Pay This Year is Shot Unless Compensation Ratios Rise Significantly

In 2009, banks' massively lowered their compensation ratios. However, in the past quarter, compensation as a proportion of revenues rose again. This is fortunate, given a) the sorry state of 2010 revenues and b) the fact that several banks have (mistakenly) decided to increase their headcount.

At Goldman Sachs, Morgan Stanley (institutional securities), JPMorgan (investment bank), Credit Suisse (investment bank) and Deutsche (corporate banking and securities), top line revenues fell anything from 6.5 percent to 25 percent year-on-year in the first half.

At the same time, many of these organisations unfortunately increased the number of people they employ. Goldman now harbors 2,900 more than at the end of Q209. JPMorgan's got 496 more, UBS's got 1,228 more, Credit Suisse's got 1,800 more, and Deutsche has got 1,725 more.

With the exception of UBS, none of these banks has anything to show for their hiring. The most woeful case is Credit Suisse, where headcount increased 10 percent year-on-year in the first half, and revenues fell 25 percent.

Q3 and Q4 Look Terrible

Nor is there much hope for a big revenue recovery in the second half.

Traditionally, investment banking revenues decline from June onwards. Taking Goldman Sachs (rightly or wrongly) as a proxy for the industry, second half revenues were an average of 8 percent lower than first half revenues across 2004, 2005, and 2006.

This year, the likelihood seems to be that Q3 will be as disappointing as Q2. Although Barclays spoke favorably last week of the (business) climate in July, Stephen Hester at RBS confessed it was, "all over the place."

Meanwhile, Sanford Bernstein analysts have delayed their predictions for a recovery in M&A and corporate finance revenues until Q3 2011 on the grounds that M&A volumes probably won't properly recover until 2011 and there's then a six month time lag until the resulting revenues are "realized," which is not good news for bloated M&A teams waiting for a dribble of fees.

Up With the Compensation Ratios

None of this particularly matters for pay, as long as banks mightily increase the amount of their dwindling revenues which they allocate to compensation.

For the moment, this appears to be happening. Goldman's comp ratio for the first was 43 percent, compared with 35.8 percent for the whole of last year. JPMorgan's was 36 percent, compared with 33 percent for last year. UBS and Credit Suisse were on around 50 percent, compared with 81.2 percent (an exception) and 42 percent respectively last year.

The real question now (for pay) is whether banks will hold their nerve and continue accruing higher levels of revenue as compensation in the third and fourth quarters.

Unfortunately, they probably won't. Remember the Bank of England's recent study pointing out that if bonuses had been diverted to recapitalisation the financial crisis would never have happened? It does sit well with higher comp ratios, does it?

Unless revenues recover, something has to give. If it's not the compensation ratio, it will be compensation itself. Or jobs.