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February 25, 2016

Aligning Compensation Plans With Bank Profitability (article)

Alignment of compensation with financial performance is accepted practice in business, yet, ironically, banks have been slow to adopt this metric. As much as banks analyze financial statements and the financial performance of customers, the industry tends to treat compensation in an archaic manner.    

This issue remains of high importance to bank directors and senior executives, according to the Bank Director’s 2015 Compensation Survey Report. The Report cited that tying compensation to performance was the top challenging topic for banks for 61 percent of respondents – ahead of retaining key people (45 percent) and compensation and benefits costs (39 percent).

Often, community to mid-sized banks have relied upon the annual cost of living increase, a highly subjective bonus plan and possibly throwing stock at more valuable performers. If you are ready to fast-forward to a new era, the following observations and suggestions might be put to good use in your organization.

Revenue Producing Roles

For people in revenue producing roles, align compensation plans with goals associated to overall monetary contribution. It may take some time to design such a program, but banks would be wise to put in place scorecards that reward an employee for total monetary contribution, tempered by safety and soundness considerations. Plans would vary, of course, by service line – commercial or consumer loans, wealth management/trust, retail, etc.

As an example, for commercial loan personnel, a set of metrics could include (1) an annual, agreed to net interest margin contribution from a loan portfolio, (2) an imputed “value” for deposit attraction, (3) fee income, (4) income from cross-selling other bank services, and (5) client retention percentages tempered by loan quality or credit risk components.

Best practice suggests designing a consistent program, simple to understand and track, followed by creating the actual reward structures and monies related thereto. Stick with a few key metrics so that participants do not need to spend an inordinate amount of their time figuring payouts or how to “game the system.” 

As a regulated industry, it will be important to align compensation methodologies with sound incentive guidelines such as those as published by the Federal Reserve, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the Federal Deposit Insurance Corporation (http://www.occ.treas.gov/news-issuances/federal-register/75fr36395.pdf), and provisions required by Dodd Frank.

Management Personnel

For management personnel, including team leaders and the like, a different but similar program would be in order. Attempt to retain common alignment with line personnel whereby team monetary contribution is measured by rolling up of individual scorecards. However, add in rewards for desired management and supervisory performance metrics, such as employee retention. This way, everyone is rowing in the same direction.

Senior Leadership

For senior leadership, a more global view should be taken. Big picture objectives must be factored into the equation, including executing a strategic plan, ROA/ROE measures, avoiding or resolving regulatory issues, earnings per share growth (if applicable), and potentially the establishment of succession planning initiatives. Such categories were mentioned in the Bank Director’s 2015 Compensation Survey Report. 

Additional Considerations

Do not make the program a purely top-down process. During the design process of your incentive program, engage employees - department by department - where applicable, subject to confidentiality and hierarchical considerations.

Use spot bonuses as a valuable tool for accomplishment of special projects or tied to effort “above and beyond the call of duty.” Such rewards are especially geared toward millennial employees who long for constant feedback and affirmation.

Equity awards and deferred compensation are good choices for retaining top performers. However, deferred compensation plans are not a popular tool, according to the Survey Report. If employed, consider tying deferred compensation plans with an employees’ life events (subject to 409A plan guidelines): (1) college education expenses for children, (2) long-term care for aging parents, and (3) retirement. In fact, executives responding to the Survey Report said that, in addition to a cash salary and bonus, what they want most is a retirement benefit, at 72 percent. Curiously, just half desire equity as part of own compensation programs.

Needless to say, the era of the annual cost of living adjustment and subjective bonuses are a thing of the past. If you are still caught in this rut, it is time to change.

If you have questions or comments, feel free to contact Jay Meschke, President of CBIZ Human Capital Services and EFL Associates, (816) 945-5401.

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