Get ready for wide gaps in how the big banks compensate their employees this year.
The ever-shifting financial markets always produce front-runners and also-rans. But bank results are diverging to an exceptionally wide degree in the second half of 2007. That may be why, with just two weeks left before many institutions close their books on the fiscal year, industry observers remain sharply divided about the outlook for year-end payouts. Indeed, even speaking of "the outlook" may be indulging in an illusion. Instead, it may be necessary to formulate distinctly separate outlooks for each major investment and commercial bank.
Goldman Sachs and Lehman Brothers are thriving, even while still-unsettled credit markets wreak havoc on rivals like Citigroup, Merrill Lynch, Bank of America, and HSBC. A majority of banks are scaling back parts of their fixed-income businesses and have announced mass layoffs, and there is rampant talk of bank executives preparing their teams for across-the-board bonus reductions. At the same time, a respected compensation consultant with deep bulge-bracket ties predicts average payouts for 2007 will exceed last year's very healthy amounts. The consultant, Alan Johnson, sees bonuses rising 10 percent or more in such departments as investment banking, prime brokerage, equity derivatives, private equity, wealth management, and even fixed-income derivatives.
Nonsense, counters Wall Street recruiter Ken Murray, the president of Mercury Partners. "Anyone who works in these (investment banking) groups, they'll tell you it's going to be down," he says. Within investment banking, Murray pegs this year's bonus ranges at 20 percent below last year's, and says the highest-paid bankers will get still less. As a foretaste of what's to come, he cites this week's news that UBS bankers and traders will receive most of this year's compensation in the form of stock, with cash pay capped at $750,000.
Goodbye To 'One Size Fits All'
A close look at various banks' actual disclosures and pronouncements suggests reality may defy any one-size-fits-all formulation.
Among eight large U.S.-based institutions, six reported lower pretax profit for the third quarter than a year earlier, and one reported a quarterly loss. Since bonuses are dictated by the bottom line, payout expectations across most of the Street shriveled in the face of poor third-quarter showings and subsequent fears that write-downs and other mortgage-related problems will continue to batter results.
For the year to date, however, pretax profit ranged from up 31 percent (Goldman) to down 63 percent (Citigroup) versus the same period of 2006. Significantly, five of the eight banks we examined reported higher year-to-date profit. And all eight institutions reported higher investment banking revenue for the year-to-date, with seven posting double-digit gains. (Note, however, that some institutions use a November fiscal year, so their third-quarter and nine-month results exclude September.)
Although influenced by a company's profit, compensation tends to be less volatile. Firm-wide compensation and benefits expense among the eight banks ranged from up 68 percent versus a year earlier (Goldman) to down 49 percent (Merrill) for the third quarter, and from up 29 percent (Morgan Stanley) to down 15 percent (Merrill) for the year to date.
On Sunday, the New York Post reported that Goldman, a perennial leader in profitability and compensation, is set to pay its three top executives about $70 million each in cash and stock. That's about 40 percent above what each man got last year. Wednesday's Wall Street Journal reports that Goldman Chief Executive Lloyd Blankfein bluntly denied rumors the firm will take a "significant write-down," as many of its peers have done - or plan to do.
Of course, the year-to-date figures do not yet reflect 2007's final quarter, when discretionary bonuses are determined. And there's a great deal of uncertainty about how the industry will fare, since most banks have ongoing exposure to sub-prime mortgages, leveraged loans, and various structured bonds they would not - or could not - unload.
Still, it's a good bet that if you're fortunate enough to work at a firm that's prospered under difficult market conditions, you'll prosper too. Conversely, if your employer is near the top of the league tables in write-offs and layoffs, expect your compensation to be affected, even if your particular area performed well. When a firm's overall profits collapse, management may shift surpluses from better-performing divisions to support bonus pools for weaker divisions in order to avoid wholesale defections.
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