A Framework for Incentive Plan Adjustments

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Over the last few years, compensation committees have used their discretion more readily to approve adjustments that impact incentive award payouts. These adjustments were a practical matter during the pandemic and a more recently, to address the rapidly changing interest rate environment. Compensation committees made decisions to achieve appropriate outcomes, given external forces, while holding management accountable for results.

While compensation committees often spend time determining whether adjustments lead to a balanced outcome, they often pay less attention proactively thinking through the process which could be used for future decision making. The following principles create a framework that operationalizes the use of adjustments to metrics from year to year.

Principle 1: Accountability
Compensation committees should determine whether a potential adjustment was due to material external changes or factors that could have been avoided through better decision making. For example, accounting and tax law changes are regularly excluded for the year in which they are enacted and after the goals have been set. Conversely, taking a certain accounting or tax position that ends up being faulty is unlikely to be excluded from actual results, since it was a management decision.

Principle 2: Impact
Any modifications should include documentation from management regarding the impact of the adjustment on the payout and a year-over-year history of adjustments. The document should walk the compensation committee through the issue, the rationale for the adjustment and the financial impact. Assessing the effect to ongoing operations is an important aspect, since adjustments may be made due to a mid-year decision but then incorporated into the banks budgeting process on a go-forward basis.

Compensation committees should discuss potential adjustments at the time business decisions are made, so that it builds in adequate time to review requests. Last-minute requests for adjustments put the compensation committee in the difficult position of understanding incentive outcomes and the rationale for adjustments at a time when agendas are jammed-packed with year-end decisions. The committee’s inclination may be to simply acquiesce and move the meeting along, leaving directors afterwards feeling strong-armed into a point of view.

Principle 3: Bank and Market Practices.
The compensation committee should develop a guideline document that identifies the categories of adjustments it may or may not exclude. For example, events outside of management’s control that could have a material impact to the business, such as tax and regulatory changes and natural disasters, are common adjustments. Certain non-recurring expenses due to mergers and share buybacks may also be excluded in the year in which a business decision is made but was not part of the annual budget. For these events, compensation committees should ascertain whether management’s decisions provided a positive impact to shareholders and the adjustment eliminated a potential disincentive to act in shareholder’s best interests.

There should be documentation summarizing current and historical adjustments the compensation committee could use as a reference to ensure consistency year-over-year. Often adjustment decisions are discussed in executive session, leaving little documentation around the rationale; and the actions become buried in multiple meeting minutes throughout the years. Listing the categories of potential adjustments and the history of past actions will help clarify which adjustments are acceptable while allowing flexibility for unique circumstances.

Principle 4: Timeframe of Adjustment
Compensation committees should assess whether the reason for adjusting is a short- or long-term issue. For example, a one-time management decision that would likely result in better performance over the long-term may reduce an annual incentive payment in the current year, but increase the value of future award payouts, in both the annual and long-term incentive programs.

Developing a framework that evaluates adjustments along with a process for deliberation is likely to result in more confidence in the outcomes, greater consistency in practice and a more efficient process for management and the compensation committee.

Responding to Uncertainty by Focusing on Bank Fundamentals

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In the face of a novel environment and great economic uncertainty, community banks should focus on their fundamentals — and their customers.

That’s the message from speakers throughout the first day of Bank Director’s 2023 Acquire or Be Acquired conference. More than 1,700 attendees started off Sunday with an overview of the challenging economic landscape, coupled with encouragement that there are opportunities for nimble operators.

“No way do I believe that size alone is a determinant of success,” says Tom Michaud, CEO of investment firm Keefe Bruyette & Woods, in the conference’s opening session. “Size hasn’t ensured success. Some of the finest banks I know are under $5 billion in assets.”

It all comes down to execution, and there is reason for banks to be cautious. It’s not clear if the economy will go into a recession or land softly, although Michaud says his firm is projecting a “softer” landing for 2023 and single-digit loan growth. The Federal Reserve has raised rates at a pace that most bankers have never experienced — a dramatic turnabout two years after the industry was deluged with $2 trillion of stimulus spending to address the coronavirus pandemic. But even with the prospect of slower growth, Michaud advises banks to keep their balance sheet clean and find opportunities to build capital. 

“An industry that is catching its breath but remains profitable is a good place to be,” he says.

For now, this rapid whipsaw is the new normal in banking. Ahead of the conference, former Comptroller of the Currency Gene Ludwig told Bank Director that one truism in banking from the last half-century is that “the ups and downs come more frequently, and probably more severely, in shorter periods than they have in the past.” Technology and globalization have accelerated the pace of change, and banks need to be prepared for the volatility. 

Ludwig speaks from experience. In addition to serving as comptroller in the 1990s, he founded IntraFi, a reciprocal deposit network formerly known as Promontory Interfinancial Network, and is now a managing partner of Canapi Ventures, a bank-focused venture capital fund that invests in financial technology companies.

Having seen a variety of economic and credit cycles, Ludwig advised management teams to operate their institutions for the long haul and resist the noise of one quarter or the next. For the former comptroller, this comes down to the fundamental focus on customers, community and deposits. “Is what I am doing, and how I’m operating, best for my customer? Am I doing that in fundamentally a safe and sound manner?”

Increasingly, low-cost deposits are an important aspect of those customer relationships. Technology has made it easier for deposits to move, creating competition for those once-sticky funds. “Bankers that cultivate good customer relationships and use modern tools are able to have more stable and lower cost funding than banks that don’t,” Ludwig said, adding that banks have a variety of methods and tools to encourage existing companies to keep their deposits. 

The environment has shifted from unprecedented levels of liquidity flowing into banks to outflows. Total deposits in the banking industry declined for the second consecutive quarter, down 1.1%, or $206 billion, from the second quarter of 2022 to the third quarter, according to the Federal Deposit Insurance Corp. Driving the shift were accounts with balances above $250,000.  

“Banks in general are going to have to start thinking about funding loans as they go along,” Michaud told Bank Director ahead of the conference. “Previously, they had this reservoir of excess funding that made it easy to make an incremental loan. Now they’re going to have to fund it marginally, and that’s why we’re seeing deposit costs rise.”

Many institutions consider themselves “relationship lenders,” but Mac Thompson, founder and president of analytics firm White Clay, points out that many bankers struggle to quantify the depth of their customer relationships. That is one imperative for community bankers to grasp ahead of a potential recession.

“Who is using your liquidity, who is using your capital and what are you getting paid for it?” he says during a lunchtime presentation. Relationship managers should know the answer to those questions by analyzing a customers’ loans and deposits. Thompson urges banks to focus on bringing customers’ operational accounts to the bank — the accounts that pay their bills — because those accounts may be harder to move in response to interest rates. 

Customer loyalty goes both ways in relationship banking, and Michaud said this is one approach banks leverage when navigating the uncertain environment. 

“Now’s the time for banks to be there for their best customers,” he said, especially as access to credit tightens. “Typically when they are, their best customers tend not to forget it.” 

A Safecracker Explores the Nature of Security

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Dave McOmie starts every job staring down a locked door.

McOmie has been a safecracker for more than 50 years, having gotten his start watching a local locksmith help out a neighbor. He became the locksmith’s apprentice and quickly discovered the work of safecracking: breaking into vaults and safes for customers that had become inadvertently locked out of them.

That took him into the world of banking. Vaults have been a mainstay feature of bank branches, but anyone who has worked in a branch will know there are other physical safety mechanisms that occasionally lock up: lockers, cash safes, undercounter units and ATMs. He’s worked on all of them and knows the stakes: Whatever is behind that locked door is important, and someone wants it.

“When the bank or credit union cannot get into their vault, that situation tends to escalate quickly,” he says. There’s usually some urgency to the situation: Someone needs a wedding ring, a passport or a will, and there’s a tight timeline. McOmie is under pressure to open the vault. “[I]t’s stressful when you have an entire family sitting in the lobby, waiting to retrieve their passport so they can go to the airport. … You don’t want to be the reason they didn’t make their flight.”

In facing these locked and secured doors, McOmie says it’s key to prepare and research in advance. A mistake can trigger other safety mechanisms in a vault, quickly shutting down his entire progress. He carefully documents his progress and the products he works on to make the next job easier. 

“It’s all about the challenge and the conquest. You’ve got a locked door in front of you. What’s the problem? How can you overcome it? And can you do it efficiently? And quickly?” he says. 

McOmie joins Bank Director to discuss how he became a safecracker, how he approaches a locked door problem and what trends in bank branching mean for vaults, physical security and the future of safe cracking. Listeners interested in learning more about his experience can read his memoir “Safecracker: A Chronicle of the Coolest Job in the World,” which includes his experience opening the musician Prince’s vault at Paisley Park.

This episode, and all past episodes of The Slant Podcast, are available on Bank Director.com, Spotify and Apple Music.

Disability and Opportunity in Banking

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Keri Cain didn’t set out to become a marijuana banker. But after her muscular dystrophy led her to give up her dream career in apparel merchandising, she moved back to Oklahoma and stumbled into the massive opportunity to support businesses operating in the newly legalized marijuana space with legitimate banking services. She currently serves as Bank Secrecy Act director of special programs at Tulsa, Oklahoma-based Regent Bank, and created the institution’s cannabis banking program. 

Her interest in this sector is informed by her curiosity as well as her disability. She shares with Bank Director her thoughts on including disability in conversations about diversity and inclusion, how banks can make their workplaces more accessible for all employees and how therapeutic cannabis may figure in her future.

This episode, and all past episodes of The Slant Podcast, are available on Bank Director, Spotify and Apple Music.

What’s Working and Why

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DI_mag_thingy.pngI am a big believer that many banks have immediate opportunities to expand what banking means to individual and business customers. This special supplement to Bank Director magazine highlights a number of interesting technologies that have re-shaped the fortunes of banks across the U.S.

Now, technology in the financial world encompasses a broad spectrum of tools. For most officers and directors, I’ve found conversations about technology naturally incite interest in mobile banking. This isn’t a surprise when one considers that 68 percent of American adults connect to the Internet with smartphones or mobile devices, according to the Pew Research Center. Smartphone penetration is highest among people with higher incomes, and the young. What an opportunity to engage and reshape your relationships with this audience! To show how Americans use smartphones, and how banks are offering mobile services to meet that demand, Bank Director compiled an infographic on pages 4-5.

Clearly, banks are trying to reach customers with the appropriate technology to stay relevant. But some banks are pushing themselves beyond what every other bank is doing. A story on page 6 features interviews with banking leaders about the most successful innovations or technological advances impacting banks right now. Among new ideas is Malauzai Software’s and Allied Payment Network’s PicturePay, which allows banks to pay customer bills with a photo of the bill taken on a smartphone. 

As many banks face pressure to grow revenue or reduce expenses, we take a look at some that are coming up with creative solutions to tackle that problem. For instance, Central Bancompany in Jefferson City, Missouri, turned to Ignite Sales to double the number of services the average new business customer uses at the bank from three to six or seven different products or services. 

Likewise, City National Bank in Charleston, West Virginia, found success with the help of StrategyCorps. About one-third of the bank’s customers have opted into a value-added checking account for $5 per month, even though free checking is still available. Inland Community Bank in Ontario, California, used Paladin fs to save money on its core information technology contracts during the sale of the bank, improving the value of the deal and saving $700,000 in termination expenses.

While most banks are far more efficient than they were just five years ago, there is money to be saved in banking. Some of the more ambitious companies, who want to stay relevant and solve their customers’ problems, are saving money and growing revenues through a variety of means. Banks have to make changes to stay relevant and address customer needs, and some of the more inventive banks are finding unique ways to do this while boosting the bottom line. On behalf of our team, please enjoy this special supplement, one we designed to inspire and shine a light into what’s possible.

Contents

When Free Checking Is No Longer Enough

By: Sandy Smith

Successful banks like City National are always looking for customer friendly ways to grow fee income, says StrategyCorps’ Dave Crook.

Giving Banks a Better Way to Cross Sell

By: Sandy Smith

When Central Company engaged Ignite Sales, it needed to help its front-line associates improve relationships with its business customers.

Saving Money on IT Contracts

By: Rick Grant

Financial institutions are generally paying too much for information technology contracts. In many cases, those contracts could negatively affect M&A transactions in the future.

Succeeding With Mobile Bill Pay

By: Rick Grant

Park Sterling Bank is increasing customer retention through mobile bill pay.

Walmart Makes a Bet on the Future of Banking

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Photo: Business Wire

When Wal-Mart Stores Inc. announced its partnership with Pasadena, Calif.-based Green Dot Corp. to launch the online and mobile-only banking alternative GoBank, the retailer was also placing its bet on where the future of banking is heading. But with all its other financial ventures up to this point still in place, like in-store branches and prepaid debit cards, Walmart is keeping a hand in all possible outcomes.

Not only is GoBank designed with modern features that would be appealing to any consumer looking for more advanced mobile banking, the account is low cost and open to almost anyone over 18 with i.d. verification. This makes the account extremely attractive to customers who simply aren’t satisfied with their current bank relationship or have limited access to traditional banking.

Data from the annual Consumers and Mobile Financial Services report published by the Federal Reserve shows that people who are unbanked (do not have a bank account) make up 11 percent of U.S. consumers, while the underbanked (minimal access to bank services) make up 17 percent. And according to data from statistician Nate Silver’s web site, Fivethirtyeight.com, states with higher percentages of unbanked households are home to more Walmart stores. Since Walmart’s traffic is more likely to have a high concentration of unbanked and underbanked customers, GoBank allows the retailer to seize the opportunity to help those people get banking products, which helps GoBank’s business grow and allows people to spend more money in Walmart stores.

“GoBank is breaking down the barriers to traditional banking and brings the benefits of a FDIC-insured checking account that’s loaded with features to a large segment of Americans,” said Green Dot CEO Steve Streit in a statement.

The move to launch GoBank now gives Walmart the opportunity to target consumers from three different angles—the traditional branch, prepaid cards and GoBank—in order to appeal to the underbanked or now, any modern bank customer.

Traditional Branches
The retailer is already offering traditional branches in nearly 40 percent of its U.S. stores. With more than 700 branches in Walmart, Woodforest Bank, headquartered in The Woodlands, Texas, has the largest presence out of the total of more than 1,600 in-store banks. Woodforest serves the underbanked with its trademarked Second Chance Checking, created to give people who would typically be denied a traditional checking account the opportunity to open one.

Prepaid Cards
10-10-14-StrategyCorps2.pngJust two years ago, Walmart partnered with American Express to launch the Bluebird prepaid card as another alternative to traditional debit and checking accounts. The prepaid cards have functionality very similar to a traditional debit card.

In Walmart’s October 2012 press release for the launch, American Express group president Dan Schulman (who was recently named the new CEO of PayPal) stated its purpose: “In an era where it is increasingly ‘expensive to be poor,’ we have worked with Walmart to create a financial services product that rights many of the wrongs that plague the market today.”

GoBank
Walmart isn’t necessarily bidding GoBank against Bluebird or its in-store branches, but rather, it is opening up even more options for underbanked customers who want to use mobile banking. The Federal Reserve found that in the U.S., 49 percent of the unbanked and 64 percent of the underbanked has access to a smartphone.

10-10-14-StrategyCorps3.pngGoBank has features more advanced than basic mobile banking. For example, its Fortune Teller feature can become a budgeting resource for customers’ shopping decisions. You simply enter how much an item costs, and the Fortune Teller is able to instantly tell you if you can afford it or not based on the budget you set. “Remember that time you won the lottery? I don’t either,” is one message you can expect from the Fortune Teller, along with lots of humanized language that’s a refreshing update from standard bank formality.

To open a GoBank account, customers buy a $2.95 starter kit at Walmart. Instead of paper checks, customers can use online bill–paying services. There are no minimum balance requirements and no overdraft fees. Plus, customers have access to 42,000 free ATMs throughout the country. The $8.85 monthly fee is waived with a direct deposit of $500 or more each month.

Of these three ventures, the financial industry will keep an eye on which survives in the long run and becomes Walmart’s go-to product.

Is Your Bank Ready for the Cloud?

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8-27-14-cisco.pngFinancial services firms, like other companies, are running out of computing and storage space with available resources, and they are turning to cloud computing as a way to deliver information technology services on an as-needed basis. Firms are now looking for ways to stretch their existing data centers, as they often need more computing and storage capacity than their own facilities provide, especially during peak high-demand times. With the importance of this from a strategy and security standpoint, the board of the bank needs to provide proper oversight over this issue.

What is Cloud Computing?
Think of the cloud of a collection of computers where services such as compute (crunching numbers and data), and storage (a place to store the data that is being crunched and the results of that), are delivered dynamically as a service, rather than as a product. These services are typically delivered over the network, and in many cases, the Internet.

Instead of a line of business requesting 40 servers for a new data analytics software package, an IT team could deploy that software package on a cloud environment and provide access to the software. A dynamic cloud environment may give more compute and storage capacity when the application needs it and allocate less in periods of slow volume. This system of dynamic resource allocation makes the cloud an economical solution for large organizations.

Challenges With Financial Services IT Delivery
Data centers are a considerable investment to build and operate. Banking in the cloud lets banks extend their data center and current infrastructure when needed, while also providing additional data storage and computing capabilities offsite. In many cases, additional computing capacity is needed only for a short time in order to run certain risk models or to provide additional reporting for regulatory requirements. In this instance, a cloud-based infrastructure could be used to augment current big data and risk/analytics environments that banks have deployed.

The Trend to Hybrid Clouds
Today’s banks are in various stages of their cloud journey. Some have built their own private cloud hosting, defined as a single-tenant environment where the hardware, storage and network are dedicated to a single client or company. The resources and equipment required to run it are usually deployed in the firm’s own data center and managed by their own IT staff. Others utilize third parties to augment their own in-house application development efforts, a hybrid approach. A hybrid cloud service is a cloud computing service that is composed of some combination of private, public and community cloud services, from different service providers. Typically in this environment, a firm may have its own in-house private cloud environment, but may connect its private cloud to another provider’s cloud. In some cases, these facilities are located off-shore in foreign countries, and are not permitted to connect to, or utilize the bank’s internal network. In these instances, banks can benefit from using cloud solutions that allow temporary computing capacity, without a significant capital expenditure or time.

The Cloud’s Differentiated Services
Financial institutions can build secure hybrid clouds that only allow certain credentials to access bank data. Private cloud solutions provide a purpose-built, secure environment in which financial services institutions can very efficiently expand their compute capacity at a very low cost. In addition, the institution has full transparency to the environment from a monitoring and systems management perspective. When the bank needs additional space, it can use a public cloud, which shares data from a number of different sources and will require a higher level of security or care in what kind of data is housed there.

Board Oversight
Given that banks are increasingly turning to cloud computing, it makes sense for the board to know whether and how the institution is using cloud computing, and provide proper risk management oversight. Questions the board should ask include:

  • Is our bank currently using cloud computing services?
  • Do we intend to?
  • Do we have a private “cloud” or do we use third parties?
  • What security do we employ?
  • What kind of data is housed there?
  • How do our regulators view the use of cloud computing?
  • What are the advantages and disadvantages of the various types of cloud computing?