COVID-19 is forcing drastic measures: Split-site operations, remote working, short-time work and tight liquidity and cost management. Are dividends and bonus payments appropriate in times like these? In this hkp.com interview, hkp/// group experts Petra Knab-Hägele and Isabel Jahn explain how banks and insurance companies are positioning themselves and which approaches they use to handle the situation.
Ms. Knab-Hägele, Ms Jahn, few industries are subject to a regularity system as stringent as that of the financial services sector. What recommendations are currently being made by the supervisory authorities when it comes to the payment of dividends and bonuses for the financial year 2019?
Petra Knab-Hägele: Well, the recommendations are not quite as clear as some would like. However, the German Federal Financial Supervisory Authority (BaFin) does advise financial institutions to assess the payout of dividends, profits and bonuses carefully. But ultimately, an institution’s individual situation is decisive when it comes to dividends. Therefore, a payout has to be convincing in its justification. The European Central Bank is a little more specific regarding the time frame involved and recommends that banks should not payout any dividends until October 1, 2020 and refrain from share buybacks.
Isabel Jahn: And at a European level, EIOPA has recommended a prudent approach to insurance companies, i.e. the suspension of dividends and, if necessary, bonus payments as long as the effects of the corona crisis are still unclear – coupled with the request that they provide the national regulator with a justification, should they currently still feel obliged to pay dividends or bonuses.
What does the time frame look like?
Petra Knab-Hägele: Dividends are usually paid out following annual general meetings. But because of the COVID-19 pandemic, many shareholders’ meetings have been postponed and some have been converted to a virtual format. In contrast, the bonus processes of most banks usually end around the end of March for regular financial years. This means that most bonuses have already been paid out or the relevant resolutions have been passed, resulting in legal obligations.
Are there any tendencies arising that indicate how institutions will act in terms of dividends?
Isabel Jahn: Numerous European and national institutions want to follow the ECB’s guidelines to not pay out dividends until October 1, 2020. In the case of insurance companies, there is more of a tendency to pay out dividends. It isn't a uniform picture.
Would a complete waiver of a dividend payout be conceivable and if yes, how would investors react?
Petra Knab-Hägele: A waiver is of course conceivable – but it is always dependent on the individual situation. Seven of the larger German banks, as well as seven of the largest banks based in Europe, have already announced a dividend waiver. Investors are likely to understand this in the current climate. However, bonus payouts at the same time of a dividend waiver could lead to increased attention and negative press. Several European countries, such as the UK, have clear expectations. The head of the British banking regulator PRA, Sam Woods, expects that banks will not pay out cash bonuses to management. Several European banks have already made clear that they will waive their cash bonuses in 2020.
Isabel Jahn: It is presumable that regulators and supervisory authorities won’t necessarily expect synchronization between dividend payouts and bonuses. What really counts is prudent handling – depending on the size of the bonus pool and the economic situation of each institution.
If most institutions have already paid out their bonuses, what liquidity-promoting scope do those have where a payment is still outstanding?
Petra Knab-Hägele: If payment is still outstanding, a postponement or waiver of bonuses for the 2019 financial year could still be considered. But generally speaking, this can only happen on a voluntary basis as ultimately there is usually a contractual agreement in place.
Are reduced bonuses or even non-payment out of the question?
Isabel Jahn: This would only be conceivable if it is suggested by the mandatory, institution-specific assessment of the bank's capital and liquidity resources. This is governed by the Remuneration Regulation for Institutions, Section 7: Conditions for determining the total amount of variable remuneration. However, this has usually already been carried out successfully in so far as the 2019 financial year was successful. In this respect, a waiver of a bonus payout for 2019 would be hard to accept for employees.
Petra Knab-Hägele: It’s important to note that for risk takers, 40 to 60 percent of the variable remuneration is subject to a deferral anyway. The assessment of whether a bank can afford to pay out bonuses not only takes place in the year in which the bonus is determined but also at the respective payment dates and is, in addition to this, also subject to backtesting.
What scope is there for making a voluntary bonus deferral or waiver more attractive?
Petra Knab-Hägele: There are of course tools that ensure that today’s waiver is an investment in tomorrow. If, for example, a bonus or part of a bonus is deferred, this could be combined with a performance bonus, which is then paid out if the desired return target is achieved after one or two years. Should this not be possible, the amount would simply earn interest.
Isabel Jahn: Listed institutions are also considering a conversion to shares, which are subject to a lock-up period. But even in non-listed companies, deferred bonuses can in principle be converted to virtual instruments or an employee participation plan, thus converting solidarity-based contributions to employee ownership.
Petra Knab-Hägele: It is important that all decisions in this context are in line with the overall approach. They should also be implemented consistently in a top down approach in order to set an example: from the Board of Management to senior management, from risk takers to employees.
How should banks proceed if they are actually considering bonus-related measures to ensure more liquidity?
Isabel Jahn: For banks, we generally recommend assessing whether a voluntary waiver or complete deferral of bonuses is possible, at least for the Board of Managing Directors, senior management and the bank’s risk takers, for whom the deferral of bonuses is already "common practice" for regulatory reasons. It can also be determined whether amending the deferral terms for past or future bonuses is possible for this group of employees – for example, changes to or postponement of the pro-rata vesting or an introduction of a cliff vesting approach at the end of the period. Here, it is necessary to assess whether this can be arranged on an individual basis, in a way that doesn't constitute a circumvention of the Remuneration Regulation for Institutions (InstitutsVergV).
Petra Knab-Hägele: It could also be investigated whether the application of a modifier is possible in accordance with the Remuneration Regulation for Institutions (InstitutsVergV). The prerequisite for this is an unforeseeable change in the economic environment that cannot be influenced or controlled. Overall, a careful assessment of the company’s risk bearing capacity, its capital planning, profit situation, capital buffer requirements as well as its capital and liquidity resources is always needed before a bonus payout. The expected additional forecast of these parameters can prove particularly challenging at present.
Isabel Jahn: The adjustment of targets and parameters for measuring variable remuneration for 2020 is also advisable, as the overall conditions for the target planning , and therefore usually also the business and risk strategies, will change; in some cases significantly.
Are you aware of any banks that are deviating from their usual payout due to the Corona crisis?
Petra Knab-Hägele: We know that many across industries, companies are considering this. So far, there have not been any binding statements from banks in Germany regarding changes to the payout of bonuses. Initial considerations are more along the lines of a voluntary salary waiver rather than a change to bonus payments, which could potentially also be retroactive. Nine of the major European banks have already announced relevant measures to address salary reductions, bonus waivers and donations.
What is the reason behind the restraint shown by banks in Germany?
Isabel Jahn: This is in part due to the regulatory requirements. Institutions are subject to a highly structured process where prerequisites are carefully examined to prevent mismanagement. The process is thoroughly assessed before any adjustments are made. Plus, the actual impact of the Corona crisis on banks is still difficult to forecast right now.
Petra Knab-Hägele: To that extent, there isn’t a one-size-fits-all solution. However, in the medium term, public opinion could have a stronger influence here. Especially if, like in a financial crisis, state aid is still being applied for, an obligation may emerge for individual institutions to cap bonuses or fully withdraw them.
Ms. Knab-Hägele, Ms. Jahn, many thanks for this interview.