Weak revenue and high expenses pushed Lazard Ltd (LAZ.N) into the red in the fourth quarter, a big miss against analyst forecasts that sent the investment bank's shares lower.
Lazard's results reflect clients' hesitancy to invest or pull the trigger on capital markets transactions in late 2011 as the European debt crisis raged, as well as the burden of high compensation costs on Wall Street.
The bank's revenue declined nearly across the board -- with drops in its bread-and-butter financial advisory business and its asset-management business -- due to volatile market conditions.
Meanwhile, compensation costs remained stubbornly high, due in part to management's decision to pay employees most of their bonuses immediately, rather than deferring big portions of pay to future years as some rivals have done.
"We are very comfortable with our approach on deferrals at the firm and we didn't need to increase it," Chief Executive Kenneth Jacobs said in an interview. "There's just no free lunch there."
So far this year, market conditions seem to have improved. Lazard's asset management business has benefited from a rebound in market values, and its advisory business has received "an increasing flow of mandates," Jacobs told Reuters.
Lazard shares fell more than 9 percent in early trading but then recouped some of the losses. They were down 4.6 percent at $27.55 in midday dealings.
Lazard said it would raise its quarterly dividend by 4 cents to 20 cents per share starting in April.
NO FREE LUNCH
From August through the end of 2011, the capital markets were plagued by downgrades of sovereign credit ratings, uncertainty over a rescue plan for troubled European states, and doubts about the pace of economic growth in the United States and fast-growing emerging markets.
Lazard is less sensitive to volatile market conditions than some of its larger Wall Street peers because it does not have a trading business and is not subject to many new, profit-crimping regulations that affect trading and capital levels.
Yet as an advisory firm and asset manager, Lazard was not immune to the twists and turns of the equity and debt markets last year. And because it has been hiring stars from other Wall Street firms that are cutting staff and reining in bonuses, Lazard's pay costs have remained higher than many other investment banks.
"Our view in regards to hiring has always been: you do it when people aren't," Jacobs said in a conference call with analysts, explaining that top talent costs less in a weak job market.
Lazard cut discretionary bonuses by 20 percent last year to reflect weaker revenue, but its compensation costs remained high because the investment bank opted to defer just 23.5 percent of pay to later years.
Other banks have been deferring more of their bonus awards to future years, partly because of mandated compensation reform and partly to reduce costs in a tough business environment. Morgan Stanley (MS.N), for example, deferred 60 percent of its cash bonuses last year, up from 40 percent in 2010.
Lazard's 2011 compensation costs of $1.2 billion represented 63.9 percent of its full-year net revenue, up from 62.7 percent in 2010. That compares to 2011 compensation ratios of 50.6 percent at Morgan Stanley, 42.4 percent at Goldman Sachs Group Inc (GS.N) and 33.8 percent at JPMorgan Chase & Co's (JPM.N) investment bank.
Citi analyst Keith Horowitz said "compensation was the largest driver" of Lazard's earnings miss.
Lazard said it aims to reduce its compensation ratio to a "high-50s percentage range" by raising compensation at a slower rate than revenue when market conditions improve.
Lazard lost $4.8 million, or 4 cents per share, during the fourth quarter, compared with a profit of $99.9 million a year earlier.
Excluding special items, Lazard earned a penny a share. On that basis, analysts' average forecast was a profit of 37 cents, according to Thomson Reuters I/B/E/S.
Weighing on profits were a 26 percent drop in revenue from Lazard's advisory business, which consults with companies on mergers, acquisitions and other capital markets deals, and a 20 percent drop in revenue from asset management, driven largely by declines in funds whose fees are based on performance.
Overall, Lazard's fourth-quarter net revenue fell 24 percent, to $451.8 million. For the full year, net revenue fell a more moderate 4 percent, to $1.8 billion, and its earnings of $174.9 million, or $1.36 per share, were little changed from 2010.
As Lazard's fourth-quarter revenue was hurt by volatile markets, many of its expenses rose.
Non-compensation expenses climbed 13 percent to $127.3 million, with higher costs for occupancy and equipment, marketing and business development, technology and information services and other professional services.
Among Lazard's biggest non-compensation expenses were a $5.5 million charge for an "onerous lease contract" in the U.K. and another $5.5 million write-off on the value of a hedge fund business Lazard acquired. Those items helped pushed Lazard into the red.
Market conditions have improved this quarter, due in part to actions taken by the European Central Bank to stabilize European debt markets, Jacobs said. That may help performance going forward, as long as there is not "another shock" like those that occurred in late 2011, he said.
"Things have been a little bit better," said Jacobs. "The tenor in Europe ... is better, but we have to stay tuned."
(Reporting by Lauren Tara LaCapra in New York and Tanya Agrawal in Bangalore; Editing by Viraj Nair and John Wallace)