What appeared to be well-grounded expectations for banks' future staffing and compensation levels have been set adrift by two dramatic events in the space of just a few hours: Goldman Sachs' compression of compensation expenses in last year's fourth quarter, and the White House announcement of the most far-reaching bank overhaul proposal of the bailout era. The Goldman compensation numbers are the more portentous of the two, in my opinion.
Wall Street analysts are scrambling to quantify each top-tier bank's earnings that could vaporize if the Obama-Volcker plan becomes law. At least one, JPMorgan's Kian Abouhossein, last September published a model that progresses from regulation-induced earnings impacts to estimate specific headcount and compensation cuts for eight big European and U.S. institutions. When juxtaposed with Abouhossein's latest downward earnings revisions spurred by the Volcker plan and a measure to regulate OTC derivatives, his model spotlights risks to both jobs and paychecks at each bank.
Those payroll-reduction forecasts rest on some very large assumptions - not least of which is that affected institutions will simply shrink rather than shift resources to other activities they think could generate as much (or almost as much) profit as current activities that get smashed by new laws or regulations. That's why the 2009 pay figures the banks themselves released this past week might provide more useful signals for future compensation levels, in my view.
Smaller Comp Ratios: Trial Balloon For 2010
In varying degree, each top-tier bank's fourth-quarter results announcement conveys a single message about compensation: The torrents of mud being hurled against banks and their employees are starting to impact pay not only in form - fixed versus variable, and shares versus cash - but in overall quantity.
The loudest message came from Goldman Sachs. If any further proof was needed that executive decisions driven by "optics" can shrink your paycheck like looking through field glasses turned backwards, its negative fourth-quarter compensation number settled the question with a shout.
Goldman's 35.8 percent compensation to revenue ratio for all of 2009 - its lowest since going public in 1999, and a major contributor to the bank's record profit - is best viewed as a trial balloon. Take CFO David Viniar at his word when he says it might or might not be repeated. Presumably, political and public reaction will decide what Goldman and other banks do about 2010 compensation. The risk is that the shrunken comp ratios reported by Goldman, JPMorgan and other firms might fail to satisfy a public foaming at the mouth to punish financial professionals en masse for the sins of a few.
Meanwhile, two trends long in place will continue. Look for U.S. and European bulge-bracket banks to:
- Lock up ever more of bonus payouts in the form of restricted stock grants; and
- Make compensation less variable, by shifting more of the total from bonuses into salaries.
Higher Base Salaries Might Restrain Hiring
Here's a scenario that came up at an informal gathering of fund professionals last night. Say a bank trader earns $200,000 base and a bonus that might be a fraction of base in a bad year or exceed $1 million in a good year. The way things are going, that payout structure might evolve into a $500,000 fixed salary and a bonus capped near $200,000. My new acquaintance who mentioned this possibility says some bank traders would find the latter deal quite satisfactory - even preferable to the potentially larger but less-certain initial pay package.
Raising fixed salaries sounds appealing on the surface. But there are two less-obvious negatives (viewed solely from the standpoint of employees):
First, job opportunities will shrink, especially at lower levels. Think of it as the college-graduate equivalent of the minimum wage: If every starting analyst costs a minimum $150,000 (i.e., base) even in a bad year, banks will employ fewer analysts (or will shift more analyst jobs to India).
Second, during downturns institutions will slash headcounts even more deeply than they've done until now. If business dries up and you need to hold compensation expense flat for the rest of the year to make plan, the only way you can do that is by laying off the entire staff. No more balancing things out with a negative $1.4 billion compensation expense allocation, like Morgan Stanley did for its institutional securities division in the 2008 fourth quarter.