What’s New?  Performance Compensation for Lenders

We have just developed a new return on equity (ROE) methodology for compensating lenders.  This methodology directly addresses the following questions:  

• How much should I be compensating my lenders?
• Are our shareholders getting their money’s worth?
• Who are my best/worst performing lenders; how do I know?

We have run across a number of simplistic lender compensation programs over the years.  Most of these are “origination-based” programs that compensate lenders based solely upon fee income or new business.  The shortcoming with these programs is you get exactly what you pay for -- loans structured to turn quickly so the lender can generate more fees.  We feel this directly contradicts the concept of relationship banking.

Shareholders are rewarded based upon the return on investment the bank generates (e.g., ROE).  Why should lenders be compensated any differently?  Aligning the compensation objectives of both groups creates a win-win situation for all.  Lenders get an unlimited compensation opportunity and shareholders get a return on their investment.

Compensating lenders based upon ROE sounds difficult, but it’s not.  Our methodology uses direct income and expense line items from your general lender or loan system (most of which you already report upon).  This avoids the often contentious issue of allocating indirect expense.  Capital is assigned to loan portfolios based upon a simple formula.  Bottom line:  Administration is simple and straight-forward since all of the data is easily obtained from your systems.

Like the traditional STAKEHOLDERS scorecards, we establish a baseline for each lender.  However, the baseline is based upon return on equity.  Once a lender’s portfolio exceeds the baseline return on equity, a percentage of the “surplus” or “excess” return is paid to the lender in the same manner that a dividend is paid to the shareholders -- the greater the return, the greater the dividend.

We can also factor elements of asset quality, deposit acquisition and other scorecards into the lender scorecard.  A typical lender scorecard will include (but is not limited to) the following KPIs:

• Average Portfolio Balance
• Portfolio Spread
• Loan Fee Income
• Average Deposit Balance
• Documentation/Technical Exceptions
• Past Dues and/or Watch List Loans
• Net Charge-Offs
• Other Scorecard Performance (e.g., Total Organization, Branch, Lending Function)

This robust set of measures gives lenders latitude to manage their line of business in the manner that best suits them.  A lender can focus on balance retention, spread maximization, fee generation, expanding relationships and/or asset quality.  This set of KPIs benefits the shareholders and, in turn, drives lender performance compensation.

Another benefit of lender scorecards is the monthly status reports.  We provide a detailed and concise set of reports for each lender scorecard developed.  This lets lenders know exactly where they stand, what they have to do, and what compensation they will receive when they get there.  

Finally, lender scorecards will provide you with a vehicle to attract and retain high performing lenders (while ensuring that your shareholders are getting an adequate return on their investment).  Poor performers will be “weeded-out” in an objective manner based upon results.