Incorporated? Loan Quality Performance Metrics Delinquencies Net Charge-Offs 90 day exceptions Non-performing loans Loan Quality Adjustment to Production Goal Example: Delinquency Provision At the conclusion of the eligible plan year, the Bank reserves the right to offset all loans originated in the prior plan year that are 60 days or more past due at the conclusion of the eligible plan year. The total sum of these delinquent loans will reduce the total amount of eligible loans which will be used to calculate the incentive award. Management reserves the right to determine whether the loan will be reinstated based on the overall performance of the loan. If the loan is delinquent more than one time in a calendar year for a 60 day period, reinstatement of the loan will not be credited to the participant 14
Commercial Lender Incentives How Can Loan Quality Be Incorporated? Qualifiers Design feature that allows bank to reduce a lender s incentive based upon one or more quality measures (i.e. loan, credit, portfolio management) Example: Three qualifiers that lender must meet in order to receive full incentive. Criteria Description Standard Net Charge-Offs Delinquencies Net Charge Offs to Total Loan Outstanding Delinquencies to Total Loans Outstanding 90 Day Exceptions 90-Day Exceptions to Total Exceptions Less than 0.20% Less than 0.90% Less than 35% Failure to achieve 3 of the above qualifiers will result in no incentive compensation to be earned or paid. Failure to achieve 1 of the above qualifiers will result in a 20% reduction of the calculated incentive compensation to be earned and paid. Failure to achieve 2 of the above qualifiers will result in a 30% reduction of the calculated incentive compensation to be earned and paid. 15
Commercial Lender Incentives How Can Loan Quality Be Incorporated? Loan Quality Modifier Incentive can be reduced up to a certain percentage (e.g. 100% or no incentive awarded) Based upon a holistic assessment of loan quality by the Manager Can also be used to address portfolio management issues 16
Commercial Lender Incentives What About Deferrals and Long Term Incentives? Holdbacks / deferrals Risk management feature that enables bank to defer portion (i.e. 15% - 20%) of lender s incentive over a certain time period (12 months 24 months). Can be used to address loan quality issues that may arise over that period Community banks have been slower to adopt deferrals while large regionals have been receiving pressure from regulators to adopt Deferrals can act as retention devices You ve paid up to get a lender now create a plan to keep them! Long-Term Incentives Used to attract and retain key lenders Being used more frequently for new hires, an above production award, or as a chairman s club award Restricted stock with cliff vesting most powerful Non-public banks using phantom or cash long-term incentive plans to compete with publicly traded competitors 17
Mortgage Lenders 18
The Mortgage Loan Originator Rule Where did it come from? 2010 was a busy year for proposed MLO regulations Federal Reserve Board issued MLO compensation regulations pursuant to the Truth in Lending Act that went into effect in April 2011 ( Loan Originator Rule ). The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd- Frank) imposed similar requirements concerning the compensation and qualification of MLOs 2011 The CFPB assumed authority of the Loan Originator Rule from the Federal Reserve Board 2013 - Rule was Finalized January - Regulations were issued to implement the new Dodd-Frank Act requirements within the Loan Originator Rule October CFPB provided further clarifications regarding the final Rule 2014 - Final Rule became effective on January 10, 2014 19
The Mortgage Loan Originator Rule What Does It Regulate and Who Falls Under It? The rule regulates compensation paid to a loan originator in most closed-end mortgage transactions by: Prohibiting a loan originator s compensation from being based on the terms of the transaction or a proxy for a transaction term; Permitting certain methods of compensating loan originators using bonuses, retirement plans, and other compensation plans that are based on mortgagerelated profits; and Prohibiting loan originators in a transaction from being compensated by both the consumer and another person, such as a creditor. The Rule applies to anyone who: Takes a residential mortgage loan application Assists consumer in obtaining or applying to obtain a loan» Advising on residential mortgage loan terms (rates, fees, other costs)» Preparing mortgage loan packages» Collecting information from the consumer to assist with the application for the loan Offers or negotiates terms of a residential loan 20
The Mortgage Loan Originator Rule Compensation What Is Permissible? Under the regulations, compensation based on the following is permissible: Loan originators overall dollar volume Long term performance of the originators loans Hourly pay rate based on the actual number of hours worked Loans made to new customers vs. loans to existing customers Fixed payment Percentage of applications closed The quality of the loan originators loan files Loan threshold levels: Example: Dollar volume of loans over a particular period (Tiered Rate Structure)» $5 million to less than $10 million: 40 basis points» $10 million to less than 15 million: 50 basis points» Over $15 million: 60 basis points The list is not an exhaustive one and other compensation structures can be used so long as they comply with the rule. 21
The Mortgage Loan Originator Rule Bonus Arrangements What Is Permissible? Under the regulations, permissible bonus compensation arrangements include: Bonuses not based upon profits, including:» A retention bonus budgeted for in advance» A performance bonus paid out of a bonus pool set aside at the beginning of the company s annual accounting period as part of the company s operating budget. Mortgage-related business profits can be used to make contributions to certain tax-advantaged retirement plans, such as a 401(k) plans A non-deferred profits-based compensation plan» Any arrangement for the payment of non-deferred compensation based in whole or in part on the profits of the mortgage-related business» Includes bonus pools, profits pools, bonus plans, profit-sharing plans and awards of merchandise, services, trips or similar prizes Example: An annual bonus plan in which an MLO would receive an award based upon the Bank s ROA performance for the year (it is considered that the profits from the mortgage business are factored into the Bank s ROA calculation) 22
The Mortgage Loan Originator Rule Bonus Arrangements What Is Permissible? There are limitations that apply when an MLO participates in a nondeferred profits-based compensation plan The amount paid cannot exceed ten percent (10%) of the individual loan originator s total compensation for that 12-month performance period (plan year) and the compensation may not be directly or indirectly based on the terms of that individual loan originator s transactions. If an originator made 10 or fewer transactions during the 12-month period (plan year), the bonus received through the plan would not be capped (i.e. the 10% of total compensation limit would not apply). Compensation under a non-deferred profits based plan is not subject to the ten percent (10%) total compensation limit if the Plan is determined with reference only to profits from a business other than a mortgagerelated business, as determined in accordance with reasonable accounting principles. 23
The Mortgage Loan Originator Rule Case Study: How to Avoid the 10% Cap Client Situation: Bank has a corporate incentive plan in which registered MLOs (Branch Managers and Mortgage Loan Officers) currently participate Budgeted plan with participants having target incentive opportunities tied to specific performance metrics and corresponding goals. Target incentive opportunities range between 10% and 15% of base salary Maximum incentive opportunities are capped at 150% of target (i.e. 15% and 22.5% of base salary) Incentive Plan Metrics» Corporate Metrics Net Income Efficiency Ratio Deposit Growth» Individual Metrics Loan volume Past dues/total loans year-to-date average 24
The Mortgage Loan Originator Rule Case Study: How to Avoid the 10% Cap Changes Implemented for 2014 Established a separate MLO incentive plan not based on mortgage related profit metrics that was budgeted within the Bank s operating budget Provided same incentive opportunity and payout range (0% - 150% of target) Metrics varying based upon role with weightings assigned to each metric» Mortgage Loan Officers 20% Overall loan growth for the Bank 50% Individual loan production 20% Individual portfolio quality 10% Referrals» Branch Managers 40% Overall deposit growth for the Bank 20% Loan Production for the Branch 20% Net Average Deposits for the Branch (customer retention) 10% Cross Selling Ratio for Branch 10% Operating Expenses vs. Budget 25
Final Thoughts 26
About PM&P s Banking Practice PM&P serves hundreds of bank clients annually through a national team of consultants exclusively dedicated to serving the banking industry. These consultants work closely with a wide range of banking organizations, from de novo banks, mutuals and credit unions to super regional and international financial institutions. Our services include compensation and governance advisory services to Compensation Committees and Boards, the development of executive and employee compensation programs tailored to the business needs of each client, and the administration of compensation surveys for bank executives, employees, and Board of Directors (including PM&P s National Banking Compensation Survey). The firm maintains offices in New York, Atlanta, Boston, Charlotte, Chicago, Houston, San Francisco, San Jose, Los Angeles, and London. For more information on our bank consulting services visit www.pearlmeyer.com/banking. Greg Swanson Vice President San Francisco / Portland (415) 651-4831 greg.swanson@pearlmeyer.com Kristine Oliver Vice President Boston 508-630-1550 kristine.oliver@pearlmeyer.com 27