Compensation surveys commonly rank loan growth as a key metric used in bonus plans for senior executives. This article explores the use of loan growth as a bonus plan metric for both federal credit unions and state-chartered credit unions in Nevada and California.
NCUA’s Loan Growth Metric Rules
The NCUA Regulations state:
Except as otherwise provided herein, no official or employee of a Federal credit union, or immediate family member of an official or employee of a Federal credit union, may receive, directly or indirectly, any commission, fee, or other compensation in connection with any loan made by the credit union.2
The regulations go on to provide some important exceptions and clarifications:
- Payment of an incentive or bonus to an employee based on the credit union’s “overall financial performance” is permissible.3
- Bonus plans for loan officers based directly on loans are subject to a carve out for non-senior management4 incentives linked to loans, provided the board establishes written policies and internal controls for the plan and monitors them at least annually. 5
As loans are the life blood of credit unions,6 loan growth plays a significant role in the credit union’s overall financial performance. To what extent, then, can a bonus plan for senior management employees use loan growth as a specific metric in its bonus plan formula?
The rule on its face appears quite restrictive ― loan growth or other related loan metrics are “in connection with any loan made by the credit union” and cannot be used as metrics for bonus plans (other than for loan officers with the noted protections).7
From our clients’ experience, however, we have learned that the seemingly black-and-white rules described above instead have various shades of gray in practice. As mentioned above, loan growth is widely used as a metric in bonus plans. We understand that when this issue comes up on exam, regulators look at various factors to analyze how the use of loan growth in the bonus plan affects risk levels for the credit union. The following are some examples of factors examiners would likely consider:
- Is there any evidence that senior managers are promoting unhealthy loan growth?
- Does the credit union have a healthy loan portfolio?
- Does the credit union have enough staff to handle loan growth?
- Are loans growing too quickly?
- Has the loan growth been a good thing for the credit union?
- Are there any loan concentration issues?
- Is there sufficient liquidity in the loan portfolio?
- How does the credit union’s loan portfolio compare to the portfolios of its peers?
- This type of review seems a fair balance between a credit union’s desire to focus senior executives on proper loan growth, and reward them for that focus with bonus compensation, and the regulators’ mission to assure safe and sound practices.
We understand that the NCUA wants the rules on bonus plan metrics to match today’s marketplace, and is open to input from the industry. As luck would have it, the NCUA’s loan rules quoted above are up for review this year as part of the regularly scheduled regulatory review process. This is a good opportunity for interested parties to give the NCUA suggestions on how to structure the rules to allow for the use of loan growth as a metric without putting the credit union at risk.
California/Nevada Loan Growth Metric Rules
For state-chartered credit unions, we can find no California or Nevada restrictions on paying bonuses for loan growth.8 The California statutes, in fact, indirectly endorse using loan growth as a metric.California has a statute addressing inducements for new memberships or additional deposits by current members. It provides:
No credit union shall pay any commission or compensation to any person for securing a new member or for getting an existing member to make an additional deposit.
The statute goes on, however, to exempt employees from the rule, allowing them to be paid for securing new members and getting current members to make additional deposits. The statute also allows credit unions to use membership growth as part of its compensation plan.
This California statute is interesting because it takes a similar approach to membership restrictions as the NCUA took to loan metrics, but did not establish loan restrictions for compensation purposes. Presumably, if using loan growth were a concern for the California legislature, it would have followed the NCUA and added the same language to its loan provisions. This coverage in the membership section and lack of inclusion in the loan section gives us more confidence in this conclusion than if the statutes were silent on the issue.
In analyzing bonus plans that use loan growth as a metric, we understand that state examiners would likely review the same standards used by NCUA examiners to determine whether the bonus plan creates proper incentives for executives to promote loan growth at the credit union.
Loan growth is commonly used as a metric in bonus plans, and we believe that practice will continue. For federal credit unions, the NCUA’s regulation should be updated to reflect current practices that are in the best interest of the executives and the credit unions, and which are already allowed by federal regulators. This will give federal credit unions more predictability as they design and administer bonus plans, and create more uniformity in the regulation of bonus plans throughout the five NCUA regions. Federal credit unions should analyze their bonus plans and business plan for loan growth using questions along the lines of those set out above. State chartered credit unions in California and Nevada do not have the same statutory restrictions, but should consider addressing the questions set out above as a best practice.
1 Jim is a partner with Sherman & Patterson, Ltd., a law firm focusing on executive compensation in credit unions and other tax-exempt entities. Jim frequently interacts with the NCUA and state credit union regulators regarding the implementation and funding of executive and director benefits, keeping clients compliant with applicable regulations.
2 NCUA Regulations §701.21(c)(8)(i).
3 Id., at (c)(8)(iii)(B).
4 Senior management employees are defined as the chief executive officer, assistant chief executive officers (e.g., assistant president, vice president or assistant treasurer/manager) and the chief financial officer. Id., at (c)(8)(ii). 5Id., at (c)(8)(iii)(C).
6 65–70% of median income reported quarterly on Form 5300 since 2005.
7 Furthermore, in the only public opinion we have found on this issue, the NCUA allowed a bonus plan to be “based solely on [the credit union’s] net return on average assets,” but not on the credit union’s “ratios of loans to assets and delinquency.” NCUA advisory opinion letter to Edward J. Gvazdinskas dated January 11, 1994. The letter interprets “underwriting, insuring, servicing or collecting a loan” to be covered by the restriction.
8 However, NCUA’s 1994 advisory opinion letter to Edward J. Gvazdinskas provides that the loan rule applies to the special reserve required for federally insured state chartered credit unions, meaning they are at least indirectly subject to the federal standard.
9 Cal. Fin. Code §14803(a).
10 Id., at (b), (c).