Pay bonanza may never return as banks evolve

Living off a salary can be hard, particularly if it is a fraction of what one is used to. But that is precisely what an increasing number of investment banking professionals are doing - and with no end in sight.

The sad fact is that the economic downturn may not be the only thing depressing pay in the glitzier areas of financial services. There also have been fundamental changes in the industry's structure. Bonuses may never again reach the giddy extremes of 1999 to 2000.

At least this is the opinion of Davide Taliente, managing director of capital markets at the strategy consultancy Oliver Wyman. Taliente forecasts that future investment banking pay will be 20% to 30% below its long-run average. "There will be a fairly strong non-cyclical mark down in compensation levels in investment banking," he says.

Consolidation through mergers, as well as the industry's growing appetite for capital, are identified as the culprits; both are eroding the importance of employees. Taliente says that consolidation means that top organisations, not individuals, are becoming all-important.

At the same time, increased capital intensity means that shareholders must be rewarded for bearing more risk; employees and their bonuses will suffer.

To support the latter point, Taliente calculates that the capital intensity of the average bank with activities in the equities and fixed-income markets, rose by 8% between 2000 and 2001.

Moreover, he says future capital requirements could rise further as universal banks offer more credit to corporate customers in order to help secure investment banking advisory work.

With the universal banking model now being widely questioned, partly as a result of loans made to Enron and a variety of other possible conflicts of interest, elements of this reasoning are questionable. But as a prophet of lower pay, Taliente is not alone.

Headhunters and banking consultants and analysts sound an equally pessimistic note: bull market or not, a career in investment banking is no longer a sure-fire way to get rich.

Rupert Channing, managing partner of financial services at headhunter Heidrick and Struggles, says that the golden days when it was possible to move steadily up the investment banking ladder and to automatically earn more for doing so, are gone forever.

From here on, pay in investment banks will reflect pure performance and nothing else, says Channing. He expects some managing directors and vice-presidents will face a long-term reduction in remuneration as a result; seniority is no longer a guarantee of employers' largesse.

It is a view shared by Jon Terry, a pay and benefits specialist at PricewaterhouseCoopers.

Because remuneration is linked ever more closely to performance, Terry says that low or zero bonuses are becoming increasingly common for mid-performers.

"About 20% of people will receive no bonus at all in 2003, and aggregate bonuses will be down 25% on 2001," he warns. This will leave many people relying more on basic salaries, which can be as much as 150,000 for a managing director.

Like Taliente, Terry and Channing argue that together with the economic downturn, industry consolidation is behind lower pay. Power is increasingly concentrated in five or six leading banks. The dwindling aspirations of second-tier banks could have a lasting effect.

John Leonard, a banking analyst at Citigroup, says: "The remuneration boom in 1999 and 2000 was supported by new players trying to enter the market. At their next strategic review, middle-sized players are expected to cut back or exit. The remaining banks will be in a stronger position to negotiate with employees."

Chris Ellerton, a banking analyst at UBS Warburg, says the industry has become more rational. "Pay is lower because irrational bidders have been eliminated. The chances of a minor player ever again deciding to try and become a bulge-bracket player are low. There are no longer madmen out there who are willing to lose hundreds of millions of dollars just to establish a beachhead."

Rational pay or not, from an employee's perspective it is not all bad news. Channing says that banks' emphasis on performance means that some star players will be just as handsomely remunerated as ever. Even now, he says, many such people are receiving guaranteed bonus. "Bonuses are being targeted much more closely at top performers," says Channing.

Nor is there any guarantee that irrationality will not return to the industry, at least in the short term. Channing says that current severe cutbacks in MBA hiring are likely to generate competition for staff at vice-president level when the market picks up.

Leonard says that banking pay bounced back quickly after previous downturns, and that it will undoubtedly do so again in the short term.

He says: "After the grinding market downturn of 1982, Wall Street was back to boom by 1985 or 1986. It will be two to three years in coming, but the steamy conditions of 1999 and 2000 will return. Remuneration will certainly rise accordingly."