Investment Bank's November Bonus Advantage

If you listen carefully, you can hear the creaking stresses mounting in investment banks' balance sheets. The iron rivets are holding fast but is there a risk they will suddenly pop?

Many of the assets held by banks and by asset managers may need to be priced down to approach more realistic valuation levels after the subprime debacle. There is no compulsory reason to do this repricing before the end of the current fiscal year and the firms holding these assets may decide to postpone mark-to-market adjustments until after the end of the fiscal year, after bonus pools for 2007 have been secured.

An interesting situation arises from the fact that many of the pure investment banks have November fiscal year ends, whereas the universal banks (banks with activities in commercial, retail, and investment banking) have December fiscal year ends (Merrill Lynch is an exception). In the margin on the right are shown fiscal year ends for the leading firms. In theory, the investment banks could lock in their bonuses at the end of November and announce writedowns in December. This could do great damage to the fiscal year results of the universal banks, and to the vast majority of asset managers (mutual funds, hedge funds and private equity funds), and to their respective bonus pools.

It is most likely that the banks will try to push their adjustments further into 2008. A big bonus year quickly followed by a series of writedowns may not pass muster with shareholders and regulators. But the banks are not acting or thinking in unison, and some confessions may come, fast and furious, in the current year.