A Compensation To-Do List For Your Board

Is your board effectively addressing the risk embedded in the bank’s compensation plans? McLagan Partner Gayle Appelbaum outlines a to-do list for boards in this video, and shares why new rules around hedging policies should be on your board’s radar. She also explains what banks need to know about these rules, along with considerations for your board’s annual compensation review.

  • Compensation Issues to Watch
  • New Rules on Hedging Practices
  • Other Practices to Address

What CEOs Want (and Directors Aren’t Giving)


compensation-7-12-19.pngChief executive officers at community banks want more equity, not more cash.

This is particularly true of community bank CEOs, who say that including equity in pay packages incentivizes them to create long-term shareholder value, aids management retention and prepares them to join the board.

While this shouldn’t come as a huge surprise, the message may be lost on some directors of these banks.

In Bank Director’s 2019 Compensation Survey—sponsored by Compensation Advisors—54 percent of CEOs said their bank should offer equity or increase the amount of equity they already provide. Directors didn’t feel as strongly about this: Only 19 percent said offering or increasing equity was a priority. They saw equity as one of a number of potential improvements, along with other options like non-equity long-term compensation, cash incentive and higher salary.

The board of directors at Talladega, Alabama-based FirstBanc of Alabama added stock grants to the compensation plan for President and CEO J. Chad Jones in 2017, after discussing how to incentivize and retain executive management. The board granted Jones 3,000 shares—1,000 of which were unrestricted and granted immediately, with the remainder consisting of restricted stock transferred over time.

“It has raised my eyebrows,” he says. “It certainly helped me focus on how to drive the stock and dividends.”

Adding the equity incentive “very minimally” diluted existing shareholders but allows Jones to benefit from the upside he creates. The board also approved a block of shares for other C-level officers, with which Jones can implement a similar equity grant program for them.

Jones added that increasing his salary beyond a certain point offered diminishing returns for him and higher expenses for First Bank of Alabama, which has $548.6 million in assets.

“You can give me 5 percent to 10 percent pay increases each year for the next 25 to 30 years. At that point in time, what good has it done?” he says. “I love the compensation side, don’t get me wrong, everyone does. But … if [the board] continues to increase my pay 5 percent and I’m the highest paid individual in this company, it doesn’t make sense for [them] to continue increasing my pay.”

Interest in and demand for equity-based compensation is expected to rise as competition for qualified executives remains stiff and a new generation of talent assumes the top spot, says J. Scott Petty, a partner at executive search firm Chartwell Partners. He says community bank boards should use it as a retention tool.

“In general, more and more CEOs want equity as a part of their compensation package,” he says. “It’s the ultimate alignment of the goals of the board and how the CEO is going to achieve those goals.”

Succession planning at First National Bank of Kentucky changed President and CEO Gregory Goff’s perspective on equity incentive compensation. He plans to retire soon from the Carrollton, Kentucky-based bank, which has $124.5 million in assets, and says he wishes he had opportunities to accumulate equity throughout his career.

“It’s one area of the bank where I didn’t push much—I did my job and went home,” he says. “I ran it like I owned all of it. But now I have no reason to stay here.”

He says the board of directors looked at different incentive compensation structures several times, but could never get comfortable with the dilution from awarding equity or alternatives like bank-owned life insurance. He says the board discussed adding him as a director after he retires, but his lack of equity makes him less interested in a seat.

When Jeffrey Rose interviewed with the board at Davenport, Iowa-based American Bank & Trust in 2016, he told them he wanted to make a bet on himself. Rose says he had been paid a salary and a bonus for turning around banks before, and it “wasn’t enough.” As president and CEO of American Bank & Trust, he hoped to capture some of the upside he created as he helped turn the bank around.

At the $366.2 million asset bank, Rose has the option to purchase a set number of shares each year at a predetermined price. The program is “very simple, very clean,” and the shares fully vest after he purchases them.

American Bank & Trust is taking the equity compensation philosophy one step further, having recently decided to compensate the board with stock instead of cash, too. Rose says the decision generated extensive discussion, but will help long-time directors become more invested in the bank and serve as a positive signal to local shareholders.

It’s tempting for a board to shy away from granting equity to executives—especially if the bank is closely held—but the benefits from doing so can outweigh the costs.

Improving Shareholder Liquidity, Employee Performance through ESOPs


ESOP-6-18-19.pngMost banks face challenges to find, incentivize and retain their best employees in an increasing competitive market for talent. Often, smaller banks and banks structured as Subchapter S corporations have the added challenge of providing liquidity for their shareholders and founders. An employee stock ownership plan can be an excellent tool for addressing those issues.

An ESOP creates a buyer for the bank’s stock, generating liquidity for shareholders of private or thinly traded banks and providing market support for publicly traded ones. An ESOP’s buying activity can reduce shares outstanding and increase a bank’s earnings per share. It can also increase employee benefits and gives them a sense of ownership that can improve recruitment, retention and performance.

ESOPs are tax-qualified defined contribution retirement plans for employees that primarily invest in employer securities. ESOPs offer accounts to employees, similar to 401(k) retirement plans. But unlike a 401(k), employees do not contribute anything to the plan; instead, the bank makes the contribution on their behalf.

ESOPs are an excellent employee benefit and a recruitment, retention and performance tool. ESOPs do not pay taxes on an annual basis, so taxes are deferred while the stock remains in a plan. When the employee retires or takes a distribution from the plan, the value of the distribution is taxed as ordinary income. Employees also have the ability to roll over the distribution to an individual retirement account.

Employees at companies that offer an ESOP have, on average, 2.6 times more in retirement assets than employees working at companies that do not have an ESOP, according to the National Center for Employee Ownership. Additionally, companies with broad-based stock option plans experienced an increase in productivity of 20 percent to 33 percent above comparable firms after plans were implemented. Medium-sized companies saw gains at the higher end of the scale. Employee ownership is also associated with higher rates of employee retention. According to a survey by the Rutgers University’s NJ/NY Center for Employee Ownership, workers at employee-owned companies are less likely to look for other jobs and more likely to take action when co-workers are not working well.

There are a couple of different ways that banks can establish ESOPs. The simplest and most efficient is called a non-leveraged ESOP, where the bank or holding company makes a tax-deductible cash contribution. The contribution can be in stock or cash and is recorded as compensation expense. If the bank contributes cash, those funds can be used to purchase stock directly from shareholders and create liquidity and demand in the stock. However, it can take years for a non-leveraged ESOP to accumulate a significant enough position to make a meaningful difference to a bank.

The other method, called a leveraged ESOP, uses a bank’s holding company to lend money directly to the ownership plan. The holding company is required because banks are not permitted to lend directly to the ESOP or guarantee a loan made to the ESOP. The holding company can use cash on its balance sheet, borrow it from a third-party lender or guarantee a third-party loan made directly to the ESOP. The ESOP uses the funds to purchase a large block of non-issued shares from the holding company or directly from shareholders. Although leveraged ESOPs have higher costs and complexity, they can make an immediate, meaningful difference in liquidity and employee benefits. This approach also has the benefit of increasing earnings per share upfront, since the shares underlying the ESOP loan to make the purchase are not considered outstanding. However, the repurchased shares negatively impact tangible common equity and tangible book value.

An ESOP can help the right bank accomplish many of its goals and objectives. Banks should carefully review their goals and objectives with qualified professionals that know and understand both the ESOP and commercial bank industries.

What Your Compensation Committee Calendar Should Look Like


compensation-3-12-19.pngA goal-oriented calendar can be the difference between a productive year and a nonproductive one for compensation committees.

Planning for the year goes beyond scheduling meetings. Compensation committee chairs should have a thoughtful plan that encompasses the goals of the committee for the year. A detailed and in-depth calendar can help both new chairs and experienced chairs craft a plan for the year that considers the short- and long-term needs of the bank.

This article provides planning tips and a cheat sheet for the core topics that should be on the committee’s annual schedule. Though the cheat sheet is specific to public banks, private banks can use the list as well.

What’s on The Agenda
The old saying goes “what gets written down, gets done.” Having a written document sets a roadmap for the year and provides your committee a timeline to stay on track. You don’t need to reinvent the wheel.

Start with the committee charter, which provides a job description for the committee’s responsibilities. Review the past year’s calendar, agendas and meeting minutes for a head start in creating your annual agenda and stick to it throughout the year.

Identifying key topics at the beginning of the year allows for communication across all stakeholders: members of the committee, your management team, and outside legal and compensation advisors.

Topics should cover both short-term and long-term items. For example, if you are looking to request more shares for your equity plan, this process should start well in advance, and may include updating your equity plan document, modeling ISS and Glass Lewis share guidelines, and redesigning your grant methodology.

Getting your outside advisors involved early can help you avoid last-minute surprises.

Frequency of Meetings
Typically, public banks hold four to six meetings in a year. This allows the committee sufficient time to cover key topics and to review the goals of the committee. In any given year, the agenda may require additional meetings for special events including merger and acquisition activity, creation of new incentive plans and other events.

committee-numbers.png

What (And When) Should Be on The Calendar
Below are key topics that should be on the regular calendar for public banks as well as additional items for consideration any time during the year. The sample covers a typical schedule, however, there is flexibility depending on the subject.

In any given year, items should be evaluated both in terms of the current short-term and the longer term needs of the bank 24 months or more from now.

compensation-calendar.png

What’s Changed in Executive Compensation Since the Crisis


compensation-3-4-19.pngA decade ago we were in the middle of an economic downturn and the world of executive compensation was under intense scrutiny.

One target for that scrutiny was executive benefits and perquisites. Things like excessive change-in-control payouts with “gross-ups” and perquisites like vehicle allowances and country club memberships were placed under the microscope.

Executive perquisite policies were put in place, and additional focus was placed on the SEC proxy statement disclosures of perquisites in the Summary Compensation Table when the aggregate amount exceeds $10,000.

To track the impact of these changes, Blanchard Consulting Group has conducted a benefits and perquisites survey three times over the last 10-year period. The most recent survey was completed in early 2019.

Here are three key areas:

Change-In-Control Agreements & Gross-Ups
The prevalence of CIC agreements has been consistently between 50 and 60 percent each time we have conducted our survey, so there has really been no change in the market surrounding who has these provisions in place. For additional reference, our public bank database indicates this segment is slightly above 80 percent prevalence for CIC agreements and this hasn’t changed much either in recent years.

What about severance multiples paid? Consistently, the most common response (around 35 percent) is the multiple for CEOs has been between 2 and 2.5 times salary or cash compensation.

So how about the “gross-up” clauses that added pay to the executive severance package if their payout was deemed excessive for Section 280G of the tax code? Our research only shows a slight decrease in the prevalence of these clauses. About 25 percent of the sample indicated they had them when we first conducted the survey and now we are just below 20 percent of the sample.

In summary, not much has changed surrounding CIC agreements and “gross-up” clauses.

Supplemental Retirement Plans
The existence of supplemental executive retirement plans (SERPs) or salary continuation agreements (SCPs) have declined from 53 percent in 2011 to 47 percent in 2018, which is not a lot of movement. Prevalence of these plans at public banks has hovered around 45 percent.

What about the benefit amounts being paid under these plans? Not much has changed here either. Around 70 percent of CEOs with defined benefit amounts are targeting something below 55 percent of final compensation, which is the same in 2018 versus 2011.

Supplemental retirement plans have not experienced much change in the banking market either.

Perquisites
Executive perquisites have not changed much surrounding car allowances or country club, hovering around 70 percent prevalence. This is very similar to the numbers back in 2011. In fact, the percentage of banks who do not offer any perquisites to their executives has only dropped a couple of percentage points, from 12 percent to 8 percent.

So once again, not much has really shifted or changed in the world of executive perquisites either.

Summary
So what should we make of the fact that there appears to be no significant adjustment, “scale-down,” or elimination of executive benefits and perquisites in the last 10 years? Did regional and community banks simply ignore the government-focused initiatives?

Some might say yes, but there’s another argument to be made.

It’s possible that community and regional banks were simply never paying their executives inappropriately or excessively. The compensation designs in place at those institutions were market-based, competitive, and reasonable. During the downturn many executives experienced salary freezes and either zero or minimal cash bonuses as bank performance dropped.

This was appropriate under pay-for-performance incentive plan designs. Since that time, compensation has increased as bank performance has increased and not much has changed in the world of executive benefits and perquisites.

These benefits and perquisites were reasonable then and are still reasonable now in the eyes of the decision-makers at community and regional banks.

Solving the Puzzle of Compensation Plans and Diversity


compensation-11-6-18.pngThere are some tasks that seem innocuous and administrative, but are nevertheless incredibly important. Assembling the puzzle pieces of effective executive and employee compensation plans is one such task.

This is why hundreds of bank executives and directors have assembled at Bank Director’s 2018 Bank Compensation and Talent Conference in Dallas, Texas, this week.

A number of themes began to emerge on the first day of the annual event, hosted at the Four Seasons Resort and Club at Las Colinas, the first of which is that many banks and their boards are still fully figuring out exactly how to structure executive and employee pay.

The starting point, according to a panel of experts from Compensation Advisory Partners and Kilpatrick Townsend & Stockton LLP during a morning workshop, is the interagency guidance issued in 2009 by the Federal Reserve, Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency.

There are three overarching principles:

  • Provide employees incentives that appropriately balance risk and reward.
  • Be compatible with effective controls and risk-management.
  • Be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.

These may seem simple in theory, but the challenges for banks are real and complicated, which explains why compensation plans at so many banks are still a work in process.

On one hand, banks face one of the most competitive labor markets in decades, with the lowest unemployment rate in half a century. To attract talented workers, banks have to pay accordingly, which is why so many bankers raised their hands during a Monday morning workshop when asked if their banks boosted their minimum wages after tax reform passed Congress late last year.

On the other hand, as Steve Hovde, chairman and CEO of Hovde Group LLC, pointed out in his analysis of the industry, banks are facing well-seasoned business and credit cycles. This creates a quandary about how aggressive a bank should be in incenting rapid growth, as loans made at the top of an up cycle tend to be the first to go sour at the bottom of the next down cycle.

Moreover, while this may seem counterintuitive, there was wide agreement among attendees at the workshop that regulators aren’t currently focused on the design of compensation plans. The sole exception, according to at least one attendee, concerns how mortgage originators are being compensated, likely a reaction to the issues that surfaced two years ago at Wells Fargo & Co.

Another theme to emerge during the workshop involved diversity and inclusion initiatives, which all banks seem focused on addressing.

It’s important to distinguish between those two initiatives, observed one of the workshop’s panelists.

“Diversity is about inviting people to the party,” she noted. “Inclusion is about giving everyone an opportunity to dance.”

The challenge in banking, as in other industries, is tackling unconscious bias—social stereotypes people form outside their own conscious awareness.

No rational banker today would admit being biased against hiring or promoting women or minorities. Yet the demographic statistics in the industry speak clearly to a lack of diversity, especially at the upper levels of management.

One way to address this is simply through awareness. This was a point that Kate Quinn, the chief administrative officer of U.S. Bancorp, echoed two months ago at Bank Director’s Bank Board Training Forum in Chicago.

“Everyone has prejudices,” said Quinn at the time. “To address them, you first have to be aware they are there.”
And this isn’t just about hiring a diverse workforce; all employees must also be given an equal opportunity to excel. This is the distinction between diversity and inclusion in the corporate world.

An interesting point brought up during the workshop was that entry-level jobs throughout the financial industry tend to be fairly representative of the broader population. But as you look up the organizational chart, that diversity dissipates.

The lack of diversity at the top sends a strong signal, noted one attendee. Her point was, if, as a woman or minority, there isn’t someone like you on the board or who serves as an executive, then you are left with the impression you don’t have the same opportunity to advance.

Ultimately, though, if you listen to bankers, it’s clear that diversity and inclusion have become priorities at many institutions.
After all, to compete for talent, it’s not only how much you pay, it’s also the culture of your institution that will serve as a magnet for the next generation of employees.

Talent and Customer Experience Can Be Evaluated Three Different Ways


incentive-10-31-18.pngTo maintain a competitive advantage over peers, two areas of strategic focus we have seen increase include enhancing the customer experience and attracting and retaining the right talent. Specifically, many banks are focused on digital transformation and technological efficiencies as well as human capital management to attract the right talent, including diverse talent, to be able to achieve the strategic priorities.

Companies are clearly emphasizing the importance of these two strategic priorities, but how you measure success is challenging. And, do you incentivize management based on progress? The goal for boards is to have executives focus on objectives that will ultimately drive performance and long-term shareholder value.

Some organizations are beginning to align incentive-based compensation with these strategic priorities; however, objective measurement of progress or success may often require a subjective judgement.

Customer experience and engagement: The banking industry runs on relationships and maintaining these connections, which is shifting as customer demand for new and faster technology evolves. While ensuring customer security is still important, the focus once on customer service has now shifted to the customer experience. To measure this, we often see a portion of the total incentive tied to customer engagement, typically measured through surveys, customer retention, or strategic technological or digital initiatives.

Two examples of companies that utilize customer-centric metrics include American Express and Unum Group. Both weight customer experience and satisfaction as standalone metrics in the annual incentive plan. Citigroup uses a scorecard to assess top management performance and compensation, 30 percent of which is tied to non-financial objectives.

Digital Transformation: The changes in the banking industry have increased the demand for tech talent to implement digital strategies, particularly those involved in improving the customer experience. Banks need to decide whether they will rely on internal talent and resources to develop proprietary new technologies, or if they will go outside the industry to find talent. In recruiting this talent, financial services firms find themselves in competition with tech companies that can provide significant equity opportunities and may have less-traditional work arrangements.

Financial services companies must be creative in attracting this talent with perks like open offices, flexible work arrangements and separate pay structures for niche talent. Goldman Sachs’ dress code, and JP Morgan Chase & Co.’s relocation of its tech team to a more modern, open-floor office are examples.

Diversity and Inclusion: Driving some of these strategic priorities are talent issues that have been a hot topic in the boardroom. Studies have shown a diverse workforce provides for more diverse thinking, and a better performing organization. We are seeing some organizations incorporate improvements in diversity and inclusion in their incentive plan metrics:

  • Prudential Financial: Performance shares include a diversity and inclusion modifier (+/- 10 pp). Executives at the senior vice president level and above will be subject to a performance objective to improve the representation of diverse persons among senior management through 2020.
  • Citigroup: 18-member operating committee will be measured on the progress of raising the percentages of women and African Americans in management positions by 2021.
  • American Express: Has had talent retention and diversity representation goals as part of the annual incentive plan since 2013.
  • Old National Bancorp: Has included diversity and inclusion targets in the annual incentive plan as a negative modifier since 2016.

The use of a modifier for Prudential Financial and Old National Bancorp may be due to the amount of influence an executive may have over the goal. Regardless of the weighting, inclusion of these metrics is a signal about the importance of the issue.

When boards are considering which strategic metrics to incentivize executives, the focus should be on management’s priorities, such as innovation, security, employee satisfaction or employee diversity. The key is attracting, hiring and retaining the right people who will align with the company’s strategic priorities. That is what differentiates one company from the next and those with a competitive edge.

Compensation Plans Should Be As Strategic As They Are Attractive


strategy-10-30-18.pngHuman capital is likely the most expensive resource a bank has, and we all know our people are important in a customer-facing business, so why not be strategic with it? Almost every business has a written strategic plan that states profitability goals, growth goals, three-year plans, etc. However, when it comes to compensation, fewer than four in 10 banks (38 percent of the 103 banks surveyed in our 2016 Compensation Trends Survey) have a formal, written compensation philosophy.

The Compensation Philosophy
Most organizations start the strategic compensation discussion with the development of a compensation philosophy. This document, often only a page or two, primarily identifies a few key items, including what the bank is trying to accomplish with its compensation programs; what compensation programs does the bank have available to our employees; who qualifies for these programs and why; and where does the bank want to position ourselves versus market? The compensation philosophy statement should be a living document that is reviewed annually and is adjusted as necessary to support business strategy changes.

Strategic Salary Planning
Banks that are strategic with compensation will also generally have a clearly defined salary grade structure, accurate and up-to-date job descriptions, utilize external market data for position benchmarking, and a salary increase matrix for annual adjustments. The annual salary increase process should be strategic, based on individual performance, foster internal equity, and fit within the overall budget of the organization. Many banks utilize a salary increase matrix to assist with determining annual raises. The matrix focuses on providing the largest increases to employees who are exceeding expectations and are positioned low in their salary grade. The days of giving everyone the same percent of salary raise are gone.

Performance-Based Incentives
Once you have the salary component figured out, the next step is incentive-based pay. This can take the form of annual cash incentives and/or equity-based incentives. The type of incentive a bank utilizes will often vary depending on the company structure—like whether it is public or private—and position level. As an example, executives may be eligible for a cash and equity incentive plan, but staff may only be eligible for cash incentives. The key to using strategic compensation is to make sure your incentive plans are based on performance and are motivating and rewarding key positions.

In today’s banking world, there is a lot of talk about incentive plans being “risky” and maybe even “evil” (example: Wells Fargo retail incentives). We disagree with this sentiment. Banks are still in the business of being profitable, and incentive plans have their place to help drive behaviors and reward performance. The key is to have a balanced approach between profitability and strategic goals.

Benefits and Perquisites
Benefits and perquisites are total compensation components that often apply primarily to executives. The broad-based benefit programs like 401(k) plans and health insurance programs have not experienced unique banking-focused changes in recent years. However, executive benefits such as salary continuation plans, change-in-control/severance plans, employment agreements and perquisites (auto allowances, country clubs, etc.) have seen reductions. These programs are still prevalent but there has been an increased focus on the business reasoning and validation behind such programs.

Executive benefits can provide some of the best retention vehicles in compensation if you have an executive leadership team you want to keep in place long-term. It is critical to ensure the benefit or perquisite is serving an appropriate business purpose.

The most successful banks are those who can appropriately balance their profitability needs with good culture, communication, and strategic compensation programs. Banks need to be financially successful to help the communities they serve. Ensuring that your compensation programs are strategically supporting the overall goals of your organization and linked to performance is essential. Make sure you are getting your “bang for the buck” with your compensation dollars being spent.

Improving Sales Incentives With Realistic Goals


incentive-11-7-17.pngThe use of incentives to influence the behavior of sales people has a long history in the United States. Short-term incentives (STIs) and sales goals have become ubiquitous in all types of sales programs, and are used to motivate employee behavior, but at what cost? Optimistically, it is assumed that growth in sales is a win-win for all involved. The manifestations of the “win” are strong company growth, shareholder gains, management and employee bonuses, customers who are better served and long-term economic growth for the United States. But a closer examination of the costs of mismanaged STIs reveal a dark, frequently unspoken, negative impact on all but a few select beneficiaries. Unfortunately, examples abound.

Many years ago Sears, Roebuck & Co. and its automotive unit was found to have performed unneeded repairs on customer automobiles when incentives were changed to provide sales people with compensation directly related to repairs. One more current example of the costs of mismanaged STIs can be illustrated by a shareholder lawsuit against Wells Fargo & Co. that alleges the company’s management “repeatedly and brazenly” failed to serve in the shareholders’ best interests during the time more than 2 million (recently increased to 3.5 million) fake accounts were created. Looking beyond this one current example, the research is clear that if left unchecked, short-term incentives can lead to, among other things, unethical and harmful behavior toward customers, which in turn leads to depressed share prices, debt downgrades and regulatory scrutiny.

Looking Closer at Employee Incentives
Today, customers have found their voices, and legislators are taking notice. It may come as a surprise to some amid all of the televised Congressional hearings and regulatory reviews that an approach and methodology to forecast, monitor and detect problematic sales practices has been developed. This new methodology is the result of research detailed in a recently completed paper “Sales Practices-Understanding the Behavior They Incentivize.” The advent of new computing technologies (e.g. machine learning) has provided insights that may have been difficult to obtain previously.

The Origin of Mismanaged STIs
Sales organizations are regularly challenged to develop accurate benchmarks or “forecasts” of future sales. The forecasts often have little, if any, basis in facts, and frequently reflect only the wishes of the finance department or management. This leads to incentive plans that are not only unrealistic, given a particular environment, but also encourage harmful behavior toward customers. It should be said that “incentive” normally means employee bonuses of cash or stock paid out for attaining certain goals. However, this interpretation excludes one of the most significant incentives companies can use to motivate employee behavior—retaining one’s job. As the psychologists Daniel Kahneman and Amos Tversky found in their research (Prospect Theory: An Analysis of Decision Under Risk, 1979), people feel a loss more strongly than a gain. To that point, an employee will likely take a greater risk to avoid losing his or her job than he or she would have taken to get a bonus.

The methodology outlined in the Sales Practices paper utilizes historic information and dynamic independent variables to provide a picture of expected performance behavior down to the individual level. If the expected performance of an individual is well understood, then any significant deviation can be detected and reviewed. This same methodology can be used to forecast behavior, given a certain set of conditions (e.g. population change, inflation, etc.) and used to set sales goals based on specific environments. Machine learning and other advanced approaches could speed up the process of determining realistic sales goals. Utilizing this methodology, organizations will no longer need to perpetuate blanket sales goals across large geographic and/or client segments, irrespective of the nuances of the various segments.

Regardless of research regarding the effect of STIs, the use (overt and otherwise) is not likely to change soon. As regulators, shareholders, and others focus more intently on the behavior that is incentivized, the utilization of scientific techniques to monitor and forecast expected performance will become more valuable to all types of organizations.

Do You Have Effective Incentive Plans for Your Commercial Lenders?


incentive-6-23-17.pngCommercial banking is a core business for most regional and community banks. It is a key driver of profitability as well as organizational growth, and frequently serves as the entry point to many of the bank’s other businesses, such as wealth management, treasury services and deposit gathering. The competition for talent and growth within commercial lending has never been higher, and as a result, commercial lenders continue to be among the mostly highly paid and highly incentivized individuals in the bank. It is of critical importance therefore to think carefully about maximizing your bank’s return on its lender compensation by thoroughly evaluating your incentive programs for this group. Do the plans motivate the right behaviors, properly consider risk elements and successfully align compensation with performance?

Incentive Goals
The first step in evaluating the effectiveness of the incentive plan for the commercial lending group is evaluating the business priorities of the lending group.

  • What is the preferred balance between profit and growth for each of the commercial businesses?
  • How should your business segmentation impact your plan design? For example, does the bank need multiple incentive plans to align with segmentation between C&I and commercial real estate, or one incentive plan covering multiple loan types?
  • What are the cross-selling or referral expectations for lenders?
  • What products and behaviors should your lenders pursue in order to encourage sticky relationships with your commercial clients?
  • What is the performance culture of the commercial lending group, and how can the incentive plan reinforce it?
  • What are the bank’s goals for specific types of commercial business in terms of client type, industry and loan size? For example, if the bank prioritizes C&I loans due to their typically higher level of fee income and associated deposits, rather than larger CRE loans, the incentive plan should reflect that priority.

These are just a few examples of the types of questions that bank board members and executives should be asking right now as they evaluate their commercial lender incentive programs. In order to properly contribute to the bank’s overall success, the incentive plan design and performance goals must reflect the bank’s priorities for the commercial lending group.

The exhibit below highlights some of the most common productivity goals used for commercial lenders at regional and community banks. Data is taken from a flash survey of regional and community banks that was conducted by McLagan earlier this year and that covered a variety of commercial lending topics.

incentive-plan-chart.png

Aligning Pay With Performance
In addition to identifying plan goals vis-à-vis departmental priorities, it is important to evaluate the alignment of incentive awards with the performance necessary to earn those awards. In short, what is the bank’s return on its incentive payments to lenders? If performance and awards are not appropriately aligned, the bank may be overpaying for mediocre performance or not appropriately rewarding its high performers, either of which can have a negative impact on long-term corporate performance.

Robust performance and payout modeling is particularly important when a new or revised incentive program is implemented—changes to plan payout methodologies may necessitate changing performance expectations for lenders. For example, if incentive payout targets are increased in order to remain externally competitive, do performance targets need to increase as well in order to provide an appropriate return to the bottom line?

Risk Considerations
While lender productivity generally has the biggest impact on plan awards, incentive plans cannot ignore risk considerations. The actions of commercial lenders today can have a significant impact on the bank’s credit quality and profitability in future years, and incentive plans should be designed to mitigate any behaviors that are not in line with the bank’s risk policies. In some cases, risk factors may be included as specific objectives under the incentive plan. More frequently, mechanisms outside of the core plan are used to safeguard against risky behaviors or poor risk outcomes. Common plan mechanisms include credit quality payout triggers, clawbacks that seek to recapture pay that has already been awarded, and deferrals that pay out based on long-term risk outcomes, among others.

In summary, commercial lenders can have a significant impact on your bank’s organizational success, and your commercial incentive plan can have a significant impact on the business and behaviors that your lenders pursue. As you begin to plan for 2018, take time now to evaluate the alignment between goals and business needs, payouts and performance, and plan features and risk policies. Doing so will help your bank maximize the potential organizational impact of its commercial incentive dollars.