Trends in Executive Compensation & Perquisites October 8, 2013 Gayle Appelbaum Principal 952.886.8242 gayle.appelbaum@mclagan.com Copyright 2013 McLagan, an Aon Hewitt Company
Agenda Summarize the bank compensation marketplace Review market changes CEO compensation trends Director compensation trends Compensation trends for other positions Regulatory Update CFPB mortgage lender rules Pay Ratio Disclosure Incentive Plan Developments Other Items Management Say-on-Pay (MSOP) Realizable pay analysis 1 Trends in Bank Compensation
Information Sources McLagan Proxy Database Proxy statements filed in 2013 reporting 2012 compensation data Compensation data compiled by McLagan for all US public banks and thrifts 622 banks and thrifts McLagan s 2013 Regional and Community Bank Compensation Survey Over 200 public and private banks and thrifts nationwide under $28 billion in assets Over 120,000 incumbents in 50 states plus DC Covers over 600 Top Management, Origination and Infrastructure positions at all levels Published in August 2013 McLagan s Mandatory Deferral Flash Survey Published in March 2013 Covers the parameters and frequency of mandatory deferrals in regional and community banks 2 Trends in Bank Compensation
Terms & Methodology Base Salary Cash Compensation Salary + Annual Incentive or Bonus Direct Compensation Cash Compensation + Equity (grant date fair value basis) Total Compensation Direct Compensation + Retirement Benefits + All Other Compensation Retirement Benefits (SERP/pension accruals, above-market earnings on deferred comp) All Other Compensation (perquisites, defined contribution plan deposits) 3 Trends in Bank Compensation
Overview: Banking Industry Performance
TSR and CEO Compensation Movement Total Shareholder Return vs. CEO Compensation Banks $1B-$5B CEO compensation exceeded pre-recession levels in 2012 Shareholders have still lost significant value since the 2007 peak 5 Trends in Bank Compensation
Compensation Trends Analysis CEO & Directors McLagan Proxy Database
2012 CEO Compensation Median Values, Public Banks Median to Median Change Assets Salary Cash Comp Direct Comp Total Comp Asset Size n ($M) 2012 % Change '11 to '12 2012 % Change '11 to '12 2012 % Change '11 to '12 2012 % Change '11 to '12 <$500M 159 307 214,796 7.2% 227,500 4.6% 246,866 9.7% 285,742 8.8% $500M-$1B 145 692 283,846 5.8% 319,454 10.9% 333,226 8.1% 416,533 10.6% $1B-$4B 186 1,674 397,025 4.0% 522,550 18.9% 629,574 18.4% 775,316 19.3% $4B-$10B 59 5,917 589,616-1.7% 1,001,951 3.2% 1,382,183-1.2% 1,620,459 3.6% $10B-$25B 33 14,913 879,800 3.5% 1,752,832 6.7% 2,928,756 19.2% 3,448,267 19.5% >$25B 29 89,236 980,000 2.2% 2,958,077 21.8% 7,091,301 10.8% 8,942,806 24.4% Source: McLagan Proxy Database Median compensation increased significantly across all elements of almost every asset size Many smaller banks deregistered in 2012 through the JOBS Act, which exaggerates the increase in median compensation for the two smallest asset cuts Median compensation for the $4B-$10B asset range was relatively flat However, on a same peer (matched sample) basis, changes within this group were more in line with the overall market Asset Size n Assets ($M) Salary Cash Comp Direct Comp Total Comp 2012 % Change '11 to '12 2012 % Change '11 to '12 2012 % Change '11 to '12 2012 % Change '11 to '12 $4B-$10B 55 5,917 589,616 4.2% 1,001,951 8.7% 1,382,183 12.8% 1,620,459 12.7% 7 Trends in Bank Compensation
CEO Compensation Changes: Banks <$1B and $1B-$4B Median CEO Compensation: 2004 2012 <$1B in Assets $1B-$4B in Assets Source: McLagan Proxy Database Median compensation surpassed historical highs in 2012. Banks under $1B generally have less leverage in their compensation plans, and therefore the decline to 2009 was more moderate than in larger banks. Direct compensation has surpassed historical highs. In 2012, median cash and direct compensation both increased approximately 18%. 8 Trends in Bank Compensation
CEO Bonus Prevalence By Region Percentage of CEOs Receiving Bonus Payouts 2011 2012 2011 CEO Bonus Prevalence Southwest 79% Northeast 74% Middle Atlantic 61% Mountain Pacific 59% Midwest 56% Southeast 26% Prevalence of bonus payments increases across all regions. For the first time since 2009, the majority of banks are paying bonuses. Increases were particularly dramatic in the Mountain Pacific (59% to 77%) and the Southeast (26% to 60%). 9 Trends in Bank Compensation Percentage of CEOs Scale Receiving Bonus Payouts 20 30 40 50 60 70 80 Source: McLagan Proxy Database 2012 CEO Bonus Prevalence Southwest 90% Mountain Pacific 77% Northeast 76% Midwest 69% Middle Atlantic 60% Southeast 60%
CEO Bonuses Prevalence of CEOs Receiving Bonus Payouts Median CEO Bonus as % of Salary Source: McLagan Proxy Database The prevalence of CEO cash bonuses increased for banks of all sizes in 2012. The size of CEO bonuses as a percent of salary increased for all banks but those $4B-$10B. Increasing size and frequency of bonuses has had a significant impact on industry median compensation levels. 10 Trends in Bank Compensation
Actual Cash Incentive Payouts Relative to Target Actual CEO Bonus as % of Target (median) Target Source: McLagan Proxy Database Overall, 2012 bonus payouts were near target levels for CEOs who received a bonus. Payouts increased relative to target levels for all asset sizes except $4B-$10B. The prevalence of bonuses increased sharply for banks $4B-$10B, but the amount of the bonuses decreased, both as a percent of salary and as a percent of target. 11 Trends in Bank Compensation
Compensation Mix CEO Compensation Mix Across Asset Sizes Source: McLagan Proxy Database Larger banks pay less of total compensation in salary and more in variable compensation Approximately half of total compensation is provided in variable pay at the $4-5B asset size The proportion of cash bonus awards to total compensation does not change significantly for banks above $4B; it is equity that increases Change in retirement benefits remains elevated due in part to the low-interest rate environment 12 Trends in Bank Compensation
A Brief History of Equity Banks $10B - $30B (Vehicle) CEO Equity Over Time 2004 and Prior - Options are expensed at intrinsic value (generally zero) - 70% of banks use appreciation only 2005 2008 - Accounting rules change and options must be expensed using estimated economic value - Immediately, less than 25% of banks use appreciation only 2009 Present - Investors want to see performance-vested equity - Smaller banks have portion in stock options; albeit minority 13 Trends in Bank Compensation
A Brief History of Equity Banks $10B - $30B (Vesting) CEO Equity Over Time 16% Use Performance-Vesting 22% Use Performance-Vesting 65% Use Performance-Vesting 14 Trends in Bank Compensation
Equity Vesting CEO Compensation Equity Vesting Type Source: McLagan Proxy Database Banks $10B-$30B are still transitioning towards granting performance-vested equity. Almost 2/3 of banks between $10B-$30B grant either only performance-vested shares or a mix of performance-vested and time-vested equity. We have seen these statistics change rapidly as more and more banks continue to adopt performance-vested equity. 15 Trends in Bank Compensation
JOBS Act & Deregistration Analysis Number of Banks Filing Proxy Data The number of banks under $1B who filed proxy statements decreased sharply in 2012. Fewer organizations will be available for executive compensation peer groups. Banks under $1B may no longer be able to use proxy data as their only comparison point for executive compensation analysis. High quality survey data will increase in importance. 16 Trends in Bank Compensation
Compensation Trends Analysis Directors McLagan Proxy Database
Board Compensation National Trends Median to Median Change Total Director Compensation % Change (Median to Median) Source: McLagan Proxy Database Equity as % of Total Compensation Asset Size n 2010 2011 2012 2010 to 2011 2011 to 2012 2010 2011 2012 <$500M 80 17,250 18,419 21,179 6.8% 15.0% 27% 30% 34% $500M-$1B 113 25,273 26,646 29,399 5.4% 10.3% 28% 22% 29% $1B-$5B 162 37,662 40,819 43,946 8.4% 7.7% 28% 32% 33% $5B-$15B 52 70,554 75,350 83,395 6.8% 10.7% 33% 32% 38% >$15B 43 144,552 143,218 144,439-0.9% 0.9% 48% 48% 47% We are seeing larger increases from 2011 to 2012 compensation. With the exception of banks with assets greater than $15 billion, 2012 director compensation increases ranged from 8% to 15% among the various asset cuts reviewed. Overall, equity as a percentage of total compensation continues to increase. 18 Trends in Bank Compensation
Board Compensation Compensation Committees Number of Compensation Committee Meetings Additional Paid to Compensation Committee Chair Source: McLagan Proxy Database Compensation committees are meeting more often than in prior years, and fees for compensation committee chairs are also increasing. Compensation committees have more oversight, more responsibility, and more liability than in prior years due to Dodd-Frank and the Sound Incentive Compensation Policies guidance. Incentive plan risk Say on Pay and investor outreach Required to be independent as of 2014 19 Trends in Bank Compensation
Compensation Trends Analysis McLagan 2013 Regional and Community Bank Compensation Survey
2013 McLagan Regional & Community Bank Survey Overview Covers over 600 Top Management, Origination and Infrastructure positions at all position levels Includes total compensation data (cash + equity) and incentive plan opportunity data Bank s employees compared to the market (incumbent by incumbent basis) Compensation Spend & Staffing Analysis Summary report showing firm-wide salary spend, incentive pay as % of net income, and infrastructure staffing ratios. Breakouts by asset size, geographic region, revenue, # branches, and # employees 21 Trends in Bank Compensation
2013 McLagan Regional & Community Bank Survey Participants Large number of participants provides reliable data and the ability to slice data in numerous ways. SIZE METRICS Asset Size All Firms <$500M $500M - $1B $1B - $3B $3B - $8B >$8B Number of Firms 205 20 45 69 34 37 Median Number of Incumbents per Firm 307 67 176 335 742 1,560 Median Number of Branches per Firm 22 3 11 23 47 116 OWNERSHIP Number of Public Organizations 130 7 26 41 25 31 Number of Private Organizations 75 13 19 28 9 6 NUMBER OF ORGANIZATIONS BY REGION Mountain Pacific 50 8 9 15 9 9 Midwest 64 3 18 25 6 12 Southwest 15 2 2 6 2 3 Southeast 16 2 4 5 2 3 Middle Atlantic 31 4 8 6 8 5 Northeast 29 1 4 12 7 5 Location of Firms Ownership Middle Atlantic 15% Northeast 14% Mountain Pacific 24% Private 37% Southeast 8% Southwest 7% Midwest 31% Public 63% 22 Trends in Bank Compensation
2012-2013 Salary Increases McLagan Survey Salary Increases By Position Group (median) Salary Increases By Level (median) National Source: 2013 McLagan Regional & Community Bank Compensation Survey Increases for Top Management positions were greater than those for other areas of the bank. Increases for individuals in Infrastructure positions were greater than increases for individuals in Origination or Branch functions. Increases were relatively consistent across the country with the exceptions of the Southeast (below national) and the Southwest (above national) Increases were relatively consistent between employee levels except for the highest and lowest levels. 23 Trends in Bank Compensation
Commercial Lender Salaries Correlation with Asset Size Commercial Lenders By Position Level Regression Analysis of Salaries for 6,400 Commercial Lenders Levels - Commercial Lending (Top Management) - Group Manager - Team Leader, Senior I - Senior II - Senior III - Intermediate - Junior & Analyst Salaries have little correlation with asset size Source: 2013 McLagan Regional & Community Bank Compensation Survey Salaries for lenders with little or no management responsibility (Senior II and below) have no significant correlation with asset size. This has implications for recruiting and pay expectations. In general, the higher the position level, the more salary varies with bank asset size. 24 Trends in Bank Compensation
Commercial Lender Manager Scope of Responsibility Number of Direct and Indirect Reports of Managers Levels - Commercial Lending (Top Management) - Group Manager - Team Leader, Senior I Source: 2013 McLagan Regional & Community Bank Compensation Survey Compensation varies significantly with asset size only for those positions which have management responsibilities. Managers at larger banks are required to oversee more employees. The chart above illustrates that the number of people managed increases most dramatically for the head of the business unit. However, the number managed also increases for Group Managers and Team Leaders at larger banks. 25 Trends in Bank Compensation
Actual Cash Incentive Payouts Relative to Target Median Actual Bonus (2011 vs. 2012) Median Actual 2012 Bonus (Public vs. Private) Source: 2013 McLagan Regional & Community Bank Compensation Survey Bonus payouts for 2012 were higher relative to target than bonus payouts for 2011 Bonus payouts for 2012 were very near target Branch delivery jobs were the noticeable exception For all positions, bonus payouts were 2% below target at public banks, and 10% above target at private banks Private banks had higher payouts than public banks for all position groups 26 Trends in Bank Compensation
Incentive Award Prevalence and Relative Size Prevalence of Award Median Award as % of Salary Source: 2013 McLagan Regional & Community Bank Compensation Survey LTI awards are not as common as AIP awards regardless of employee level. LTI prevalence drops off more quickly than AIP prevalence. 25% of incumbents in the $90K-$115K range received an LTI award. Nearly 80% of incumbents in the same range received a short-term award. AIP awards are larger as a percent of salary than LTI awards. The size of LTI awards decreases more rapidly than the size of AIP awards below the top levels 27 Trends in Bank Compensation
Long-Term Award Type Details Type of LTI Awards by Level Source: 2013 McLagan Regional & Community Bank Compensation Survey The type of LTI granted remains relatively constant for all salary ranges. Approximately half of the incumbents receiving LTI receive restricted stock only. 28 Trends in Bank Compensation
Direct Compensation Mix By Salary Level Public Private Private banks may have limited ability to grant real equity to employees. They have several alternatives for replacing this missing compensation element: Emphasize salary Emphasize cash bonus Use phantom equity/long-term cash Source: 2013 McLagan Regional & Community Bank Compensation Survey The graphs above show that private banks generally emphasize salary rather than long-term incentives. The weighting on annual cash bonus does not vary between public and private banks. 29 Trends in Bank Compensation
Cash Incentives as % of Net Income Cash Incentives as % of Net Income Cash Incentives as % of Net Income by Asset Size Higher net income = higher cash incentives Source: 2013 McLagan Regional & Community Bank Compensation Survey (Random Sample) Aggregate firm-wide cash incentive payouts are correlated with company net income. This is true regardless of whether incentives are paid under formulaic or discretionary incentive plans. Larger banks tend to pay a smaller portion of net income in cash incentives. At median, banks <$1B in assets paid 12% of their net income in cash incentives, while banks >$8B in assets paid only 8%. 30 Trends in Bank Compensation
Regulatory Update
Dodd-Frank Act Where Are We? Dodd-Frank Effective Rules Published Notes 1. Say on Pay January 21, 2011 SEC January 25, 2011 Small reporting companies are subject to this in 2013 2. Say on Golden Parachutes January 21, 2011 SEC January 25, 2011 3. Compensation Committee Independence Earlier of 2 nd annual meeting after Sep, 2012 or Dec, 2014 SEC June 20, 2012; NASDAQ Sept. 25, 2012 4. Compensation Committee use of Advisors January 11, 2013 SEC June 20, 2012; NASDAQ Sept. 25, 2012 Adoption of listing standards of 6 factors to consider 5. Compensation Consultant Disclosure Proxies filed on or after January 11, 2013 SEC June 20, 2012; NASDAQ Sept. 25, 2012 This is effective now with the six factor test 6. Pay Ratio Disclosure Expected 2016 shareholder meetings SEC Sept. 18, 2013 Fed Register Oct. 1, 2013 Proposed rules; 60 day comment period from publication in Fed Register 7. Pay For Performance Exhibit Unknown SEC Unknown 8. Clawbacks Unknown SEC Unknown 9. Incentive Compensation Arrangements Unknown SEC Unknown All banks $1+ B reporting; mandatory deferral for >$50B 32 Trends in Bank Compensation
Regulator Focus on Regional & Community Banks Significant Users of Incentive Compensation (Banks $1 to $50 billion) Focus has been on large banks (approx. 79% of all assets) Regulators are on-site in the process of regular, ongoing regulatory reviews In 2013, 40% of the large complex banking organizations (LCBOs) received letters asking for information for their 2012 incentive pay decisions. The letter requests were similar to annual reporting requirements under proposed Section 956 rules Another example of how the focus has been and continues to be on this specific group There appears to be little motivation to approve Section 956 of Dodd-Frank Regulators have guidance through SICP that applies to all banks (effective June, 2010) Dodd-Frank Section 956 explicitly applies to banks of $1 billion and greater in assets Section 956 rules not promulgated (finalized and published) General lack of consistent approach from regulators At present, it appears that regional regulatory agencies are working on their own Clients report they either have received audit request lists, been put on notice they will be evaluated or have had random questions Audit lists have up to 20 questions asking for detailed information on incentive arrangements Recent client experiences suggest the Fed is backing off of full scale audits in this space due to resource limitations McLagan: There is no clear path as to when and at what depth formal regulatory reviews will occur for these banks We recommend a thorough process that evaluates covered incentive arrangements for each bank 33 Trends in Bank Compensation
Mortgage Lender Compensation CFPB proposed rules on mortgage lender compensation are effective January 1, 2014 Adapts and enhances TILA/Reg Z prohibitions on pay, which were effective April 1, 2011 Broadens the definition of mortgage loan originator to include certain non-mortgage roles What makes someone a loan officer? Taking an application Arranging a credit transaction Assisting a consumer in applying for credit Offering or negotiating credit terms Making an extension of credit Referring a consumer to a loan originator or creditor Advertising or communicating to the public that you can or will perform any loan origination services Why is this a problem? Some firms have branch Sales staff (non-mortgage) process and close HE loans Some firms have branch sales staff (non-mortgage) take applications to pass along to MLO s Some firms have Financial Advisors that take applications to pass along to MLO s OR book themselves Many of these roles have pay tied to profitability or revenue generated out of the branch. This would be prohibited under the CFPB Mortgage rule They would need to be registered under the SAFE act 34 Trends in Bank Compensation
Mortgage Lender Compensation (cont.) Loan originators will need to conform to the prohibitions on pay developed in TILA/RegZ, which are: Prohibits a loan originator s compensation from being based on the terms of a transaction (with limited exceptions) or a proxy for a transaction term. This impacts ability to receive compensation tied to profits of the organization. Exception if less than 10% of total compensation Exception for 10 or fewer transactions per year This compensation must not be based on the terms of that individual loan originator s transactions Prohibits loan originators in a transaction from being compensated by both a consumer and another person, such as a creditor. What do firms need to do? Determine what roles within the branch network are covered under this rule There are two paths: Adjust/redesign plans to remove any mortgage loan component from the revenue/profit based award (two plans paying separately), OR limit the award to 10% of total comp Change the profile of the role to exclude them from originating Mortgage and HE loans (HELOCs are allowed under the provisions). The firm would then need to establish a referral program so that these loans get processed through the Mortgage Loan Officers. 35 Trends in Bank Compensation
Pay Ratio Disclosure SEC proposed rule on September 18 th, 2013 162 pages of reading enjoyment! 50 pages are the economic analysis 60 day comment period beginning after Oct. 1 Federal Register publication; final rule published thereafter Rule will most likely be effective for proxy statement filed in 2016 for 2015 fiscal year compensation Applies to all public companies; not just banks Does not apply to emerging growth or small reporting companies Requires companies to disclose the ratio between CEO annual total compensation and median total annual compensation for the firm s entire employee population Proposed rule allows for flexibility, e.g., if the CEO s compensation was 45 times the median of all other employees: Ratio: As a ratio with median of annual total compensation of all employees equal to one, or 1 to 45 Narrative: As a narrative with the multiple of the CEO's annual total compensation to the median of annual total compensation of all employees The Chief Executive Officer's annual total compensation is 45 times that of the median of the annual total compensation of all employees. Reasonable estimation and sampling appear to be potential alternatives Covers all employees, as of end of fiscal year, including temporary and part-time associates See McLagan Client Alert published Sept. 25 th for more complete analysis of the proposed rule 36 Trends in Bank Compensation
Incentive Plan Developments
Primary Issues Forcing Changes to Incentive Plans Issues Economic challenges Regulatory environment Balancing Risk Management Say-on-Pay Challenges NIM, Profitability SICP, Fed Horizontal Reviews, Dodd-Frank Lack of clarity from regulatory bodies ISS, Glass Lewis, shareholder activism 38 Trends in Bank Compensation
Incentive Plan Design: Competing Interests 39 Trends in Bank Compensation
Incentive Plan Design: Regulators vs. Shareholder Advisors Regulators and shareholder advisory firms have competing interests which must be carefully considered in the evaluation of incentive plans. Topic Regulators Shareholder Advisors General Attitude Reduce pay at risk and recapture pay if problems emerge Pay-for-performance, risk is good, focus on total shareholder return Risk Risk Off Risk On Return Lower Higher Horizon Long-term: 3-5 years Short-term: 1-3 years Opportunity Levels Decreased leverage Traditional higher leverage Measures Quality & Profit Profit TSR Dislike Desire STI vs. LTI Measures Ok to be the same Need to be different Robust Goals No Yes Shareholder Interests Rule No Yes Balance Incentive Risk Yes deferrals or performance adjustments No Time Vesting No Within limits Statutory Clawbacks (for restatements) Yes Yes Performance Clawbacks Yes, rules forthcoming Emerging issue Discretion Downward from maximum opportunity Limited percentage of LTI opportunity 40 Trends in Bank Compensation
Mandatory Deferrals Mandatory deferrals are one way for banks to mitigate risk and better align compensation with long-term firm performance. Employee groups subject to mandatory deferrals Eligibility is most commonly determined by title or job grade, but criteria can vary by firm At some banks, eligibility is determined by reaching an incentive threshold CEOs and NEOs/Executive Team are most likely to be subject to mandatory deferrals SVPs are next most common group No participants in McLagan s Mandatory Deferral Flash Survey indicated that all employees are subject to mandatory deferrals 41 Trends in Bank Compensation
Other Items
Management Say-on-Pay (MSOP) 2013 Proxy Season Only one bank within the Russell 3000 failed their MSOP vote East West Bancorp This compares to the 2012 proxy season where 4 banks failed their MSOP votes Impact of shareholder advisors in 2013 ISS recommended against votes for 18 banks Many companies were flagged by ISS and Glass Lewis for inadequate disclosure regarding shareholder engagement efforts following a year of perceived "low" vote results for an MSOP (i.e., below 70% for ISS, 75% for Glass Lewis). Special one-time compensation awards (equity or cash) received an increased amount of negative commentary from ISS this year (regardless of whether performance hurdles were added to such awards, and/or outstanding short and long-term performance justified such an award). ISS also has started reviewing year-over-year incentive plan metric changes (i.e., if the goal has been adjusted without adequate justification). Glass Lewis reports continue to contain inaccurate data at a fairly high rate, and conclusions and vote recommendations appear to be more subjective than in prior years (same fact patterns often yield very different results depending on the analyst). 43 Trends in Bank Compensation
Management Say-on-Pay (cont.) Overall ISS and Glass Lewis are becoming more nuanced in their say on pay evaluations. Their standards continue to evolve and become more complex, making it difficult for issuers to comply with all standards The most effective strategy for mitigating negative scrutiny from proxy advisory firms is to engage with top investors outside of the proxy season. This often translates into issuers passing SOP with results above 60%, even if one or both of the leading proxy advisory firms issues a negative vote recommendation. Important to speak to the proxy side of the house, not the investment side Find out if they follow advisory firm guidance or make independent evaluations Find out what is important to them as they make their decisions re: Say-on-Pay Listen first, tell second 44 Trends in Bank Compensation
Realizable Pay Beginning to see significant discussion about realizable pay Background Present compensation disclosure in the Summary Compensation Table reflects equity at grant date as well as retirement benefits on an accrual basis. The summary compensation table does not accurately reflect what an executive actually earns Equity has moved to performance-vested vs. time-vested Long-term interest rates have been at historically low The Conference Board has a position advocating the use of realizable pay analysis Goal of realizable pay To show how much compensation was actually received or earned in a given year Issues with implementation There is no common definition of what realizable pay is Example: how do you value mid-cycle stock options and performance-vested full value shares? There are five different definitions of realizable pay among the top executive advisory firms McLagan s Perspective This is an expensive analysis to develop This is likely to be a standard process in next two to five years 45 Trends in Bank Compensation
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