Media new battle ground in I-bank bonus season war

It is hard to open up a newspaper right now and not read about the anxiety currently swirling around investment banking circles at the Canadian bank-owned dealers. First it was Boyd Erman’s piece (“Stirrings of revolution on the Street “) in the Tuesday Globe and Mail, arraying all of the reasons why bank boards are going to pull back on bonus pools this year. This will have sent shivers down the spines of more than a handful of Managing Directors.

Showing a flair for media and Board management, a few senior investment bankers shot back via Andy Willis’ column (“Is there a new independent dealer coming?“), hinting that there was some massive momentum behind creating a new independent dealer should bonuses at the bank-owned dealers not meet expectations. Mr. Willis’ column was filed at 10:41 pm on Tuesday.

Tit-tat.

There used to be a rule of thumb about bonuses, and it was always quite simple: bank-owned investment banks pay you the absolute minimum number that you’ll accept and not quit. With about 20 years under their belts as purveyors of i-banking, and one extraordinary and recent market meltdown behind them, chartered banks are likely wondering: “have we, for all of these years, miscalculated what it takes to keep people from quitting, as long as we all move in unison?”

And, the banks have also come to learn that whatever the number is, most senior i-bankers will say not “thank you”, but “that’s a three out of ten” on the scale of expectation. I’m not kidding. Whatever the number is. One parcularly poisoned and bonus-focused fellow rehearses the line prior to sitting down for his annual bonus review session.

There are four generic types of overall comp packages at bank-owned dealers: what the guys on the desk earn, what the deal-makers earn, what the folks in research earn, and what the senior management team earns to oversee the other three groups. As the most mobile of the four teams, the folks on the desk make it easy: stick with a formula, and no one gets hurt. If you are in a capital intensive part of the trading world, you have less leverage than the folks who do certain types of proprietary agency work; unless your team’s risk-arb skills are sought around the continent.

On the equity side, a chunk of trading flows are pre-ordained based upon “the grid”; what buysiders pay each year via trading commissions in exchange for Research. That’s not to say that large institutional accounts don’t have favourite salespeople or traders; they truly do. But revenue steering is less doable than 10 year ago.

The deal teams in investment banking are tougher to price, particularly if there are no direct client relationships. But, even then, the complexity of bonus calculations are compounded if the client is a loan customer. Did we win the deal because of your coverage efforts, or our balance sheet? Good question.

Management comp is another old chestnut. How much should you pay someone (“Mr. Internal’) to make sure that the pitches are getting developed and presented? That harrassment policies are being followed? And how can he make less than the people he’s managing (sorry about the use of “he”, but 99% of senior Canadian i-bankers are still men)? A fair question remains: do you need to pay someone $2 – $3.5 million to manage an office, even an office full of unmanagable thoroughbred i-bankers?

If you work at an independent dealer, the bonus pool this year will likely be somewhere between 40-50% of revenue, netting out some of the costs of doing business, draws, and so forth. This sounds rich, but the fact of life is, they are also the shareholders of the firm. Whether profits make their way to shareholders or “performers”, they are ultimately the same people. The only question is allocation between the senior team members, not “us” vs. “the bank board”.

As every bank board knows, it takes between $400 million and $750 million of capital to run a diversified investment bank with a fullservice trading operation. And that excludes the capital required to make mega corporate loans to Teck, TransCanada, or Onex’s portfolio companies, for example.

A small boutique needs between $10 million and $75 million of capital, but the product suite is far more narrow by nature. FX traders need not apply. And, as many bank boards suspect, it takes a certain type of person, a particular type of hustle, to win a deal when the business card he’s carrying doesn’t come with a 150 year old reputation behind it. And, there’s rarely a retail network to speak of.

I think the answer to the bank dilemma is simple: combine the merits of both systems. If your team wants more upside, have them put up 20%-35% of the capital. Not through free shares, but the way Tony Fell, John MacNaughton and Ken Copland had to do in the 1970s and 80s: cut a cheque. It works at Goldman.

Create the best of both models. The bonus pool can never be big enough to satisfy most of the people under your employ. And those bank shares they currently own, they’ve largely been gifted as part of prior year comp packages.

Have them contribute fresh capital to the firm. Have them police the guy next door who has run up huge exposure on a commodity trade, or is recommending a risky bought deal. You can’t have “direct drive” without also suffering the same direct hits that come when an independent dealer screws-up. That’s why bank boards must continue to wonder why such a high percentage of revenue winds up in the pool. Heads you win, tails I lose.

The bank-owned dealers are full of brilliant and talented people, many of whom are worth $1 million a year or more to their shareholders. But I think, deep down, they want to be “owners” and not “employees”.

Investment banking by nature lends itself to employee ownership. And ownership breeds wonderful behaviours: retention, an awareness of the benefits of cost containment, pride in the workplace, and probably better risk management.

In the meantime, ignore the pending “new independent dealer” spin. I admire the media messaging, but this is probably the 5th year this decade they’ve rolled out that same threat. Nobody’s buying it anymore. But that’s not to say there isn’t a better way to run the railroad.

MRM