How Bank Executives Can Address Signs of Trouble

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As 2021’s “roaring” consumer confidence grinds to a halt, banks everywhere are strategizing about how best to deal with the tumultuous days ahead.

Jack Henry’s annual Strategic Priorities Benchmark Study, released in August 2022, surveyed banks and credit unions in the U.S. and found that many financial institutions share the same four concerns and goals:

1. The Economic Outlook
The economic outlook of some big bank executives is shifting. In June 2022, Bernstein Research hosted its 38th Annual Strategic Decisions Conference where some chief executives leading the largest banks in the U.S., including JPMorgan Chase & Co., Wells Fargo & Co. and Morgan Stanley, talked about the current economic situation. Their assessment was not entirely rosy. As reported by The New York Times, JPMorgan Chase Chairman and CEO Jamie Dimon called the looming economic uncertainty a “hurricane.” How devastating that hurricane will be remains a question.

2. Hiring and Retention
The Jack Henry survey also found 60% of financial institution CEOs are concerned about hiring and retention, but there may be some hope. A 2022 national study, conducted by Alkami Technology and The Center for Generational Kinetics, asked over 1,500 US participants about their futures with financial institutions. Forty percent responded they are likely to consider a career at a regional or community bank or credit union, with significant portion of responses within the Generation Z and millennial segments.

3. Waning Customer Loyalty
The imperative behind investing in additional features and services is a concern about waning customer loyalty. For many millennials and Gen Z bank customers, the concept of having a primary financial institution is not in their DNA. The same study from above found that 64% of that cohort is unsure if their current institution will remain their primary institution in the coming year. The main reason is the ease of digital banking at many competing fintechs.

4. Exploding Services and Payment Trends
Disruptors and new competition are entering the financial services space every day. Whether a service, product or other popular trend, a bank’s account holders and wallet share are being threatened. Here are three trends that bank executives should closely monitor.

  • The subscription economy. Recurring monthly subscriptions are great for businesses and convenient for customers: a win-win. Not so much for banks. The issue for banks is: How are your account holders paying for those subscriptions? If it’s with your debit or credit card, that’s an increased source of revenue. But if they’re paying through an ACH or another credit card, that’s a lost opportunity.
  • Cryptocurrency. Your account holders want education and guidance when it comes to digital assets. Initially, banks didn’t have much to do with crypto. Now, 44% of execs at financial institutions nationwide plan to offer cryptocurrency services by the end of 2022; 60% expect their clients to increase their crypto holdings, according to Arizent Research
  • Buy now, pay later (BNPL). Consumers like BNPL because it allows them to pay over time; oftentimes, they don’t have to go through a qualification process. In this economy, consumers may increasingly use it to finance essential purchases, which could signal future financial trouble and risk for the bank.

The Salve for It All: The Application of Data Insights
Banks need a way to attract and retain younger account holders in order to build a future-proof foundation. The key to dealing with these challenges is having a robust data strategy that works around the clock for your institutions. Banks have more data than ever before at their disposal, but data-driven marketing and strategies remains low in banking overall.

That’s a mistake, especially when it comes to data involving how, when and why account holders are turning to other banks, or where banks leave revenue on the table. Using their own first-party data, banks can understand how their account holders are spending their money to drive strategic business decisions that impact share of wallet, loyalty and growth. It’s also a way to identify trouble before it takes hold.

In these uncertain economic times, the proper understanding and application of data is the most powerful tool banks can use to stay ahead of their competition and meet or exceed account holder expectations.

Wait Wait, Don’t Quit

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The Covid-19 infection rate across much of the country is in decline, but banks and other employers trying to bring workers back to the office are dealing with another problem: an acute labor shortage.

Last month acquired the nickname #striketober, as the U.S. reached a record high percentage of people quitting their jobs. The latest data from the U.S. Bureau of Labor Statistics found that 4.7 million people, or 2.9% of all employees, quit their jobs in August. Nonfarm employment as of October was 4.2 million shy of what it was pre-pandemic. Wages are climbing, and banks feel the pressure from companies like Bank of America Corp., which announced that it will pay workers at least $25 an hour by 2025.

The ability to work-from-home in such an environment has suddenly become a retention tool — no longer simply a response to the pandemic. As I head to Bank Director’s Bank Compensation & Talent Conference at the Four Seasons Resort and Club in Dallas Nov. 8 to 10, where close to 200 people will discuss those and other issues, it’s clear that flexibility is becoming the new 401(k).

At $1.6 billion State Bank of Cross Plains, in a suburb of Madison, Wisconsin, allowing non-branch staff to work from home a few days per week has become an important benefit, said Chief Financial Officer Sue Loken at a recent Bank Director conference in Chicago.

In Buffalo, New York, at $152 billion M&T Bank Corp., employees will come back to the office three days a week starting in January 2022. Some already were coming into the office voluntarily or if their work required it.

Hybrid work looks like a better alternative to most banks than remote work. An unscientific audience poll at Bank Director’s recent Bank Audit and Risk Committees Conference in Chicago found that fewer than 5% of 57 respondents thought that more than half their employees would work remotely in the future. The most popular answer was that fewer than a quarter will work remotely, in line with Bank Director’s 2021 Risk Survey conducted at the beginning of the year.

That fits with what Paul Ward, chief risk officer at $15 billion Community Bank System in DeWitt, New York, had to say at the conference. Most employees are back at the office full-time, though a few still are working remotely.

Community Bank’s senior executives believe those in-person conversations are critical to building culture at the bank. Executives at M&T Bank also felt that culture is best cultivated in person, not via video conferencing. Michele Trolli, M&T’s head of corporate operations and enterprise initiatives, told The Buffalo News last October that M&T was “living off an annuity” acquired pre-pandemic by being together and knowing each other. “And that annuity, at some point, that runs out,” she said.

Compensation Considerations in a Merger of Equals

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2021 has been a very active M&A year for regional banks, with some organizations combining through a merger of equals.

As the term suggests, a merger of equals is when two banks of comparable size merge to form a larger new company. There is a lot to consider in these situations to ensure the combination effectively unlocks value for stakeholders. Developing the human capital strategy and compensation program at the pro forma bank is a key factor for the management teams and boards of directors to consider. It is critical they get this right in order to retain and engage critical talent through the key milestones in the merger and beyond. In this guide, we identify some of the key compensation-related items that must be addressed in a merger of equals.

Leadership Structure and Executive Team
In a typical acquisition, the executive team of the acquirer often stays in place and the executive team of the target may take on newly created executive roles or leadership roles in a subsidiary business. In a merger of equals, the combined executive team is typically comprised of executives from both legacy organizations. Companies should identify the best talent to lead the bank well before the close of the merger so they can seamlessly execute on the integration and develop a retention plan.

Companies must also determine if they will combine the roles of CEO and chairman of the board, or if the roles will be split between the two legacy CEOs. It is common in a merger of equals to split the roles for a defined time period. This approach gives the pro forma bank the benefit of the leadership of both legacy CEOs as it navigates how to effectively operate as a new organization and create a harmonized organizational culture.

Compensation Philosophy and Competitive Market
It is important for the newly formed entity to have a cohesive compensation philosophy promoting a “one company” mindset among employees who are from different legacy organizations. The compensation philosophy should guide how the bank now pays its employees, including mix between fixed and variable compensation, mix between cash and equity compensation and where compensation is positioned relative to the market. If the two legacy banks have different compensation philosophies, the pro forma bank should develop a strategy to harmonize these philosophies in the near-term. For example, it set a goal to pay all corporate employees using the same mix by the anniversary of the close of the merger.

The combined entity will also need to define its new competitive market. Clearly, it will need to compare itself to larger institutions than the legacy banks, but it should also consider if there are other differences that should define the competitive market, like if the two legacy banks operated in different geographies or had different operating characteristics. It is paramount that the board compensation committee and management teams identify relevant criteria to define a competitive market that best reflects the combined bank’s business.

Retention and Success Awards
Once the banks establish the compensation philosophy and define the new leadership team, it is important to consider how ongoing compensation programs can incent and retain the new team. A common approach to tie the new team together is by providing a long-term incentive award, often referred to as “success awards.” A portion of the award typically vests based on performance linked to achieving deal-based objectives such as synergies or systems conversions. A portion of the award may also vest over a period of time to provide an additional retentive hook. Success awards with performance conditions are better received by external investors and proxy advisory firms. The combined entity should also consider retention risks among the executive team, including the ability to trigger change in control severance and current equity holdings. This may influence which executives receive additional awards or larger success awards.

A merger of equals can be an exciting but also uncertain time for an organization. Early planning on the new bank’s compensation philosophy, leadership team compensation program and success and retention award approaches can help alleviate some of the uncertainty and allow the executive management team to focus on successfully completing the integration. A well thought-out program can combine the best of both legacy organizations into a harmonized compensation program that supports a “one bank” strategy and culture.

Improving Shareholder Liquidity, Employee Performance through ESOPs

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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.

One Way to Compensate and Keep Your Bank’s Top Talent

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compensation-6-11-19.pngBank-owned life insurance (BOLI) continues to be an attractive investment alternative for banks, given the number of banks that hold policies and high retention rates across the industries. An increasing percentage of banks hold BOLI, many of them using the policies as an important part of their compensation and retention strategies for key personnel.

A significant industry trend driving interest in BOLI is their use by banks in compensation strategies to attract and retain the best talent. Bank management and boards of directors are reevaluating their existing compensation plans and strategically implementing new ones in order to retain key executives given increasing competition for scarce talent.

BOLI assets reached $171.16 billion at the end of 2018, growing 2 percent year-over-year, according to the Equias Alliance/Michael White Bank-Owned Life Insurance (BOLI) Holdings Report. Sixty-four percent of banks reported holding BOLI assets; about 71 percent of banks with more than $100 million in assets owned BOLI. Most BOLI purchased is by banks that hold existing policies; of those banks, more than half have purchased BOLI as an add-on for a current group of executives. In 2018, about 86 percent of new premiums were invested in general account products, compared to hybrid and separate account products, according to IBIS Associates.

Although the pace of BOLI purchases slowed last year compared to 2017, purchases exceeded $1.7 billion and were steady throughout 2018. The reasons for slower BOLI purchases were due to continued strong loan demand that reduced bank liquidity and the reduction in the tax-equivalent yield on BOLI following the federal corporate tax cut.

Credited interest rates and net yields, the crediting rate minus the cost of insurance charges, on new BOLI purchases are expected be similar to 2018 figures. The interest rates that carriers can obtain on investment-grade securities held for between five and 10 years has remained relatively flat, given the modest increases in this portion of the yield curve. Corporate bonds usually comprise the largest holding in the portfolio, but it can also include commercial mortgages and mortgage-backed securities, private placements, government and municipal bonds, a small percentage of non-investment grade bonds and other holdings.

BOLI plans fund many of the most common retention plans, which can include supplemental executive retirement plans, deferred compensation plans, split-dollar plans and survivor income plans. Additionally, some banks are using deferred compensation plans to create flexibility in designing plans to retain young “up and coming” officers. Unlike a supplemental executive plan, which provides a specific benefit at a specific date or age, a deferred compensation plan allows the bank to make contributions to the executive’s account using a fixed dollar amount, fixed percentage of salary or bonus or a variable amount based on performance. A deferred compensation plan also permits voluntary deferrals of compensation, which could be valuable to executives who would prefer to defer more compensation but are limited in the 401(k) plans.

BOLI financing helps offset and recover some or all of the expenses for the employer. For example, a bank provides an officer with supplemental retirement benefits of $50,000 per year for 15 years, for a total cost of $750,000. The bank could purchase a BOLI policy on the officer with a net death benefit of $1 million to $2 million that would allow it to recover the cost of the paid benefits, as well as a return on its premium.

We expect that community banks will continue to implement these types of nonqualified benefit plans in 2019, using BOLI to help attract and retain key personnel.

Compensation Strategies to Attract, Retain and Motivate Millennials

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compensation-9-18-17.pngDistinguishing between retirement plans for a bank’s older executives and other key high performers and shorter-term incentives for its younger millennials, who are the bank leaders of the future, continues to be an important strategy for boards of directors. Compensation committees are willing to provide some type of mid-term incentive plan as a retention strategy focused on their younger workers. Boards also want to have both short- and long-term, performance-driven plans in place that are aligned with shareholder interests and retaining their key officers.

As with most employees, effective compensation plans and performance management programs can help attract, retain and motivate millennials. Providing a competitive base salary may not be at the top of their priority list, but certainly being rewarded for performance is important.

The next generation of leaders have been impacted by the recession, both from watching their relatives endure job loss and financial stress and from experiencing the post-recession economy directly. They are also the largest group carrying student loan debt. As a result, money is very important to them and while they may not be worrying about retirement, they are focusing on shorter term financial needs.

While millennials have essentially the same financial needs as the generations preceding them, their time horizon to retirement can be 30-plus years or more, which is too far into the future for them to focus on when faced with immediate financial planning decisions, like retiring student debt, purchasing a home and providing for their children’s education.

Nonqualified benefit plans including deferred compensation plans can be an effective tool for attracting and retaining most key bank performers—both those focused on retirement as well as more interim financial needs—because of their design flexibility. According to the American Bankers Association (ABA) 2016 Compensation and Benefits Survey, 64.5 percent of respondents offered some type of nonqualified deferred compensation plan for top management (chief executive officer, C-Level, executive vice president).

For this next generation of leaders, boards should consider a type of plan that allows for in-service distributions timed to coincide with events such as a child entering college. Plan payments made to the participant while still employed can be made at some future point such as three, five or 10 years.

These plans could be used in lieu of stock plans with a similar time duration and are important to younger leaders looking to shorter, more mid-term financial needs in a long-term incentive plan. Plans with provisions linking plan benefits to the long-term success of the bank can help increase bank performance and shareholder value as well as to reward key employees for longer-term performance. Defined as either a specific dollar amount or percentage of salary, bank contributions are discretionary or dependent on meeting budget or other performance goals. Interest can be credited to the account balance with a rate tied to either an external index or an internal index such as bank return on equity.

The plan can also include a provision that the account balance, or a portion thereof, is forfeited if the key employee goes to a competitor. In addition, it is typical to see events such as a change in control or disability accelerate vesting to 100 percent.

Let’s look at two examples, one for a retirement-based plan and the other for an in-service distribution to help pay for college expenses.

Assume that the bank contributes 8 percent of a $125,000 salary for a 37-year-old employee each year until age 65. At age 65, the participant will have $1,370,000 in total benefits, assuming a crediting rate equal to the bank’s return on assets, with an annual payment of $130,000 per year for 15 years. This same participant could also have had part of the benefit paid for out via in-service distributions to accommodate college expenses for two children. Assume there are two children ages three and seven and a desire to have $25,000 per year distributed for four years, for each child. Thus, these annual $25,000 distributions would be paid out when the employee was between the ages of 49 and 56. The remaining portion available for retirement would be an annual benefit of $78,000 for 15 years beginning at age 65.

Regardless of the participant’s distribution timing goals, both types of defined contribution plans can be tied to performance goals. The bank contribution percentage to each participant’s account could be based on some defined performance goal. Again, the ABA’s 2016 Compensation and Benefits Survey results showed that bonus amounts were based on several factors including: 85.6 percent bank; 74.9 percent individual; and 26 percent department/group. Aligning the bank’s strategic plan goals with the participant’s incentive plan provides a better outcome for both shareholder and participant.

In addition, many banks have implemented defined benefit type supplemental retirement plans as a way to retain and reward key executives. These plans can also be structured as performance based plans.

Regardless of a participant’s time horizon, it is important to reward both your older and younger leaders with compensation that is meaningful to them and will help them accomplish their personal financial objectives, while balancing the long-term interests of shareholders.

Compensation Planning In Today’s Talent Market

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How do banks attract young employees and retain key executives? David Fritz Jr. and Patrick Marget of Executive Benefits Network explain that bank compensation plans should appeal to multiple generations and outline how Bank-Owned Life Insurance (BOLI) can offset compensation costs.

  • Challenges in Attracting & Retaining Employees
  • Focusing on Long-Term Incentives
  • BOLI’s Role in Compensation Planning

Safeguarding Top Talent Is Key for Making Mergers Succeed

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mergers-3-22-17.pngBanks merge because of the obvious benefits—longer client lists, greater real estate holdings, stronger intellectual property, and wider market share, among others. While there is no denying the positives of a merger and acquisition (M&A), a common downside is that change can disengage and drain your talent pool if not managed correctly. It is critical through this unstable transition period that the best talent engage in the transition process, be informed about the long-term vision of the new company, and that business continuity and quality service not be compromised. Complicating matters is that while the window of time to pull off an M&A agreement often is very brief, a long period of employee uncertainty may precede regulatory approval.

Managing Change Properly Starts With Due Diligence
Procedural adjustments, such as changing lock box addresses, are very straightforward. What’s trickier and needs to be a priority is helping employees adopt the associated changes. Closely learning about the culture of the other company—how it is aligned and how it is different from the acquiring company’s culture—can be done by interviewing stakeholders, conducting informal or formal surveys, or even studying the look and feel of employee communications and polices in the employee handbook. These simple exercises will prevent hasty decision-making and will help structure the new company so that objectives are met without unwanted employee turnover.

Taking the time required to get a more intimate understanding of the bank being acquired also will speed things up when it’s time to fit the right people into key roles. The new organization ideally will represent the best of both companies, so it’s critical to identify not just where value was strongest at the former company, but why it developed and who was responsible. Getting that right early in the transition will help make it seamless. Productivity will be less likely to drop, will snap back quickly and unwanted employee turnover will be manageable.

Change Management Fails Because of Poor Communication
When employees are kept in the dark, productivity slacks and resumes start flying out the door. And your best people have the most options. Don’t underestimate the impact change has on long-time employees when they are not involved in the transition as stakeholders. They want to understand where the new company is heading, if it shares the values they are accustomed to, and what role they will play in the days and years ahead. Seventy percent of change initiatives fail due to factors involving employee and cultural resistance. Timing and engagement both matter in preventing discord at the top because it always trickles down.

Unlike in other sectors, regulatory approval can slow the process of bank mergers to a halt, and time can make miscommunication fester. Often when a merger is announced, both parties have to wait five months for approval. The uncertainty of this period can turn into a harmful fog unless handled the right way.

One way to help clear things up is to have employees from both banks interact at social events or give the acquired employees opportunities to learn about the acquiring bank’s culture to see what change looks like in settings that are casual. Another way to keep communication open with key employees from the bank being acquired is to involve employees from both banks in teams to help broker transition objectives. Any step to include employees from the bank being acquired is better than no communication. In the absence of a story, human nature is to make one up, and it’s likely to be negative.

Identify Problems Early
The best way to identify potential issues for the merging organizations is impact analysis, a method that takes a qualitative approach to assessing the way each organization handles different aspects of its business, and then developing a quantitative solution to make both sides sync. For example, an impact analysis of the culture of a lending group—how decisions are made and by whom—would create a working hypothesis about what needs to happen in the group post-integration. Identifying strengths and weaknesses is necessary for closing the gap between the organizations and creating a cohesive roadmap to move forward.

In short, managing change successfully requires focusing on four key areas:

  1. Identify the most effective leaders and transition them to roles where they can thrive. Take advantage of the merger by making needed changes to your organizational structure.
  2. Get in front of the talent most likely to be a flight risk and help them see how they play an essential role in the new company.
  3. Focus on leading employees into the new culture and on their individual transition through incentives, training and new opportunities. Keep communication open and clear.
  4. Make sure payroll and benefits transition by day one. Mishandling paychecks or other mechanics will sabotage all of your prior efforts.

Talent Management at the Top

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U.S. Bancorp emerged from the financial crisis as a desirable workplace for talented employees, enabling the bank to better attract and retain talented employees. In this presentation, Jennie Carlson, executive vice president of human resources, outlines U.S. Bancorp’s transparent and analytical process to identify, reward and engage top employees. Millennials are changing how banks groom the next level of executive talent, which includes an increased commitment to diversity. 


It’s More than Just the Money

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Offering competitive compensation programs is an important factor in employee satisfaction and retention. But is it the most important thing? First Financial Bankshares Chairman, President and CEO Scott Dueser believes that the culture of your organization and how you treat your employees are even more important. In this presentation, one of the country’s top bankers explains how his company motivates its employees to perform at the highest levels.