Goldman’s Pay Pool Shrinks Fastest as Traders’ Fortunes Dwindle
Wall Street traders, who typically receive the fattest year-end bonuses among bank employees, are poised to suffer the biggest pay cuts as revenue at their divisions dropped an average of 12 percent so far this year.
Goldman Sachs Group Inc. (GS), the New York-based bank that makes most of its money from trading and set a Wall Street pay record in 2007, slashed average compensation 26 percent in the first nine months. By contrast, Charlotte, North Carolina-based Bank of America Corp., which employs branch managers and brokers as well as bankers and traders, raised average pay 10 percent.
While some compensation consultants say traders’ pay will rebound as soon as revenue recovers, new regulation and capital requirements may lead to sustained reductions in the multimillion-dollar awards that sparked popular outrage and spurred investigations by politicians and regulators after the 2008 financial crisis, analysts say.
“The industry will be significantly less profitable going forward, also significantly less risky,” said Douglas J. Elliott, an economics fellow at the Washington-based Brookings Institution and a former JPMorgan Chase & Co. (JPM) banker. “The lower profitability means there will be less net revenue to distribute between the shareholders and the employees. I do think there will be a squeeze on compensation over time.”
Compensation trends at eight of the world’s biggest banks (see table below) show the reversal that has taken place since the first quarter, when many trading desks earned money every day for three months. While average pay per employee has dropped 0.8 percent this year at the eight banks, it has fallen 11 percent at six that focus most on trading, such as Goldman Sachs and the investment bank unit of Credit Suisse Group AG. (CSGN)
“There’s been a drop-off in activity -- predominantly around client volumes and related trading flows -- that has impacted the revenues,” said John Lee, a New York-based partner at recruitment firm Heidrick & Struggles International Inc. (HSII) who leads the North American global markets practice.
Fixed-income traders’ pay will probably fall as much as 30 percent this year, according to a new report from New York-based compensation consultants Johnson Associates Inc. Compensation for merger advisers will be flat to 5 percent higher, and investment bankers who manage stock and bond sales will see a range between 5 percent up and 5 percent down, the report said. Pay for retail and commercial bankers will be slightly higher, and asset-management staff will see increases up to 15 percent.
“The economics of these firms and their pay is less than we would have thought three or six months ago because things have clearly gotten harder,” said Alan Johnson, president and founder of Johnson Associates. For traders “it’s going to be harder to make large amounts of money without being able to take risk or use as much capital” because of rule changes, he said.
At New York-based JPMorgan, the second-biggest U.S. bank by assets, the total compensation pool for the first nine months fell 1.2 percent from the same period in 2009, and average pay per worker dropped 8 percent. Within the firm’s investment bank, the pool shrunk 10 percent, even as the number of employees swelled 6.2 percent, to slash average pay 15.5 percent.
Goldman Sachs’s compensation pool fell 18 percent this year, the fastest of all the banks, and more than its 14 percent revenue decline. When compared with rivals’ investment bank units, Goldman Sachs’s drop is second biggest after the 20 percent reduction in compensation expense at Credit Suisse. The figures include a tax levied on bonuses by the U.K. government.
Banks report their expense for compensation and benefits, which includes salaries, bonuses and severance costs. Because many pay packages include stock awards that vest over several years, each year’s compensation expense can include a portion of previous equity awards vesting in the current year.
“We are seeing compensation down from 2009 anywhere from 22 to 27 percent” for traders, said Michael Karp, chief executive officer of recruitment firm Options Group in New York. “We are in a tough regulatory environment, and in a situation where revenues and volumes are down, it’s hard for any bank to pay its employees more.”
Spokesmen for all eight banks declined to comment.
New regulations following the worst financial crisis since the Great Depression have focused on reducing risk-taking at banks and requiring them to do a better job aligning pay with performance. New York-based Morgan Stanley (MS) and Credit Suisse in Zurich are among banks paying a larger portion of year-end bonuses in restricted stock over several years or cash that can be clawed back if trading positions or investments backfire.
The Dodd-Frank financial reform law passed in the U.S. in July requires regulators to write stricter rules for proprietary trading, or bets firms make with their own capital, and derivatives trading, which was one of the fastest-growing sources of investment bank revenue before the crisis.
Executives at Goldman Sachs, the most profitable securities firm in Wall Street history, estimated earlier this year that proprietary trading made up about 10 percent of its revenue, while derivatives contributed as much as 35 percent. Derivatives are contracts whose value is based on underlying securities such as stocks or bonds or changes in currencies, interest rates or the weather.
Provisions in the Dodd-Frank law will shave between 18 percent and 21 percent from 2010 pretax earnings at the largest U.S. banks, Standard & Poor’s analysts wrote in a report this week. Many of the new rules won’t take effect fully until 2013, when a better economy may help offset some of the drop in revenue, the analysts said.
In addition, the Basel Committee on Banking Supervision is drafting new global requirements known as Basel III that increase the capital banks must hold and limit leverage, or the use of borrowed money. While the requirements won’t begin taking effect until 2013, and won’t be implemented fully until 2018, they could herald a long-term change in profitability and compensation, according to Brad Hintz, an analyst at Sanford C. Bernstein & Co. (AB) in New York.
“Under Basel III, it looks very difficult for the major trading groups of any of the banks to beat their costs of capital based on historic margins,” said Hintz, who was rated the top analyst covering broker-dealers in a survey of fund managers published by Institutional Investor magazine last month. To improve margins “you can increase commissions and spreads or you can cut the compensation of the people who work there, and my guess is that both of them happen.”
Banks may cut pay for administrative staff, including those in human resources, communications and finance, by outsourcing more tasks to low-wage countries such as India and by using technology to automate benefits and other internal functions, said Robert Dicks, a principal at New York-based Deloitte Consulting LLP who focuses on compensation and benefits. He said Wall Street firms currently pay such back-office employees as much as four times what they would get elsewhere.
“These firms are recognizing that they need to streamline, they’ve got to become more efficient, and that money very quickly comes back to the front-office producers” such as bankers, brokers and traders, Dicks said. “Wall Street adapts very fast.”
Investment banks are also seeking ways to replace revenue from complex structured products such as collateralized debt obligations that fell out of favor after they led to losses and government bailouts. A surge in government bond and foreign exchange trading that buoyed earnings last year and early this year has also faded.
Goldman Sachs is looking at opportunities for growth in emerging markets such as Brazil, Russia, India, China and South Korea, according to David Hendler, an analyst at CreditSights Inc. in New York who recently met with David Viniar, the company’s chief financial officer.
Competition for investment banking deals in emerging markets can mean minimal fees. In August, three people familiar with the situation said Goldman Sachs submitted a bid to manage a share sale by state-owned Power Grid Corporation of India Ltd. that would have generated a fee of 2 rupees (5 cents).
“It’s a big question mark for these companies where they’re going to find new revenue to make up for some of the businesses, like structured credit, that have gone away,” said Eric Moskowitz, head of market intelligence in the global financial markets practice of Los Angeles-based executive search firm Korn/Ferry International. “While many are seeking growth in emerging markets, they’re finding that the fees they receive in those markets are often much lower than they can make in the developed countries.”
Return on Equity
Even with the new Dodd-Frank rules and Basel capital requirements, Goldman Sachs hasn’t revised its target of generating an average 20 percent return on equity throughout the economic cycle, which takes into account that some periods will be lower and some will be higher.
The firm’s annualized return on equity for the first three quarters was 11.6 percent, or 13.2 percent excluding one-time costs for a U.K. bank tax and a $550 million settlement with the Securities and Exchange Commission in July. That compares with a 19.2 percent annualized return on equity in the first nine months of 2009.
Revenue from trading fixed-income, currencies and commodities, the biggest money-maker for most investment banks, fell at six of the eight banks, while equities trading revenue dropped at five. The biggest declines were the 42 percent drop in fixed-income trading at Credit Suisse and the 32 percent fall-off in equities trading at Goldman Sachs during the first nine months of the year compared with the same period in 2009.
Among the gainers, Morgan Stanley posted a 41 percent rise in fixed-income trading and a 29 percent improvement in equities, and UBS AG (UBSN)’s negative fixed-income revenue a year ago swung to a gain this year.
While earnings at banks such as Bank of America, New York-based Citigroup Inc. (C) and JPMorgan featured lower trading revenue this year, firms were able to release reserves set aside for bad loans in previous years. That helps staff in areas outside of the investment bank most, said Rose Marie Orens, a senior partner at Compensation Advisory Partners LLC in New York.
“That’s going to really go to the core bank more than to the investment bank,” Orens said. Still, “it’s not to say that their actual pay is getting closer” to that of investment bankers and traders, she said.
Indeed, the gap between what traders make and the average compensation of bank employees is wide. Goldman Sachs’s $387,655 per worker -- down from an average $527,192 in the first nine months of last year -- compares with Bank of America’s average $92,723 per employee and Citigroup’s $72,264. Neither Bank of America nor Citigroup provide compensation and employee numbers for their investment bank, so the figures include loan officers and tellers as well as traders and advisers.
UBS, Morgan Stanley
While the totals for the eight firms show faster declines in investment bank pay than in overall compensation, there are exceptions. Average pay per employee at UBS’s investment bank, which is hiring to rebuild its fixed-income operation, surged 14 percent, while the Zurich-based bank’s overall average rose less than half a percent. Average pay at Morgan Stanley, which owns the largest U.S. brokerage, also climbed as the company sought to add employees.
At Frankfurt-based Deutsche Bank AG (DBK)’s investment bank, average pay slid 3.6 percent to 285,353 euros ($403,004), exceeding the average at Goldman Sachs.
Investment banks pay out a larger percentage of revenue to their employees than do consumer banks. For example, 39 percent of the revenue generated by JPMorgan’s investment bank went to pay employees compared with 28 percent for the bank as a whole. Goldman Sachs has set aside 43 percent of revenue to pay workers this year, and Morgan Stanley has allocated 50 percent.
Banks often revise their ratios of pay to compensation at the end of the year, which can mean they dole out much more or less than appeared likely after the third quarter. Last year Goldman Sachs slashed its full-year ratio of compensation to revenue to 36 percent, its lowest level ever, after having set aside 47 percent for the first nine months.
Not everyone sees the decline in traders’ pay this year as a symptom of a long-term change in compensation.
“Assuming we’re headed back into an economic growth phase, we’ll look back at this and it will be a total aberration,” said Joseph Sorrentino, managing director at compensation consultant Steven Hall & Partners LLC in New York. “I do get the sense that once we have a rebound that these positions are going to return to their previous levels.”
The following is a table of compensation and employees at eight global banks that have reported earnings for the first nine months of this year.
Company Comp Employees Comp/ Employee Bank of America $26.3bn 284,169 $92,723 Citigroup $18.64bn 258,000 $72,264 Credit Suisse CHF11.23bn 50,500 CHF222,337 Deutsche Bank EU9.59bn 82,504 EU116,285 Goldman Sachs $13.72bn 35,400 $387,655 JPMorgan Chase $21.55bn 236,810 $91,014 Morgan Stanley $11.99bn 62,864 $190,682 UBS CHF13.14bn 64,583 CHF203,506
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