European and British investment banks should slash pay and cut jobs to redress the balance between employees and shareholders, according to three of the U.K.’s largest institutional investors.
Banks such as Barclays Plc, Deutsche Bank AG, UBS AG and Credit Suisse Group AG, which are among the top 10 investment banks in Europe by revenue, raised base salaries and hired more staff following the 2008 credit crisis even as the shares tumbled and the banks cut or halted dividends. Now, shareholders have had enough.
“Investment banks are like football clubs,” said Julian Cane, who helps manage 106 billion pounds ($173 billion) at F&C Asset Management Plc in London, who says he’s “underweight” in Barclays shares. “Being a footballer must be great fun and very lucrative. But owners of football clubs rarely make any money. It’s better to play for the club than to own it.”
Last year, Barclays paid 22 pounds to employees for every 1 pound paid to its owners, while at Deutsche Bank the ratio was 16 to one. UBS hasn’t paid its investors a cash dividend since 2006, while giving 16.9 billion Swiss francs ($21.1 billion) to its personnel last year.
Barclays handed 11.9 billion pounds over as compensation, against 531 million pounds in dividends, according to filings. Deutsche Bank gave staff 12.7 billion euros ($18.1 billion) in compensation and benefits for 2010, while shareholders got 816.4 million euros in dividends.
‘The Same Trough’
Falling revenue from sales and trading of stocks, bonds, currencies and commodities at investment banks has driven stock prices lower. Rising capital requirements have also forced firms to reduce return-on-equity targets. UBS and Credit Suisse, both Zurich-based, this week announced thousands of job cuts. It may not be enough, investors say.
“Their cost-to-income ratios are too high compared to the volatility of their revenues,” said Will James, who helps manage 157 billion pounds at Standard Life Plc and holds BNP Paribas SA and Societe Generale SA stakes. “They’re all feeding from the same trough and that trough is getting smaller. They need another leg of cost cutting.”
The STOXX Europe 600 Banks Index is the second-worst performing industry group of the wider STOXX 600 Index this year after the basic resources sector. The measure has dropped 18 percent compared with a 5 percent drop in the wider index. Along with their holdings of European sovereign debt, the banks have been hurt by clients’ risk aversion, leading to lower sales of stocks, bonds, commodities and currencies.
While investors are feeling the pain, employees are still being rewarded. Barclays Capital, the investment bank of London-based Barclays, said in April pretax profit declined by 33 percent in a “challenging” market. Compensation costs were 44 percent of revenue, compared with 43 percent for 2010.
Credit Suisse’s cost-to-income ratio at its investment bank rose to 91 percent in the second quarter of 2011, compared with 81 percent in the second quarter of 2010. The majority of the bank’s cost is staff compensation. UBS’ investment bank’s cost-to-income ratio, which was the highest among the nine biggest investment banks last year, rose to 86 percent in the quarter compared to 67 percent in the same period in 2010.
“There are some problems with this industry that we’ve struggled with for the last 10 years or so, such as the distribution of the profits between the outside shareholders and the insiders in the bank, whether that’s the senior management or traders,” said Gerald Smith, chief investment officer of Edinburgh-based Baillie Gifford & Co., which manages 74 billion pounds. Colleagues at Baillie Gifford may have different views, he said.
Difficult to Analyze
Fund managers also say it’s difficult to analyze investment banks, with Bertie Thomson, who helps oversee 186 billion pounds at Aberdeen Asset Management Plc, saying “to understand how they make money is nigh on impossible.”
“There are bits of UBS and Credit Suisse we like, such as the private bank and wealth management side,” he said. “But that’s more than mitigated by the volatility and the opacity you get from the investment banking side. That’s similar for BNP Paribas. The core French corporate and retail bank is attractive but the investment banking arm is a cause for concern.”
Spokesmen for Credit Suisse, UBS and Barclays declined to comment, while a spokeswoman for Deutsche Bank wasn’t immediately able to comment.
Following the political backlash from the 2008 banking crisis, Barclays, Frankfurt-based Deutsche Bank, Credit Suisse and UBS reduced bonuses and introduced claw-back mechanisms if earnings dropped. To prevent staff from quitting, they raised base salaries instead.
‘Fabled Top Performers’
“The total compensation of the fabled top performers is more or less staying where it was,” said John Purcell, founder of executive search firm Purcell & Co. “It has just been reallocated in different ways, usually with a significant increase in base salary.”
That left banks with higher fixed costs that give them less flexibility to reduce pay in a downturn, according to Jonathan Nicholson, a managing director at recruitment firm Astbury Mardsen in London.
“What we now have is a big chunk of compensation now fixed and the variable amount much smaller, so your ability to shore up profits if revenues are down is a lot harder,” he said.
That makes redundancies rather than pay cuts more likely, according to Standard Life’s James, who owns shares in BNP Paribas and Societe Generale, as well as Scandinavian lenders DnB NOR ASA and Svenska Handelsbanken AB.
‘Difficult to Cut’
“It’s difficult to cut pay when people are on fixed salaries, so they’ll need a round of efficiency savings and redundancies,” he said. “The industry as a whole didn’t take enough capacity out after the credit crunch. Now it’s time to strip out the fat.”
Credit Suisse and UBS, Switzerland’s two largest banks, this week announced plans to cut costs after adding employees and raising pay in the last two years. Credit Suisse added 3,100 staff including investment bankers and wealth managers since the end of 2009, bringing the total to 50,700 by June 30.
The bank yesterday announced plans to cut about 2,000 jobs after second-quarter profit tumbled 52 percent on lower earnings from trading.
It’s a similar story at UBS. Switzerland’s largest bank scrapped its 2014 profit target this week after second-quarter net income fell 49 percent and announced plans to cut 2 billion francs in costs.
Banks’ dividends have also fallen. Credit Suisse paid 1.30 francs per share in dividends for 2010 compared with 2.50 in 2007, while Barclays paid a final dividend of 2.5 pence a share for 2010 compared with 11.5 pence in 2007. Deutsche Bank paid a dividend of 75 euro cents per share for 2010 compared with 4.50 euros for 2007.
“It wasn’t that long ago they went through a near-death experience after which they were saying investment banking is an exciting area and they were building it up again,” said Baillie Gifford & Co.’s Smith. “That behavior has put us off the sector.”