What does "bonus" mean to a banker?

[Billdo]

@Keeve

I honestly want to know what people do that gets them seven-figure salaries – bonus or not. The way I figure it, regardless of whether it is a loan or a deposit, if a person makes a million dollars, and that is just a sliver of the interest on that account – let’s say 1/10 of one percent – then that account (or those several accounts) must be at least a billion dollars. Are there a thousand such new accounts each year?

The money, and these big salaries, aren’t really in deposits, but in structuring deals, whether they are loans, public securities offerings, mergers and acquisitions, underwriting, securitizations, or any of a variety of other transactions. The people we are talking about are not the bank officers in local branches, but the people in New York, London, Tokyo and other financial centers who bring deals to market.

Oversimplifying greatly and pulling a number out of my behind, let’s say that a bank gets fees of 1% of the transaction amount for the average deal they do. So, if the bank does $1 billion dollar deal (arranges the sale of a $1 billion company, underwrites the sale of $1 billion of stock, etc.), it gets fees of $10 million. Of that $10 million, a relatively small amount of it is used to pay the overhead of the bank (offices, electricity, computers, accounting and HR, etc.), and the rest is available to pay your people and to be profit to the bank. From that deal income, a large chunk will (and should) be paid to the team that arranged the deal, who convincing the client to come to the bank, had the experience and connections to complete the deal, and actually got the thing done.

In many ways, this is just like a homeowner paying their bank a point (1%) to get their mortgage or a real estate broker a commission to sell their house. The individual professionals get paid out of those transaction costs.

A big bank will complete mutiple billions (or more) of deals in a year, and take a small slice out of that transaction flow. Of that small slice, a big portion of the slice is paid to the individual bankers who generate the deals and make the deals happen. Because the value in a bank is not really in fixed assets or equipment, it is mostly in the people, who demand pay relative to their contribution.

[LonghornDave]

@Keeve

And it is indeed sad that you will probably get less than that. My question is this: Exactly what is it that you do, which brought in such large profits? Do you make loans to companies that did not default? Did you get humongous deposits from gigantic companies?

I honestly want to know what people do that gets them seven-figure salaries – bonus or not. The way I figure it, regardless of whether it is a loan or a deposit, if a person makes a million dollars, and that is just a sliver of the interest on that account – let’s say 1/10 of one percent – then that account (or those several accounts) must be at least a billion dollars. Are there a thousand such new accounts each year?

I manage a portfolio of companies that are usually both borrowers and depositors of our bank. These could be companies that were put on the books recently or several years in the past. We can make money both from deposits or loans. My job is both to originate new business and monitor existing deals. Each loan that I make is structured so as to provide for frequent monitoring.

Here is an example of how a bank could make a lot of money on a single transaction. Let’s say they underwrite a $1 billion loan to a company. That loan may cost a fee of 2% ($20 million) and be pricing at Libor + 2.50% and have a maturity date of 3 years. The bank’s cost of funds may be close to Libor so they are essentially making a 2.50% spread per year. The bank will not take the entire exposure themselves, so they will sell $950 million of it to a syndicate of other banks and pay each of them a fee of 1%. Therefore, the bank that underwrote the loan scraped $10 million of the upfront fee for themselves and is making $2.5 million a year in net interest income. They make a total of $17.5 million on a $50 million three year deal for a rate of return of 11.7%.

[Keeve]

Many thanks to Billdo and LonghornDave. I’m finally starting to get an idea of what you guys do.

[LonghornDave]

@LonghornDave

They make a total of $17.5 million on a $50 million three year deal for a rate of return of 11.7%.

Should be income of $13.75 million and a return on assets of 9.2%.

Also, Billdo has provided a good example of a transaction that an investment banker may put together. My example is for a commercial banker.

[Kent_Clark]

As I understand it, a lot of these compensation arrangements were set up when companies were true partnerships. Businesspersons A, B and C would organize company D so they could go after bigger deals than they could arrange by themselves. However, they still made individual deals. A share of their money from the deals would go into the operation of the company, but they would keep their own shares. At the appropriate time, bonuses would be paid for their participation in the big deals.

As a result they were getting money from two streams – the deals they put together themselves, and their share of the deals that the company as a whole put together. An individual partner might have a good year while the company had a bad year, or vice versa.