COMPENSATION DISCUSSION AND ANALYSIS
In this section, we discuss our executive compensation philosophy and programs. The “Committee” refers to the Compensation Committee in this Compensation Discussion and Analysis. Following this discussion, we disclose compensation of our named executive officers (“NEOs”) in the Summary Compensation Table and other compensation tables. The following individuals are our NEOs for 2018:
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NEO
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Title
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Brian L. Vance
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Chief Executive Officer of Heritage
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Jeffrey J. Deuel
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President of Heritage and President and Chief Executive Officer of Heritage Bank
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Donald J. Hinson
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Executive Vice President and Chief Financial Officer of Heritage and Heritage Bank
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Bryan D. McDonald
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Executive Vice President of Heritage and Executive Vice President and Chief Operating Officer of Heritage Bank
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David A. Spurling
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Executive Vice President and Chief Credit Officer of Heritage and Heritage Bank
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On July 9, 2018, Mr. Vance announced his plans to retire as CEO of Heritage effective July 1, 2019, at which time he will become Executive Board Chairman. As part of the announced leadership transition, effective July 2018, Mr. Deuel was promoted to President of Heritage and President and CEO of Heritage Bank and Mr. McDonald was promoted to Executive Vice President of Heritage and Executive Vice President and Chief Operating Officer of Heritage Bank.
Executive Summary
Our Business
Heritage is the parent company of a wholly-owned subsidiary bank, Heritage Bank, headquartered in Olympia, Washington, with a branch network of 64 locations from Portland, Oregon to Bellingham, Washington. Heritage Bank is committed to being the leading community bank in the Pacific Northwest by continuously improving customer satisfaction, employee empowerment, community investment and shareholder value.
2018 Business Highlights
Heritage embarked on several key initiatives during 2018, which included a continued expansion in our Seattle and Portland metropolitan markets, the optimization of technology to improve the customer experience, the development of a mergers and acquisitions guide and project plan, and the continual improvement of the employee experience. These key initiatives have required a disciplined management team to integrate multiple initiatives while continually focusing on strategic and organic growth, credit quality, and capital and balance sheet management. To augment the ongoing growth initiatives, Heritage acquired Puget Sound Bancorp, Inc. on January 16, 2018 and Premier Commercial Bancorp on July 2, 2018. Throughout 2018, Heritage stayed focused on the business fundamentals and achieved solid financial and operating results, as demonstrated below:
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Performance Metric
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At or For the Year Ended December 31, 2018
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At or For the Year Ended December 31, 2017
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% Change
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Total Assets
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$5.3 billion
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$4.11 billion
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29.0%
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Net Income
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$53.1 million
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$41.8 million
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27.0%
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Diluted earnings per share
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$1.49
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$1.39
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7.2%
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Total Loans, Net
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$3.62 billion
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$2.82 billion
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28.4%
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Total Deposits
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$4.43 billion
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$3.39 billion
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30.7%
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Overhead Ratio
(1)
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3.00%
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2.78%
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7.9%
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Dividends Paid (special and regular)
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$0.72
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$0.61
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18.0%
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(1) Non-interest expense divided by average assets
2018 Executive Compensation Highlights
During 2018, the Committee acted in accordance with Heritage’s compensation philosophy and provided our NEOs compensation aligned with Heritage’s financial performance and each NEO's individual performance. Compensation was commensurate with market comparisons and the Committee continued to consider shareholder value and prudent risk management.
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Base Salary:
NEOs received base salary increases from 12.5% to 36.7% due to promotions and alignment with peers.
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Annual Incentive Compensation:
Annual cash incentives ranged from $112,504 to $315,384, or 19.3% to 22.5% of total compensation, based on a cash incentive plan with predetermined performance metrics.
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•
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Long-term Incentive Compensation:
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◦
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Equity incentive awards ranged from $82,110 to $266,322, or 14.0% to 18.7% of total compensation, based on 2017 performance results.
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◦
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50% of the target equity incentive awards are performance-based, earned according to cumulative results over a three-year performance period and 50% are subject to three-year ratable service-based vesting.
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◦
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Deferred compensation contributions ranged from $81,101 to $234,531, or 11.6% to 16.5% of total compensation. Deferred compensation contributions are generally performance-based with a 16.7% of base salary fixed portion for the CEO.
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2018 Say-on-Pay Results and Shareholder Outreach
At the 2018 shareholders’ meeting, over 95% of the shares present and entitled to vote supported the executive compensation program. Management, the Board, and the Committee pay careful attention to communications received from shareholders regarding executive compensation, including the results of these non-binding advisory votes. The Committee believes that these votes reflect our shareholders’ affirmation of our compensation philosophy and the manner in which we compensate our executives. We value our shareholders’ feedback and, as a result, entered into our fifth shareholder outreach program during 2018. We requested feedback from fourteen of our institutional shareholders to further understand what, if any, concerns they may have with our compensation programs, governance and internal audit practices and board structure. The feedback we obtained from our shareholders during this outreach was very positive and supported these practices.
Best-Practice Features
Embedded in our overall compensation program are additional features that align the interests of our shareholders with those of our executives.
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WHAT WE DO
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WHAT WE DO NOT DO
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Strong emphasis on variable performance-based pay
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No excessive perquisites; perquisites are very limited and each has a specific business rationale
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Adhere to stock ownership guidelines
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No stock option repricing, reloads, or exchanges without shareholder approval
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Enforce clawback provisions
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No tax gross-ups
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Annually assess incentive compensation risks
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No hedging of Heritage common stock
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Engage independent compensation consultants
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No single trigger for accelerated vesting for service-based awards
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Actively reach out to our institutional shareholders
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Fixed compensation is not heavily weighted
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The annual cash incentive plan is not paid if the Tier I Leverage ratio drops below 8%
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2018 Key Performance Metrics
The graphs below capture the key performance metrics used to determine 2018 incentives for our NEOs. The 2017 and 2016 performance metrics are provided to demonstrate trends and were not used in measuring the 2018 performance for the NEOs.
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*
Total shareholder return is for a trailing 36-month period. Metric utilized relative to peers for long term incentives.
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**
Non-interest expense divided by average assets.
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Philosophy and Objectives of Our Executive Compensation Program
Heritage’s compensation philosophy provides clear guidelines for establishing and managing all elements of compensation. The philosophy is to target total executive compensation at market competitive levels in order to manage base salary levels, allow for meaningful performance-based compensation and recruit and retain key talent. Our compensation philosophy takes into account factors such as internal consistency of executive pay, and the experience, tenure and scope of responsibility for each of our NEOs. Officer compensation is weighted toward Heritage’s achievement of stated annual and long-term performance objectives.
Our compensation programs are designed to link a meaningful portion of compensation with performance, taking into account competitive compensation levels at peer group institutions and in the markets where we compete for talent. The policies and underlying philosophy governing our compensation programs include the following:
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Employer of Choice
—We view compensation as a key factor to be an employer of choice in our markets. We believe that competitive compensation and benefits allow Heritage to attract and retain well-qualified, key employees who are critical to our long-term success.
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Pay Aligned with Performance—
We strive to provide a competitive salary combined with incentive opportunities that reward outstanding individual and Company performance that contributes to creating shareholder value.
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Prudent Management of Risk—
We evaluate, design and manage compensation programs to ensure that we are properly and prudently assessing and managing any risks created by these programs. The Committee has the authority and responsibility to mitigate such risks, where necessary, through procedural oversight or program modification.
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Flexibility—
We recognize that the market for key talent requires flexibility in compensation design in order to attract qualified individuals. Salary ranges and individual compensation decisions take into account local competitive pressures and changing market conditions, as well as regulatory restrictions. Furthermore, the targeted position relative to market may vary depending on the type and level of position, recognizing the different recruiting conditions and relative importance of various qualifications.
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This compensation philosophy is reviewed periodically by the Committee and is modified, as appropriate, to reflect market trends and industry best practices.
Role of the Compensation Committee
The Compensation Committee, composed entirely of independent directors, establishes and monitors compensation programs for employees of Heritage and its subsidiaries. The Committee’s responsibilities are to:
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review the goals, policies and objectives of the compensation plans of Heritage and Heritage Bank;
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review and administer our compensation plans in light of the goals and objectives of these plans, and adopt and recommend new compensation plans or amendments to existing plans, as necessary or advisable;
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review and approve actions affecting salaries, annual cash incentives, benefits, equity compensation grants and other compensation arrangements for the CEO and other NEOs;
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review and approve the corporate goals and objectives for the NEOs annually;
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review and recommend to the full Board for approval the director fees, benefits and equity compensation grants;
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review the results of any shareholder advisory vote regarding executive compensation and consider whether to implement any changes as a result of such advisory vote;
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review and evaluate risks posed to Heritage by the design and administration of various compensation programs and ensure appropriate risk management and controls to avoid or mitigate any excessive or unreasonable risk to Heritage;
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approve and recommend to the Board for adoption any programs or policies regarding the recovery of previously paid or earned compensation later determined to have been based on inaccurate financial information;
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review and discuss the Compensation Discussion and Analysis with management; and
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review our policies regarding tax deductibility of compensation paid to executive officers for purposes of Section 162(m) of the Internal Revenue Code.
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In order to fulfill these responsibilities, the Committee’s charter provides it the authority and adequate funding to retain and terminate any third-party advisors for the purpose of evaluating the compensation programs for, and performance of, Heritage’s directors, CEO and senior executive officers.
Role of Management in Compensation Committee Deliberations
The Committee frequently requests that Mr. Vance and other members of senior management be present at Committee meetings to discuss executive compensation. Executive officers in attendance may provide their insights and suggestions, but only Committee members may vote on decisions regarding executive compensation. The Committee may discuss Mr. Vance’s compensation with him, but final deliberations and all votes regarding all compensation are made in executive session with independent directors and without management present. The Committee also reviews input from the independent compensation consultant and/or legal counsel when making decisions regarding the compensation of Mr. Vance and the other NEOs.
Compensation Consultants and Advisors
The Compensation Committee utilizes the services of Pearl Meyer & Partners (“Pearl Meyer”), an independent compensation consulting firm. Pearl Meyer provides assistance and advice related to a variety of Committee responsibilities on an as-needed basis, such as review of incentive plans, review of compensation philosophy and strategy, evaluation of compensation-related proposals from management, and ongoing Committee education on compensation topics. Pearl Meyer does not perform any services for the Company other than those directed by the Committee. After the Committee’s review of applicable rules for independence, the Committee determined that there are no known conflicts of interest between Pearl Meyer and its affiliates and the Company and its affiliates. Pearl Meyer reports directly to the Committee.
The Committee has the authority to retain, at Heritage’s expense, legal counsel and other advisors on an as-needed basis, and has and will evaluate the independence of such advisors as the Committee deems appropriate and as may be required by the Nasdaq listing standards.
Use of Competitive Data
During 2018, a peer group benchmarking study was performed by Pearl Meyer. The peer group was identified based, generally, on the following criteria:
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publicly-traded financial institutions;
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geographic priority given to western United States with a small group outside of the western region which were determined to be appropriate based on size and business model;
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asset size and operating revenue range of 0.5 to 2.5 times Heritage as of December 31, 2017;
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market capitalization range of 0.33 to 3.0 times Heritage at December 31, 2017; and
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comparable business model.
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The resulting benchmarking peer group consisted of the following 19 companies:
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Banner Corporation
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Glacier Bancorp, Inc.
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Seacoast Banking Corporation of FL
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Bank of Marin Bancorp
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Guaranty Bancorp
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Southside Bancshares, Inc.
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Bryn Mawr Bank Corporation
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Heritage Commerce Corp
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State Bank Financial Corp.
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Byline Bancorp, Inc.
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HomeStreet, Inc.
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TriCo Bancshares
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CenterState Bank Corporation
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Lakeland Bancorp, Inc.
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Westamerica Bancorp
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CoBiz Financial Inc.
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Mercantile Bank Corporation
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CVB Financial Corp.
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Pacific Premier Bancorp
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In addition to analyzing the pay practices and performance of our benchmarking peer group, the Pearl Meyer executive compensation study was considered by the Committee in making pay decisions for 2018.
The following summary data for the benchmarking peer group was obtained from S&P Global's database as of December 31, 2018.
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Percentile
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Market Capitalization
($ in millions)
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Total Assets
($ in thousands)
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25
th
Percentile
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$597.39
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$4,870,052
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50
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Percentile
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$1,049.28
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$6,237,968
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75
th
Percentile
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$1,666.28
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$11,497,829
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Heritage Financial Corporation
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$1,095.90
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$5,317,852
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Heritage Financial Corporation Percent Rank
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53%
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30%
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When the Committee selected the above benchmarking peer group, Heritage was at the 46th percentile of the peer group in total assets as of December 31, 2017. During 2018, CoBiz Financial, Inc., Guaranty Bancorp and State Bank Financial Corp. were acquired. The Committee typically reviews the benchmarking peer group every two years.
Performance-based Equity Peer Group
We have also developed a performance peer group solely for determining payouts under our performance-based equity awards by measuring our performance relative to that of the performance peer group. The composition of the performance peer group is established by the Compensation Committee at the beginning of each performance cycle and generally consists of all U.S. commercial banks (or their holding companies) traded on a major exchange with total assets at the beginning of the performance period between one-half and twice the total assets of Heritage. See "2018 Equity Award Determinations" below for a description of performance-based equity granted to the NEOs in 2018. No performance-based equity performance cycles were completed during 2018.
Components of Compensation
The following table lists the major components of the compensation program.
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Component
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Key Characteristics
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Purpose
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Base Salary
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Fixed compensation component—reviewed annually and adjusted, if and when appropriate.
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Intended to compensate an executive officer appropriately for the responsibility level of the position held as well as be competitive within the banking industry.
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Cash Incentives
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Annual incentives, variable compensation component.
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Intended to motivate and reward executives for achieving annual goals. The annual incentives are performance-based and reflect the actual performance results compared to pre-established goals.
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Equity-based Compensation
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Long-term incentives, variable compensation component, typically granted annually. Equity is awarded with 50% performance vesting and 50% time vesting.
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Intended to motivate executives to achieve our business objectives by tying incentives to long-term performance. The stock ownership aligns executive and shareholder interests and serves as a retention tool.
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Deferred Compensation
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Long-term incentives, variable compensation component—performance-based award opportunity, typically granted annually.
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Intended to provide a retirement planning mechanism while motivating executives to achieve our business objectives by tying incentives to long-term performance.
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Post-employment Compensation
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Fixed compensation component.
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Intended to provide temporary income following an executive’s involuntary termination of employment and to retain senior executives in a competitive marketplace.
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Target Pay Mix
Target pay mix represents the relative value of each of the primary compensation components as a percentage of total compensation. We seek to compensate our executives through an appropriate balance of fixed and performance-based pay, as well as short and long-term pay. The graphs below represent the target pay mix for 2018. Our CEO and other NEOs have significant variable pay at-risk, with 50% of their target 2018 equity award and a meaningful portion of deferred compensation opportunity subject to pre-established performance goals (50% of the target deferred compensation contribution for our CEO is performance-based; 100% for the other NEOs). In total, performance-based pay represents 50% of target total compensation for the CEO and 47% of target total compensation for the other NEOs.
Base Salary
Salary levels are designed to be competitive within the banking industry and are based on the experience, tenure, performance and responsibility of each executive. We utilize various compensation surveys and peer group comparisons to ensure that executive compensation is reasonable in comparison to competitors of a similar size or within our market areas. The Committee generally meets in June of each year in order to approve the base salaries of our NEOs effective July 1 of that year. This timing coincides with the review of the NEO's performance and the prior year performance of Heritage and its subsidiaries, as well as the availability of current proxy information for members of our peer group. If warranted, base salaries may be adjusted at other times during the year to accommodate for promotions or added responsibilities.
Salary Adjustments Made in 2018
Salary adjustments were made during 2018 to provide for alignment with peers and for promotions related to succession planning and new responsibilities. The base salaries for 2018 and 2017 were as follows:
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Name
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2018 Base Salary ($)
(effective July 1, 2018)
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2018 Base Salary ($)
(effective January 1, 2018)
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2017 Base Salary ($)
(effective July 1, 2017)
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Year over Year % Increase
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Brian L. Vance
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640,000
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532,600
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532,600
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20.2%
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Jeffrey J. Deuel
(1)
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468,000
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390,000
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342,400
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36.7%
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Donald J. Hinson
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329,800
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274,800
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274,800
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20.0%
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Bryan D. McDonald
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356,500
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310,000
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283,900
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25.6%
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David A. Spurling
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307,900
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273,700
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273,700
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12.5%
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(1)
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In connection with Heritage's succession planning, Mr. Deuel was promoted to President of Heritage and President and CEO of Heritage Bank
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Annual Cash Incentives
We use annual cash incentives to focus attention on annual strategic priorities and encourage achievement of corporate objectives. These incentives are provided under our Management Incentive Plan. The objectives of the plan are to reward and retain high performers, to drive Heritage’s long-term financial success, to encourage teamwork and to create an environment where executives are rewarded if Heritage achieves or exceeds pre-determined annual performance criteria. The Management Incentive Plan’s design incorporates annual incentive awards that are linked to the achievement of pre-defined performance goals with targets and maximum percentages determined by roles and responsibilities. The incentive ranges (as a percentage of salary) are designed to provide market competitive payouts for the achievement of threshold, target and maximum levels of performance. The annual awards are determined by previously approved goals, calculated based on actual financial and individual performance results and then recommended by the CEO to the Committee. The Committee then reviews and approves or disapproves the annual cash incentive recommendations.
The Committee approves the funding level for the Management Incentive Plan based on meeting or exceeding corporate performance goals. Each performance goal has an established threshold (minimum), target and maximum expectation level. No payment will be made for a goal if performance falls below the threshold level. Performance ratings for each specific corporate and individual goal between threshold and target or between target and maximum will result in a proration of the annual cash incentive payout. Each NEO has a scorecard with performance results. The 2018 Management Incentive Plan provided that no bonus payments will be paid from the plan should the corporate Tier 1 Leverage Ratio drop below 8% at December 31, 2018. The Committee reserves the right, in its sole discretion, to adjust incentive payouts when extraordinary circumstances occur during the performance period.
2018 Annual Cash Incentive Award Determinations
The opportunities for 2018 cash incentive awards and resulting payouts for our NEOs are as follows:
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Name
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Target Opportunity
as % of Base Salary
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Maximum Opportunity
as % of Base Salary
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Actual Annual Cash Incentive Received as a % of 2018 Base Salary Earned
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Earned Annual
Cash
Incentive ($)
(1)
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Brian L. Vance
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50%
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75%
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53.8%
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$315,384
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Jeffrey J. Deuel
(2)
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40% / 45%
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60% / 67.5%
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46.0%
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$197,200
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Donald J. Hinson
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35%
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52.5%
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37.7%
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$113,829
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Bryan D. McDonald
(2)
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35% / 40%
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52.5% / 60%
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40.5%
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$135,071
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David A. Spurling
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35%
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52.5%
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38.7%
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$112,504
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(1)
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Based on the Adjusted 2018 Performance as presented in the next table to account for one-time non-recurring items.
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(2)
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Messrs. Deuel's and McDonald's target and maximum opportunities were increased as presented in the above table effective July 1, 2018 to align with their promotions.
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Annual Cash Incentive Performance Goals
For 2018, the Committee approved the following corporate performance goals for our NEOs:
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Corporate Goal
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Weighting
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Threshold
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Target
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Maximum
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Actual 2018
Performance
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Adjusted 2018 Performance
(4)
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Earnings per Share
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40%
(1)
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$1.33
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$1.48
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$1.63
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$1.49
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$1.61
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Net Charge Offs/Average Loans
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20%
(2)
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0.19%
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0.11%
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0.03%
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0.06%
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0.06%
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Overheard Ratio
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40%
(3)
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2.94%
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2.84%
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2.74%
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3.00%
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2.88%
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(1)
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35% for Mr. Spurling.
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(2)
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30% for Mr. Spurling.
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(3)
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35% for Mr. Spurling.
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(4)
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The adjusted performance accounts for one-time non-recurring items related to merger-related expenses for the acquisition of Premier Commercial Bancorp, the impact of the consultant agreement buyout, and the net gain on sale of buildings. The consultant agreement buyout was related to the early termination of a third-party contract related to the deposit product realignment. Due to the growth within the Heritage and various systems conversions, management determined it was advantageous to buyout the third-party contract.
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Equity-Based Compensation
Equity-based compensation is intended to more closely align the financial interests of our executives with our shareholders in the creation of long-term shareholder value, and to assist in the retention of key executives. Beginning in 2017, the equity-based compensation program design was modified to incorporate a target percentage of base salary dependent on roles and responsibilities, with a portion granted as time-based vesting awards and a portion granted as performance-based vesting awards linked to the achievement of the pre-defined performance goals relative to the pre-defined peer group. The Committee reviews and approves or disapproves the equity-based compensation recommendations from management and the equity-based compensation awards are ultimately discretionary.
The Heritage Financial Corporation 2014 Omnibus Equity Plan allows for the granting of stock options, stock appreciation rights, restricted stock, restricted performance stock, unrestricted stock or performance unit awards to directors, officers and other employees of Heritage and its subsidiaries.
Restricted stock grants awarded prior to 2017, vest ratably based on continued service over four years from the date of grant. Heritage applies target award opportunities expressed as a percentage of salary, as described in the table below. Each NEO target opportunity is based upon factors such as their role and scope of responsibilities. If an NEO did not meet the performance goals under the Management Incentive Plan for the prior year, the officer may receive a reduced award or no award. Additionally, the NEO is required to maintain a satisfactory performance rating to receive an equity award. The Committee may make discretionary grants of restricted stock units, based on factors relating primarily to the responsibilities of individual executives, their expected future contributions to Heritage and the recruitment and development of new officers.
2018 Equity Award Determinations
In February 2018, our NEOs were granted restricted stock units based on their respective target percentages of their respective January 1, 2018 base salaries as outlined in the table below. For our NEOs, 50% of the target award is
subject to three-year ratable service-based vesting and 50% of the target award will be earned based on cumulative performance over the three-year period January 1, 2018 through December 31, 2020. The performance metrics selected by the Committee for the performance-based awards were return on average assets and three-year total shareholder return, in each case, relative to an established bank peer group. The Committee chose this mix to increase the pay-for-performance feature while preserving the retention benefit of the awards.
The following table contains the target opportunity, expressed as a percentage of base salary, for each of our NEOs, as well as their actual 2018 awards.
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Name
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Target Opportunity
as % of January 1, 2018 Base Salary
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Equity Awards
Granted ($ Value)
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50% in Target Performance Stock Units ($)
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50% in Restricted Stock Units ($)
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Brian L. Vance
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50%
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$266,322
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$133,161
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$133,161
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Jeffrey J. Deuel
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35%
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$136,493
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$68,247
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$68,247
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Donald J. Hinson
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30%
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$82,467
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$41,234
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$41,234
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Bryan D. McDonald
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30%
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$92,999
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$46,499
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$46,499
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David A. Spurling
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30%
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$82,110
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$41,055
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$41,055
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The performance metrics for the performance awards granted in 2018 are as follows:
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Corporate Goal
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Weighting
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Threshold
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Target
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Maximum
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Actual 2018
Performance
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Return on Average Assets
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50%
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25th Percentile
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50th Percentile
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75th Percentile
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26th Percentile
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3-Year Total Shareholder Return
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50%
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25th Percentile
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50th Percentile
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75th Percentile
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83rd Percentile
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Stock Ownership Guidelines
Heritage maintains stock ownership guidelines for our NEOs. These guidelines were established to promote a long-term perspective in managing Heritage and to align the interests of our NEOs with our shareholders. The stock ownership goals are three times base salary for the CEO and one and one half times base salary for the other NEOs. The guidelines require NEOs to retain not less than 50% of shares received (on a net after tax basis) until the NEO satisfies the ownership requirements. If an NEO fails to satisfy the ownership requirement, 25% of the NEO's annual cash incentive bonus will instead be paid in Heritage shares. The guidelines provide the NEOs five years to reach the required ownership level. As of December 31, 2018, all NEOs were in compliance with the guidelines. Information about ownership guidelines for our non-employee directors can be found in “Director Compensation” of this proxy statement.
Regulatory Considerations
As a publicly-traded financial institution, Heritage must contend with multiple layers of regulations when considering and implementing compensation decisions. These regulations do not set specific parameters within which compensation decisions must be made, but do require the Company and the Committee to be mindful of the risks associated with compensation programs designed to incentivize superior performance. While the regulatory focus has been heightened over the last several years, the incorporation of general risk assessment concepts into compensation decisions is not a recent development.
Under its
Interagency Guidelines Establishing Standards for Safety and Soundness (Safety and Soundness standard)
, the Federal Deposit Insurance Corporation ("FDIC") has held that excessive compensation is prohibited as an unsafe and unsound practice. In describing a framework to determine whether compensation is excessive, the FDIC has indicated that financial institutions should consider whether aggregate cash amounts paid, or noncash benefits provided, to employees are unreasonable or disproportionate to the services performed by an employee. The FDIC encourages financial institutions to review an employee’s compensation history and to consider internal pay equity, and, as appropriate, to consider benchmarking compensation to peer groups. Finally, the FDIC provides that such an assessment must be made in light of the institution’s overall financial condition.
In addition, the various financial institution regulatory agencies have jointly issued,
Guidance on Sound Incentive Compensation Policies (Guidance)
that serves as a complement to the
Safety and Soundness
standards. As its title would imply, the
Guidance
sets forth a framework for assessing the soundness of incentive compensation plans, programs, and arrangements maintained by financial institutions. The
Guidance
is narrower in scope than the
Safety and Soundness
standards because it applies only to senior executive officers and those other individuals who, either alone or as a group, could pose a material risk to the institution. With respect to those identified individuals, the
Guidance
is intended to focus the institution’s attention on balanced risk-taking incentives, compatibility with effective controls, and risk management, with a focus on general principles of strong corporate governance.
Also, as a publicly-traded corporation, the Company is subject to the SEC’s rules regarding risk assessment. Those rules require a publicly traded company to determine whether any of its existing incentive compensation plans, programs, or arrangements create risks that are reasonably likely to have a material adverse effect on the Company. The Committee completed its annual risk assessment of all of the Company’s compensation programs and components in September 2018. We do not believe that our incentive compensation plans, programs, or arrangements create risks that are reasonably likely to have a material adverse effect on the Company.
The Committee believes that a sensible approach to balancing risk-taking and rewarding reasonable, but not necessarily easily attainable, goals has always been a component of its overall assessment of the compensation plans, programs and arrangements it has established for the Company’s NEOs. In this regard, the Committee has revisited the components of the frameworks set forth in the
Safety and Soundness
standards and the
Guidance
as an effective tool for conducting its own assessment of the balance between risk and reward built into the Company’s compensation programs for its NEOs.
In making decisions about executive compensation, we also consider the impact of other regulatory provisions, including: the provisions of Section 162(m) of the Code that may limit the tax deductibility of certain compensation; Section 409A of the Code regarding nonqualified deferred compensation; Section 280G of the Code regarding excise taxes and deduction limitations on golden parachute payments made in connection with a change in control; and the impact of FASB ASC Topic 718, which requires us to recognize the compensation cost of grants of equity awards based upon their grant date fair value.
Clawback Policy
Heritage maintains a clawback policy which provides the Board with the authority to recover certain bonus or other incentive compensation (whether paid in cash or stock) paid to any NEO in appropriate circumstances where there has been a restatement of Heritage’s financial statements filed with the SEC. While the Committee believes its risk assessment procedures are effective, it is prepared to implement any additional steps that may be deemed necessary to fully comply with the rules required to be issued under the Dodd-Frank Act.
Retirement Benefits
401(k) Plan:
We maintain the Heritage Financial Corporation 401(k) Plan Profit Sharing Plan and Trust as a retirement plan. The Plan is a defined contribution plan and is designed to provide employees (including NEOs) with savings opportunities and financial security during retirement. There are two possible Company contributions to the Plan:
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A matching contribution equal to 50% of an employee’s salary deferral contributions up to a maximum of 6% of an employee’s eligible compensation; and
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A profit-sharing contribution that includes a discretionary contribution based on a percentage of an employee’s eligible compensation based on Heritage’s financial performance and management’s recommendation, as may be approved by the Board. For 2018, the Company did not make a discretionary contribution to the Plan.
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Deferred Compensation Plan
: Under the Deferred Compensation Plan, participants are permitted to elect to defer compensation and Heritage has the discretion to make additional contributions to the plan on behalf of any participant based on a number of factors. The notional account balances earn interest on an annual basis. The applicable interest rate as initially selected by the Committee is the Moody’s Seasoned Aaa Corporate Bond Yield as of January 1 of each year. Generally, a participant’s account is payable upon the earliest of the participant’s separation from service with Heritage, the participant’s death or disability, or a specified date that is elected by the participant in accordance with applicable rules of the Internal Revenue Code. Heritage’s obligation to make payments under the Deferred Compensation Plan is a general obligation of the Company and is to be paid from Heritage’s general assets. As such, participants are general unsecured creditors of Heritage with respect to their participation under the Plan. The Committee believes that the Deferred Compensation Plan provides Heritage with another tool to attract and retain the best qualified individuals to serve in key roles within the organization.
Each of the NEOs entered into participation agreements pursuant to which Heritage will make performance-based contributions to accounts maintained on their behalf under the Deferred Compensation Plan. A portion of Mr. Vance's annual contribution is fixed and a portion is performance-based. The terms of the particular participation agreements for the named executive officers are described in more detail following the Nonqualified Deferred Compensation table below.
The Committee approved the following performance goals for the 2017 performance period:
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Corporate Goal
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Weighting
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Threshold
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Target
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Maximum
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Actual 2017
Performance
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Adjusted 2017 Performance
(1)
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Earnings per Share
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50%
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$1.24
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$1.37
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$1.50
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$1.39
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$1.42
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Net Charge Offs/Average Loans
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50%
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0.25%
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0.15%
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0.05%
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0.12%
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0.06%
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(1)
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The adjusted performance accounts for one-time non-recurring items related to growth initiatives such as the Puget Sound Bank acquisition, start-up costs of the new Portland team and the write-offs of acquired loan pools.
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The following table reflects the 2018 deferred compensation contributions based on 2017 performance results:
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Name
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Earned Deferred
Compensation Incentives ($)
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Earned Deferred
Compensation Incentive as
Percentage of Total
Compensation (%)
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Brian L. Vance
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$234,531
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16.4%
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Jeffrey J. Deuel
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$101,461
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11.6%
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Donald J. Hinson
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$81,437
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13.8%
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Bryan D. McDonald
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$84,123
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12.8%
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David A. Spurling
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$81,101
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14.1%
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The Committee approved the following performance goals for the 2018 performance period:
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Corporate Goal
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Weighting
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Threshold
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Target
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Maximum
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Actual 2018
Performance
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Adjusted 2018 Performance
(1)
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Earnings per Share
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50%
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$1.33
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$1.48
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$1.63
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$1.49
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$1.61
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Net Charge Offs/Average Loans
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50%
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0.25%
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0.15%
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0.05%
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0.06%
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0.06%
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(1)
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The adjusted performance accounts for one-time non-recurring items related to merger-related expenses for the acquisition of Premier Commercial Bancorp, the impact of the consultant agreement buyout, and net of the gain on sale of buildings.
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In February 2019, the Compensation Committee approved Company contributions to the Deferred Compensation Plan of $292,860, $145,958, $102,856, $111,183 and $96,026 on behalf of Messrs. Vance, Deuel, Hinson, McDonald and Spurling, respectively, based on 2018 performance results.
Perquisites and Other Benefits
Heritage NEOs participate in all Heritage benefit plans on the same terms as other employees. These plans include medical, dental and vision insurance, life insurance, long-term disability insurance and flexible spending accounts. Messrs. Vance and Deuel additionally receive perquisites in the form of club memberships and Messrs. Vance, Deuel and McDonald receive perquisites in the form of Company provided automobiles. These perquisites are considered a priority for these individuals because of their community involvement and business development activities. In addition, each of our NEOs are a party to a split dollar agreement with Heritage Bank that provides additional life insurance in an amount equal to 100% of their base salary.
Tax and Accounting Considerations
Heritage takes into account tax and accounting implications in the design of its compensation programs. For example, in the selection of long-term incentive instruments, the Committee reviews the projected expense amounts and expense timing associated with alternative types of awards. In selecting appropriate incentive devices, the Committee reviews extensive financial scenarios and analyses and considers the related tax and accounting issues.
Section 162(m) of the Internal Revenue Code, as amended, generally limits the tax deduction for compensation in excess of $1 million paid by a public company to anyone covered by the recently expanded definition of a "covered employee" in a taxable year. During 2018, compensation otherwise payable to Mr. Vance exceeded the $1 million deductibility threshold, and accordingly, such excess was automatically deferred pursuant to the terms of his transitional employment agreement. More information can be found on Mr. Vance's transitional agreement in the "Employment Agreements and Severance/Change in Control Benefits" section of this Proxy Statement. These deferred amounts will be paid to Mr. Vance in the first tax year in which such payments will be deductible by Heritage. The Committee retains the discretion, however, to pay non-deductible compensation if it believes doing so would be in Heritage's best interests.