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Swiss bank annual earnings are here so we might as well check in on what they’re up to with comp. You and I may think of comp in pretty straightforward ways – if you did good, and your employer did good, you get paid well, and if not not – but Credit Suisse and UBS take a delightfully arcane wheels-within-wheels approach, constantly changing how they pay employees to send signals, fine-tune incentives, and optimize regulatory capital. I suppose if I worked there I’d be so pleased by the complexity of the edifice that I’d be okay with otherwise disappointing pay. Current employees may disagree.
Anyway we talked about UBS the other day; per the FT they are handing out bonuses in the form of high-trigger CoCo bonds that get written down to zero if UBS’s regulatory capital falls below 7 percent. The bonds “will pay a market-based interest rate” though that’s not saying much; any interest rate is “market-based” in the sense that it can be decomposed into, like, Treasuries plus a number. Presumably the number here is high.
As part of the 2012 annual compensation, the Group awarded a portion of variable compensation to certain senior employees for services performed in 2012 in the form of Plus Bond units.
Plus Bond units are cash-based awards linked to a portfolio of asset-backed securities originated and managed in the Investment Banking division. These awards provide recipients with semi-annual payments and a final settlement in 2016 in cash or shares at the Group’s discretion, based on the initial award value less portfolio losses after a first loss retained by the Group. The Plus Bond unit constitutes a transfer of risk from the Group to these employees.
As of the December 31, 2012 grant date, Plus Bond awards had a fair value of CHF 187 million and were fully vested and expensed.
That CHF 187 million is down from last year’s $800 million in Partner Asset Facility 2 structured notes, and the structure seems at first glance less gloriously convoluted than PAF2’s CVA-hedging function, though possibly in the same ballpark.
Both of these things are likely designed for capital relief: UBS’s thing counts toward Swiss regulatory requirements that allow up to 3% of capital from high-trigger contingent capital; Credit Suisse’s shunting of structured credit to employees, as in previous years, is likely designed to transfer capital-inefficient assets from the bank to its employees who, for the time being, are not subject to Basel III in their personal accounts.
They’re also, of course, designed for incentives, and here the differences are sort of instructive. You can draw them, though you miss some nuance:
UBS would appear to be pretty committed to its plan of transforming from a freewheeling investment bank that will occasionally lose an Adoboli or two into a boring, boring, boring private wealth manager. And this bonus structure reflects that. The UBS cocos have a (presumably healthy) coupon, no upside, and tons of stark downside. They link to the liabilities-and-equity side of UBS’s balance sheet. They make UBS bankers feel, not like owners, but like guarantors of their company. If you owned a lot of this stuff, you’d be a very risk-averse, very boring manager of UBS’s balance sheet.
Credit Suisse’s thing is … not wholly dissimilar. There’s limited upside there too – it’s a 3.5-year fixed-income instrument – though the downside is much less drastic. The symbolism is different, too. These things like to the asset side of CS’s balance sheet, making its bankers feel more like co-investors alongside their company: they link to a specific portfolio that, if managed right, will do well for CS’s bankers no matter what else happens on the capital side. Bloomberg notes that “While the instrument will make up part of bonuses for the top investment bankers, other employees can elect to receive it as well instead of share awards.” It’s hard to imagine anyone at UBS electing to get more of a high-trigger, goes-to-zero-on-capital-breach UBS coco, but CS actually does have a record of paying people in toxic assets that do very well.
Even the name: “Plus Bonds” sound good. Have some Plus Bonds! They’re … Plus! UBS’s sound a little like “punishment bonds.”
This is surely not accidental. The two big Swiss banks have had a bittersweet parting of the ways recently. As the Journal puts it:
Credit Suisse’s results underscore the significant differences between its strategy and that of UBS. Credit Suisse is pursuing a universal banking model that allows it to offer a full suite of services to its customers. UBS, on the other hand, is shrinking its investment bank — the business that underwrites share and bond offerings, conducts trading and advises on mergers — effectively exiting the fixed-income business and refocusing on private banking and wealth management, its historic strengths.
If you want universal banking and FICC trading, then you want people who are happy to take (intelligent) FICC risk, and who like the idea of being paid in the structured credit assets they cooked up. If you want boring private banking, you want people who will carefully mind the shop in exchange for a comfortable return, and who are terrified of losing money by the threat of drastic and all-or-nothing punishment. What the Swiss banks have in common these days is that they take seriously the idea of using compensation to send signals about what they’re looking for in their bankers. Right now they’re looking for very different things.
Credit Suisse May Pay Less in Asset-Linked Bonuses Than in 2011 [Bloomberg]
UBS leads way with bonuses shake-up
Credit Suisse Fourth-Quarter and Full-Year 2012 Results [CS]
Credit Suisse Returns to Profit [WSJ]