Provident New York Bancorp (PBNY) has set some lofty growth targets for the New York City market and a good chunk of its chief executive's compensation is riding on the outcome.
Starting this year, CEO Jack Kopnisky and other top executives of the Montebello company will receive a portion of their pay in so-called performance shares. Unlike with stock options, the performance shares can only be collected by the bosses if Provident meets certain profit targets.
The $3.7 billion-asset company has disclosed little about how its program will be structured, but if it's anything like that of other banks, the executives will be un able to cash in performance-share awards for at least three years and must hold onto much of the stock until retirement.
If Provident's aggressive expansion (it has hired several teams of commercial lenders away from rival banks and recently announced plans to buy Sterling Bancorp (STL) in New York) fails to boost the bank's profits or improve its efficiency, Kopnisky and other top managers could in some years wind up receiving no performance shares at all.
Jean Strella, the chief human capital officer at Provident, says the bank added performance shares to it compensation mix to better align the interests of shareholders and executives.
"Shareholders are more interested [than in the past] in ensuring that executive pay is really linked to the performance of the company, rather than just on continued employment," she says.
Performance shares have been around for years, but they have become an increasingly larger part of bank pay packages in the wake of the financial crisis as shareholders and regulators have demanded greater accountability from executives, says Jean Riley, a vice president at McLagan, a consulting firm that specializes in executive compensation and is a unit of Aon Hewitt.
Performance shares' growing popularity with compensation committees is consistent with the broader trend of tying how well executives do to how well shareholders do over extended periods.
"The biggest trend we're seeing is more focus toward long-term compensation as opposed to annual incentives," says Riley.
Many banks do still offer straight-up stock options and time-vested stock options, but increasingly they're becoming an smaller part of the mix. TrustCo Bank (TRST) in Glenville, N.Y., recently reduced the number of stock options it grants each year and replaced them with performance share units that execs will only earn if the $4.4 billion-asset bank hits certain earnings-per-share targets.
At Huntington Bancshares (HBAN) in Columbus, Ohio, stock options now account for just 25% of executives' long-term pay, down from 70% in 2011. Performance shares, which were not even part of the compensation mix until May 2012, now account for half of executives' long-term pay.
Stock that vests when executives reach a certain number of years with a company have fallen out of favor because "they feel like a giveaway, where [executives] just have to sit in their jobs and wait," says Susan O'Donnell, a managing director at compensation consulting firm Pearl Meyer & Partners.
Regulators generally dislike traditional stock options because they can encourage banks to take undue risks with the sole intention of driving up the stock price, O'Donnell says. Think Enron and Lehman Brothers.
Performance shares are typically tied to measures other a company's stock price. The thinking is that if certain profitability or other metrics are met, the stock price will rise accordingly, says O'Donnell.
The most popular measures banks use to determine how they award performance are earnings per share and return on assets. Other metrics include efficiency ratios and even credit quality. Some banks base awards on a single metric, while others will use multiple measurements.
TrustCo, for example, designed its program to award shares based solely on earning per share. If that measure increases by less than 6% from the prior year, the performance shares will not vest. If they increase by 12% or more, executives will receive 125% of the targeted number of shares, but they will only vest if the company sustains the performance over a three-year time frame.
(The company's performance will need to improve if executives hope to cash in on the performance shares; in 2012 EPS increased by just 3% from the prior year.)
Huntington, by comparison, uses three measurements — return on assets, efficiency ratio and revenue growth — to determine performance share awards for chief executive Stephen Steinour and several of his direct reports.
Huntington's 2013 proxy statement says it chose the three metrics because it believes that they are the "key to its long-term success."
Revenue growth carries the most weight, accounting for 40% of the total, while the bank's efficiency ratio and ROA account for 30% each. Huntington's target ROA is its peer group's median; revenue and efficiency are internal targets the company did not disclose in its proxy statement.
With the company in the midst of a major in-store branch expansion, perhaps its biggest challenge will be meeting efficiency targets. In 2012, revenues increased by 8% from the prior year and its ROA widened by 14 basis points, to 1.15%, but its efficiency ratio fell only slightly to 63.7%.
Still, efficiency ratio is part of the mix because "the company believes that improvements in efficiency ratio are integral to long-term value creation for shareholders," Huntington said in its 2013 proxy statement.
Huntington did not immediately respond to a request to discuss its recent adjustments to compensation. Its program appears designed in part to appease regulators, who generally discourage peer comparisons. Instead, regulators would prefer that banks set absolute targets — as Huntington did with efficiency ratio and revenue growth — and work toward achieving those goals.
In tough times, as during the recent financial crisis, peer comparisons can be problematic because even a marginal performance can look good when measured against rival banks that might be struggling with credit quality.
In good times, "regulators are afraid that if you're chasing peers it will encourage more risk-taking," O'Donnell says.
Another concern with peer group benchmarking is the criticism that they've contributed to outsized pay gains because each board tends to set its CEO's pay near the high end of the range, putting continuous upward pressure on the averages.
In contrast, O'Donnell says many shareholders like peer comparisons because they worry absolute targets will be set so low that they're relatively easy to achieve. That's especially a concern these days, with interest rates hovering near historic lows and loan demand remaining relatively weak.
"I don't recommend setting absolute targets because it's not in the best interests of shareholders," O'Donnell says. "With absolute [targets] you can just put a fluff goal out there."