MADISON, Wis. – Credit union boards may have to get even more creative and aggressive with CEO compensation if they want to attract and retain talented leaders, say credit union compensation experts. Credit union CEO total compensation is up 9.67% this year according to the CUES 2003 Credit Union Executive Compensation survey, but there's still a considerable gap with bank executives (See sidebar page116.) CUNA Mutual Executive Benefit Specialist Dan Balogh said while credit unions are starting to wake up to better ways to retain CEOs, they are way behind banks and the for-profit world in terms of compensation sophistication. He offered up the real world example of a bank EVP who was interviewing with a $600 million CU for an executive position. "He started asking about the deferred compensation plan, the bonus plan, and what the credit union's answer was for the stock options he was going to lose. They (board members) all sat at the table with their mouths agape. They didn't know, and this is a $600 million credit union," said Balogh. Balogh believes credit unions aren't using defined incentives or bonuses enough. "So much is done by boards by the seat of their pants, sort of a whim about how they feel," said Balogh of a CEO's annual bonus. That's unfair, said Balogh, as the bonus should be tied to various performance measures. Charlie Carlson with Survey Research Associates, the firm that conducts the CUES annual salary survey (see charts on next page for this year's results), said Balogh is exactly right in that short-term compensation (bonuses, incentive programs) is where credit unions need to focus. "Banks have very identifiable, measurable objectives that are agreed upon to base short-term compensation. At credit unions, particularly as you move down to the medium and small size, those goals haven't been articulated as specifically and tied to a performance bonus," said Carlson. Carlson believes boards should be awarding not just one bonus, but two. He said a true bonus is more subjective and can be where boards get in trouble if that's all they have. The subjective bonuses are fine to dole out said Carlson, as long as there's also an incentive bonus program in place that is tied to measurable goals. Balogh said often times boards are hung up on salary, salary, salary, and don't look at other tools to lock in a talented CEO. "Boards are of the opinion that they're paying the CEO well, so why can't they save their own money. That's old world thinking, and doesn't play well for the long-term goals of retirement," said Balogh. Even worse some boards set compensation by what they made in their own careers. That's a problem, especially if there are a lot of longtime directors on the board. Another problem is communication. Credit union CEOs are hesitant to ask for more from their board because it seems so self-serving, said Balogh, and boards typically don't initialize a conversation about new ways to compensate the CEO. Carlson said one of the credit union industry's strengths is also one of its weaknesses. He said in a more corporate environment boards are made up of people who are leaders in companies of either similar sized or types of businesses. "They have been or are at the level you would like to achieve, so you can turn to them for policy advice. At the credit union, the membership elects. That's good and democratic, but the frame of reference may not be there," said Carlson. Of course recent history of corporate boards isn't great either as debacles on Wall Street have proven. There's been so much concern of board oversight at publicly traded companies, that they now have many new rules and procedures to follow. Why is compensation so important these days? David Hilton, president of Hilton and Associates, said a dearth of talent in the industry could develop as CEOs retire. Some estimates have 25% of credit union CEOs retiring over the next five years. "If you look at the marketplace, and it really doesn't make much difference in terms of size, there are going to be a tremendous number of retirements. I don't want to say there's a shortage of talent, but there are so many jobs available even now," said Hilton. Attracting a CEO from one CU to another isn't easy these days. Hilton said CEOs seem more family-oriented and unwilling to uproot their families to move to another state for a 20% increase in salary. To get around that, boards need to have a compensation plan that essentially sets the CEO up for life. "If people are going to be willing to move in their late 40s and early 50s, they want to know they will be taken care of in retirement. That is now a retention tool. What is the new credit union going to do that is that much better?" he said. One tool to answer that question is the 457, said Hilton. There are two types of 457 plans, the 457(b), which mirrors a 401(k) plan contribution limit (this year it's $12,000) and the more liberal 457(f) plan, where boards can really make a difference, says Hilton. Hilton's firm is probably best known for its executive recruitment, but it has a sister company D.Hilton Financial Services that specializes in compensation. He said that business is booming, with about 100 current clients. "The 457 offers greater compensation than the 401(k) and it's discriminatory. The board doesn't have to offer it to everybody," said Hilton. 457 is the section of the Internal Revenue code that allows credit unions to set money aside today to be paid out as a future income stream. There are no dollar limitations on contributions to a 457(f), except by which the IRS defines as reasonable based on compensation. "For someone making $200,000, we couldn't put $10 million in a 457(f). That's not reasonable," said Balogh. There is tremendous activity in the CU world with 457(f) plans, according to Balogh. The plans are great for the credit union he said because there is more risk of forfeiture on the CEO's part than other plans, giving the credit union a level of protection should the CEO quit. There are four ways a CEO could lose their 457(f) benefit. One is if they leave their position prior to a specific magic date that was defined by the board. The second road to forfeiture is if the CEO is terminated with cause. The third way is if they die or become disabled by the magic date. And the last is if the credit union were to go bankrupt and have assets attached by creditors. The 457(f) needs to be structured properly or the CEO could wind up with a huge tax problem. Balogh said there are plenty of horror stories of poorly set up deferred compensation plans that leave the executive with a giant tax bill. Benefits should be grossed up and paid out to the exec through the CU, said Balogh. The board has to look now at the tax implications down the road. For example, assuming a board wants to offer a CEO $500,000 at retirement. If the CEO is in the 33% tax bracket the credit union needs to set aside $746,000, not $500,000 "The credit union should accumulate this $746,000 and flow it through payroll like a one-time bonus. Taxes are withheld at the credit union and the CEO gets the $500,000," said Balogh. He also said boards that wait too long in deferred compensation find there are few options to make up for the lost years. He recalls one CU buying a $300,000 annuity for a soon to be retired CEO. It was a clear catch-up move; the problem was the CEO was paying a lot of taxes each month as the annuity paid out. The Million-Dollar CEO is Here Ray Bauschke, CEO of credit union consulting firm Bauschke and Associates, said incentive-filled employment contracts with termination clauses are becoming more common. The employment contract should have measurable goals that result in bonus-like payouts for the CEO when goals are met. The termination clause outlines what the CEO will receive if he or she leaves before the contract ends. Both parties have money on the line. If the CEO quits, he or she may forfeit a large bonus or a payout based on the timeline of the employment contract, while the board has money at stake because it would have to pay the CEO for what is often 12 months of salary if terminated for reasons that didn't reflect immoral or illegal behavior. Bigger salaries of course are still a solid way of attracting CEOs, especially when the salaries are eye-catching. Bauschke said many CEOs still look at salaries first because it's cash for the here and now. With more CEOs earning $500,000 salaries, and getting big bonuses, million-dollar-a-year compensation will start to crop up more regularly, said Bauschke, who already knows of CU CEOs who make a million dollars a year. "The $1 million CEO is here. When I started in the `60s the big credit unions were those with $1 million in assets. Things have changed." Bauschke noted that often times very large CUs do not participate in CU salary surveys, so their salaries may not be reflected in the data. Bauschke sees more CU CEOs coming from community banking. "Quite a few have already come from community banks. Aside from stock options, it's a perfect fit. They really know how to operate in the community," said Bauschke. How to split up the compensation pie is one of the biggest issues boards face, said Bauschke. He said not all CEOs are as focused on long-term money. "They have two kids in college and they want the money now. It's different for everyone. The board should come up with the correct amount and consider how the CEO wants it divided up." Carlson believes the compensation gap between bank CEOs and credit union CEOs will never completely go away, nor should it, because of philosophical differences. "I'm not sure they'll ever close it completely, that's contradictory to credit unions' culture, but it has to be closed to the extent that you want to be competitive," said Carlson. Salary compression is another problem boards will face in the future, said Carlson. If credit unions start bringing in high-performers from banks to fill executive spots, yet not necessarily the CEO spot, that new person's bank salary may already be close to the credit union CEO's salary. The board will have to make adjustments to get some spread between positions, said Carlson. Balogh wants boards to know that other financials may start tapping the credit union industry for executive talent. "Credit unions are now competing with banks and other for-profits for executive talent," he said. -

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