Plan Now for Peak Performance

By Trey Deupree

As we move beyond the COVID-19 pandemic’s acute phase, the question “How much should bank executives get paid?” is not the most pressing one bank boards face. However, a silver lining to the cloud of the COVID-19 crisis is that it provides an opportunity to rethink executive compensation in ways that focus management’s efforts on moving beyond survival mode to how the bank can flourish once the crisis is over.

To do this, boards must pay attention to talent right now. All banks say that people are their most important asset, but forward-looking institutions are using compensation as a strategic tool to attract key talent, retain their best-performing employees and motivate executives to achieve their objectives.

Incentive plans—if managed properly—can be a powerful tool for the bank to drive individual, department and bank-wide performance. An incentive plan can have the following advantages:

  • Motivate and recognize top performance
  • Focus employees’ efforts on tasks that further the bank’s most important mission or operational goals and strategies
  • Serve as retention mechanisms for key talent through long-term incentive vehicles
  • Manage the bank’s fixed salary costs through awards that are “at risk”

The use of incentive plans to reward and drive executive performance has risen over the past decades. Short-term incentives, such as annual bonus plans, have an “instant gratification” element and are typically paid out in cash. Long-term incentive plan awards may also be paid in cash; however, to give key employees further incentive to remain with your bank, delayed or deferred compensation should be considered. The most common performance metrics banks use in designing these programs are related to bank income, return on equity, stock price appreciation, earnings per share and return on assets.

Deferred compensation plans

A non-qualified deferred compensation plan is a plan under which the bank may make contributions or an officer may voluntarily defer current income to a future date, and the employer makes an unsecured promise to pay the officer future compensation. More long-term than incentive bonus plans, this option is flexible and designed to allow key officers to take advantage of the voluntary pretax deferral of salary, bonuses, incentive pay and 401(k) contributions over the contribution dollar limit.

Properly designed DCPs are customizable, cost-efficient and focused on high performance. Banks can vary the contributions based on the financial performance of the bank and the individual criteria or some combination. Contributions are often based on a percentage of salary or a fixed dollar amount. They can also be tailored to meet specific criteria, much like a bonus plan. The credited interest rate on the contributions is typically based on the bank’s return on equity or another agreed-upon indexed rate. After separation, the rate is usually a defined fixed rate.

Banks can design DCPs to reward officers with shorter-term financial goals by providing a benefit that is payable in the near future. A financial institution could establish a program under which its top loan officers receive a contribution of 5 percent to 15 percent of salary annually for five years. The deferred compensation earns interest, and the balance pays out over two years at the end of the fifth year. The bank could restart the plan and have another payout in five more years or could use a rolling vesting schedule. While the contributions and interest credited to the account are additional expenses to the bank, the costs are made up through retention and higher performance from the officers.

Customized benefits addressing financial burdens, such as student loan debt and college tuition are excellent tools to recruit and retain key talent. For example, one Texas bank is helping pay college tuition costs for the children of several key officers. Benefit payments begin when the children reach age 18 and continue for four years. After these payments are made, the plan then converts into a supplemental retirement program, which further encourages retention.

Phantom stock plans

Top performers expect to be paid well, and if they help create economic value, it’s customary for them to share in some of the value they have created. Publicly traded banks will frequently use compensation plans tied to their stock to distribute long-term incentives in the form of stock options or restricted stock. Some private or thinly traded banks will use these types of “real” stock programs; however, many of these banks have limited availability of actual stock. As an alternative, private banks may use synthetic equity, such as phantom stock or stock appreciation rights, which are settled in cash without diluting ownership interest.

Phantom stock programs are modeled to look and feel like restricted stock, where the participant receives the full value of the share plus any appreciation over time. The value of phantom stock is typically linked to the company’s stock price or book value per share. In addition, dividends could be factored into the phantom stock value during the vesting period, typically three to five years. Ultimately, these phantom stock awards will be settled in cash.

Offsetting benefit costs with BOLI

Banks of all sizes, faced with decisions on investing excess cash, improving margins and yields on earning assets, and the rising expense of employee benefit plans, have looked to bank-owned life insurance as an alternative strategy. Of 5,116 banks as of March 31, 2020, 64.7 percent reported holding BOLI assets. The tax attributes of BOLI, coupled with its unique structure favorable for bank purchase, have proven over the years to be an excellent alternative to other investments.

Whether banks use DCPs, synthetic equity, BOLI or some combination, executive compensation is not a one-size-fits-all solution, as each bank has unique challenges and goals. As banks compete for talent in the new post-COVID environment, a customized strategy could provide an ideal opportunity for a bank to differentiate itself and provide a competitive advantage.

Trey Deupree is a consultant with NFP Executive Benefits, which ABA endorses for executive and board benefits consulting, administration of BOLI and nonqualified benefit plans, BOLI portfolio solution and BOLI risk assessment. Deupree is also a registered representative with Kestra Investment Services (investor disclosures).