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Banking industry pay-for-performance update: Continued volatility in the banking industry could cause a decline in 2019 incentive payouts

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By Arpha Suwansatisakorn and Michael Montane | October 2, 2019

The current trajectory suggests incentive payouts in the banking industry may recede.

The banking industry has witnessed a slowdown in financial performance in the first half of 2019 as uncertainty around foreign affairs, including a trade war between the U.S. and China, has largely stalled growth in the economy while banks are also seeing profit headwinds due to the levelling off of interest rates in the U.S.

Our article this quarter updates 2019 banking industry performance trends and expectations, complementing our last publication that focused on the pay implications of 2018 performance. Annual incentives for 2018 trended notably above target and higher than the broader S&P 1500, reflecting the industry’s financial growth over the past two years. Additionally, long-term incentives (LTI) ticked up to 125% of target when compared to 101% of the prior year. (For more details, see “Banking industry 2018 pay-for-performance update: earned incentives trended above target,” Executive Pay Matters, July 16, 2019.)

Figure 1 reviews early 2019 analysts’ expectations compared with 2018 results. Analysts estimated weaker income statement growth as revenue, earnings before interest and taxes (EBIT), and earnings per share (EPS) growth expectations are lower than 2018 results, while return on equity (ROE) was expected to slightly increase. The movement of these performance measures in the banking industry generally aligns with the broader S&P 1500.

Figure 1. Banking industry analysts’ growth expectations for 2019
Figure 1. Banking industry analysts’ growth expectations for 2019

Source: S&P's Capital IQ database

Most financial performance measures after the first six months of 2019 are tracking below 2018 results while remaining in line with investment analysts’ estimates for 2019. As a result, incentive earnings may lean close to or slightly below expectations, as analysts have predicted a downward trend in 2019. Figure 2 shows financial performance measures in the first half of 2019 compared with the same six-month period last year:

  • The results for profitability are mixed, with an increase in return on assets but decrease in ROE.
  • Financial soundness remained relatively strong, although the Tier 1 capital ratio declined.
  • Revenue growth and EPS growth is slower compared to first-half 2018.
  • Improved shareholder returns due to strong stock market performance in first-half 2019, but the third quarter has been more volatile.
 
  Banking sector median*  
Measures 1st half 2018 1st half 2019 2019 trend
Profitability      
Return on assets 1.2% 1.5% This is a green arrow pointing up indicating and upward trend
Return on equity 9.5% 9.1% This is a red arrow pointing down indicating a downward trend
       
Financial soundness      
Net charge-offs to loans 0.0% 0.0% This is a yellow arrow pointing to the right indicating no significant change in the trend
Nonperforming assets to assets 0.4% 0.1% This is a red arrow pointing down indicating a downward trend
Tier 1 capital ratio 11.9% 9.5% This is a red arrow pointing down indicating a downward trend
       
Growth      
Net revenue growth 9.2% 5.9% This is a red arrow pointing down indicating a downward trend
Book value growth 5.4% 9.1% This is a green arrow pointing up indicating and upward trend
Earnings per share growth 27.1% 9.5% This is a red arrow pointing down indicating a downward trend
       
Market-based measures      
Price/earnings ratio 15 13 This is a red arrow pointing down indicating a downward trend
Total shareholder return (TSR) -2.9% 15.8% This is a green arrow pointing up indicating and upward trend
       

Figure 2. Banking industry first-half performance scorecard

*Financials through first two quarters; TSR represents composite performance through June 30, 2019
**Earnings before interest, taxes, depreciation and amortization
Source: S&P's Capital IQ database

Expectations for the banking industry will continue to lean on the conservative side, as the expected 2019 performance will most likely remain flat to down in absolute terms versus 2018 results. The immediate profitability gains realized in 2017 and 2018 due to the Tax Cuts and Jobs Act have played out, while the expectations for near-term interest rate cuts by the Federal Reserve will result in banks earning a lower deposit spread in their lending business. There are differing opinions as to the probability of a recession in the near term, which would have further negative impacts on bank profitability should it come to pass.

Based on the conservative performance expectations, 2019 annual incentive payouts for the banking industry could be slightly below 2018 levels. Whether the overall trend will be below target depends on whether companies took a conservative approach when setting 2019 incentive plan goals.

As part of the annual goal-setting process more companies are bringing additional analytics to the discussion, including predictive analytics. Willis Towers Watson’s predictive performance model (PPM) helps clients measure the probability of achieving goals and aligning pay and performance. To learn more about PPM, follow the link here and watch a brief video (mid-page) explaining how our model can help you calibrate your incentive plan goals.

For a look at first-half results for 2019 in the broader S&P 1500, see “S&P 1500 pay-for-performance update: Will weaker 2019 performance reduce incentive payouts?Executive Pay Matters, October 2, 2019.

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