* Goldman, Morgan Stanley face pressure to reduce pay
* Weak trading, high compensation costs weigh on returns
* Banks start penny-pinching to boost their bottom lines
By Lauren Tara LaCapra
NEW YORK, July 8 Large Wall Street banks are
starting to scale back compensation on trading desks as
shareholders grow increasingly restless over weak returns.
Goldman Sachs Group Inc (GS.N), Morgan Stanley (MS.N) and
some other large U.S. investment banks are not just laying off
weak performers and back-office employees. They are also
cutting the pay of those they are keeping, scrutinizing expense
reports and expecting even the most profitable workers to bring
in more business for the same amount of compensation.
"Put simply, in order to get your $1 million bonus before,
you had to generate X amount of revenue; now it's X plus 50
percent," said Mark Poerio, a partner at law firm Paul,
Hastings, Janofsky & Walker who advises banks on pay.
Wall Street has been overhauling pay practices over the
past 2-1/2 years to better align incentives with risk. Banks
have lifted base salaries, deferred bonus payments and
introduced clawback provisions to protect against trades and
deals that seem profitable at first, but may later go awry.
Wall Street pay reached new heights in 2009 and early 2010,
in tandem with rising markets, but now the game appears to be
changing. With the securities industry entering its fifth
consecutive quarter of stagnant trading income -- and expecting
more difficulty once regulatory reforms take effect -- banks
are bolstering profits by restraining costs.
Bernstein Research analyst Brad Hintz said the big players
must slash pay levels of managing directors by 20 percent to 25
percent, automate more trading and cut jobs.
On Thursday, Hintz slashed his 2011 earnings estimates for
Goldman and Morgan Stanley, saying damage from low trading
volumes would probably far outweigh cost-cutting.
James Freeman, founder and CEO of advisory firm Freeman &
Co, believes that if trading activity remains as weak as it is
now, overall compensation could drop 15 percent to 20 percent
at large trading houses.
Only the strongest traders will survive, he said. "It's not
a pretty picture. It's just, 'Eat what you kill.'"
WIELDING THE AX
While compensation is Wall Street's biggest cost, it's also
the most difficult to reduce.
Banks have been tightening staffing throughout the
downturn, and they are reluctant to trim the pay of their top
stars for fear they will leave for less-frugal competitors.
"Our clients have become more efficient over the years, and
efficient clients do more with less headcount," said Deloitte
Consulting principal Robert Dicks, who works with large banks.
"For top 50 percent performers, I haven't seen a real change in
salaries. If I were in the bottom half, that's where we've seen
a real change both in job security and in compensation."
One key difference from five years ago: A diminished focus
on all but the biggest, most profitable clients, and fewer jobs
available for traders who do not handle such accounts.
Pay and benefits represented 44 percent of Goldman's
revenue during the first quarter, up from a year earlier and on
par with 2007, before the crisis struck. At Morgan Stanley,
compensation rose to 57 percent of revenue from 49 percent a
year earlier, partly because of big losses in a trading joint
venture with Mitsubishi UFJ Financial Group (8306.T).
Meanwhile, return on equity, a key measure of shareholder
profitability, has fallen sharply.
Goldman's annualized ROE has ranged from 7.9 percent to
12.2 percent since the second quarter of 2010, down from more
than 30 percent in the company's boom years.
Morgan Stanley's ROE has been more erratic because of
movements in credit spreads, the sale of businesses, a tax gain
and Mitsubishi losses. It stood at 6.2 percent last quarter,
down from 17.1 percent a year earlier and 8.5 percent for all
At $430,700 per employee, on average, Goldman has one of
the highest salaries on Wall Street. At Morgan Stanley, the
average is $256,596.
Some shareholders have gotten impatient.
While bank shares have historically traded at multiples of
book value, Goldman stock was at a premium of just 4.3 percent
at Thursday's close, while Morgan Stanley was at a 21.7 percent
Carret Asset Management, which has $1.4 billion in assets
under management, recently took a small position in Goldman,
but remains cautious.
"I thought Goldman at $130 was worth a look," said
portfolio manager Jack Kaplan. "But there are risks involved.
They're vulnerable to the trading environment -- they're not
making what they used to -- and the compensation structure is a
Goldman and Morgan Stanley have been scrutinizing expenses
in recent months.
Goldman plans to lay off hundreds of U.S. employees this
year and cut noncompensation expenses by $1 billion by
mid-2012. Traditionally, the bank has kept a tight lid on
travel and technology costs during tough times.
Morgan Stanley has cut weak performers in its
wealth-management business and is using penny-pinching tactics
to slash costs further. It has begun spelling out the cost of
market data services, BlackBerry use, travel and other running
expenses to employees, encouraging them to cut back.
"Numerous smaller opportunities ... collectively can be
meaningful, given that we're a firm of 60,000 people," Chief
Financial Officer Ruth Porat said at a conference last month.
The austerity measures seem to be having an effect on some
traders, who have become more cautious in recent months.
"It's tense -- everyone is constantly looking over their
shoulder," said one former fixed income trader at a large Wall
Street firm who recently moved into a risk-management role.
"I'm not expensing lunch, and I'm taking the subway home."
(Reporting by Lauren Tara LaCapra; editing by Jed Horowitz,
Knut Engelmann and Lisa Von Ahn)