Few reasons to be cheerful on Wall Street
US investment banks face making further cuts as an expected recovery in fortunes has not materialised, write Lina Saigol and Gary Silverman
Published: March 21 2002 19:56 | Last Updated: March 21 2002 20:15
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The mood on Main Street may be brightening, but the gloom on Wall Street remains. In spite of quickening growth in the US economy, there is little sign yet of a rebound in investment banking revenues - and that makes more job cuts a certainty.
Since the collapse of technology and telecommunications stocks just about two years ago, investment banks have cut tens of thousand of jobs, while hoping that the decline in dealmaking activity would prove short-lived. Those expectations have been confounded. Many Wall Street bankers now accept that any revival in investment banking will lag behind recovery in the overall economy.
"We thought it would be like 1998, where the markets recovered pretty quickly after the Asian crash," says one senior figure. "Everyone thought that there would be an upturn in the third or fourth quarter [of 2001]."
The growing realisation that a change in fortunes may be some way off has forced a rethink about the likely size of the industry. Between 1997 and 2000, head count at Wall Street's leading firms grew 37 per cent and remuneration soared 88 per cent, according to Freeman & Co, a consultancy that focuses on the finances of Wall Street. Revenues during that period rose 78 per cent.
Last year, as revenues fell 13 per cent, employment and pay declined 8 per cent and 12 per cent respectively.
The industry has, to some extent, been insulated by the bond markets, which have allowed investment banks to turn in record performances in their debt businesses. Just this week, Bear Stearns reported a 13 per cent gain in first-quarter earnings, boosted by record fixed-income revenues.
But the most lucrative activities - in particular mergers and acquisitions - remain weak. The volume of global M&A fell nearly 50 per cent to $1,745bn in 2001, from $3,459bn in 2000. The number of deals announced globally dropped to 28,828 from more than 38,200 in 2000, according to Thomson Financial Securities Data.
First-quarter earnings, reported this week, have added to the gloom. Goldman Sachs admits its pipeline of deals contracted during the period. Guy Moszkowski, an analyst at Salomon Smith Barney, estimates that completed M&A this year could drop to only $700bn.
Meanwhile, the collapse of Enron and the resulting focus on corporate financial reporting has added to the caution in company boardrooms.
Hence the talk of deeper cuts, particularly at firms that have so far resisted widespread job losses. Last year, Morgan Stanley created an internal stir in London by abolishing baskets of fresh fruit in the office. Goldman Sachs scrapped night taxis home. This year, the cuts may slice deeper.
Some firms have already taken strong steps to cut costs. Merrill Lynch, which was criticised for scaling back too quickly in response to the Asian financial crisis of 1998, cut about 20 per cent of it staff last year as Stan O'Neal, its new president and chief operating officer, moved to pare its international brokerage network. Dresdner Kleinwort Wasserstein has abandoned marginal businesses such as debt trading and cash equities from Asia.
Recent mergers have also helped the industry get rid of excess capacity. JP Morgan Chase has cut up to 20 per cent of staff in wholesale banking since Chase Manhattan bought JP Morgan to create the company.
"The industry is about two-thirds to three-quarters of the way there," says Richard Strauss, securities industry analyst at Goldman Sachs, of the retrenchment. "They are managing their business to what a normal time would be. Normal is not what it was in the late 1990s."
Others are less sanguine and expect the cuts to go on for some time. "The first quarter has been a disaster. The second quarter pipeline looks like a disaster," says James Freeman of consultants Freeman and Co. "We are going to see a significant series of cuts. They are going back to 1997-1998 levels of employment and pay."
To this end, pay structures are now top of the agenda. On average, about 70 per cent of banks' costs are remuneration, and of this 70 per cent is discretionary.
John Mack, nicknamed "Mack the Knife" for his cost-cutting zeal, started attacking senior bankers' bonuses at Credit Suisse First Boston soon after his arrival last year as chief executive. He went so far as to ask some to give back their contract guarantees for the good of the firm.
"It takes a whole career to make a senior banker and if you fire one during a downturn, you won't be able to get him back when the market recovers," says one corporate financier. "The banks are now getting rid of people they won't be able to replace in an upswing."
Others have realised that although the bonus pool will shrink in the next few years, the top performers can still be paid well. JP Morgan Chase, for example, fired so many people early on last year that its bonus pool shrunk by about 30 per cent - but it found that with employee numbers reduced by 40 per cent, there was more money to go around those remaining.
Goldman Sachs has started paying senior staff in options instead of stock, which is dilutive to earnings. As an added bonus, some costs of options are not required to be put through banks' profit and loss accounts until they vest, so they can help flatter profits.
But while all these changes will reduce inflated cost structures, investment banking is a people business and even the travel and entertainment budgets cannot be cut endlessly. "In theory, all these costs are variable," one banker says. "But if you cut too hard, you lose the people and investment banking is about people."
Consolidation remains one way of bringing down costs further and creating synergies. Broadening the base of their businesses to reduce volatility is another option. Banks such as Citigroup, which has a giant retail operation, has been better able to weather the storm.
"It is about to reach the point where the banks will have done what they can to cut costs and can't progress without real ones - the type you get from big, global mergers," one senior investment banker says, adding: "In fact, the only mega-merger this year will probably be the banks merging among themselves." |
