Executive and Incentive Compensation

Executive and Incentive Compensation 1255 West 15th Street, Suite 830; Plano, TX 75075 / www.bcc-usa.com Attracting Quality Developing Loyalty Embracing Leadership Bank Compensation Consulting Offering compensation programs that are competitive is key to attracting and retaining officers and executives. Bank Compensation Consulting (BCC) specializes in assisting banks with the evaluation of their compensation programs. With BCC s help, banks identify deficiencies in their current programs and create customized plans to fill these gaps. BCC s team of consultants and service personnel collectively have over 250 years of experience, working with more than 600 banks in 40 states. They assist their clients with achieving their financial goals and enhancing shareholder value. BCC understands the regulatory complexity of designing and administering these plans. In order to provide stress free guidance to their clients, BCC has developed strategic relationships with highly-rated insurance carriers and national accounting and law firms that specialize in nonqualified benefits and BOLI for banks. 1

About Bank Compensation Consulting Maria Kell, CFP Sr. Consultant Provides educational speeches and seminars nationwide Worked for over 25 years in the financial industry, and uses her skills honed in the banking industry to provide innovative solutions for her clients Capabilities, Products & Services Compensation Consulting Executive & Director Benefits Plans Succession Planning Benefit Expense Offset/BOLI Long-Term Care & Disability Income Planning Administrative Services BCC s Mission Help community banks achieve and sustain profitable quality growth by designing and implementing compensation plans that are significant in value to executives and insignificant in cost to the shareholders. 2

Compensation Plan Guidance Recruiting Tool Incentive-Based Motivation Method to Retain Balance Risk & Financial Results Effective Controls & Risk Management Active Oversight by Board of Directors Regulatory Changes & New Compensation Rules Compensation Rules Interagency Guidance on Sound Incentive Compensation Policies (Federal Reserve Guidance) June 25, 2010 Dodd-Frank Wall Street Reform & Consumer Protection Act (Dodd-Frank) July 21, 2010 Regulation Z rules for compensating mortgage loan originators (MLO) Basel III restricting discretionary bonuses 3

The Key to Future Profitability and Outstanding Shareholder Value People are the Key to Future Profitability and Outstanding Shareholder Value Two Fundamentals for Today Integrating Pay for Performance (Incentive Motivated Executives) with Pay for Attendance (Salary Satisfied Executives) 4

Four Functions Performed by Executive Compensation Recruit Reward Retain Retire Key Executives Compensation Trends More emphasis on incentive compensation to retain & reward key personnel More bonus deferrals in light of Fed guidance Stock Options and Restricted Stock are still viable Increased interest in Phantom Stock Plans & Stock Appreciation Rights Plans Clawback provisions implemented with incentive plans Longer term incentive plans 5

Banker Requested Executive Compensation Plans Executive compensation has been driven by bankers that want sustained profitable quality growth BCC designs these plans at the request of bankers These incentive compensation plans are responsive to the changing dynamics of the market place by helping bankers who: Wish to accomplish certain objectives Have to respond to the job offers competitors are putting on the table for their best officers Compensation Plans & Objectives 6

Annual Cash Incentive Plan (ACIP) Plan Highlights Employees selected by bank Discretionary or scorecards to measure performance bank wide branch wide department wide individual Design affordable plan Incentive Compensation Enhances the Strategic Plan Bank's Strategic Plan Communication of Goals Establishment of Criteria to Achieve and/or and/or Bank Department Individual Goals Goals Goals X% Y% Z% Performance Exceeds Budget If Achieved Shareholders Executives 95% of Excess $ 5% of Excess $ 7

Preliminaries About ACIP Design Two Levels of ACIP Design Consideration Affordable costs for the bank Desired impact on targeted individual s effort and performance An essential element of ACIP Design is to model the impact on both the individual and the bank Incentive payments to executives must be: Affordable for the bank; Consistent with safe and sound banking practices Deferred Cash Incentive Plan (DCIP) Plan Highlights Employees selected by bank Deferral period at bank s discretion Bonus compensation often percentage of salary Performance targets with scorecards or discretionary Interest set by bank Benefit forfeited upon early termination 8

Deferred Cash Incentive Plan (DCIP) Eligibility: Available to a senior and junior officers Term: Five year deferral plan with officer receiving payment early in sixth year of each deferral (January or February) Specifics: Additional cash compensation, often percentage of salary Payable in short-term, five years Deferred amounts may earn at the bank s ROE Forfeited if they leave the bank ( golden handcuffs ) Plan is flexible with multiple variations DCIP Accounting Detail - First Year Participant Plan Completion 3% Year 1 to Year 5 Years 1-5 Age: 65 Inflated 10%* 8%** Year Age Salary Deferral Interest Balance Benefit 1 41 110,000 11,000 0 11,000 0 2 42 113,300 0 880 11,880 0 3 43 116,699 0 950 12,830 0 4 44 120,200 0 1,026 13,856 0 5 45 123,806 0 1,109 14,965 0 6 46 127,520 0 0 14,965 14,965 *10% Deferral made at end of the plan year **Interest credited at 8% at the end of the plan year Formula gets deferred money into the DCIP Deferred money earns at ROE of the bank Payout following year five 9

DCIP Long Accounting Detail $62,610 at risk if participant leaves the bank Cliff vesting, 100% at risk until paid 3% Years Yr 2 to Yr 6 Yr 2-6 Yr 3 to Yr 7 Yr 3-7 Yr 4 to Yr 8 Yr 4-8 Inflated 1-5 10% 8% 10% 8% 10% 8% Year Age Salary Benefit Deferral Int Balance Benefit Deferral Int Balance Benefit Deferral Int Balance Benefit 1 41 110,000 0 0 0 0 0 0 0 0 0 0 0 0 0 2 42 113,300 0 11,330 11,330 0 0 0 0 0 0 0 0 0 3 43 116,699 0 0 906 12,236 0 11,670 0 11,670 0 0 0 0 0 4 44 120,200 0 0 979 13,215 0 0 934 12,603 0 12,020 0 12,020 0 5 45 123,806 0 0 1,057 14,273 0 0 1,008 13,612 0 0 962 12,982 0 6 46 127,520 14,965 0 1,142 15,414 0 0 1,089 14,701 0 0 1,039 14,020 0 7 47 131,346 0 0 0 0 15,414 0 1,176 15,877 0 0 1,122 15,142 0 8 48 135,286 0 0 0 0 0 0 0 0 15,877 0 1,211 16,353 0 9 49 139,345 0 0 0 0 0 0 0 0 0 0 0 0 16,353 10 50 143,525 0 0 0 0 0 0 0 0 0 0 0 0 0 previous slide 62,610 Long-Term Wealth Accumulation Plan Highlights Employees selected by bank Supplemental retirement income Formula driven Offsets caps on qualified plans Vesting schedules ( golden handcuffs ) Plan provisions at bank s discretion Covered by ERISA Top-Hat rules 10

Salary Continuation Plan (SCP) Summary of Benefits Name Current Age Retirement Age Current Salary Inflation Rate Projected Final Salary Benefit Percent Benefit Payment Benefit Payment Duration President 54 65 195,000 3% 262,064 50% 131,032 15 Years EVP 1 49 65 145,000 3% 225,905 40% 90,362 10 Years EVP 2 47 65 132,000 3% 218,176 40% 87,270 10 Years EVP 3 41 65 110,000 3% 217,095 30% 65,128 10 Years Salary Continuation Plan Accounting Detail Rows 15-25 hidden President Benefit Accrual & Liability (1) (2) (3) (4) (5) (6) Accrual 5.00% Benefit Retirement Service Interest Annual Year Age Payment Liability Cost Cost Accrual Cumulative 1 54 0 69,414 1,609 71,023 71,023 2 55 0 71,768 5,297 77,065 148,088 3 56 0 74,533 9,303 83,836 231,924 4 57 0 77,822 13,668 91,490 323,414 5 58 0 81,792 18,439 100,231 423,645 6 59 0 86,684 23,679 110,363 534,008 7 60 0 92,878 29,467 122,345 656,353 8 61 0 101,040 35,912 136,952 793,305 9 62 0 112,495 43,178 155,673 948,978 10 63 0 130,526 51,548 182,074 1,131,052 11 64 0 168,106 61,696 229,802 1,360,854 12 65 120,113 1,380,805 14,282 67,758 82,040 1,322,781 13 66 131,032 64,631 64,631 1,256,380 14 67 131,032 61,234 61,234 1,186,582 26 79 131,032 4,010 4,010 10,874 27 80 10,919 45 45 0 28 81 0 0 0 0 1,965,480 1,965,480 1,081,340 884,138 1,965,478 11

Equity Plans Plan Highlights Restricted Stock real equity actual certificates Stock options ISO Incentive/Statutory Options NSO Nonqualified/Non-Statutory Options Stock Appreciation Rights (SAR) future appreciation Phantom Stock or Performance Stock Units (PSU) current & future appreciation synthetic equity no certificates more generous & costly Stock Appreciation Rights Bank grants employee a stock appreciation right (SAR) SAR has initial value SAR is a right to cash payment equal to the increase in FMV above the initial value over time Employee usually does not receive dividends on SAR Example 1. 1,000 SARs granted to employee 2. Initial value $10.00 3. Bank pays $2.50 per share cash dividend on stock 4. FMV at exercise $60.00 5. Employee receives $50,000 cash payment at exercise 12

Rows 15-25 hidden Stock Appreciation Rights Accounting Detail President Cumulative BOY EOY Annual Total SAR Forecast SAR Book Book Increase in Annual Cumulative Annual Age Allocation Value Value Bk Value SAR Gain Benefit Duration EOY Year End per Share per Share per Share Gain EOY Payment 1 54 600 49.10 53.73 4.63 2,777 2,777 0 2 55 1,200 53.73 58.89 5.16 6,196 8,973 0 3 56 1,800 58.89 64.55 5.66 10,187 19,161 0 4 57 2,400 64.55 70.75 6.20 14,873 34,034 0 5 58 3,000 70.75 77.55 6.80 20,397 54,431 0 6 59 3,600 77.55 85.01 7.46 26,857 81,288 0 7 60 4,200 85.01 93.18 8.17 34,312 115,599 0 8 61 4,800 93.18 102.13 8.95 42,982 158,581 0 9 62 5,400 102.13 111.95 9.82 53,001 211,582 0 10 63 6,000 111.95 122.70 10.75 64,482 276,064 0 11 64 6,600 122.70 134.50 11.80 77,902 353,966 0 12 65 340,135 37,958 13 66 325,295 37,958 14 67 309,382 37,958 26 79 0 37,958 353,966 569,370 Offsetting the Costs Offsetting the Costs of Deferred Compensation and Other Executive Nonqualified Benefit Plans 13

What are the Two Most Common Ways of Paying these Executive Benefit Plan Costs? Pay out of current increased earnings If the bank has unutilized Bank Owned Life Insurance (BOLI) capacity, use additional BOLI as a source of incremental earnings to cover the costs An Elusive Paradigm Shift if Required Bank Owned Life Insurance Traditional Retail Life Insurance Cash Surrender Value Death Benefit Death Benefit Cash Surrender Value 14

Benefit Expense Offset/BOLI Tax Results of Alternative Assets vs BOLI (1) (2) (3) Asset Placement: $2,750,000 Alternative First Year Gain/Loss Asset BOLI Due to BOLI Income Income 2.00% 3.29% First Year Gross Income 55,000 90,400 35,400 Load / Surrender Charges 0 0 0 Income Tax 34% 18,700 0 18,700 Net Earnings Impact 36,300 90,400 54,100 Rows 15-30 hidden Income Statement with Employee Expenses (1) (2) (3) (4) (5) (6) Annual Annual Annual Annual Annual Cumulative After-Tax BOLI Alternative Net BOLI Bank Bank Year Expenses Gain Asset Cost Gain Impact Impact 1 (62,376) 90,400 (36,300) 54,100 (8,276) (8,276) 2 (64,015) 90,836 (36,779) 54,057 (9,957) (18,233) 3 (67,611) 91,117 (37,265) 53,853 (13,758) (31,991) 4 (71,409) 93,616 (37,757) 55,859 (15,550) (47,541) 5 (75,421) 95,579 (38,255) 57,325 (18,097) (65,638) 6 (79,659) 97,546 (38,760) 58,786 (20,873) (86,511) 7 (84,136) 100,590 (39,272) 61,318 (22,818) (109,328) 8 (88,865) 103,836 (39,790) 64,046 (24,818) (134,147) 9 (78,049) 107,674 (40,315) 67,359 (10,690) (144,837) 10 (66,985) 111,496 (40,847) 70,649 3,664 (141,173) 11 (59,658) 118,042 (41,386) 76,656 16,998 (124,175) 12 (59,967) 121,188 (41,933) 79,255 19,288 (104,887) 13 (60,294) 124,042 (42,486) 81,556 21,263 (83,624) 14 (60,638) 126,810 (43,047) 83,763 23,125 (60,499) 31 0 54,295 (17,932) 36,363 36,363 2,290,452 32 0 54,293 (18,169) 36,124 36,124 2,326,576 33 0 54,165 (18,409) 35,756 35,756 2,362,332 34 0 54,013 (18,652) 35,361 35,361 2,397,693 35 0 609,492 (18,898) 590,594 590,594 2,988,287 (1,194,626) 4,182,913 2,988,287 15

Scenario: Bank lost a key lender to competition Bank desires to properly compensate all employees Bank only has an Annual Cash Incentive Plan Bank realizes the need to implement additional compensation plans in order to attract, retain and reward key people Bank is looking for a vehicle to pay for the additional benefits Census Data and other key factors: Bank has 5 key officers who are part of the executive team Bank has additional key officers in management Bank needs several revisions to the current ACIP Bank desires to implement a short-term DCIP Bank wants to include a SCP for retirement Bank desires to implement a plan for Directors Bank considered BOLI to assist in paying for benefits 16

Step One: Create Scorecards for CEO, and other key officers Use the scorecard for both the ACIP and DCIP criteria Scorecard Criteria for Executive Team: Threshold and maximum set for all criteria ROA (excluding MLO s) Weighted 45% Efficiency Ratio (excluding MLO s) Weighted 25% Overall Bank Loan Growth Weighted 35% 17

Scorecard Criteria for Executive Team: Takeaways cannot exceed 100% Overall Bank Charge-offs Weighted: minus 20% CAMELS 3 or worse Weighted: minus 100% Bank Net Income must be a minimum level Weighted: minus 100% Step Two: Determine participants in the DCIP Tier the officers into three groups Group 1, eligible for 10% of salary Group 2, eligible for 7.5% of salary Group 3, eligible for 5% of salary 5 year mandatory deferral 18

Step Three: Determine participants in the SCP Tier the benefits CEO: 50% of salary per year at retirement payable for 15 years EVP s: 40% of salary per year at retirement for 10 years SVP s: 30% per year at retirement for 10 years Step Four: Design a plan for Directors Options: Director Fee Deferral Plan Director Fee Continuation Plan Phantom Stock Plan Long-term Care Plan Bank chose a traditional Director Fee Deferral Plan and Long-term Care Plan 19

Step Four (cont): Director Fee Deferral Plan Voluntary plan Directors can defer all or a portion of annual fees Fees were deferred until age 72 (mandatory retirement age) Long-term Care Plan: Bank provided $3000 per month in benefit Director s could personally pay to increase benefit Step Five: Analyze the options for cost recovery Design a BOLI Plan to assist in offsetting the costs of the nonqualified benefit plans Include a Survivor Income Benefit Plan for officers participating in the BOLI Bank s budget allowed for some cost annually 20

Plan Accomplishments: Bank had a clearly defined plan that is now aligned with the strategic plan of the bank Bank succeeded in the retention of key officers Bank is able to use the plan as a recruiting tool Officers can elevate to a higher tier and receive higher benefits as they advance in their career with the bank Thank You! Maria Kell, BCC Consultant 1 800 781 2099 ext. 108 maria.kell@bcc usa.com 21