Buoyant Market Could Push Comp Ratios Up

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Despite hiring extra staff and paying higher bonuses, most banks kept a good handle on costs in 2005. But there are signs that costs could be harder to keep under control in the year to come.

Banks gauge their containment of employee expenses using the compensation and benefits ratio, or the amount they pay employees compared to revenues coming in. Alan Johnson, of Johnson Associates, a Wall Street pay consultancy, says the average ratio fell back in 2005. "When times get better, the ratio goes down very slightly - that's what we've been seeing."

Most banks aim to keep compensation and benefits below 50% of revenues, and last year was no exception. At Lehman Brothers, for example, compensation and benefits were 49.3% of revenues in 2005, versus 49.5% in 2004.

However, there are indications that costs may be beginning to creep up. Compensation and benefits at Morgan Stanley soared 41% in the final three months of 2005. Bear Stearns saw its compensation ratio rise from 43.8% to 46.2% between 2004 and 2005. Goldman Sachs also saw staff costs rise, from 46.7% to 47.2% of revenues between 2004 and 2005.

Goldman Less Golden

Johnson says Goldman's increase is down to the firm having abnormally low costs in previous years, but others are not so sure.

According to Brad Hintz, an analyst at Sanford C. Bernstein, Goldman's costs are rising at an accelerating rate. "The marginal compensation ratio at Goldman is rising," he says. "For every additional member of staff, pay is increasing faster than revenues."

Hintz says this is a common occurrence mid-cycle, and an omen of things to come. "After a couple of good years banks begin to lose discipline," he says. "To use a theological metaphor, it's not a massive mortal sin that gets them, but a lot of little venial sins - another Bloomberg screen, an extra technology initiative, or another associate for a managing director. It all adds up."

With Goldman, Bear Stearns, Lehman and Barclays Capital all planning to add staff in 2006, Hintz says the problem could worsen. "Everyone wants to build in hot areas like commodities," he says. "As a result, prices are rising and we are going to see compensation ratios popping up."

CSFB the Exception

The exception to this rule could be Credit Suisse First Boston. The bank has traditionally had one of the highest compensation ratios on Wall Street, at 55% or higher.

Vasco Moreno, an analyst at the London office of Keefe, Bruyette & Woods, says this is because CSFB puts less capital to work in its trading businesses than its rivals.

However, CSFB's is curing itself of its profligate ways by focusing on higher margin activities such as derivatives and leveraged finance. In the first nine months of 2005 its compensation ratio fell to 54.4%, down from 57.1% in the same period of 2004.

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