Two Ideas to Lower Operating Cost Per Account

Last week I wrote a TKG Perspective's article on Bank Profitability in 2019. I congratulated community financial institutions for delivering a positive trend in business checking account operating cost per account. The challenge is, aside from residential mortgages, all other product categories showed negative trends in operating cost per account.

In the below video blog, I offer two ideas to drive down long-term cost per account in other categories. 

Click HERE to view the TKG Perspectives article. 

Click HERE to view the cited blog post on re-thinking branch staffing.

~ Jeff

Bank Board Compensation: An Amateur's View

Lately I have been asked to opine on bank Board compensation. Although not a compensation expert by any means, I suspect I am being asked for an outside-the-box opinion. This reminds me of one of my colleagues favorite quotes; "those that live outside the box have never been in it." But with most areas that are outside of my technical expertise but within my industry expertise, I tend to revert to common sense.

What are we trying to accomplish with Board compensation?

The FDIC Pocket Guide for Directors identifies the Board's responsibilities as:

- Select and retain competent management.

- Establish, with management, the institution's long and short-term business objectives in a legal and sound manner.

- Monitor operations to ensure that they are controlled adequately and are in compliance with law and policies.

- Oversee the institution's business performance.

- Ensure the institution helps to meet its community's credit needs.

How do we establish a compensation plan that is consistent with the above?

I have opined in the past that financial institutions' fixed to variable expense equation tilts too much towards fixed. So why exasperate the situation by creating more fixed expense with Board compensation? 

But there are certain moral hazards to incentive compensation at the Board level. Basing it on short term financial performance encourages greater risk taking. And the Board is responsible for the safety and soundness of the institution. To overcome this moral hazard, I suggest two things: 1) make the incentive compensation based on three-year average performance, and 2) include safety and soundness metrics to the equation.

This is similar to an unnamed bank that was suggested to me by an industry compensation consultant. I looked it up in their proxy, and their plan, which was for both executive management and the Board, looked similar to the below table.

The unnamed bank did not name the performance metrics, calling them "Category 1", "Category 2", etc. because the actual metrics need not be disclosed. Shareholders that deem themselves compensation experts are a dime a dozen so why give them ammunition! 

So I decided to insert what I thought would be performance metrics consistent with Board responsibilities. 

The metrics are relative to a pre-selected peer group, which is very common in executive compensation. But rather than limiting performance metrics to short-term, the unnamed bank used three-year averages. Meaning that there would be no payout for the first three years. All calculations thereafter would be based on three-year averages.

This did two things: 1) encouraged longer-term thinking so strategic investments can be made so long as it improved longer term performance, and 2) discouraged short-term risk taking that might result in future losses. It is not perfect, but what plan is?

The above table goes beyond the traditional performance metrics, and includes risk ratios such as leverage ratio growth, non-performing assets to total assets, net charge-offs to loans, and the one-year repricing GAP to assets. These are all risk metrics. But they should also be consistent with the Bank's strategic plan. If the plan calls for better than market growth, perhaps the leverage ratio will decline in relation to peers, etc. In such a case, perhaps exceeding long-term projected leverage ratios would be the metric.

The final addition, which was not in the unnamed bank's comp plan, was achievement of strategic objectives. I have expressed my concern over banks short-term, budget-centric focus on business results that discourage long-term strategic thinking that builds sustainable institutions. Why would I encourage it in a Director Comp Plan? 

So achieving strategic objectives is a litmus test to making the incentive comp available for payment. Note that not all strategic objectives need to be achieved because incenting for 100% success encourages sand-bagging, which is another industry obstacle to long-term excellence.

If adopted, Director's that received $30,000 in annual compensation could be eligible for incentives that increase total compensation by one third. Not an immaterial sum. Such comp could be paid in cash or stock, and expensed as incurred.

I recently mentioned to an industry colleague and bank Board member that you don't want to create unfunded liabilities for Board compensation that will ultimately get deducted from a buyer's offer to your shareholders, should one come your way. The savvy shareholders will catch on, and could make your life a little uncomfortable. 

What are your thoughts on incentive comp for Board members?

~ Jeff

Best Branch: Incentives that count

I recently read, and subsequently reviewed (see post link below), The Nordstrom Way to Customer Service Excellence. In that book, the authors cited FirstMerit Bank as an example of a financial institution that implements Nordstrom-like tenets throughout their company. One concept mentioned was a competition for Best Branch. This got me thinking of how community banks could create an objective incentive system for branch personnel to culminate in the awarding of “Best Branch”.

So many banks create branch incentive systems that are opaque, i.e. not understood by the persons that are supposed to be motivated by them. If this describes your incentive system, I suspect it doesn’t properly motivate your branch personnel. When I was a branch manager many moons ago, my incentive system was totally transparent and I knew my quarterly bonus to the penny. Problem was that it was a sales system, which brings me to another challenge, incentives that position your bank as a product pusher. This incentive manifests itself in offering the product du jour to every customer your branch personnel comes into contact with, much like when my 20 year-old daughter’s bank called her for a home equity loan.

The final common challenge of branch incentive compensation is that it is not meaningful. It equates to nothing more than a holiday bonus. If any of these three branch incentive systems describes yours, I offer you the following to consider.

The jeff-for-banks (JFB) Best Branch Incentive System

The JFB branch incentive system consists of three components: Profit performance, customer service, and branch improvement. Each component is equally weighted to determine branch ranking in a hypothetical bank’s 20-branch system. The bonus is distributed as follows: Top quartile (ranked 1 through 5) receives a $40,000 bonus (for the entire branch); 2nd quartile receives a $25,000 bonus; and 3rd quartile receives a $15,000 bonus. The lower quartile receives either no bonus or the traditional small holiday bonus. An individual branch in hypothetical bank has approximately $250,000 in annual salary and wage expense. Therefore, top quartile performers’ bonus would equate to 16% of employees’ salaries... not an insignificant amount.

Profit Performance: The accompanying table illustrates how the system works. For spread measurement, hypothetical bank uses coterminous market rates to credit deposits, and to charge loans. Your bank can have some other method to determine spreads. So long as it is used consistently and you can explain it, it will provide the same incentive. There are three components to the profit performance piece: deposit spread plus fee income, loan spread less provision, and pre-tax profit. Using profitability as the driver for incentive compensation motivates branch personnel to focus on those customers and prospective customers that are most valuable to your bank… customers that don’t squeeze you for every nickel of rate or want all fees waived. Imagine the change in branch personnel behavior. Will they plead for a rate promotion to grow deposits? Will they contact their supervisor to give a CD-only customer a special rate? Or will they develop a calling plan to build deeper relationships with those customers that deliver superior spreads to your bank?

Customer Service: Many banks already utilize external mystery shopping firms to objectively gauge the quality and consistency of customer service. The JFB Best Branch Incentive System makes those scores meaningful to the pocketbook of those being measured.

Branch Improvement: The final measurement tool is how much the branch has improved in profit performance and customer service. It is recognition that moving a poor performing branch from point A to point B will receive its just rewards.

The JFB Best Branch Incentive System can have objective add-ons, such as awarding a branch a 0.50 kicker if they ranked 1st in any of the three categories. You decide what will best motivate your branch employees to execute on your bank’s strategy, continuously improve, and increase profits.

Making incentive compensation transparent and more meaningful will identify top performers, elevate their level of compensation, and make the branch a career destination instead of a waypoint to the next best thing. After all, keeping high performing branch bankers in critical customer contact positions is key to your success, isn’t it?

- Jeff

Link to Book Report: The Nordstrom Way to Customer Service Excellence

http://jeff-for-banks.blogspot.com/2010/03/book-report-nordstrom-way-to-customer.html