The end of the bonus bonanza?

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Investment bankers' pay has been pushed through the roof as European firms seek to compete with Wall Street. But now banks are squeezing costs as they see their growth prospects fade. For all but the very best employees, the days of sky-high salaries may soon be over. So don't spend that seven-figure bonus all at once - it may be the last for some time. By Suzanne Miller.

This year investment bankers may not be taking home the diamonds and gold bars which, for tax reasons, used to be part of big bonus packages. But when they tot up their bonus earnings for 1997, a good number will find they can easily afford such extravagances. For European and US investment bankers, it's promising to be the best bonus year yet, even with fourth-quarter global market setbacks, not least because the first three quarters were so very good to most.

"All indications say 1997 should be a peak year," says Michael Mahoney, a 25-year-old Wall Street veteran who runs a New York firm of bond-trader headhunters. "The securities business made more money than ever. That means the top of the market will be paid 25% to 50% more than last year." Mahoney figures there are 400 to 500 investment bankers spread throughout global high-yield securities sectors who will be taking home a minimum of $1 million each in bonus. Many of them command base salaries of $200,000 to $250,000.

Running to eight figures

In such high-yielding domains as emerging markets, some young traders with just one to two years' experience working, say, in Russian securities will net $100,000 and more. For more seasoned traders, some bonuses will run to eight figures. One of those lucky few rumoured to be a potential eight-figure earner is Andrew Ipkendanv, who runs Credit Suisse First Boston's emerging markets desk in London. Word has it that Ipkendanv, who could not be reached for comment, will have taken home some $20 million in his year-end pay packet.

There will also be generous pay-outs for a good number of top corporate financiers, after a dynamic year for mergers and acquisitions. Many corporate-finance specialists can expect to see 40% pay increases, according to a survey by Russell Reynolds, a London headhunting firm. The firm reckons that a managing director at an investment house who earned £800,000 ($1.4 million) last year will take home at least £200,000 more this year.

For many, 1997 may well be remembered like a fine vintage wine, seasoned by seven bull-run years, but perhaps uncorked too soon with the advent of the new mood of uncertainty in the markets. For some, though, the time from October when global stock markets took a nasty spill may if anything have enhanced their bonus spoils.

"I think it's going to be a very good year. From a risk-management perspective, people are going to be compensated very well - in some cases at two and three times multiples of salaries," says Tony Marshall, a former trader and now co-head of a London recruiting firm that caters to global investment banks. "In this day and age," he says, "most would have been insured through the derivatives market, though some would have got it wrong. When you start getting 100-point moves in one day, the ones with the cash are going to make the money."

Paul Roy, London head of European and Asian equities at Merrill Lynch, says the mood on his trading floor was upbeat when the markets began to crash. "People were looking to do some business. One caters to a two-way business. When you see sharp moves in markets like this it encourages business."

But while many fat bonus-stuffed cheques will arrive this month and in March, there are likely to be fewer at investment banks across the board the same time time next year. There's a gnawing worry that the fourth quarter of 1997 could signal tough times ahead, with the glittering performance many enjoyed in the first three quarters fading into memory.

Blows to confidence

Investment banks earn their bread and butter from advising on M&A in domestic and emerging markets, as well as ushering new issues to market. But since October 27, when the Dow Jones Industrial Average plunged 7.2%, its biggest one-day fall since October 26 1987, there's been a knock-on effect that has shaken confidence just about everywhere and is bound to reduce the number of deals being done. A couple of large emerging-market privatizations have been called off in India and Croatia, while at least 20 international share issues were pulled within the first two weeks of October 26.

"It is highly probable that 1997 will have been a peak year for investment earnings," says Martin Green, analyst with Merrill Lynch in London. Green, who says his team is having a close second look at market implications for next year's investment-bank earnings, says the market volatility signals underlying worries. "Confidence in markets is needed for new issues and volatility is an expression of lack of confidence," Green points out.

In the meantime, there's already evidence of a new mood of austerity. There's talk that Deutsche Morgan Grenfell, one of the single biggest spenders on staff for the past couple of years, will be counting its pennies more carefully when it calculates this year's overall bonus pool. And then there are the regulators, who have not forgotten the Nick Leeson and Peter Young scandals, or the derivatives lossethat ultimately undermined NatWest Markets, and which many believed were made possible because of the way staff are remunerated.

In March last year, the Bank of England warned: "We want [banks] to look at the way their payment-incentive systems, which are very powerful drivers of behaviour, interact with their risk controls."

In January, the Futures & Options Association will be making bonuses the subject of its annual City Debate conference. Anthony Belchambers, chief executive of the association, says: "There are concerns that bonuses may increase the appetite for risk. Personal aspirations can sometimes impede loyalties." Belchambers wants a serious debate about how investment banks think they can better impose risk limits on individuals. "The psychology of the trader who performs very well and earns big bonuses sometimes engenders a macho attitude, a bit like what happened at Barings," he says.

Belchambers is clear about wanting investment banks, and not the regulators, to take action. "Personally, I don't think the regulatory way is the way ahead," he says. "The whole concept of regulation is moving to risk-based supervision. Firms are being given more say in the ways of curbing risk. Regulators should ideally look at what the firms have done."

This year, investment banks, aware of such worries, have stepped up their efforts to grapple with weaknesses in their back offices and credit-risk divisions. A spokesman for Monks Partnership, a group that tracks hiring trends in the industry, says: "Extreme concern is being expressed by many organizations about four areas, namely risk, back office operations, documentary credits and information technology." He says banks, in an effort to shore up expertise, are luring junior staff from competitors with 25% and more base pay increases. Between August and November this year, the going advertised rate in the UK for a senior derivatives settlements clerk rose from £21,500 to £28,000. And the salaries of senior analyst programmers have jumped some £10,000 over the same period to an average of £43,667.

Let's cut costs

Investment banks, faced with these and other escalating costs as they seek to compete in a cut-throat industry, are for their own reasons starting to think twice about hefty compensation costs. "Everyone's been thinking about cost," admits one official from a bulge-bracket investment bank in London. "Competition is fierce so margins are under pressure. And everyone is faced with the obligatory expense of the millennium and getting ready for European monetary union."

Remuneration packages eat up some 50% of investment banks' operating revenues. With this type of cost burden, and regulators peering over management shoulders, investment banks are beginning to re-evaluate pay.

Some senior executives are also waking to the uncomfortable reality that those they've been hiring are earning higher base salaries than themselves. "I was just negotiating with a top investment banker, trying to get an individual a £300,000 package and a base guarantee of £110,000," one London headhunter recently recalls. "The guy who recruited him, who earns £750,000 a year, looked at his own salary and found he's actually getting a base of £65,000."

Industry veterans in investment banking and headhunting firms warn that a distinct two-tier salary structure is emerging. By next year, fewer investment bankers in the middle and lower strata will be sharing in the wealth of their firms, while the top performers of the industry - reckoned to be about 5% of investment banking professionals - will continue to get richer.

"There's definitely tiering going on," says Mahoney from his New York office. "The top people are getting paid more, the bottom tier are getting fired and the middle tier are lucky to have a job. You have to be very talented to make a lot of money. The market has become very performance-oriented." Mark Hoge, a banking analyst with Credit Suisse First Boston, agrees: "There's a tremendous gap opening up, where there are increasingly a few stars. If you're a good investment banker, you're going to pull in the money."

It is widely believed that Deutsche Morgan Grenfell (DMG), the investment-banking arm of Germany's Deutsche Bank, will be in the vanguard of those taking austerity measures, just as it was in the vanguard of the hiring frenzy that drove many salaries through the roof last year. It is believed that DMG is getting ready to cut the size of its bonus pool this year to tackle ever-escalating costs. For the first nine months of 1997, its costs rose 24% to Dm13.5 billion ($7.9 billion), partly because it continued to expand in investment banking. Some estimates have put potential cuts from the overall DMG bonus pool at around £70 million.

"It's all fine-tuning," says the managing director of a London financial recruiting firm. "You'd be daft not to look at the cost line. Some hires are working; some are not. They have to ask, did some people buy in for a fast buck or for a career? DMG has had a clear strategy: to buy the good, the bad and the ugly - and then to pull out the cherries."

DMG has been a seminal force in pushing up European salaries and bonuses to levels more competitive with rates on Wall Street over the past two years. For this, they are well loved by London's headhunting firms, and roundly criticized by rivals. Still, most admit DMG has had a hand in changing the dynamics of remuneration in Europe. "Five years ago, Goldman Sachs was at the top of the investment-banking pyramid in terms of pay," says a London banking analyst. "Now they're a small hump in the ground. Expertise and money have spread out across the board."

Until recently, DMG had been joined in its remuneration crusade by the investment-banking arms of Britain's NatWest Group and Barclays. Some are now suggesting that the withdrawal of these two banks from the global investment-banking rat race may result in part from a lack of nerve to commit to the longer-term costs involved. "People in the UK have a more egalitarian sense," says Martin Cross, analyst at UBS in London. "They don't like the lavish amounts needed to fund senior investment bankers. This may be one of the reasons why Britain cannot do investment banking."

Barclays did show its nerve, at least for a while, when it promised Bill Harrison a fixed £1.25 million bonus for 1996 and a £900,000 bonus for 1997 to become chief executive of BZW. Now that it is exiting that business, the bank has been forced to pay expensive golden handcuffs to stem a bloodletting of top staff.

Others worry about the prospects for the global players who are sticking it out. "Our real concern is the ability of the industry to manage in a downturn," says John Leonard, banking analyst with Salomon International in London. "How much in costs is committed, or fixed, and how flexible? How spread out are the costs? The question, too, is how much have costs gone up?"

Final determinations of 1997 bonuses have yet to be made at most banks in the aftermath of October's market turmoil. The first three quarters of 1997 brought record earnings for investment banks. Deutsche Bank's net profits, for instance, rose 56% to Dm2.38 billion ($1.38 billion) in the first nine months of the year, thanks in part to the general buoyancy of world capital markets.

But it is still far from clear what toll the fourth-quarter market shake-up will take on final profits and bonuses. For many a trader, a whole year's profit and loss can ride on two or three transactions. And for some, the fourth quarter has already spelt disaster. One $110 million US hedge fund bet the wrong way on S&P index contracts and was wiped out during the initial week of the so-called crash. Others, betting the stock markets were headed one way - down - sold all their stock and lost a fortune when the US market recovered.

Most will be spared such dramatic fates. But many are bound to feel a squeeze, even if it's only a small one in the context of three previous stellar quarters. From his New York office, Mahoney figures that when the line is finally drawn for 1997, many investment bankers will be taking home thinner bonus packages as a direct result of the late-year global market fallout. "It's going to hurt bonus pools by around 15% overall," he forecasts.

Jason Garner, director of Robert Walters Associates, one of the biggest financial recruiting firms in London, agrees that bonus packages may be nipped by the fourth-quarter markets. "The level of bonuses as a percent of overall profits will be a fraction less than last year and the year before." But he also suggests that because the first three quarters of 1997 were so exceptional for most, "there will be more underlying profits, so I don't think it will be too noticeable".

Stratospheric sums

Certainly, there will be those who only notice huge profits. As Garner points out, there will be those making "£5 million bonuses here and there". He expects sums of this kind to go to such people as top derivatives traders and fund managers. Last year, for instance, Carol Galley, vice-chairman at Mercury Asset Management, received a £6 million package.

And then there will be an entirely different breed of bonus earners - those earning the eight-figure packages that leave even those taking home $1 million wondering just what someone does with all that money.

One of those expected to make such a stratospheric sum this year is CSFB's Andy Stone, managing director of the bank's New York commercial mortgage product division. Stone is well known for his ability to demand and command staggering salaries.

For 1997 it's rumoured his total pay will be some $20 million. But if the stories about his pay the previous year are correct (the highest figure was put at $25 million, the lowest around $17 million), he could well be looking at a haul of much more than $20 million. Stone flatly refuses to discuss his pay package, but does manage to let drop: "I'm overpaid, whatever the case." And what about those rumours that his salary will be capped because it's looming out of control? "There are no caps," is all he will say on that.

This year has, in any event, been particularly good to Stone and his commercial mortgage group. "There have been record levels of new issues, and spreads have done well [relative] to other fixed-income areas," he says. This year, his group originated or purchased $8 billion of real-estate debt compared with just $500,000 last year.

"Much to my luck," he admits, the commercial mortgage market "has been one of the best performers in fixed income this year". And his group may be in for more good times. "I think we're still in the bull phase," says Stone. "We've come off the bottom where it's easy to buy. Now we have to be more selective. I think over the next two to three years there will be more rallies in the real-estate market."

Some may find these pay scales outrageous, but many steadfastly defend them. John Keefe, a former Drexel Burnham Lambert securities analyst who now runs a software firm in New York, puts it like this: "If you didn't have the compensation structure, Wall Street wouldn't be what it is, the capital markets wouldn't be what they are. It's a hard place to work, and requires an unusual balance of self-denial and self-expression."