Safety, soundness, and compensation: These are words most often associated with the evaluation of large depository institutions. However, increasingly auditors are looking towards such standards in interpreting and implementing the newest regulations pertaining to compensation, and various guidelines applicable to nearly all financial institutions have expressly incorporated such concepts in evaluating an organization’s viability and compliance. Moreover, as a matter of profit maximization and risk mitigation, considering the balance of risk and reward in establishing compensation–especially for management–should assume top priority to an institution’s decision-makers.
For instance, rather than pay sales managers or team leaders a simple override, an entity could implement a higher than standard deferred override subject to partial forfeiture dependent upon the maintenance of certain benchmarks in regard to the capture of third party borrower fees, and avoidance of defaults and/or missed locks. By focusing a manager directly on such issues (even though they may not directly effect a loan officer’s compensation due to the amendments to Regulation Z it leads to better oversight and focus of loan officers in regard to such matters. When dealing with managers who do not originate, even more aggressive compensation practices and considerations can be applied.
Similarly, automatic pay increases/decreases can be utilized to incentivize staff based upon objectively measurable criteria that best balance risk and reward. Rather than simply compensating an executive or manager based upon profitability, consider weighting certain aspects of the profitability calculation to diminish risk since, in many cases, the true cost to an entity as a result of a loss is rarely captured in a simple profit and loss equation. Further, even if the P&L does fully account for such losses the manager is often only “paying” a small portion of that loss in terms of compensation–assuming they are even still with the entity when the loss is sustained.
In addition, the use of retirement, funded severance packages, phantom equity, deferred profit sharing and similar methods of compensation can spread the compensation over time to better allow for the realization and allocation of risk. As long as an entity carefully considers tax laws (which must always be a consideration in dealing with deferred compensation), the use of such creative methods can lead to a better alignment of interests between key employees and the organizations they serve. This alignment of interests best serves to focus managers on matters of critical significance to an entity’s long-term success, rather than short-term profit maximization. Such a focus can only benefit an institution in both the short and long-term.
