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Richard Lipstein of Boyden New York quoted in April's Investment Dealers' Digest

Money to Burn

By Avital Louria, Investment Dealer's Digest

If 2005 was a year for investment bankers to build their nest eggs, 2006 was the year they could start spending indiscriminately. Thanks to record profits at the major banks -totaling some $90 billion last year, a 38% annual jump, according to the Boston Consulting Group - bankers saw their compensation climb as much as 20%, on average, in 2006. And so far, 2007 looks like it may eke out another increase, according to some compensation sages, as inGestment banks are again expected to increase their profits. (Boston Consulting predicts another 9% to 15% improvement.) And despite cautionary signs, such as worries about subprime mortgages, hiring remains frenzied and competition for top bankers has become only more intense.

"Sitting here today, it is too early to talk about the yearend, but all indications are that 2007 is going to be another strong year," says John Rogan, global head of the fmancial services practice at search fm Russell Reynolds." Intuitively, people think there has to be a slowdown or downturn, but I can't get anyone to tell me why."

"We have been unbelievably busy," adds Laura Lofaro, managing partner at search firm Sterling Resources. "Hiring has been extremely competitive. Everybody is looking for top producers in the same sectors."

Banks have been chasing rainmakers in energy, real estate and retail, not to mention bankers with connections to the private equity marketplace. But it's not just the seasoned pros attracting suitors. At the junior level, the banks have been actively pursuing new recruits to get enough processing manpower to chum the deal machine, and thirdand fourth-year associates have also seen their pay rise substantially during the past couple of years. While junior bankers were harshly downsized in the last slowdown, banks have made a concerted effort since the recovery to keep this population of employees happy, especially considering that the hedge funds and private equity firms have ratcheted up the competition. As a result, fourth-year associates and second-year VPs saw their paychecks grow in the range of 15% to 20%, say recruiters.

A FIG Bubble?

Even as profits continue to climb, the risk of a slowdown after four years of double-digit increases lurks in the background. The marketplace is secretly concerned about the timing as well as the severity of a slowdown, and news of a restructuring at Citigroup, where 15,000 jobs reportedly could be cut, only heightens those fears. Still, compensation gurus believe salaries will be safe in 2007 and are likely to top 2006. All bets are off in 2008, however, as few pros see the salary escalation going on indefinitely.

"We've had one great year on top of another," says Alan Johnson, president of compensation consultant Johnson Associates. He notes that alternative assets, such as hedge funds and private equity, have fueled the record performance in banking, but he worries that the tone of the current cycle evokes memories of the tech heyday just seven years earlier. "We're in a FIG bubble," he says. "I can't think of another FIG bubble of this magnitude. I hope it lasts forever, but it's easy to be pessimistic about where this will go."

From a compensation perspective, bubbles aren't measured by IPOs or even profits. Rather, for some, the telling sign of a bubble is the emergence of three-year guarantees. Contracts of this length are still the exception, though some anticipate that could change and few see it as a good sign. "At some point, if this continues, we'll go back to the dreaded three years," Johnson says, adding, "In times of exuberance, the three-year [guarantee] is a sign the end is near."

One factor that hasn't changed in recent years is the makeup of pay packages. Roughly two-thirds of compensation is given in cash, with the balance paid in stock. The exact ratio depends on pay size and seniority as well as a particular firm's practices. Most banks award stock on a sliding scale, giving the most equity to those at the top and the least to the bottom ranks. Junior bankers, for example, may get as little as 15% of their compensation in equity, while senior executives may get as much as 45%. Lehman Brothers has its own system. It grants stock based on title, with managing directors receiving 50% equity, senior VPs 35%, VPs 25% and associates 10%.

Using equity and a vesting schedule can help with retention, but banks walk a fine line trying to hold onto employees this way. The equity portion is granted mostly in the form of restricted stock following Wall Street's move away from stock options over the past three years. Restricted stock has been used as a form of golden handcuffs, forcing employees to wait out the vesting schedule before striking out to new jobs (which helps explain why many bankers prefer cash). Too large a share of restricted stock can alienate some employees, especially if a firm's stock is not on the rise. ACcording

to bankers, Jefferies paid some of its employees as much as 55% in stock and suffered a slew of defections thereafter- a direct result of the stock-heavy I salaries according to these bankers.

Finding the hotspots

Regardless of how much bubble talk emanates from the industry, the reality is that Wall Street banks have been able to generate unimaginable profits and pay their employees handsomely. In 2006, the Street awarded a record $36 billion in bonuses, according to the Options Group, with Goldman Sachs giving out a staggering $600,000 per employee on average.

Top producers within investment banking generally saw their total compensation rise 20%, and at times more, according to Johnson. But pay increases vary widely among bankers, with some receiving a smaller or higher increase. "Pay is now a meritocracy," says Sterling's Lofaro. "The increase in 2006 over 2005 was 15% to 20%," she says. "If you are a business developer and produced a lot of revenue, your compensation would be higher than that. But if you are an execution person you are not going to be up like that."

In other areas, pay varied as well. Fixed-income professionals got a 10% hike last year, while traders and equity bankers each got a bump of roughly 15%. Typical of Wall Street, regardless of the size of the packages, there is always some unhappiness with the bonuses. With banks becoming increasingly global, acrimony is now taking on a geographic flavor. Banks do not pay New York packages everywhere in the world. For example, Johnson says that bankers moving from New York to Mumbai for several years will likely get pay packages comparable to what they would have received domestically, but those living permanently overseas typically get paid based on the local scale.

With private equity a dominant theme in M&A, financialsponsor coverage pros have been in high demand. "Wherever the financial sponsors have an interest, that's where our clients have an interest," says Richard G. Lipstein, a managing director at Bayden blerbal Executive Search.

Relationships are a key factor. Bankers with an intimate knowledge of the private equity landscape win larger paydays. A successful investment banker may bring in around $100 million in revenue, but successful bankers in financial sponsor groups may bring in $125 million to $150 million. Top players can do even better: Some account for more than $200 million in revenue, and even as much as $250 million. Street sources estimate that top earners in private-equity coverage account for the top 20% of investment bankers' pay, with many earning in the $5 million to $6 million range.

In the flush credit markets, relationships are emphasized more as liquidity has become a commodity. "Every bank will have capital for the deal," says Russell Reynolds' Rogan. "The ones who distinguish themselves are those with the C-level relationships, who work with top executives in an advisory capacity which will help them win the business."

Such areas as leveraged finance, which hand-in-hand with buyouts, have also been hot lately, especially in London, where a limited pool of talent and growing demand in leveraged finance have inflated pay. The shortage translates to a hiring premium in London of as much as 25% over New York compensation, recruiters say, as European firms and the European arms of US banks actively shuttle in leveraged finance bankers from the US.

While relationships are crucial, they are not the only reason bankers get business. Creativity in financing is often the key element that wins a deal. A growing need for idea generation and innovation has encouraged continuing development of mini think tanks inside Wall Street firms. These groups, called anything from transaction development groups to strategic advisory groups, are composed of out-of-the-box thinking pros, who can dream up a solution to a seemingly dead-end problem. These brainy types include math PhDs and other academies, and are expected to continue to be sought indefinitely. "Although the hiring season begins to wind down toward the beginning of the second quarter, certain talent is always in high demand, especially individuals with strong quantitative skills coupled with the ability to sell," says Deborah Rivera, president of executive search firm The Succession Group. "Structured products and 'solutions' groups are always looking for the best talent - regardless of the state of the market."

Moreover, sector expertise has become essential in many corners of Wall Street, especially as Chinese Walls have kept bankers from working hand-in-hand with research departments. Energy, because of its complexity and volatility in recent years, has been one of the hotter areas of recruitment, with real estate a close second. Green energy, however, is not one of those areas despite the increasing activity in the sector. Since it generally involves smaller deals, it has not generated much recruiting assignments among large firms, which often cover the niche within their energy groups. Smaller firms, such as Jefferies, on the other hand, have created entire green energy groups, and others, such as Cowen and Thomas Weisel Partners, have hired bankers with expertise in this area, according to recruiters.

One sector attracting a lot of interest is financial services, while health care, natural resources, retail and consumer goods have also been strong. And the rise of  infrastructure funds has generated its own wave of hiring. Morgan Stanley recently hired an infrastructure banker from Macquarie Bank, and looking ahead, recruiters anticipate this will be an area that will continue to grow.

Although the industry's hiring spree reflects a bullish view of the economy, some banks are bracing for a change. Many are either bolstering or creating restructuring teams in the event of a credit crunch, a trend evident in an extreme form when Macquarie last month paid an estimated $100 million for Giuliani Capital Advisors, which boasts a strong bankruptcy practice.

The broad reach of private equity, along with the increasing involvement of hedge funds in financing debt, has also stirred up the middle market - which frequently swings from hot to cold but is considered white-hot today, recruiters say. Traditional groups in middle-market financing, such as General Electric and CIT, have been fighting for top talent, and even such bulge-bracket banks as Deutsche Bank and Goldman have begun dipping into the market, adding heat to the recruitment contest.

Seeking an end?

With all of the hiring, recruiters have their work cut out for them, even as pay scales have climbed, "We are hitting some demand- supply issues," says Russell Reynolds' Rogan. "Everyone is recruiting at the same time. There is a bit of a logjam."

But recruiters, like the bankers with record paydays, know better than to complain in this kind of market. "I've been asking a lot of people on the Street since the third quarter of last year - people who have been around a long time - what they think," says Rogan. "They say, 'It is going to stop, but I cant tell you why.'"

Naturally, people would rather focus on the positives.

Tracking CEO Compensation

Record Year, Record Pay

A record year for Wall Street has translated into record bonuses for the Street's top executives. Leading the pack is Goldman Sachs whose pre-tax profit rose 76% from 2005 and stock price rose 56%. It awarded its chief, Lloyd Blankfein a compensation package worth $55 million. The package consisted of cash, stock options and restricted stock. Blankfein, who took over from Hank Paulson in the summer when the former chief went on to become treasury secretary, saw his pay rise 42%.

Of course, not everyone agrees with the pay. Perennial shareholder activist Evelyn Davis sued Goldman in an effort to stop it from awarding stock options. Goldman is one of Wall Street's last holdouts that still award stock options.

Financial success also drove pay hikes for Morgan Stanley CEO John Mack, whose pay rose 43% from 2005 to a total of $41 million. Similarly, Bear Stearns had a terrific year last year and its stock rose 37%, while its pre-tax income climbed 43%. It awarded its CEO James Cayne a $33.85 million compensation package, which consisted of a cash bonus of $17.1 million and $15 million in restricted shares that vest over five years.

Citigroup was the exception to the pay-for-performance link. It awarded its CEO Charles Prince $25 million in compensation, a 10% increase from 2005. The company's stock rose 15%, but its pre-tax income gained only I%, remaining flat versus 2005 at $30 billioon.

CEO Compensation

Inv Bank Pay

Inv Bank Pay 2005