Bank Board Members Address COVID-19 in Compensation Design

Do banking industry board members plan to adjust 2020 annual incentive plans to address COVID-19’s impact? At an NACD and Compensation Advisory Partners (CAP) virtual roundtable hosted on September 30 and titled “Compensation Strategy for an Unpredictable Future in the Banking Industry,” 52 percent of attendees in response to a poll said that they’d exercise discretion.

Meanwhile, 22 percent said that they’d adjust performance goals to reflect that COVID-19 made goals unattainable, 26 percent said they plan to make no adjustments, and not a single attendee responded that they’d exclude the pandemic’s impact from performance calculations.

As moderators Kelly Malafis, founding partner at CAP, and Eric Hosken, a partner at the firm, laid out in the discussion, incentive plans set in the first quarter of this year are not necessarily realistic anymore given all that has transpired since the pandemic was declared in March.

“We’re using a lot of upward discretion,” one attendee said. “We’re looking at metrics that maybe weren’t on the annual plan, the net interest margin compared to peers and performance in the Paycheck Protection Program. We’ve come up with three to four harder metrics even though they’re not in our plan and laid those over the individual’s [plan].”

Another attendee remarked on the impact of the adoption of the Current Expected Credit Losses (CECL) standard, which came into force this year. The standard requires financial institutions to proactively predict the losses they expect to incur over a loan’s lifetime. “CECL clearly impacted how we look at our financials this year. CECL has been treated differently by different banks, so the relative comparison is hurt. We’ve used discretion in setting up a scorecard—a resilient scorecard with pillars of financial, strategic and operational, risk and regulatory, and culture and talent, and [will score] one through five whether each point under those pillars is reached. We tried to create some degree of objectivity even though previous metrics had not been reachable. We also needed to determine what a capped amount for 2020 is.”

Overall, Malafis said, “You want to keep management engaged, but it won’t be at or above the target bonus—but it may not be a zero year. In a few cases, the performance is there to even support an above-target payout.”

Outstanding Performance Stock Units

A polling question asked attendees how the compensation committee will respond if their outstanding performance stock units (PSUs) have been impacted, and the majority, at 57 percent, said that they would make no adjustments. Other popular polling answers to the same question included that the committee will respond by adjusting performance goals or metrics to reflect COVID’s impact and the low-interest rate environment (21%), exercising discretion to adjust PSU payouts independent of calculated PSU awards (14%), and eliminating 2020 performance from the calculation (7%). No respondents said that they’d use pre-CECL methodology or net charge offs in place of provision.

Some respondents who answered that no adjustments would be made were concerned about accounting issues, such as the potential reversal of PSUs back into income.

“If you modify these PSUs, that would likely require disclosure of additional compensation in the proxy’s Summary Compensation Table; with annual incentives, you don’t necessarily have the same hurdles,” Hosken replied. “Companies making adjustments to PSUs—it’s hard to do. There are accounting and shareholder implications.”

Executive Retention

Hosken noted that stock prices for banks are still below pre-pandemic levels and asked, “With executive retention, are you going to have issues because the value of stock holdings are way down compared to companies in other industries?”

In the corresponding polling question, CAP asked if executive retention is currently a major concern for attendees and their boards. Almost half (52%) responded that it is not a primary concern right now, while 39 percent said it is, but no more so than last year. Nine percent replied that it is, and much more so than at the same time last year. In response, Hosken noted that these results are consistent with conventional wisdom. “Often you feel like talent will go to other banks, who are now facing the same situation. It would be more [of an issue] if there’s a concern that other businesses would recruit your talent.”

One attendee’s bank has seen two CEO departures in two years due, in part, to the coronavirus. “A variety of consultants told us it isn’t a good year to have much annual incentive compensation. At 40 percent of book value, it’s not terrible for banks we benchmark, but it’s below peers; that’s given us a lot of cover. All sorts of things seem to be going badly. But it’s tough because people worked extremely hard. In the CEO search, the response from consultants was really looking for us to focus on the long-term incentives part—it was portrayed as an industry shift toward multiple-year [incentives].”

Before and Beyond

In looking to the years ahead, the group also looked backward. One attendee asked for insight into the 2008 financial crisis and how what banks did then compares to what banks are doing now.

“The financial crisis was strange, lots of banks were subject to the [Troubled Asset Relief Program],” Hosken replied. “Pre-Provision Net Revenue was used frequently, there was a slower move into PSUs—it wasn’t heavy in the mix. They still had stock options. During the last crisis, banks were under scrutiny because they were viewed as partly responsible for the crisis—now it’s not so much about what the banks did, it’s something out of left field. I hope there’ll be more sympathy come proxy season.”

After the financial crisis, “banks asked how they could better adapt to unforeseen adverse impacts,” Malafis said. “More discretionary elements and metrics came about” as a result.

So, what changes were attendees considering at the time of the roundtable as they look toward the 2021 annual incentive design in light of COVID-19? For this polling question, respondents could select multiple answers, and 61 percent said that they would add relative measures or increase the weighting of relative measures, 33 percent would increase committee discretion, and 28 percent would consider using pre-provision performance measures, as well as wider performance ranges.

Hosken observed that a lot of compensation committees haven’t decided what they’re going to do yet. Between reflecting on 2020 and looking ahead to 2021, discretionary and wait-and-see approaches seemed to rule the day.

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