Compensation Advisory Partners (CAP) examined 2020 CEO compensation levels and pay practices among 40 regional banks. The banks were analyzed using three groups based on FY’20 asset size: $1B – $5B in assets (“small banks”; n=13), $5B – $10B in assets (“medium banks”; n=13) and $10B – $20B in assets (“large banks”; n=14). This report discusses both the similarities and differences in compensation levels and incentive plan design, including COVID-related compensation changes between the three groups. We also highlight current issues facing the banking industry in 2021 and as we head into 2022.

Highlights

• 2020 Performance and Pay Outcomes: 2020 was a down year for banks resulting in annual incentive payouts at or below target for all three groups; CEO compensation was generally flat compared to 2019 levels
• COVID-Related Compensation Changes: Over 60% of the banks made changes due to COVID to recognize the unforeseen impact of the pandemic and overall performance within a challenging year; most prevalent change was exercising discretion to adjust the annual incentive payout. Larger banks were more likely to make changes to incentive plans due to COVID as the larger banks place more weight on metrics impacted by loan loss provisions and less on qualitative (subjective) factors
• Total Pay Mix: As banks increase in size, a higher percentage of CEO total pay shifts from fixed compensation to at-risk or variable compensation
• Annual Incentive Plan Metrics: For all banks, the most prevalent metrics generally include Asset Quality, Efficiency Ratio, Earnings Per Share (EPS), Return on Assets (ROA), Net Income, and Return on Equity (ROE), with smaller banks also factoring in Loan and Deposit levels more frequently
• Long-Term Incentive Plan Metrics: For all banks, relative Total Shareholder Return (TSR), ROE, EPS and ROA are frequently used together
• Looking Ahead: Future monetary policy will play a key role in banks' financial performance. Specifically, inflation and the interest rate environment will have an impact on banks' profitability. Additionally, Environmental, Social, and Governance (ESG) continues to gain attention and is a topic increasingly discussed at the Compensation Committee and Board level

2020 Performance and Pay Outcomes

Performance Results

Across all banks in the sample, financial and stock performance were weaker in 2020 compared to a strong performance year in 2019. Impacting performance in 2020 was the COVID-19 pandemic, specifically, government mandated shut-downs, high unemployment leading many financial companies to provide relief on mortgages and interest rates kept at zero. Additionally, the volatility from current expected credit losses (CECL) and the new loan loss provisioning standard materially impacted earnings. Earnings somewhat benefited from the Paycheck Protection Program. Excluding the impact of loan loss provisions, pre-provision net revenue growth was strong for all the banks. When comparing financial performance across all three groups, the small banks had the strongest performance year in 2020. Medium banks had the weakest performance year among the three groups, as earnings were down the most compared to the small and large bank groups. Negative 2020 TSR for all banks in our sample was consistent with the downward TSR trend seen in the overall market and across larger banks.

CEO Annual Incentive Payouts

Small bank CEO annual incentive payouts as a percentage of target were the highest among the three groups, supported by stronger performance in 2020 based on the financials reviewed. Small banks paid annual incentives at 100 percent of target at median, and only five banks in the small bank group paid annual incentives below target, compared to seven banks in the medium bank group and eight banks in the large bank sample. Annual incentive payouts across all groups declined from 2019 levels, where all three groups generally paid out at or above target.

COVID-Related Compensation Changes

Over half of the banks in our sample made changes due to COVID to recognize the unforeseen impact of the pandemic and overall performance within a challenging year. As size increased, banks were more likely to make changes to compensation plans due to COVID, likely due to the larger banks placing more weight on metrics impacted by loan loss provisions and less weight on individual and strategic (qualitative) measures.

The most prevalent change was exercising discretion to adjust the annual incentive payout. Nearly all the companies that exercised discretion adjusted annual incentive payouts upward. Changes to outstanding long-term incentive plans were much less common.

These findings are consistent with institutional shareholder and proxy advisory firm guidance around COVID-related adjustments (more openness to adjustments for annual incentives and more scrutiny on adjustments to long-term incentives) and CAP's COVID-19 research on a sample of the S&P 1500.

Total Pay Changes

Consistent with stronger relative financial performance and higher annual incentive payouts as a percent of target, small banks were the only group to see CEO actual total compensation1 (base salary, annual incentive payouts, and long-term incentives) increase in 2020. For the medium and large banks, CEO actual total compensation was flat year-over-year. The 3.8% increase among the small banks was driven by a combination of base salary increases (+3.7%) and annual incentive payouts (+6.0%). While annual incentives were paid at target for small banks (vs. 109% of target in 2019), 2020 bonus opportunity increases led to a year-over-year increase in value, as increased salaries led to increased target bonus values. Long-term incentive values were flat for the small and large banks and increased for the medium banks (+3.9%). LTI grant date values are driven less by company performance and generally determined by competitive market positioning.

Chief Executive Officer (CEO) Pay Mix

Similar to our findings in prior-year studies, CEOs at the larger banks have higher pay levels and more of their total pay delivered in at-risk or variable compensation such as annual or long-term incentives. Conversely, CEOs at smaller banks are often paid more fixed compensation or base salary. For banks, asset size is a strong indicator of complexity as larger banks have more branches and a higher comprehensive list of financial accounts and services, corresponding to greater challenges and risks for management.

Pay Practices

Annual Incentive Plans

The most common annual incentive plan approach is a “goal attainment” plan where actual financial achievement is compared to pre-established goals made at the beginning of the fiscal year. The banks in our sample typically utilize several corporate metrics when determining their annual incentive payouts. Approximately 70 percent of the small, medium, and large banks use three or more weighted financial metrics. Asset Quality (i.e., non-performing assets, non-performing loan ratio), Efficiency Ratio, EPS, ROA and Net Income are the most prevalent metrics used at these banks. Returns (ROA or ROE), EPS and Net Income were typically weighted more (approximately 30-40 percent of the total plan) than Efficiency Ratio and Asset Quality metrics (approximately 15-20 percent of the total plan). The small banks differ from the medium and large banks in that they more frequently use Loan or Deposit measures in their plans, with these metrics accounting for no more than 20 percent of the total plan.

Small and medium banks also tend to use and assign higher weightings to individual performance. In all cases they represent 20-40 percent of the total plan as a standalone weighted metric. These individual measures are prevalent at 46 percent of the small and medium banks studied compared to 29 percent of the large banks; however, the large banks are more likely to incorporate strategic goals such as customer satisfaction, risk management, technology initiatives and community presence.

Long-term Incentive (LTI) Plans

The most typical long-term incentives used across industries, including the banking industry, include stock options, time-vested stock (restricted stock (RS) or restricted stock units (RSUs)) and performance-vested stock. Similar to the broader market, the banks in our sample use a portfolio approach in their long-term incentive plans, with approximately two-thirds granting two or three LTI vehicles. The small and medium banks more frequently use either a single LTI vehicle (36%) or have no long-term incentive plan (15%). The LTI mix seen between the three groupings is fairly consistent, with stock options continuing to be the least utilized LTI vehicle, averaging about 4 percent of the overall LTI mix. Time-vested RS typically makes up about 30 percent to 45 percent of the LTI mix among these banks, with performance plans comprising the bulk (about 50-65%) of LTIs in the total sample.

Performance plans are typically granted annually and have overlapping three-year performance periods. Payouts can fluctuate based on achievement of performance measures, and the upside is normally limited to 150 percent to 200 percent of the target level. Over three-quarters of companies in each asset grouping (that utilize performance plans) measure performance against two or more metrics. The most prevalent metrics used are relative TSR, Returns and EPS for all three groupings, and it is common that two of these measures are paired together to determine all, or the majority of, the payout. Asset Quality is a fairly prevalent metric among medium-sized banks (used by nearly a quarter of the companies).

TSR is almost exclusively measured on a relative basis, often against either the company-defined peer group or an industry index. In our sample of banks, relative TSR is more commonly installed as a weighted metric, and only 5 percent of all banks use it as a modifier of the calculated payout. Other common relative metrics include Returns and EPS growth. Among the total sample, 40 percent of banks use a relative measure other than TSR.

Looking Ahead

Federal Reserve Monetary Policy and Bank’s Loan Loss Provisions

As banks report third quarter 2021 financial performance, there continues to be uncertainty on the outlook of the economy and the financial performance of the banking industry. The following factors will have a lasting impact on 2021 and 2022 financial performance.

• Inflation and Impact on Interest Rates: As prices to continues to rise, the Federal Reserve may tighten monetary policy sooner than expected. Interests rates are near zero and with a rise in interest rates, banks' financials, profit margins and loan growth may be impacted depending on the monetary policy imposed by the Fed. Any increase in rates may deter borrowing and cut into demand for cars and houses, eventually slowing price increases and growth
• Government Aid Programs: Consumers and businesses were helped financially in 2020 from benefits and programs offered by the government; however, the additional income for consumers and businesses, as well as low interest rates, which were meant to bolster the economy, impacted banks' loan growth and overall profitability in 2021
• Loan Loss Provisions: Early in the pandemic, banks set aside billions of dollars to prepare for the recession, sending profits lower. Now that the economy has recovered more quickly than expected, banks have been releasing those reserves for several quarters, increasing their profits. It is not clear what “normal” financial performance is in the banking industry in the near term
• While stock price performance through September 30, 2021 has been strong for the banking sector (+23% for all banks), it is prudent for banks to be prepared for market uncertainty, and to understand how program changes can mitigate uncertainty and volatility.

ESG in Incentive Plans

ESG issues are hot-button topics among all companies, and more information is being disclosed in company filings and on their websites. Investors have increased their attention on company efforts on this topic, particularly Diversity, Equity & Inclusion (DE&I) and how progress in this area should be linked to executive pay. For banks, there is a growing focus on increasing diversity in the industry. The natural question is whether such initiatives should be including in compensation decision making. Only one bank in the sample (Trustmark Corporation) includes ESG, DE&I goals as part of a standalone weighted metric in the annual incentive plan. While not prevalent among our sample of 60 banks, Compensation Committees are discussing ESG objectives in the boardroom today. While larger banks tend to be the trendsetters, we expect smaller regional banks to follow suit, as there will be increased pressure from shareholders and the public.

Conclusion

Despite the impact COVID-19 had on bank financial performance in 2020, few companies in our sample adjusted their program designs in 2021. Compensation program practices have remained steady among our sample of banks. Adjustments for 2021 typically focus on the types of metrics used, goal setting for absolute and relative measures as well as building in some flexibility using wider performance ranges around target. For 2022, with the increased regulatory focus on ESG and continued investor attention on this topic, we expect banks to be clear on their ESG strategies and ultimately how they link to compensation. Bank directors and management teams will need to consider how to best align their pay programs with performance considering the external economic and regulatory environment.

For questions or more information, please contact:

Kelly Malafis Partner
[email protected]
212-921-9357

Shaun Bisman Principal
[email protected]
212-921-9365

Stefanie Kushner, Theo Allen and Fariha Haque provided research assistance for this report.

Regional Banks in CAP’s Study (n=40)

Small Banks ($1B – $5B in assets)

• Camden National Corporation
• Capital City Bank Group, Inc.
• Central Valley Community Bancorp
• CNB Financial Corporation
• Evans Bancorp, Inc.
• Farmers National Banc Corp.
• First Business Financial Services, Inc.
• First Financial Northwest, Inc.
• Heritage Commerce Corp
• Independent Bank Corporation
• National Bankshares, Inc.
• Sierra Bancorp
• Stock Yards Bancorp, Inc.

Medium Banks ($5B – $10B in assets)

• 1st Source Corporation
• Amerant Bancorp Inc.
• Banc of California, Inc.
• Brookline Bancorp, Inc.
• Enterprise Financial Services Corp
• First Commonwealth Financial Corporation
• First Foundation Inc.
• German American Bancorp, Inc.
• Lakeland Bancorp, Inc.
• Park National Corporation
• Seacoast Banking Corporation of Florida
• Univest Financial Corporation
• Westamerica Bancorporation

Large Banks ($10B – $20B in assets)

• Atlantic Union Bankshares Corporation
• Banner Corporation
• Berkshire Hills Bancorp, Inc.
• Cadence Bancorporation
• Community Bank System, Inc.
• First Busey Corporation
• First Merchants Corporation
• Glacier Bancorp, Inc.
• Great Western Bancorp, Inc.
• Heartland Financial USA, Inc.
• Pacific Premier Bancorp, Inc.
• Trustmark Corporation
• United Community Banks, Inc.
• WesBanco, Inc.

Compensation Advisory Partners (CAP) examined 2019 CEO compensation levels and pay and governance practices among 40 companies in the regional bank industry. The banks were stratified into three groups based on FY’19 asset size: $1B – $5B in assets (“small banks”; n=13), $5B – $10B in assets (“medium banks”; n=13) and $10B – $20B in assets (“large banks”; n=14). This report discusses both the similarities and differences in compensation levels, incentive plan design and governance practices between the three groups. We also highlight current issues facing the banking industry in 2020 and as we head into 2021.

Highlights

• Total Pay Mix: As banks increase in size, a higher percentage of CEO total pay shifts from fixed compensation to at-risk or variable compensation
• 2019 Financial Performance: Banks performed well in 2019 resulting in annual incentive payouts around target for all three groups; however, CEO annual incentives were lower than in 2018 as 2019 financial performance lagged 2018 growth levels
• Annual Incentive Plan Metrics: For all banks, the most prevalent metrics generally include Efficiency Ratio, Asset Quality, Return on Assets (ROA), Earnings Per Share (EPS), Return on Equity (ROE), and Net Income with smaller banks also factoring in Loan and Deposit levels more frequently
• Long-Term Incentive Plan Metrics: For all banks, relative Total Shareholder Return (TSR), EPS, ROA and ROE are frequently used together. Medium and large banks are more likely to measure performance on both an absolute and relative basis
• Stock Ownership Guidelines: All large banks have policies in place for executives compared to less than three-fourths of small and medium banks
• Clawback Policy: Across all banks in our study, over 80 percent have a policy that extends beyond Sarbanes-Oxley requirements. More of the large banks have a policy in place compared to the small and medium banks
• Looking Ahead: The impact of COVID-19 on incentive plans and the 2020 presidential election is creating a lot of uncertainty as banks close out 2020 and prepare for 2021. Additionally, diversity and inclusion will continue to gain attention and is a topic increasingly discussed at the Compensation Committee and Board level

Chief Executive Officer (CEO) Actual Pay Levels and Mix

Similar to our findings in prior year studies, CEOs at the larger banks have higher pay levels and more of their total pay delivered in at-risk or variable compensation, such as annual or long-term incentives. Conversely, executives at smaller banks are often paid more fixed compensation or base salary. For banks, asset size is a strong indicator of complexity as larger banks have more branches, products, and services offerings, corresponding to greater challenges and risks for management.

Specifically, 52 percent of compensation was fixed at the small banks compared to 43 and 32 percent at the medium and large banks, respectively. Larger banks also grant more compensation in the form of equity, which is tied to either multi-year vesting and/or performance criteria. These equity grants make up 32 percent of medium bank pay for CEOs and 40 percent at the large banks in the sample. By comparison, small banks only grant 21 percent of their compensation in these long-term equity vehicles.

2019 Performance and Pay Outcomes

Performance Results

Financial performance showed strong growth in 2019. Comparing 2018 to 2019, 2018 was a better year for the banks, which can be attributed, in part, to three interest rate cuts in 2019 (first rate cuts since 2008), creating pressure on net interest margins. Small banks had the strongest performance year among the three groups in 2019 with the majority performing in line with analyst expectations. Large banks had the weakest performance year among the three groups as more than half of the large banks underperformed against analyst expectations. ROE increased for only the small banks and one-year TSR was strong for all groups, significantly outpacing 1-year 2018 TSR. Strong 2019 TSR was consistent with the upward TSR trend seen in the overall market and super regional and Wall Street banks.

CEO Annual Incentive Payouts

Overall, the small banks had the strongest year of the three groups in 2019 based on the financials reviewed. This performance was ultimately rewarded by annual incentive plans, as seen in CEO annual incentive payouts. Small banks had the highest annual incentive payouts as a percentage of target, 109 percent, and only four banks in the small bank group paid annual incentives at or below target, compared to seven banks each in the medium and large bank sample. Annual incentive payouts across all groups declined from 2018 levels, where all three groups generally paid out above target.

Total Pay Changes

CEO actual total compensation (base salary, annual incentive payouts, and long-term incentives) increased in 2019. The largest increases were at the large and small banks (9.6% and 5.2%, respectively) which was driven by a combination of base salary increases and larger long-term equity grants. While annual incentives were paid at target for medium banks, 2019 bonus opportunity increases led to a 14.6% year over year increase in value. The increase in long-term incentives was likely due to strong performance in 2018, as long-term incentives are generally granted in the first quarter (early 2019) and based on prior year (2018) performance. Large banks performed stronger in 2018 compared to the small and medium banks, which may explain the larger year-over-year increase in long-term incentives.

Pay Practices

Annual Incentive Plans

The most common annual incentive plan approach is a “goal attainment” plan where actual financial achievement is compared to pre-established goals made at the beginning of the fiscal year. The banks in our sample typically utilize several corporate metrics when determining their annual incentive payout. Approximately 75 percent of the small, medium, and large banks use three or more weighted financial metrics. Efficiency Ratio, Asset Quality (i.e., non-performing assets, non-performing loan ratio), ROA, EPS, ROE and Net Income are the most prevalent metrics used at these banks. Returns (ROA or ROE), EPS and Net Income were typically weighted more (approximately 30-40 percent of the total plan) than Efficiency Ratio and Asset Quality metrics (approximately 15-20 percent of the total plan). The small banks differ from the medium and large banks in that they more frequently use Loan or Deposit measures in their plans, with these metrics accounting for no more than 20 percent of the total plan.

Smaller banks also tend to use and assign higher weightings to individual performance. In all cases they represent 20-50 percent of the total plan as a standalone weighted metric. These individual measures are prevalent at 46 percent of the small banks studied compared to 14-15 percent of the medium and large banks; however, the medium and large banks are more likely to incorporate strategic goals such as digital strategies, community presence or customer satisfaction.

Long-term Incentive (LTI) Plans

The most typical long-term incentives used across industries, including the banking industry, include stock options, time-vested stock (restricted stock (RS) or restricted stock units (RSUs)) and performance-vested stock. Most medium and large banks use a portfolio approach in their long-term incentive plan, with approximately two-thirds of these banks granting two or three LTI vehicles. The small bank sample more frequently either uses a single LTI vehicle (38%) or has no long-term incentive plan (15%). The LTI mix seen between the three groupings is fairly consistent, with stock options continuing to be the least utilized LTI vehicle, on average about 8 percent of the overall LTI mix. Time-vested restricted stock typically makes up about 30 percent to 40 percent of the LTI mix among these banks, with performance plans making up the bulk (about 50-65%) of LTIs in the total sample.

Performance plans are typically granted annually and have overlapping 3-year performance periods. Payouts can fluctuate based on achievement of performance measures, and the upside is normally limited to 150 percent to 200 percent of the target level. Over three-quarters of companies in each asset grouping (that utilize performance plans) measure performance against two or more metrics. The most prevalent metrics used are relative TSR, Returns, EPS, and Asset Quality for all three groupings, and it is common that two of these measures are paired together to determine all, or the majority of, the payout. Asset Quality is a fairly prevalent metric among medium sized banks (used by a third of the companies).

As banks increase in size, it becomes more likely that both absolute and relative comparisons are made when determining payouts; 42 percent of the large and medium banks look at performance on both an absolute and relative basis compared with 12 percent of small banks. These smaller banks may be challenged in setting 3-year goals, and, therefore, rely more heavily on relative performance.

TSR is almost exclusively measured on a relative basis, often measured against either the company-defined peer group or an industry index. In our sample of banks, relative TSR is more commonly installed as a weighted metric and only 5 percent of all banks use it as a modifier of the calculated payout. Other common relative metrics include Returns, EPS and Loan or Deposit growth.

Governance Practices

Stock Ownership Guidelines

The prevalence of stock ownership guidelines among the different asset groupings varies by group. All of the large banks have stock ownership guidelines in place for the named executive officers (NEOs) compared to 69 percent at the medium banks and 54 percent at the small banks. The larger banks grant a larger portion of long-term incentives in equity; therefore, it should not be surprising that executives must meet a required ownership guideline.

Clawbacks

The proposed rules under the Dodd-Frank Act require companies to adopt policies that would claw back incentive compensation paid to current and former executives based on inaccurate financial results. Despite the rules being proposed in 2015 and not being finalized to date, many companies have adopted policies that are similar to the anticipated rules. Among our sample of banks, 83 percent of banks across all asset sizes have a clawback policy in place. The prevalence is greatest among the large banks.

Approximately 50 percent of the banks across all asset sizes have clawback triggers for financial restatement regardless of fraud or misconduct and 36 percent of banks can recoup incentive compensation due to fraud, misconduct, or material inaccurate financials beyond a financial restatement.

It is common for organizations to adopt stronger governance protocols such as stock ownership guidelines and clawback policies as they increase in size and may be more closely scrutinized by investors, regulators, and proxy advisory firms.

Looking Ahead

Impact of COVID-19 on Incentive Plans

Many banks set their 2020 incentive plan goals early in the year, before the onset of the COVID-19 pandemic in the U.S. As the second half of 2020 continues and the true economic impact of COVID-19 is felt globally, CAP expects some banks to use discretion to adjust 2020 annual incentive payouts, widen or change goals for outstanding performance-vested LTI goals and modify the 2021 annual incentive and LTI design. Most banks are waiting until year end to make specific decisions on any potential adjustments to incentives, as companies will try to quantify the COVID-19 related impact and address elements that were outside of management’s control (i.e., zero interest rate environment). Further, with stock prices down over 30 percent to date, equity worth less today compared to the grant date fair value, and annual and long-term performance plans projected to pay out well below target, Compensation Committees may feel the pressure to adjust incentive plan payouts or award retention bonuses in order to motivate and retain key talent.

Diversity and Inclusion Metrics in Incentive Plans

Diversity and inclusion is a topic that is increasingly being discussed among Board members and Compensation Committees specifically. With a growing focus on increasing diversity in the industry, the natural question is whether such initiatives should be included in compensation decision making. One large bank in our sample considers the achievement of certain diversity and inclusion targets as part of its individual assessment. While currently a minority practice to include diversity and inclusion measures in incentive plans, a discussion around each banks' diversity and inclusion statistics is increasingly becoming an agenda topic at Board meetings.

Given today’s climate, CAP expects an increase in the number of companies measuring the progress of diversity though the approach may vary between a quantitative metric or a more qualitative assessment. Compensation Committees have the flexibility to tailor goals that will impact payouts to the executives most responsible for this progress. The inclusion of diversity and inclusion progress in incentive compensation plans could highlight the importance of a company’s commitment to these objectives.

2020 Presidential Election

The banking industry has generally benefited from the policies of the current administration and reduced level of regulations. Two recent pieces of legislation have had a positive impact on the banking industry’s financial performance.

• 2017 Tax Cuts and Jobs Act: Meaningful benefit for corporations due to the reduced corporate tax rate
• 2020 Coronavirus Aid, Relief, and Economic Security Act: Benefited banks from fee income related to the Paycheck Protection Program loans

By contrast, the Democratic candidate Joe Biden plans to raise taxes and stiffen oversight of the banking industry. Given the uncertainty regarding taxes and regulation, banks financials may be impacted with an increase in taxes and heavier regulation in 2021 and beyond.

Conclusion

Compensation program practices have remained steady among our sample of banks. We expect to see changes in 2020 and beyond given the pandemic and focus on diversity and inclusion. As was the case after the 2008/2009 financial crisis, the ability to adjust and adapt to a changing environment is critical to the success of banks in attracting, motivating, and retaining key talent. While employee retention will be a key objective for management and Compensation Committees, banks must balance rewarding employees for their extraordinary efforts in response to the pandemic with pay for performance alignment and the shareholder experience. Further, given the heightened focus on diversity and inclusion and public commitments to diversity, companies are committing resources for initiatives aimed at promoting a diverse and inclusive workplace. We expect banks in our study to continue their efforts to make progress on the diversity and inclusion front.

For questions or more information, please contact:

Kelly Malafis Partner [email protected] 212-921-9357

Shaun Bisman Principal [email protected] 212-921-9365

Chris Callegari Senior Analyst [email protected] 646-486-9747

Stefanie Kushner and Felipe Cambeiro provided research assistance for this report.

Regional Banks in CAP’s Study (n=40)

Small Banks ($1B – $5B in assets)

• Bridge Bancorp, Inc.
• Capital City Bank Group, Inc.
• Central Valley Community Bancorp
• CNB Financial Corporation
• Evans Bancorp, Inc.
• Farmers National Banc Corp.
• First Business Financial Services, Inc.
• First Financial Northwest, Inc.
• German American Bancorp, Inc.
• Heritage Commerce Corp
• Independent Bank Corporation
• National Bankshares, Inc.
• Sierra Bancorp

Medium Banks ($5B – $10B in assets)

• 1st Source Corporation
• Amerant Bancorp Inc.
• Banc of California, Inc.
• Boston Private Financial Holdings, Inc.
• Brookline Bancorp, Inc.
• First Busey Corporation
• First Commonwealth Financial Corporation
• First Foundation Inc.
• Lakeland Bancorp, Inc.
• Park National Corporation
• Seacoast Banking Corporation of Florida
• Univest Financial Corporation
• Westamerica Bancorporation

Large Banks ($10B – $20B in assets)

• Ameris Bancorp
• Atlantic Union Bankshares Corporation
• BancorpSouth Bank
• Bank of Hawaii Corporation
• Berkshire Hills Bancorp, Inc.
• Cadence Bancorporation
• Community Bank System, Inc.
• First Merchants Corporation
• First Midwest Bancorp, Inc.
• Glacier Bancorp, Inc.
• Great Western Bancorp, Inc.
• Old National Bancorp
• Trustmark Corporation
• United Bankshares, Inc.

Compensation Advisory Partners (CAP) examined executive compensation levels and design practices at 12 publicly traded, U.S. investment banks. The 12 companies in the study are independent, advisory-focused investment banks, and they have a revenue range of $100 million to $7.7 billion. As an additional reference point for comparison purposes, CAP also reviewed executive compensation levels and practices at three large, diversified financial institutions (“Wall Street Banks”) with significant investment banking operations. Revenue at the Wall Street Banks ranged from $35.5 billion to $110.0 billion.1 CAP also assessed the impact of the COVID-19 pandemic on the investment banks' performance and pay programs.

Key Takeaways:

• The COVID-19 pandemic has stifled mergers and acquisitions activity – both in the United States and globally – since early March. The outlook for the rest of 2020 remains uncertain.
• The investment banking industry’s approach to incentive compensation is significantly different than standard practice in most other industries. It is important to understand the investment banking pay model to effectively evaluate market data.
• Median pay levels for chief executive officers (CEOs) decreased 6.5 percent, in line with the modest decrease in operating margin among these companies from 2018 to 2019. Pay levels for chief financial officers (CFOs) increased 7.8 percent because of incumbent changes, while pay levels for other named executive officers (NEOs) decreased 5.6 percent.
• The median compensation and benefits ratio increased by 4 percentage points, from 59.9% to 63.9%

The Impact of COVID-19 on the Investment Banking Industry

The pandemic jolted the global economy and derailed mergers and acquisitions activity. Barron’s recently reported that second-quarter mergers-and-acquisitions deal value was down 83 percent in the United States and 52 percent globally. Of note, results are not down in all business areas at investment banks. For example, 2020 has been a busy year for restructuring groups and in trading operations.

Compensation and benefits are the largest expense category for investment banks, and the biggest component of compensation is annual year-end bonuses. This variable cost structure provides investment banks with more flexibility than companies in other industries to better understand (i.e., wait and see) the full-year impact of the pandemic before taking broad-based employment actions, such as potential reductions in headcount.

In response to COVID-19, two investment banks announced pay cuts at the executive level, although one action was disclosed as being volunteered by the CEO. To date, the remaining employment actions in response to COVID-19 were positive, such as increased paid time off and new virtual health benefits. Two investment banks announced plans to honor analyst and associate employment offers, either now or in 2021. The bank that proposed 2021 start dates offered a deferral bonus for new hires.

Results during the remainder of 2020 will be significantly impacted by the course of the pandemic, the execution of backlogged deals and the appetite for new deals, whether opportunistic or strategic. Currently, consensus analyst estimates project more than a 25 percent decline in profits and a one percent decrease in revenue, at median, among these investment banks from 2019 to 2020. Should these projections materialize, they will trigger a corresponding decrease in year-end incentive pools. Targeted headcount reductions would also be likely, with variation by firm.

A Unique Industry

From economic, performance and compensation perspectives, independent investment banks stand apart from general industry and other financial services firms. The unique aspects of the industry are important to understand when looking at executive compensation levels and practices.

Human Capital Focus. The investment banking industry has a strong human capital focus: The industry’s most valuable assets are its people. Most individuals in the industry are highly educated, trained and compensated. A firm’s success depends on its ability to attract, reward, and retain highly skilled bankers with strong business networks and deal-execution skills. Given the industry’s human capital focus, the largest expense category is compensation and benefits.

Year-to-Year Results. Like most professional services firms, investment banks focus heavily on year-to-year financial metrics, such as revenue growth, operating margin, and profitability. The industry tends to be cyclical and sensitive to overall economic conditions. In addition, a firm’s results for the year can be skewed by factors such as a large deal closing in January instead of prior to December 31.

A key metric in the evaluation of most senior, non-corporate investment-banking professionals is annual revenue generation. Long-range planning is largely limited to senior corporate executives, and firm investments often generate returns more quickly than in capital-intensive industries.

The Investment Banking Pay Model. Investment banks approach executive compensation in a manner that is distinct from general industry norms. At investment banks, each year a total incentive is determined based on an often-discretionary review of prior-year performance. The total incentive is then delivered to executives as a mix of annual cash bonuses and deferred, long-term incentive compensation. Of the investment banks in CAP’s study, all but one use this investment banking pay model for top executives, as do all three Wall Street Banks.

The investment banking pay model contrasts with the broadly used, traditional compensation model where annual and long-term incentive components are separate and determined independently. In most other industries, the annual cash incentive is often determined in a structured, formulaic manner, and the annual long-term incentive grant value is largely market-based, with the target grant value being typically independent of prior-year performance.

While executive incentive awards in the investment banking industry tend to be more discretionary in nature when juxtaposed with the more formulaic approach used in general industry, the investment banks do base their year-to-year incentive decisions on specific criteria, such as revenue and profitability. In fact, several of the investment banks in the study disclosed information about their incentive decision-making processes, which can be thought of as following a “structured discretion” approach.

2019 Industry Performance

The investment banks in CAP’s study reported mixed operating results for 2019. Revenue increased 2.5 percent, and pre-tax operating income increased 5.2 percent. Notably, operating margins decreased 3.0 percent, while return on equity (ROE) was flat. Total shareholder return (TSR) – which quantifies stock price appreciation and dividends – was up 17.5 percent during 2019, buoyed by a strong stock market.

In addition to financial and market-based performance measures, investment banks also track and report a human-capital metric, the compensation and benefits ratio. This ratio expresses compensation and benefits expenses as a percentage of revenue. The median compensation and benefits ratio among CAP’s investment banking sample increased by 4 percentage points for full year 2019 versus full year 2018. The increased compensation and benefits ratio reflects the industry’s modest revenue growth being outpaced by human capital costs.

Source: S&P Capital IQ financial database

As expected, the compensation and benefits ratio is higher for the investment banks in the study relative to the Wall Street Banks. The Wall Street Banks have a more diversified workforce in terms of employee roles and pay levels.

Named Executive Officer (NEO) Compensation

CAP analyzed 2018 and 2019 pay levels for the five NEOs disclosed in proxy statements by each of the investment banks. We assessed compensation by position for the CEO and CFO, and as a group for the remaining NEOs. From 2018 to 2019, base salaries were flat across all NEO roles. Base salaries are often not increased on an annual basis for senior leadership roles at investment banks.

Incentive pay, which includes annual bonuses and long-term incentives, decreased 7.1 percent from 2018 to 2019, at median, for CEOs and 6.3 percent for other NEOs. Similarly, total direct compensation decreased 6.5 percent, at median, for CEOs and 5.6 percent for other NEOs. These pay decreases are significant as they include a decrease in the grant-date value of long-term incentives, the largest component of compensation. The investment banking pay model resulted in incentive awards aligned with financial results.

In contrast, incentive pay increased 8.4 percent from 2018 to 2019, at median, for the CFO role, and total direct compensation increased 7.8 percent. The increase in CFO incentive pay for 2019 can be primarily attributed to incumbent changes and recognition of contribution to successful completion of a merger/acquisition.

Pay Mix and Incentive Compensation

As shown in the pay-mix charts that follow, the investment banking industry places significant emphasis on performance-based, variable incentive compensation. Annual CEO compensation was 89 percent performance-based in 2019, on average. CFO compensation was 79 percent performance-based, and other NEO compensation was 85 percent performance-based. Annual incentives represented 42 percent of total compensation for investment banking CFOs and other NEOs. In contrast, CEO compensation focuses more heavily on long-term incentives, with the grant-date value of long-term incentive awards making up 58 percent of total compensation.

Investment banks deliver incentive compensation using a mix of cash and deferred equity vehicles, such as restricted stock, restricted stock units (RSUs) and performance share units (PSUs). The long-term incentive component adds a retention hook by deferring payment of a portion of annual incentive pay, most typically for three years. It also provides a link to the company’s long-term shareholder value creation. A significant portion of compensation for investment banking NEOs is deferred and delivered through restricted stock, RSUs and PSUs. Approximately two-thirds of incentive pay is deferred for CEOs, while about half of incentive pay is deferred for CFOs and other NEOs.

The investment banks in this study have been gradually shifting their mix of long-term incentive vehicles to include PSUs. Most CEOs in the study group now receive annual PSU awards, with prospective, generally three-year performance requirements. Among the CEOs who receive PSUs, close to half of long-term incentive compensation is provided through these awards. The most common performance metrics associated with PSUs in the investment banking industry are TSR and return measures, such as return on equity (ROE), followed by revenue growth and operating margin. Performance-based long-term incentive vehicles such as PSUs, with prospective multi-year goals, are favored by Institutional Shareholder Services (ISS) and Glass Lewis, the two most prominent proxy advisory firms.

Specific to 2020, while the full economic impact of the COVID-19 pandemic will not be known for quite some time, compensation committees should evaluate their “in flight” PSU awards. As of July 2020, the stock prices for the investment banks studied are now near, equal to, or above where they were before the COVID-19 pandemic. In contrast to the shareholder experience—recognizing that two of the investment banks temporarily reduced dividend payments—in-flight PSU awards that have absolute performance goals are now projected to pay out below target or not at all. Compensation committees should consider whether this reflects the intended pay-and-performance alignment.

Compensation should be used as a management tool to support business strategy. Accordingly, PSU performance goals are often based on financial metrics, such as ROE, revenue growth, or operating margin, that are aligned with the companies’ business plans. Also, many companies’ compensation plans try to correct for events that are outside management’s control. The pandemic disrupted many companies’ annual and long-term business plans. Compensation committees may want to evaluate their in-flight PSU awards and consider improvements that better align pay and performance. Adjustments to consider include relative performance measures instead of absolute measures, the implementation of pre-defined or discretionary adjustments to the calculation of metrics so that management is not penalized for events outside its control, among other alternatives.

Equity Overhang

CAP also analyzed equity overhang, which is a measure of potential shareholder dilution. Median equity overhang for the investment banks was 31 percent, up from 28 percent last year. Notably, the median equity overhang among the investment banks studied exceeds ISS “excessive dilution” thresholds. The ISS thresholds do not consider industry-specific factors, such as investment banking’s human-capital focus and the partnership model from which these public companies emerged. In contrast, the average equity overhang for the Wall Street banks was 11 percent.

ISS uses its Equity Plan Scorecard (EPSC) model to determine its shareholder vote recommendation for new share requests for equity and incentive compensation plans. The EPSC includes certain “overriding” factors, one of which is “excessive” dilution. This factor, which applies to S&P 500 and Russell 3000 EPSC models only, will be triggered by ISS when the company’s equity compensation program is estimated to dilute shareholders’ holdings by more than 20% (S&P 500 model) or 25% (Russell 3000 model). This overriding factor may warrant an ISS “against” vote recommendation, despite an acceptable overall EPSC score. All but one of the investment banks in the study are in the Russell 3000, while only two of the companies are in the S&P 500. All three Wall Street banks are in both indices.

Two-thirds of the investment banks studied have equity overhang levels that would exceed the ISS “overriding” factor threshold. This indicates that, for a majority of publicly traded investment banks, ISS would likely recommend that shareholders vote against a new share request, no matter what the plan features are or what the benefits of maintaining an ongoing equity compensation plan are to various stakeholders, including the company, employees and shareholders. The ISS “overriding” factor threshold does not make sense for the investment banking industry and exemplifies why industry-specific understanding is important when designing and evaluating compensation programs.

When publicly traded investment banks seek shareholder approval for new share requests, shareholder outreach is advisable, and the resolution should include information that makes a strong case for the share request. Also, setting internal expectations for the likely (low, but passing) level of shareholder support is important. For example, among non-S&P 500, Russell 3000 investment banks, median shareholder support for such new share requests during the past three years was 68 percent. ISS recommended that shareholders vote against all but one of the proposals, but each time the proposals passed with majority shareholder support (albeit, with lower support than broader market norms).

Equity Run Rate

CAP also analyzed the equity run rates for the investment banks. The equity run rate measures shareholder dilution from equity grants made in a particular fiscal year. In recent years, the median annual gross run rate for the investment banks has ranged from 3.2 percent to 4.5 percent. The three-year average gross burn rate is 4.3 percent at median.

Given its human-capital focus and approach to incentive compensation, this industry often focuses more on the net run rate, which takes into account forfeitures and repurchases, than on the gross run rate used in most industries. For example, the net run rate is frequently the only version of run rate discussed in new share request proposals in this industry. Among the investment banks studied, the median net run rate has ranged from approximately -3.0 percent to -0.2 percent in recent years, with a three-year average net run rate of -1.0 percent, at median. In this industry, buybacks are often viewed as a tool used to limit or net-out annual shareholder dilution from compensation programs.

Peer Groups for Compensation Benchmarking

CAP assessed the size and composition of the peer groups used by investment banks for compensation benchmarking purposes. Publicly traded companies generally disclose the peer groups they use for compensation benchmarking purposes in their annual proxy statements. Relative to most other industries, the peer groups used by the investment banks are smaller and more industry focused.

Among the investment banks studied, the median peer group size is 12 companies, while the 75th percentile is 13 companies. The peer group size for the Wall Street banks is even smaller, with an average of 6 companies. In contrast, a recent Equilar and CAP study of 500 companies across different industries found the median peer group size to be 17 companies.

The investment banking peer groups are smaller than those used in most other industries because the executive compensation programs in this industry are unique (see “Investment Banking Pay Model” above), and companies choose to compare themselves mostly with publicly traded direct competitors – of which a limited number exist. This is very different than how peer groups are approached in many other industries where companies are screened more broadly for size and other operating metrics. In the 500-company general industry sample noted above, only 8 percent of companies maintained a peer group where at least 75 percent of constituent companies were from the same industry classification, and only 30 percent of companies maintained a peer group where 100 percent of constituent companies were from the same industry sector classification.

CEO Pay Ratio

The CEO pay ratio, which most public companies are required to report annually in the proxy statement, is the ratio of CEO compensation to that of the median employee. For the investment banks, CEO compensation in 2019 was 40 times the compensation of the median employee at their companies. This is significantly less than the median CEO pay ratio among Russell 3000 companies, which was 80 times the compensation of the median employee. The lower CEO pay ratio at investment banks is driven by much higher median employee pay relative to general industry.

The average CEO pay ratio for the three Wall Street Banks was 282 times in 2019, much higher than both the investment bank and the Russell 3000 pay ratios. Among the Wall Street Banks, CEO pay averaged $30 million, and the average median employee pay was nearly $105,000. CEO pay at the Wall Street Banks reflects the size and complexity of the organizations, and the lower median employee pay reflects the greater variety of business lines and employee roles.

Conclusion and Looking Ahead

During 2019, the investment banks in CAP’s study rewarded executives commensurately with operating performance outcomes. Looking ahead, we expect to see an increasing prevalence of PSU awards – with prospective, pre-defined, multi-year performance goals – for corporate leaders at public investment banks. We have seen the industry heighten its focus on gender pay equity and representation by women in the management ranks; this trend will continue.

The industry outlook for the rest of 2020 remains uncertain and depends on the course of the pandemic, the execution of backlogged deals and the appetite for new deals, whether opportunistic or strategic. Unless business results significantly improve during the balance of the year, 2020 incentive funding will be down, likely double digits for advisory and, to a lesser extent, for underwriting.

Even during economic downturns, top talent will be sought. Companies can choose to compete or fall behind. Given the industry emphasis on year-end incentives, further cost-cutting and headcount reductions will be increasingly likely — especially if a quick recovery is not the consensus expectation — with variation by firm and across different business lines and areas of industry focus and expertise.

Lastly, designing an effective executive compensation program in investment banking requires real-time industry insights, deviation from the market practices that are common in other industries, and a compensation-focused shareholder communication strategy that specifically addresses industry-specific distinctions.

For questions or more information, please contact:

Bonnie Schindler Principal [email protected] 847-636-8919

Matt Vnuk Partner [email protected] 212-921-9364

Zaina Jabri, Stefanie Kushner and Brooke Warhurst provided research assistance for this report.

Appendices

Investment Banks

• Cowen Inc.
• Evercore Inc.
• Greenhill & Co., Inc.
• Houlihan Lokey, Inc.
• Jefferies Financial Group Inc.
• JMP Group LLC
• Lazard Ltd
• Moelis & Company
• Piper Sandler Companies
• PJT Partners Inc.
• Raymond James Financial, Inc.
• Stifel Financial Corp.

Selected Wall Street Banks

• The Goldman Sachs Group, Inc.
• JPMorgan Chase & Co.
• Morgan Stanley