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Tuesday, 16 September 2014

Dresdner Kleinwort court judgement enshrines pay for failure

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Commerzbank didn’t have a good Wednesday. First, the UK High Court ruled that the bank had to pay 104 former Dresdner Kleinwort bankers €52m in bonuses accruing from 2008; the judge saying they were contractually entitled to receive them even though the bank made a loss of around €6.5bn that year. This has been a long-running saga and the verdict must have hurt. And it came on the day the bank posted a 63% decline in first-quarter net profits.

IFR Editor-at-large Keith Mullin

IFR Editor-at-large Keith Mullin

On top of that, not everyone is convinced that Commerzbank’s balance sheet manoeuvrings have filled its €5.3bn EBA capital shortfall with hardcore capital, less still with an additional €1.1bn buffer. Gossip that the bank will eventually have to seek some sort of State aid refuses to go away.

The shares are down 27.5% year-to-date and it’s hard to see them staging anything of a major turnaround at present (notwithstanding the fact that they rose 1% Wednesday on comments by bank executives that the capital hole had indeed been filled).

On the performance front, it’s also hard to get a really good read on what the current numbers mean for future business generation, as Commerz is still in the midst of a fairly wide-ranging restructuring and still, for example, hasn’t fully run down real-estate subsidiary Eurohypo.

But management did admit the bank won’t hit its €1.2bn first-half net profit target, even though operating profits are stable year-on-year. (That is if you exclude the one-off positive €358m effect stemming from capital-structure improvements – i.e. discounted debt buybacks – and the €158m negative effect of own credit spread adjustments.)

For CEO Martin Blessing, the name of the game continues to be balance sheet deleveraging and fortifying the capital position. On the plus side, this ongoing process has had quite an impact. The Corporate and Markets division has cut operating expenses by 23% year-on-year and the bank has cut the amount of capital allocated to it by a quarter, to €3.2bn – thanks to the reduction in risk-weighted assets.

The ruling comes, of course, at a fascinating time when shareholder activism around the pay for performance culture has suddenly got tough.

The Dresdner Kleinwort bonus saga has been going on for years, and even though the High Court ruled against Commerzbank, the bank plans to go to the Court of Appeal to have the decision overturned. The ruling comes, of course, at a fascinating time when shareholder activism around the pay for performance culture has suddenly got tough.

Citigroup’s pay proposals were rejected, while large swathes of UBS, Credit Suisse, and Barclays shareholders voted against their respective remuneration plans. In the non-bank arena, Andrew Moss, CEO of UK insurer Aviva, was forced to quit this week over a pay revolt.

The decision to grant the former DrK bankers bonuses ‘promised’ to them does appear grossly counter-intuitive. It appears that the-then DrK CEO Stefan Jentzsch continually promised – verbally – discretionary payouts to bankers out of his €400m guaranteed bonus pool regardless of the losses being racked up by the bank, in an attempt to prevent them walking.

In an environment of greater scrutiny over governance standards, the court decision caused a frisson of shock and disbelief, perhaps more because it will give carte blanche to others deprived of contractual bonuses to seek copy-cat payouts.

Lawyers, commenting on Wednesday’s ruling, point to the wider relevance it has today where some banks battling liquidity problems or those contemplating takeovers may still have to reward failure.

One element that does truly shock is that during the trial, it appeared that lawyers acting for the bankers argued that Dresdner had been warned by the FSA that it should seek to avoid an exodus of staff which might destabilise at a time it was running heavy losses; and it was that warning which led to the whispered promises of bonus payouts. In his judgement, Mr Justice Owen chose the narrow issue of specific contractual claims over the broader issue of banker bonuses and remuneration structures.

The fact that there was a complete mental separation between heavy losses and personal payouts shows how perverse the culture had become. The fact that the bank was making heavy losses didn’t appear in the eyes of the bankers even remotely to contradict the notion that they would be eligible for bonuses.

Lawyers, commenting on Wednesday’s ruling, point to the wider relevance it has today where some banks battling liquidity problems or those contemplating takeovers may still have to reward failure. Seems like not much has changed.

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