Compensation Advisory Partners (CAP) conducted a study of executive compensation trends in the regional banking industry. The study examined 2023 CEO compensation levels and pay practices among 40 regional banks across three groups based on FY’23 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 compares both compensation levels and incentive plan design across the groups and highlights current issues facing the banking industry in 2024.

Highlights

2023 Performance and Pay Outcomes

Performance Results

Bank financial performance was down in 2023 as banks shifted their priorities to focus on deposit gathering vs. loan growth following bank shutdowns at Silicon Valley Bank, Signature, and First Republic early in 2023. Many banks also undertook cost-cutting measures to rein in pandemic-era overexpansion and withstand persistent economic uncertainty. Amid this environment, earnings, profitability and return metrics largely declined in 2023 vs. 2022.

Among the three groups, small banks performed the best in 2023, with EPS and Net Income declining at a slower rate compared to medium and large banks. As of December 31, 2023, small banks also outperformed in TSR over 1- and 3-year periods, although the 1-year TSR still reflected a 4.5 percent decline compared to the previous year.

CEO Annual Incentive Payouts

At median, CEO annual incentive payouts were at or below target across all groups and notably decreased 18 percent, 40 percent and 46 percent year-over-year for the small, medium and large banks, respectively; 28 banks (70 percent of total sample) paid bonuses below target compared to 11 last year. Payouts among the three groups notably decreased at all percentiles year-over-year, which can be attributed to the banks’ weaker performance in 2023.

Annual incentives would have decreased further if not for adjustments to financial metrics. In response to the banking crisis, just over one-third of companies with formulaic or goal-based plans modified their bonus plan metrics or provided a discretionary payout. 8 percent of these banks (n=3) would have paid no annual incentive but opted to adjust their metrics or provide a discretionary bonus. Banks commonly adjusted for the interest rate environment, the special FDIC assessment, and deposit volumes.

Total Pay Changes

Consistent with 2023 financial performance and annual incentive payouts as a percent of target, CEO actual total compensation1 (base salary, annual incentive payouts, and long-term incentives) increased modestly for the small banks and decreased for the medium and large banks. Large banks experienced the steepest decline in total compensation (-7 percent), followed by medium banks (-1 percent), while CEO pay at small banks rose by 3 percent. The 7 percent decline at large banks was primarily driven by a 30 percent drop in annual incentive payouts. Medium banks saw a 1 percent decrease, also largely due to a 26 percent reduction in annual incentives, though this was partially offset by a 6 percent increase in long-term incentives. Small banks saw modest increases of 3 percent to 4 percent in CEO cash compensation, while long-term incentive values remained flat year-over-year for both small and large banks. Long-term incentive grant values were less influenced by company performance and were generally determined by competitive market positioning. The significant decrease in annual bonuses for medium and large banks was attributable to their weak financial performance in a challenging operating environment. Additionally, bonuses fell because performance goals had been set prior to the 2023 banking crisis, as banks shifted their strategy to focus on new priorities. Approximately 75 percent of medium and large banks paid bonuses below target, while around 60 percent of small banks did the same. Like in 2022, base salary values remained steady across the banks, with median increases ranging from 4 percent to 6 percent.

Chief Executive Officer Pay Mix

Similar to our findings from prior years, CEOs at the larger banks have higher overall pay levels and more of their total pay delivered in at-risk or variable compensation (i.e., annual or long-term incentives). Conversely, CEOs at smaller banks are often paid more fixed compensation (i.e., base salary). The portion of total compensation delivered in the form of annual incentives shrunk for both medium banks – from 32 percent in 2022 to 19 percent in 2023 – and large banks – from 34 percent in 2022 to 24 percent in 2023 – stemming from the steep year-over-year decline in payouts for these groups. Since the CEO pay mix reflects actual compensation, greater emphasis is placed on base salary and long-term incentives in 2023 for medium and large banks. The pay mix for small banks was similar year-over-year.

Pay Practices

Annual Incentive Plans

The most common approach to funding annual incentive plans is "goal attainment," where actual financial performance is measured against pre-established targets set at the start of the fiscal year. The banks in our sample typically utilize several corporate metrics when determining their annual incentive payouts. Approximately 75 percent of the small, medium and large banks use three or more weighted financial metrics. EPS, Efficiency Ratio, Asset Quality (i.e., non-performing assets, non-performing loan ratio) and ROA are among the most prevalent metrics used at these banks. Among the banks that use them, Earnings (EPS and Net Income) were typically weighted more (on average approximately 40 percent of the total plan) than Returns (ROA or ROE), Efficiency Ratio and Asset Quality metrics (approximately 15 to 25 percent of the total plan). The small and medium banks differ from the large banks in that they more frequently use Loan or Deposit measures in their plans, with these metrics accounting for no more than 25 percent of the total plan.

Individual goals are prevalent among all asset groups. The small and medium banks predominantly incorporate individual performance as a standalone weighted metric (typically 20 percent weighting), while over half of the large banks that measure individual performance use a discretionary assessment. The medium and large banks are more likely to incorporate strategic goals such as audit quality, risk management, net promoter score, succession planning, and customer service.

Long-term Incentive (LTI) Plans

The most common long-term incentives used across industries, including banking, are stock options, time-vested stock (restricted stock or restricted stock units), and performance-vested stock. Similar to the broader market, the banks in our sample take a portfolio approach to their LTI plans, with around 70 percent of them granting two or three types of LTI vehicles. The small and medium banks more frequently use a single LTI vehicle (37 percent, on average), and only one bank in the entire sample does not grant equity. The LTI mix among the three groups is consistent, with stock options continuing to be the least utilized equity vehicle – on average about 0 to 8 percent of the overall LTI mix. Time-vested RS typically comprises about 30 to 45 percent of the LTI mix among these banks, with performance plans making up the bulk (about 55 to 65 percent) of LTI plans in the total sample.

Performance-based awards 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 to 200 percent of the target level. Approximately 80 percent of companies in each asset grouping (that utilize performance plans) measure performance against two to four metrics. The most prevalent metrics used are Returns, relative TSR 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.

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, relative TSR is used mostly 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 ROE, ROA and EPS growth. Among the total sample, approximately 60 percent of banks use a relative measure other than TSR.

ESG in Incentive Plans

Among our sample, 20 percent of banks included ESG goals in their annual incentive plans for 2023. Over the past year, ESG issues have become increasingly politicized and remain a hot-button issue for employees, activist investors, institutional investors, politicians, and the public. Companies across industries have modified their DE&I policies following threats of legal action from conservative groups; some have reduced or removed DE&I components from their executive pay structures, while others are shifting from DE&I metrics to broader human capital or workforce-related measures. Against this backdrop, among the banks in both this and last year’s study we have seen a slight decline in the use of ESG metrics in incentive plans. Two banks removed ESG-related metrics from their plans while one added it, generating a net loss of one ESG-using bank. This year, three banks have standalone weighted components in their annual incentive plans tied to ESG (weighted 10 to 20 percent), a unique practice among the sample. The remaining banks measure performance on a qualitative basis either as part of a standalone strategic or individual component (weighted 15 to 25 percent). None of the banks in this year's sample made discretionary adjustments to plan funding. Given the rise in anti-ESG sentiment and fears of backlash, banks may be hesitant about adding new goals and may rethink the ways in which they currently incorporate ESG into their incentive plans. Wall Street banks have already begun to deemphasize DE&I initiatives, which may have a cascading effect throughout the financial services industry.

Looking Ahead

The year 2024 has been marked by unpredictability. As November draws near, the market is bracing for the outcome of one of the most divisive and turbulent campaign cycles in recent history. The Supreme Court’s recent decision to overturn the Chevron doctrine has raised questions about existing federal agency rules, creating short-term uncertainty for regulated industries, including banking. Meanwhile, with inflation showing signs of easing, the Federal Reserve is widely expected to cut interest rates at its September meeting, a move that could have significant implications for bank financial performance and incentive plan outcomes.

As of the 2nd quarter of 2024, regional banks have announced negative year-over-year earnings and returns, lower net interest margins and slower loan growth, though year-to-date TSR is up in the high single digits. However, it remains to be seen how the banking industry will respond to the evolving political and economic landscape for the remainder of the year. The economy remains resilient and fears of a damaging recession are waning, with jobless claims staying relatively low in the face of high interest rates and consumer spending increasing.

Each bank's financial performance is influenced by various factors, including asset size, product mix, sector concentration, growth strategy, and loan portfolio. As we approach the end of 2024, all banks will need to strike a balance between aligning pay with financial results and shareholder returns.

For questions or more information, please contact:

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

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

Theo Allen
Associate
[email protected]
646-568-1157

Hanna Borsack and Becca Friday provided research assistance for this report.

Regional Banks in CAP’s Study (n=40)

Small Banks
($1B – $5B in assets)

• Bar Harbor Bankshares
• Capital City Bank Group, Inc.
• Community West Bancshares
• Enterprise Bancorp, Inc.
• Evans Bancorp, Inc.
• Farmers National Banc Corp.
• First Business Financial Services, Inc.
• First Financial Northwest, Inc.
• LCNB Corp.
• MVB Financial Corp.
• National Bankshares, Inc.
• Oak Valley Bancorp
• Sierra Bancorp

Medium Banks
($5B – $10B in assets)

• 1st Source Corporation
• Amerant Bancorp Inc.
• Camden National Corporation
• CNB Financial Corporation
• German American Bancorp, Inc.
• Heritage Commerce Corp
• Heritage Financial Corporation
• Independent Bank Corporation
• National Bank Holdings Corporation
• Park National Corporation
• Stock Yards Bancorp, Inc.
• Univest Financial Corporation
• Westamerica Bancorporation

Large Banks
($10B – $20B in assets)

• Banner Corporation
• Berkshire Hills Bancorp, Inc.
• Brookline Bancorp, Inc.
• Community Financial System, Inc.
• Enterprise Financial Services Corp
• First Busey Corporation
• First Commonwealth Financial Corporation
• First Foundation Inc.
• First Merchants Corporation
• Heartland Financial USA, Inc.
• Renasant Corporation
• Seacoast Banking Corporation of Florida
• Trustmark Corporation
• WesBanco, Inc.

Introduction

On May 6, 2024, several federal financial regulators re-proposed a 2016 rule outlining acceptable practices for incentive-based compensation at certain banks. The rule is required by Section 956 of the Dodd-Frank Act and has been in the works for well over a decade. Regulators initially proposed principles-based rules in 2011 and proposed revised, more prescriptive rules in 2016. The new proposed rules are identical to the rules proposed in 2016; however, regulators have also requested comment on specific alternatives to the 2016 rules.

To-date, four agencies, including the Federal Deposit Insurance Corp. (FDIC), Office of the Comptroller of the Currency (OCC), the Federal Housing Finance Agency (FHFA), and the National Credit Union Administration (NCUA), have issued rules. Notably, the Securities and Exchange Commission (SEC) and the Federal Reserve have not yet issued rules. The SEC is expected to follow the four agencies that have already issued rules. The Federal Reserve’s view on the proposed rulemaking is less clear. The rules must be issued jointly by all six regulators, including the Federal Reserve.

This article summarizes the proposed rules and highlights the 2024 alternatives on which regulators are seeking feedback.

Requirements And Prohibitions Applicable To All Covered Institutions

The proposed rules restrict all covered institutions from establishing or maintaining incentive based compensation arrangements that encourage inappropriate risk taking and providing covered persons with excessive compensation, fees, or benefits that could lead to material financial loss to the covered institution. A covered institution is one with at least $1 billion in assets.

Excessive Compensation: Compensation, fees, and benefits will be viewed as excessive when amounts paid are unreasonable or disproportionate to the services provided by a covered person, considering all factors, including:

• Combined value of all compensation, fees and benefits to a covered person;
• The compensation history of the covered person and other individuals with comparable expertise at the covered institution;
• The financial condition of the covered institution;
• Compensation at comparable institutions (specific criteria described in the proposal);
• For post-employment benefits, the potential cost and benefit to the covered institution;
• Any connection between the covered person and any fraudulent act or omission, breach of trust or fiduciary duty, or insider abuse with regard to the covered institution.

Risk Balancing: An incentive-based compensation arrangement will be considered to encourage inappropriate risks that could lead to material financial loss to the covered institution, unless the arrangement:

• Appropriately balances risk and reward;
• Is compatible with effective risk management and controls;
• Is supported by effective governance;
• Includes financial and non-financial measures of performance;
• Is designed to let non-financial measures of performance override financial measures of performance, when appropriate; and
• Is subject to adjustment to reflect actual losses, inappropriate risks taken, compliance deficiencies, or other measures or aspects of financial and nonfinancial performance.

Board Oversight: The proposed rule requires that the Board of Directors:

• Conduct oversight of the covered institution’s incentive –based compensation program;
• Approve incentive-based compensation arrangements for senior executive officers, including amounts of awards, and at the time of vesting, payouts under such arrangements; and
• Approve material exceptions or adjustments to incentive-based compensation policies or arrangements for senior executive officers.

Covered Institution Categories

The proposed rules segment covered institutions into three main categories:

• Level 1: Greater than $250 billion assets
• Level 2: Greater than $50 billion assets, less than $250 billion assets
• Level 3: Greater than $1 billion assets less than $50 billion assets

The requirements of the proposed rule vary by type of institution with the more prescriptive aspects of the rule having the most impact on Level 1 and Level 2 covered institutions which due to their size and complexity are viewed as the most likely organizations to contribute to systemic risk. It should be noted that the Agencies have reserved the authority to require certain Level 3 institutions with assets between $10 billion and $50 billion to comply with the more rigorous requirements applicable to Level 1 and Level 2 organizations if they find that the complexity of operations or compensation practices are comparable to those of a Level 1 or Level 2 covered institution.

Risk Management And Controls

Level 1 and Level 2 institutions would be required to have a risk management framework in place for their incentive-based compensation programs that is independent of any lines of business and includes an independent compliance program to provide controls, testing, monitoring and training of the institution’s policies and procedures. In addition it would require covered institutions to:

• Provide individuals in control functions with appropriate authority to influence the risk-taking business areas they monitor and ensure that covered persons in control functions would be compensated independently from the areas they monitor; and
• Provide for independent monitoring of whether plans are appropriately risk balanced, events that relate to forfeiture or downward adjustments and compliance with the institution’s policies and procedures

Most large institutions have developed well defined risk management functions that independently oversee/monitor incentive compensation programs and participate in evaluating individual and plan compliance.

Governance

The proposed rule formally requires Level 1 and Level 2 institutions to establish an independent compensation committee (comprised of directors who are not members of management) to assist the Board of Directors in carrying out its responsibilities. It would be expected to obtain input from the institution’s audit and risk committees related to the effectiveness of the institution’s overall program and related processes. Management will be required to submit a written assessment of the effectiveness of the program, compliance and processes that are consistent with the risk profile of the covered institution. Separately, the compensation committee would also be required to annually obtain a similar written assessment from the audit or risk management function. Level 1 and Level 2 institutions have generally integrated their processes for reviewing compensation programs and individual decision making with the risk (and audit) committee at least annually. Additionally, compensation committees receive reports on a periodic basis from internal risk management. The rules provide a more detailed set of processes and documentation for these activities.

Disclosure And Record Keeping Requirements

The proposed rule requires all Level 1 and Level 2 covered institutions to create annually, and retain for seven years, documents that cover the following:

• Senior executives and significant risk-takers (listed by legal entity, job function, organizational hierarchy, and line of business)
• Incentive-based compensation arrangements for senior executives and significant risktakers, including percentage of incentive-based compensation deferred and the form of award
• Any forfeiture, downward adjustments, or claw back reviews and decisions for senior executives and significant risk-takers
• Any material changes to the covered institution’s incentive-based compensation arrangements or policies

Based on our experience, in their interactions with regulators, most covered institutions have been required to develop and maintain extensive record keeping around their incentive compensation arrangements, so the main new requirements are the specific content of the record keeping and the seven year retention period.

Covered Persons

The proposed rule describes specific employees that will be subject to the proposed rule labeled as senior executive officers and significant risk-takers. These categories are roughly equivalent to Category 1 and Category 2 employees under the original 2011 proposed rules; however, they were expanded somewhat in 2016 and the rules for defining significant risk-takers are somewhat more prescriptive.

Senior Executive Officers:

• The following positions:
  • President, Chief Executive Officer, Executive Chairman, Chief Operating Officer, Chief Financial Officer, Chief Investment Officer, Chief Legal Officer, Chief Lending Officer, Chief Risk Officer, Chief Compliance Officer, Chief Audit Executive, Chief Credit Officer, Chief Accounting Executive, or head of a major business line or control function
  • Anyone performing the equivalent function to the above titles

Significant Risk-Taker:

There are two main tests to determine whether someone is a significant risk taker. If either test is met, the employee is a significant risk-taker

• Relative Compensation Test: For a Level 1 institution, are they among the 5 percent highest compensated covered persons; for a Level 2 institution are they among the 2 percent highest compensated covered persons
• Exposure Test: Does the covered person have the authority to commit more than 0.5% of the capital of the covered institution
• One-Third Threshold: A covered person will only be considered a significant risk-taker if 1/3 or more of their total compensation is incentive-based compensation

We suspect that many covered institutions will find that their current list of Category 2 employees has significant overlap with who will ultimately be considered significant risk-takers. However, organizations that have spent the past few years developing rigorous criteria for identifying Category 2 employees may find it frustrating to have to comply with a new set of criteria, particularly since the new criteria appear to be more sweeping and less tailored to the nature of specific institutions’ lines of business.

Deferral, Incentive Vehicles, And Goal-Setting

• Deferral Period: Deferrals cannot vest any faster than a pro rata basis over the full deferral period (i.e., for a Level 1 Senior Executive, the deferral of a short-term incentive cannot vest any faster that 25% per year over the four anniversaries of the award date; for a long-term award deferral commences at the end of the performance period).
• Form of Deferral: Under the proposed rules, incentive-based compensation will be deferred in cash and equity like instruments. While the rules do not propose specific percentages for each form, they expect a degree of balance between the two. The rules are specific as to how much incentive-based compensation can be deferred in the form of stock options.
• Stock Options: Under the proposed rules, stock options cannot represent more than 15% of the total incentive compensation used to meet the minimum required deferred compensation awarded for that period.
• Acceleration of Deferrals: Level 1 and Level 2 covered institutions are prohibited from accelerating deferrals in any circumstances other than the death or disability of the covered person (i.e., no ability to accelerate upon other termination scenarios as is common today).

The more challenging aspects of the new requirements will be the mandatory deferral of both cash and equity in proportionate amounts, long-term performance plan payouts and the prohibition of the acceleration of deferrals. Companies may reconsider the amount of deferred compensation delivered in long-term performance plans if the new rules remain in place, as it will potentially diminish the value associated with plans due to the longer vesting period and increase the complexity of compensation programs. Many of these plans among Level 1 institutions have only recently been adopted and are well-received by long-term investors. In addition, it is a fairly common practice to accelerate payouts of deferred compensation upon a termination of employment following a change in control or other termination scenarios (e.g., involuntary termination without cause or retirement).

Forfeiture And Downward Adjustment

The guidance defines two new terms for practices that many covered institutions have already implemented in response to the original 2011 proposed guidance:

• Forfeiture: A reduction of the amount of deferred incentive-based compensation that has been awarded but not yet vested.
• Downward Adjustment: A reduction of the incentive-based compensation not yet awarded to a covered person for a performance period that has already begun.

Under the proposed rules all deferred incentive-based compensation will be subject to forfeiture and all not yet awarded incentive-based compensation will be subject to downward adjustment under the following circumstances:

• Poor financial performance attributable to a significant deviation from the covered institution’s risk parameters set forth in the covered institution’s policies and procedures;
• Inappropriate risk-taking, regardless of the impact on financial performance;
• Material risk management or control failures;
• Non-compliance with statutory, regulatory, or supervisory standards resulting in enforcement or legal action brought by a federal or state regulator or agency, or a requirement that the covered institution report a restatement of a financial statement to correct a material error; and
• Other aspects of conduct or poor performance as defined by the covered institution.

Under the proposal, the covered institution can exercise discretion in determining how much, if any, of an award will be impacted by forfeiture or downward adjustment. However, in the proposal, there are specific factors that should be considered in making the determination, including the intent of the covered person, the covered person’s responsibility or awareness of the circumstances around the triggering event, actions that could have been taken to prevent the triggering event, the financial and reputational impact of the event, the cause of the events and any other relevant information related to the event, including past behavior of the covered person. Based on our experiences with covered institutions, we expect this portion of the rule to be straightforward to comply with as most organizations have developed rigorous processes to cover forfeiture and downward adjustments over the past few years.

Clawback

The proposed rules include a clawback provision covering any incentive compensation (cash and equity) for seven years from the time that the award vests. This would mean that some forms of deferred compensation could potentially be subject to claw back for more than ten years from the date that they were originally awarded. The claw back will apply to a current or former senior executive officer or significant risk-taker. While the timeframe for the new provision is long in duration, the triggering events for a claw back are described more narrowly than the events that would trigger a review for forfeiture or downward adjustment. Specifically, the triggering events for a claw back are defined as:

• Misconduct that resulted in significant financial or reputational harm to the covered institution;
• Fraud;
• Intentional misrepresentation of information used to determine the senior executive officer’s or significant risk-taker’s incentive-based compensation.

2024 Alternative For Comment:

Clawback: The Agencies are considering making the clawback a requirement rather than an option. Similar to the mandating of forfeiture or downward adjustment, this change would require definition of the triggers for the claw back and a methodology for determining the amount to be clawed back.

Hedging

The proposed rule will prohibit covered institutions from purchasing hedging instruments on behalf of covered persons. As a practical matter, many financial institutions go further than this as they prohibit executives from engaging in hedging activities on their own behalf.

2024 Alternative For Comment:

Hedging: The Agencies are considering an alternative to prohibit institutions from offering incentive-based plans that allow individuals to personally hedge their compensation.

Maximum Incentive-Based Compensation Opportunity (Also Referred To As Leverage)

Since proposing the original rule in 2011, regulators have raised concerns with covered institutions over the degree of leverage in short-term and long-term incentive compensation arrangements. While many companies had incentive compensation arrangements with upside leverage of 200% of the target incentive opportunity when the 2011 rules were issued, most now have upside leverage of either 150% of target or 125% of target for their formulaic incentive-based compensation arrangements. The new proposed rule explicitly limits the upside leverage allowed for Level 1 and Level 2 institutions:

• Senior Executives: 125% of the target incentive opportunity
• Significant Risk-Takers: 150% of the target incentive opportunity

The professed intent is not to create a ceiling on incentive compensation but to constrain a plan feature that may contribute to inappropriate risk taking. However, it will likely be viewed by institutions as weakening their ability to align pay with performance on the downside and the upside and as an uncompetitive feature when compared to other non-covered financial service firms or other companies.

Volume-Driven Incentive-Based Compensation

The proposed rules prohibit incentive compensation for Level 1 and Level 2 senior executive officers and significant risk-takers based on volume-based performance measures without regard to the quality of the products sold or compliance with sound risk management. This restriction is more likely to have implications for incentive-compensation plans for significant risk-takers than for senior executive officers. In practice, most institutions have added assessments of compliance with risk management and credit quality to individual evaluations for incentive-based compensation so this may be more of a formality in terms of going forward compliance.

Conclusion

Many aspects of the 2024 proposal (essentially the 2016 Proposal), will require significant changes from covered financial institutions, particularly the claw back provisions, deferral of long-term incentives and increased deferral percentages and longer deferral periods. Of particular concern in the revised proposal is that almost all of the alternatives raised by the regulators will result in less Committee or Board flexibility and discretion in governing incentive compensation. For example, the alternative for comment that calls for approving incentive plan performance targets prior to the beginning of a performance period is a major departure from current practice and may have unintended consequences (e.g., less robust performance goals, fewer pre-defined performance goals). We expect that the regulatory agencies will receive robust comments on the proposal, including the new alternatives for comment. Given the political environment and the past history with implementing Dodd-Frank 956, we expect that this will be challenging to bring to the finish line.

For questions or more information, please contact CAP’s banking team:

Eric Hosken
Partner
[email protected]
212-921-9363

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

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

Mike Bonner
Principal
[email protected]
646-486-9744

Compensation Advisory Partners (CAP) conducted a study of executive compensation trends in the banking industry. The study includes 18 U.S. banks with greater than $50 billion in assets across three groups: Money Center banks (n=4), Custody banks (n=3), and Super Regional banks (n=11). This report summarizes the pay and performance relationship for these 18 banks in 2022, executive compensation trends in the industry, and outlook for the industry in 2023.

Highlights

Recap – Pay and Performance Outcomes Mixed for 2022

Following a strong 2021, 2022 performance results were mixed among the banks in our study based on business mix and balance sheet makeup. For example, banks that generate a significant portion of revenue from investment banking faced greater headwinds in 2022 than other banks. At median, pre-provision net revenue increased vs. 2021 due to rising interest rates and stronger net interest income; however, Earnings Per Share (EPS) and Return on Equity (ROE) were both down vs. 2021 when banks’ bottom lines benefited from a reduction in provisions for loan losses. 1-year Total Shareholder Return (TSR) was down -19 percent at median over the period for the banks in our sample, commensurate with the S&P 500, which was down -18 percent at median.

The chart below summarizes median performance results for the banks in CAP’s study:

In 2022, total direct compensation (i.e., the sum of base salary, annual cash bonus, and awarded long-term incentives) increased 3 percent at median, though changes in pay varied significantly from bank to bank based on performance and other factors. Just over half of the banks in our study increased CEO compensation levels for 2022. Banks that decreased CEO compensation for 2022 did so primarily through the annual cash bonus, which is closely linked to 1-year financial performance. This is in stark contrast to 2021 where most banks paid out bonuses above target, resulting in a 36 percent increase at median due to strong financial performance buoyed by the release of loan loss provisions. 2022 long-term incentives also increased modestly at median (i.e., +6 percent), compared to 2021 when banks increased long-term incentives more significantly (i.e., +21 percent at median).

Incentive Plan Design Trends – Spotlight on Discretion

Most banks in our study did not make changes to annual or long-term incentive plan metrics or structure in 2022. One area of focus in incentive plans revolves around how banks apply discretion to annual incentive payouts. Of the banks in our sample, 56 percent have fully discretionary annual incentive plans. A fully discretionary plan indicates that the compensation committee determines annual incentive payouts based on a holistic review of company and individual performance results. Fully discretionary plans are particularly common among the money center and custody banks. The remaining 44 percent of banks in our sample use formulaic incentive plans that payout based on performance relative to pre-defined goals; however, most of these banks maintain the ability to exercise some discretion over the final payout. These banks incorporate discretion in a variety of ways, including maintaining a weighted discretionary component or modifier, making discretionary adjustments to metrics, and applying discretion to increase or decrease the final payout.

2022 highlighted differences in philosophies around applying discretion across the banks in our sample, specifically with regard to how banks allowed higher than expected interest rates to influence incentive plan payouts. Some banks paid out based on calculated results under their formulaic plan while others made negative discretionary adjustments to recognize that the positive impact of higher than budgeted rates on performance results was outside of management’s control. These differences in philosophy led to differences in actual incentive payouts across the group.

New for 2022 – SEC Required Pay Versus Performance Disclosure

On August 25, 2022, the SEC adopted final rules implementing the pay versus performance disclosure requirement under the Dodd-Frank Act. For the first time in 2023, companies had to comply with the new rule, which requires, among other items, a table highlighting the relationship between pay and various performance metrics, including TSR, net income, and an additional company-selected measure (CSM).

Overall, we saw more similarities than differences in disclosure among the banks in our sample. The banks generally showed alignment between pay and performance and with each other. Compensation Actually Paid, a new measure that considers the change in value of equity awards after grant, was below Summary Compensation Table (SCT) pay in 2020, above SCT pay in 2021, and aligned with SCT pay in 2022. The relationship between Compensation Actually Paid and SCT pay generally aligns with TSR over the period as stock price change is a significant driver of Compensation Actually Paid.

78% of banks used a return on equity measure as the CSM, indicating that most banks view return on equity as the “most important financial measure” used to link Compensation Actually Paid to company performance. Specifically, the most common return on equity measure was Return on Tangible Common Equity (ROTCE).

The disclosure also required companies to select a TSR peer group against which to compare their own TSR performance. Companies could select either an industry index or the peer group used to assess pay. Nearly all the banks in our sample used an industry index for the TSR comparator peer group. The KBW Nasdaq Bank Index was the most common, followed by the S&P 500 Financials Index.

Though the disclosure required significant investment from companies to produce, it has received minimal attention from shareholders and the media. We expect the disclosure to remain compliance-focused in the coming years.

On the Horizon – Potential Challenges to Non-Compete Arrangements

In June 2023, legislators in New York fast-tracked a bill that, if signed, would ban non-compete agreements in the state. This move follows the Federal Trade Commission’s proposal earlier this year to ban non-compete agreements at the national level. As non-compete agreements are especially prevalent in the banking industry, it will be important for banks to keep an eye on the progress of non-compete bans as the New York bill could spark momentum for passing similar bills in other states.

Looking Ahead – Volatility in Banking in the Second Half of 2023

2023 has been a challenging year for banks, marked by the failures of SVB Financial, Signature Bank, and First Republic in the U.S. and Credit Suisse internationally. The shutdown of these major institutions stoked fears about the health of the banking sector. Year-to-date, total shareholder return for the banks in our study is down -21 percent at median while the S&P 500 is up +15 percent.

Though regulators have not finalized any new rulemaking, the bank shutdowns have inspired discussion about regulations that could potentially impact both bank performance and executive compensation practices. Two separate bipartisan groups of senators have introduced two separate clawback bills into the senate. The bills would expand the FDIC’s ability to clawback compensation from the executives of failed banks to different degrees. The most recent is the Recovering Executive Compensation from Unaccountable Practices (RECOUP) Act, which passed the Senate Banking Committee in June.

Additionally, in July, the Federal Reserve’s vice chair for supervision, Michael Barr, proposed a change to the oversight of America’s largest banks that would require banks with assets over $100 billion to increase their capital holdings. The aim of this regulation would be to address vulnerabilities exposed by the collapse of major banks earlier this year and boost resilience during crises. Critics of Barr’s comments say that such regulation will impede these banks’ ability to lend.

As we approach the end of 2023, the outlook for the full year, and in turn, projected compensation outcomes, is less certain. Performance expectations have declined significantly from the beginning of the year – for example, at median, analyst estimates for 2023 EPS have declined 11% from Q1 for the banks in our study. The decline has been more significant for the super regional banks than for the more diversified money center and custody banks. We expect lower results to drive 2023 bonus payouts to be lower than 2022 bonus payouts for many banks. As banks begin the year-end compensation decision-making process, they will need to consider how to appropriately balance the need to retain top talent in this volatile environment with their objective to align executive pay outcomes with performance.

For questions or more information, please contact CAP’s banking team:

Eric Hosken
Partner
[email protected]
212-921-9363

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

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

Mike Bonner
Principal
[email protected]
646-486-9744

Stefanie Kushner
Associate
[email protected]
646-532-5931

Banks in CAP’s Study (n=18)

Money Center Banks

• Bank of America Corporation
• Citigroup, Inc.
• JPMorgan Chase & Co.
• Wells Fargo & Company

Custody Banks

• The Bank of New York Mellon Corporation
• Northern Trust Corporation
• State Street Corporation

Super Regional Banks

• Citizens Financial Group, Inc.
• Comerica, Inc.
• Fifth Third Bancorp
• Huntington Bancshares, Inc.
• KeyCorp
• M&T Bank Corporation
• The PNC Financial Services Group, Inc.
• Regions Financial Corporation
• Truist Financial Corporation
• U.S. Bancorp
• Zions Bancorporation

Compensation Advisory Partners (CAP) conducted a study of executive compensation trends in the regional banking industry. The study examined 2022 CEO compensation levels and pay practices among 40 regional banks across three groups based on FY’22 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 compares both compensation levels and incentive plan design across the groups. We also highlight current issues facing the banking industry in 2023.

Highlights

2022 Performance and Pay Outcomes

Performance Results

Bank 2022 financial performance reflects the market normalizing post-pandemic, following a strong performance year in 2021. Earnings, profitability and return metrics were all stronger in 2021 vs. 2022. For 2022, the high interest rate environment lifted net interest margin and increased net interest income growth, which in turn helped boost earnings and profitability.

When comparing across all three groups, the small banks generally had the strongest performance year in 2022, as EPS and Net Income grew at higher rates than the medium and large banks. As of 12/31/2022, TSR performance on a 1- and 3-year basis was also better for the small banks.

CEO Annual Incentive Payouts

At median, CEO annual incentive payouts were above target across all groups but decreased 9 and 17 percent year-over-year for the small and medium banks, respectively; 11 banks paid bonuses below target compared to just five last year. Payouts among the larger banks increased modestly at all percentiles year-over-year despite poorer performance in 2022, which can be attributed to market-based increases in target bonus opportunities following strong 2021 results and high performance on individual and strategic components.

Total Pay Changes

Despite a moderation in financial performance and annual incentive payouts as a percent of target, CEO actual total compensation1 (base salary, annual incentive payouts, and long-term incentives) increased for all asset groups in 2022. Large banks saw the largest increase in total compensation (+12 percent), and CEO pay at small and medium banks increased +5 percent and +3 percent, respectively. The 12 percent increase among the large banks was primarily driven by annual incentive payouts (+19 percent). Increases for small and medium banks were led by long-term incentive increases of +16 percent and +4 percent, respectively. While long-term incentive grant date values are generally determined by competitive market positioning, the comparatively strong 2022 performance among small banks amidst an industry-wide downturn may have had an outsized impact on this compensation element. The increase in annual bonuses among large banks can be attributed to market-based adjustments to target opportunities year-over-year and strong performance against individual or strategic goals; about 80 percent of large banks consider such goals, which are primarily determined on a discretionary basis and subject to greater volatility in a given year. Like 2021, base salary values were consistent across the banks, with increases ranging from about 3 to 5 percent at median.

Chief Executive Officer Pay Mix

Like our findings from prior years, CEOs at the larger banks have higher overall pay levels and more of their total pay delivered in at-risk or variable compensation (i.e., annual or long-term incentives). Conversely, CEOs at smaller banks are often paid more fixed compensation (i.e., base salary). The portion of total compensation delivered in the form of long-term incentives increased year-over-year for both small banks – from 18 percent in 2021 to 23 percent in 2022 – and medium banks – from 23 percent in 2021 to 28 percent in 2022. The pay mix for large banks was similar year-over-year.

Pay Practices

Annual Incentive Plans

The most common annual incentive plan funding approach is “goal attainment,” in which 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 75 percent of the small, medium and large banks use three or more weighted financial metrics. Efficiency Ratio, EPS, Asset Quality (i.e., non-performing assets, non-performing loan ratio) and ROA are among the most prevalent metrics used at these banks. Among the banks that use them, Earnings (EPS and Net Income) were typically weighted more (approximately 25 to 50 percent of the total plan) than Returns (ROA or ROE), Efficiency Ratio and Asset Quality metrics (approximately 15 to 25 percent of the total plan). The small and medium banks differ from the large banks in that they more frequently use Loan or Deposit measures in their plans, with these metrics accounting for no more than 30 percent of the total plan.

Individual goals are prevalent among all asset groups. The small and medium banks predominantly incorporate individual performance as a standalone weighted metric (typically 20 percent weighting), while half of the large banks that measure individual performance use a discretionary assessment. The medium and large banks are more likely to incorporate strategic goals such as audit quality, risk management, net promoter score, succession planning, customer service and technology initiatives.

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. Like the broader market, the banks in our sample use a portfolio approach for their LTI plans, with nearly 75 percent of these banks granting two or three LTI vehicles. The small and medium banks more frequently use a single LTI vehicle (31 percent, on average), and only one bank in the entire sample does not grant equity. The LTI mix among the three groups is consistent, with stock options continuing to be the least utilized equity vehicle – on average about 1 to 7 percent of the overall LTI mix. Time-vested RS typically comprises about 30 to 45 percent of the LTI mix among these banks, with performance plans making up the bulk (about 55 to 65 percent) of LTI plans in the total sample.

Performance-based awards 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 to 200 percent of the target level. Approximately 80 percent of companies in each asset grouping (that utilize performance plans) measure performance against two to four metrics. The most prevalent metrics used are Returns, relative TSR 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.

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, relative TSR is used mostly 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 ROE, ROA and EPS growth. Among the total sample, approximately 55 percent of banks use a relative measure other than TSR.

ESG in Incentive Plans

Given that ESG issues remain an area of focus for employees, institutional investors, and the public, banks are increasingly linking compensation to measurable ESG initiatives such as DE&I. Among the banks in our sample, while still a minority practice, we have seen an uptick in the use of ESG metrics in incentive plans. In 2022, 10 banks included ESG goals in their annual incentive plans, up from five in 2021. Most banks measure performance on a qualitative basis either as part of a standalone strategic or individual component (weighted 10 to 25 percent), or as part of a discretionary adjustment to plan funding. Two banks (Evans Bancorp and Berkshire Hills Bancorp) have standalone weighted components of their annual incentive plans tied to ESG (15 to 20 percent, respectively), a unique practice among the sample. The inclusion of these goals continues to evolve, and we may see banks revisit the use of ESG goals in incentive plans given the recent Supreme Court decision on affirmative action and a rise in anti-ESG shareholder proposals. While larger banks may continue to lead the push for ESG metric incorporation in incentive plans, we may see greater hesitance from small and medium banks as uncertainties abound regarding this hot-button issue.

Looking Ahead

Each week brings new and potentially conflicting signals about the health of the economy. For the banking industry, there continues to be uncertainty surrounding the rise in interest rates, consumer spending habits, inflationary environment, deposit competition, unrealized losses in bond portfolios, worsening credit conditions and the overall regulatory environment. As we approach the final months of 2023, financial performance and incentive plan results will be heavily impacted by the interest rate environment, decrease in mortgage origination, economy’s impact on loan quality and interest rate spreads, volatility with provisioning, and competition for deposits.

As of the 2nd quarter of 2023, regional banks have posted flat year-over-year returns and earnings, poorer Efficiency Ratios, slower deposit growth and double-digit decreases in TSR. However, despite the Federal Reserve raising interest rates to a 22-year high, the economy remains resilient, inflation is leveling off at lower rates than in 2022, unemployment is low, residential housing construction and consumer spending are strong, credit quality remains sound, and loan losses are at historically low levels.

Each bank’s financial performance is impacted differently based on asset size, product mix, sector mix / concentration, growth strategy, and loan portfolio. As we approach the end of 2023, all banks will need to strike a balance between aligning pay with financial results and shareholder returns, which may be challenging in the current environment of moderate to flat growth and profitability and double-digit decreases in stock price performance.

For questions or more information, please contact:

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

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

Theo Allen
Associate
[email protected]
646-568-1157

Hanna Borsack and Gray Broaddus provided research assistance for this report.

Regional Banks in CAP’s Study (n=40)

Small Banks ($1B – $5B in assets)

• Bar Harbor Bankshares
• Capital City Bank Group, Inc.
• Central Valley Community Bancorp
• Enterprise Bancorp, Inc.
• Evans Bancorp, Inc.
• Farmers National Banc Corp.
• First Business Financial Services, Inc.
• First Financial Northwest, Inc.
• Independent Bank Corporation
• LCNB Corp.
• National Bankshares, Inc.
• Oak Valley Bancorp
• Sierra Bancorp

Medium Banks ($5B – $10B in assets)

• 1st Source Corporation
• Amerant Bancorp Inc.
• Banc of California, Inc.
• Brookline Bancorp, Inc.
• Camden National Corporation
• CNB Financial Corporation
• First Commonwealth Financial Corporation
• German American Bancorp, Inc.
• Heritage Commerce Corp.
• Park National Corporation
• Stock Yards Bancorp, Inc.
• Univest Financial Corporation
• Westamerica Bancorporation

Large Banks ($10B – $20B in assets)

• Atlantic Union Bankshares Corporation
• Banner Corporation
• Berkshire Hills Bancorp, Inc.
• Community Bank System, Inc.
• Enterprise Financial Services Corp.
• First Busey Corporation
• First Foundation Inc.
• First Merchants Corporation
• Heartland Financial USA, Inc.
• Lakeland Bancorp, Inc.
• Renasant Corporation
• Seacoast Banking Corporation of Florida
• Trustmark Corporation
• WesBanco, Inc.

Compensation Advisory Partners (CAP) is conducting a market pulse survey to get a sense of banks’ compensation expectations for the balance of 2023 and initial thinking for 2024. Questions will cover salary increases, 2023 projected bonus funding and retention awards. We estimate the survey will only take 5 minutes to complete and are asking for submissions no later than Friday, June 30. We will distribute results on an aggregate basis to all participants at no cost. Individual results will be kept confidential.

2022 Results

Following an exceptional 2021 for the banking industry, 2022 performance results were mixed with results varying significantly from bank to bank based on business mix. Overall, revenue increased in 2022, driven by high interest rates. At the same time, net Income declined somewhat but remained well-above 2020 levels. In line with these results, CEO compensation increased in 2022 but more modestly than it did in 2021.

2022 bonuses, which payout based on annual performance results, paid out above target, though to a lesser degree than 2021.

2023 Results To-Date and Outlook

The first half of 2023 has been a volatile period in the banking industry, marked by the failures of Silicon Valley Bank, Silvergate, Signature, and First Republic in the U.S. and Credit Suisse internationally. In the wake of these bank failures, the macroeconomic uncertainty that lies ahead and potential regulation and the impact it could have on performance has led to depressed stock prices for many banks. The S&P 500 Banking index has decreased 14% since the end of 2022 compared to the broader S&P 500, which has increased 10% over the same period.

Many banks are beginning to consider the impact these dynamics will have on their compensation programs. CAP is conducting a market pulse survey to get a sense of banks’ compensation expectations for the balance of 2023 and initial thinking for 2024.

Please use the link below to participate in the survey. The survey should only take 5 minutes to complete and the deadline to participate is Friday, June 30. We will distribute results on an aggregate basis to all participants at no cost. Individual results will be kept confidential.

Click here to participate in the survey.

If you have any questions, please contact Kelly Malafis ([email protected]), Eric Hosken ([email protected]), Mike Bonner ([email protected]), or Shaun Bisman ([email protected])

Key Takeaways

1. Publicly traded, advisory-focused investment banks posted outstanding performance in 2021, surging out of the COVID-19 pandemic with demand for advisory services fueled by low interest rates and high economic activity.
2. Median total pay levels for Chief Executive Officers (CEOs) increased 30% from the 2020 to 2021 performance years. Pay was up 33% for Chief Financial Officers (CFOs), and up 32% on average for other Named Executive Officers (NEOs). Pay levels at investment banking firms are highly correlated with revenue, which increased year-over-year 30% at median for the companies in our study.
3. Looking toward first quarter 2023 incentive compensation decisions, investment banks are contending with lower year-over-year revenue and profit performance and high interest rates. CAP is projecting that – on average – total compensation levels will fall at least 15% to 25% for the 2022 fiscal year.
4. CAP’s study is based on a sample of 12 publicly traded investment banks with revenue ranging from $300 million to $10 billion. CAP also looked at three large, diversified financial services companies that have significant investment banking operations. These three companies – with revenue ranging from $60 billion to $130 billion – are referred to as Wall Street Banks in this report.

Compensation & Benefits Expense vs. Revenue

CAP expects total pay at public investment banks to decrease at least 15% to 25% for 2022, on average, versus prior year.

Investment banks’ success depends on their human capital. As a result, the primary operating expense is compensation and benefits. Given how critical human capital is, investment banks report the portion of their revenue allocated to compensation and benefits expenses for all employees.

CAP looked at the relationship between changes in compensation and benefits expenses and changes in revenue over the last five years and – as expected – found a strong relationship between the two. The median revenue increase for the 2021 fiscal year was 30%; the median increase in compensation and benefits expenses for all employees was 23%. Changes in revenue are highly predictive of changes in pay.

The analysis found that, looking back at the last 5 years, for every 1.0% change revenue there was approximately a 0.75% change in compensation and benefits expense.

Key Financials

2021 performance was outstanding compared to the prior year, also a strong year. Like many U.S. companies, investment banks are experiencing a slowdown in 2022.

*Reflects analyst consensus estimates per S&P Capital IQ

Executive Compensation in a Human Capital-Focused Industry

Given the importance of human capital to investment banks, they report a supplemental metric in their financial statements: the compensation and benefits ratio. The ratio is calculated by dividing compensation and benefits expenses by total revenue. The investment banks typically try to manage their compensation and benefits expenses within a certain range. For the past three years, the compensation and benefits expense has generally fallen in the range of 58% to 68%.

In contrast, the Wall Street Banks are diversified financial services companies with broader business lines, including wealth and investment management, brokerage and banking. The Wall Street Banks’ compensation and benefits ratios tend to fall in the 30% to 40% range.

Investment banks approach executive compensation differently than companies in general industry. While general industry practice is to target competitive pay in total and by component, investment banks calibrate total pay to annual performance using structured discretion. Structured discretion considers firm performance, as well as unit and individual performance. Revenue is the key driver of company performance.

The resulting pay mix for investment banking NEOs is heavily weighted toward incentives, as shown below.

Many public investment banks offer add-on long-term incentives based on multi-year performance. Performance-based plans for the CEO and NEOs are favored by shareholders and proxy advisors.

Key Compensation Metrics

Investment banks tend to grant more shares as a percent of common stock outstanding compared to other industries because of the human capital-focused nature of the business and the prevalence of granting equity deep in the organization. These companies often focus on “net burn rate” when reviewing annual equity use.

For the investment bank sample, median equity overhang exceeds the ISS acceptable “excessive dilution” threshold. The ISS threshold does not consider the unique industry factors that cause higher overhang in the investment banking industry.

Equity Overhang measures potential shareholder dilution, calculated as shares outstanding and shares available for grant under equity compensation plans divided by common stock outstanding.

Net Equity Burn Rate, shown below, which can also be referred to as Net Burn Rate, measures shareholder dilution from equity awards made in a particular fiscal year, calculated as the difference of shares granted and forfeited or repurchased under equity compensation plans, divided by common stock outstanding.

Looking Ahead

• On average, incentive pay based on fiscal year 2022 performance is expected to fall at least 15% to 25% given projected declines in 2022 financial results
• Further cost-cutting and headcount reductions are expected in Q1 2023 given the projected decline in results for the 2022 performance year; however, some investment banks have signaled their commitment to maintaining staff through the downturn in results

For questions or more information, please contact:

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

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

Louisa Heywood
Senior Analyst
[email protected]
646-568-1160

About the Sample

Investment Banks

12 publicly traded, advisory-focused investment banks:

• Cowen
• Evercore
• Greenhill & Co.
• Houlihan Lokey
• Jefferies
• Lazard
• Moelis & Company
• Perella Weinberg
• Piper Sandler Companies
• PJT Partners
• Raymond James
• Stifel

Wall Street Banks

Supplementary group with significant investment banking operations

• Goldman Sachs
• JPMorgan Chase
• Morgan Stanley