As Kenny Rogers sang, you shouldn’t count your winnings while you’re still sitting at the table. This advice is particularly apposite in the case of a leveraged buyout deal. Although the transaction might have been completed and the fees booked, you don’t really know how much money you made until all the debt is syndicated and sold. In the current environment, the market for junk debt is more or less frozen, with secondary market prices indicating writedowns; that means that a lot of deals which looked great at the time are going to look much worse in retrospect.
Which raises a pretty serious question about bonus expectations. In many ways, it’s obvious that the bankers who thought they had made some great deals ought to reset their expectations – there can’t be any real economic sense in which losses on syndicating the debt financing aren’t part of the P&L of the transaction.
Except … this is investment banking, in which every profit has a dozen parents while every loss is an orphan. From the point of view of the advisory bankers, the deal was done – why should they be penalised if capital markets couldn’t do their job? Capital markets will blame sales & trading for not moving the securities on fast enough, while sales & trading will argue, not completely unreasonably, that they didn’t ask to be stuck with a load of junk debt that nobody wants.
So whose P&L – and whose bonus pool – will bear the loss? The answer at most firms will come down to internal politics. In some banks, sales & trading will be seen as the “deep pockets” that can handle the cost, as they have had exceptionally strong results in other markets. At other places, people will reason that the advisory side got paid very well last year, so they can’t really lay much claim to other divisions’ pools this year. And if market conditions stay where they are, a lot of firms will conclude that capital markets bankers aren’t in anything like as much demand as they used to be, so there’s no need to pay up to retain them.
In the longer term, though, the people who ought to be worrying most might be the private equity professionals themselves. They’ve had an incredibly strong run for more than a decade, but it’s all been based on having an almost limitless supply of cheap credit from the banks. It only takes a few nine-figure losses to change risk appetite, and without the financing, a leveraged buyout firm is just a buyout firm.
And, of course, part of the deal with PE compensation is that a lot of it is held in the form of “carried interest” and tied up in the funds. That means that the private equity guys could get a very large proportion of the big bonuses they thought they’d earned in previous years clawed back due to worse performance later in the realization cycle. You’ve got to know when to…
Read More: Risk of bonus clawbacks for bankers who made millions last year
