The Right Peer Group Can Help Boards Gauge Performance

A peer group of similarly oriented financial institutions can help a bank’s board understand how the organization measures up to others, but how do directors know if the measuring stick itself is trustworthy?

It’s common practice for bank management to put together lists of similarly sized banks in their markets in order to provide a basis of comparison for financial performance or executive compensation. Peer groups can also be helpful when valuing shares.

When looking at those peer groups, boards should first know whether those banks are similar in ownership structure or business model; it may not make the most sense for a publicly traded bank to compare its financials against those of a mutual bank, for example.

”I have seen [bank leadership] get locked into geography and asset size, and not think about the business model and the ownership structure of the bank,” says Josh White, a shareholder at the accounting firm Elliott Davis.

Second, boards should consider the size of the peer group. A group of five or six banks, for example, is probably too small and could be skewed by merger activity or outlier performance. “You do want to have enough that it’s not going to be blown up if there’s a few years of M&A,” White says. A peer group of 15 to 24 banks would be more reliable as a data set.

To expand the peer group, leadership can look at the bank’s geographic footprint first. If there aren’t enough banks of a similar asset size in the immediate market, consider banks of similar sizes within the broader region or nationwide. In some cases, it may be useful to have multiple peer groups sorted by size, geography and business approach; those can then be combined to come up with statistically useful financial metrics, says Bill Herrell, executive vice president and managing director with Bank Director.

“What you want is an adequate data set. And some of the data points may [not be applicable to every bank in the group], so you may have to expand your data set in order to capture more potential data points,” Herrell says.

When looking at a peer group for the purposes of evaluating compensation, it’s particularly important to consider the types of markets those peers are operating in, says J. Scott Petty, a partner with Chartwell Partners who leads the executive search firm’s financial services practice. Banks that operate in mostly metropolitan areas with a higher cost of living will generally pay their executives more; those may not provide the best comparison for banks in largely rural markets.

Boards should also remember the purpose of a peer group is to provide a view of market practices; it should not be treated as a mandate, says Daniel Rodda, a partner with Meridian Compensation Partners. “You have to evaluate your particular circumstances, your particular executives, your particular strategic objectives,” he says. “All of those need to weigh into your actual decision. Don’t just follow whatever the data that comes out of this group is telling you to do.”

Peer groups should be reviewed on a high level at least annually. Make sure those peers still make sense as a basis for comparison and remove any that may have grown too large via merger.

However, banks with ambitious growth plans may benefit from having an additional, aspirational peer group to reference. “Take a look at banks that are twice your size, see what their ratios look like and see how you differ materially, and make sure you know how to get there,” Herrell says.

When evaluating compensation practices in the context of future growth, boards should consider the kinds of leadership skills the bank will need as it grows. “Your compensation structure is going to change naturally because your C-suite is going to be more strategic leaders of their functions,” Petty says. “For example, your CEO is no longer carrying a book of business or generating customer relationships but is managing a chief lending officer who is then managing market presidents.”

Finally, the peer group is most useful as a basis of comparison when the board considers its bank’s performance over a long period of time and not simply on a quarter-to-quarter basis, says Herrell. Too often, boards simply look at how their bank performed relative to peers in the most recent quarter, he says. “A snapshot in time is not as relevant as looking at the trend analysis.”