(The authors are Reuters Breakingviews columnists. The opinions
expressed are their own.)
By Antony Currie and Richard Beales
NEW YORK, Oct 11 (Reuters Breakingviews) - James Gorman is
right that investment banking is overstaffed and underpaid, as
he told the Financial Times last week. But neither the Morgan
Stanley (MS.N) boss nor his global peers have proven adept at
taking action. Last year, total wages at securities firms that
are members of the New York Stock Exchange and the average pay
per employee in New York increased even as industry profit fell,
according to a report this week from the state’s comptroller.
In third-quarter earnings reports that begin with JPMorgan’s
(JPM.N) on Friday, U.S. banks have an opportunity to set aside
less for pay. Across seven top Wall Street and European banks
the bill for traders, advisers and money managers needs to drop
by about a third from the current total approaching $100 billion
just to give shareholders an unexciting return on equity of
around 10 percent, according to a new interactive Breakingviews
Compensation has declined since the financial crisis. Most
investment banking units now set aside between 40 percent and 45
percent of their trading, advisory, asset management and
securities services revenue to cover salaries, bonuses and
benefits – down by up to five percentage points on pre-recession
numbers. JPMorgan's bill is the lowest at around 35 percent.
But shareholders are still suffering. Of the leading firms,
only JPMorgan and Barclays (BARC.L) are on track to post a
return on equity of 10 percent or more this year, according to
Thomson Reuters data. That's a level widely seen to just about
cover the cost of capital for bulge bracket securities houses.
Goldman Sachs (GS.N) is the best of the rest, with 8.5 percent.
The others, Bank of America (BAC.N), Morgan Stanley, Citigroup
(C.N) and Deutsche Bank (DBKGn.DE), are return-on-equity
dwarves. Someone invested equally in all seven banks is likely
to reap an average ROE of only about 7 percent this year.
Most financial giants, in other words, need to worry less
about their employees’ paychecks and more about their
shareholders. The old argument that reducing pay would leave
firms exposed to mass defections has lost some force. As Gorman
made clear, there are already too many bankers chasing too few
fees. And hedge funds and boutique advisory firms have already
lured away many of the brains they want.
Taking the seven banks collectively, to reach a 10 percent
ROE would require slicing more than $30 billion, or about a
third, out of their pay allocations, the Breakingviews
calculator shows. That gives an idea how far the industry still
has to go. But it’s simplistic – targeting the same ROE for all
the banks and achieving it solely by cutting investment banking
pay creates some oddities, like a 90 percent cut in BofA’s
compensation pool and an increase in Barclays’ pay because it’s
on track to beat that ROE hurdle this year.
Alternatively, suppose all the banks including Barclays just
reset the ratio of investment bank and asset management
compensation to revenue to the same, lower level. Targeting an
average 10 percent ROE for the seven banks overall requires this
pool of compensation to fall to about 28 percent of revenue.
Apply that rate to all the banks, and their returns this year
would range from BofA at 5.8 percent to Barclays and Goldman at
That is an extreme scenario for pay. But for at least some
banks, it would provide shareholders with returns much closer to
what they are hoping for. Of course, despite market conditions,
a big risk would be that top bankers leave en masse. But with
per-head pay overall still close to $200,000, investment banking
would hardly be a hardship posting. A bit of warning, for
instance in the coming earnings reports, would give employees
time to adjust their expectations. And if some were to quit,
that would at least prune the industry's overgrown ranks.
SIGN UP FOR BREAKINGVIEWS EMAIL ALERTS:
- Run the numbers: How much does bank pay still need to
fall? Target an average 2012 return on equity for seven global
banks, and see what that means for average compensation – and
their individual ROEs if they cut pay accordingly: link.reuters.com/ruk33t
- The third-quarter earnings season for U.S. banks kicks off
on Oct. 12. JPMorgan and Wells Fargo are set to report results
then. Citigroup follows on Oct. 15, Goldman Sachs on Oct. 16,
Bank of America on Oct. 17 and Morgan Stanley on Oct. 18.
- Thomas DiNapoli, the New York State comptroller, on Oct. 9
released an analysis of securities industry profit, jobs and
- DiNapoli analysis: link.reuters.com/jud33t
Below the line dancing [ID:nL5E8KAIE3]
German bite [ID:nL4E8K425C]
Off kilter [ID:nL2E8IH2P4]
- For previous columns, Reuters customers can click on
[CURRIE/] and [BEALES/]
(Editing by Richard Beales and Martin Langfield)
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