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Industry leaders say there will be some targeted trimming, however, particularly at investment banks with sizable operations in the United States, where the business mix often differs from Canada.Mark Blinch/Reuters

A dramatic drop in deal flow, coupled with the stock market’s free fall, has investment bankers and corporate lawyers nervous for the first time in years. And as the revenue pipeline shrinks with each passing interest rate hike, the fears of an industry-wide job cull are only growing stronger.

Yet capital markets executives and managing partners plan on mostly standing pat, according to 10 sources familiar with hiring, firing and compensation decisions at the country’s largest investment banks, corporate law firms and private equity firms. The Globe and Mail is not identifying the sources because they are not authorized to speak publicly on the matter.

Pay cuts will be common, and in some cases quite drastic, but widespread staff cuts aren’t expected. At least not yet.

Industry leaders say there will be some targeted trimming, however, particularly at investment banks with sizable operations in the United States, where the business mix often differs from Canada. BMO BMO-T has also already booked $49-million in severance pay in its capital markets arm, and RBC RY-T said this week it is trimming U.S. investment banking staff, making “minimal” changes at the more junior levels.

Bay Street’s big chill sets in as share sales crater, sapping fees from investment banks

BMO Nesbitt Burns and RBC Dominion Securities both run leveraged finance divisions in the U.S. that specialize in financing high-risk borrowers, and these units have been hit hard by choppy credit markets. Both banks recently reported underwriting markdowns in these businesses worth $88-million and $385-million, respectively.

In late August, RBC chief executive Dave McKay told analysts and investors the bank will prioritize investments in advisory work and equity financings. Mergers and acquisitions advisory work, for instance, is fee-based and does not put the bank’s balance sheet at risk the way leveraged finance does. Spokespeople for both investment banks declined to comment for this story.

For the most part, bankers, corporate lawyers and private equity partners are sanguine about the moribund deal flow, privately acknowledging the record level of initial public offerings and deals couldn’t last.

At the Big Six banks, underwriting and advisory fees, which are the bread and butter of investment banking, have dropped an average of 25 per cent through the first nine months of their fiscal years relative to the same period in 2021.

At Canaccord Genuity, Canada’s largest independent investment bank, these fees have dropped 31 per cent over its past three quarters relative to the same period a year earlier – with a particularly sharp drop in the most recent quarter. (Canaccord’s fiscal year ends March 31, versus Oct. 31 for the big banks.)

Yet these fees are still higher at every single Big Six investment bank than they were during the same period in 2019, before the COVID-19 pandemic. The same is true for the net incomes of their entire capital markets divisions.

In fact, capital markets net income at Canadian Imperial Bank of Commerce CM-T and National Bank of Canada NA-T was higher in the first nine months of this year than the same period in 2021. And while BMO’s recent severance charge fuelled fears of a street-wide staff cull, the bank’s capital markets arm booked $120-million worth of severance just before the pandemic, nearly 2.5 times the current amount.

The fact Bay Street is hitting pause rather than culling can sound overly optimistic in these markets, especially because it seems out of step with Wall Street giants such as Goldman Sachs GS-N, which recently announced it will cull its poor performers this year.

But the decision makers stress some nuance is necessary. Goldman, for instance, is reinstating a trimming it used to conduct annually, and some of its rivals aren’t sounding the alarm.

Earlier this month, Daniel Pinto, JPMorgan’s JPM-N head of corporate and investment banking, warned fees from his division could fall 45 per cent to 50 per cent this quarter from the year prior, but added that slashing willy-nilly wasn’t in the cards. “You need to be very careful when you have a bit of a downturn, to start cutting bankers here and there, because you will hurt the possibility for growth going forward,” he said.

While deal flow has plummeted relative to the pandemic’s banner years, there is still hope that there will be enough of it to avoid major restructurings. Private equity firms, for instance, raised bundles of cash over the past two years and they plan to deploy it even though interest rates are rising, making buyouts more expensive. Many acquisition targets are now trading so far below their net asset values the math can still work, which should deliver M&A fees for the advisers.

Canadian capital markets also have some unique characteristics that alter the culling equation. Crucially, employment laws in Canada are much more restrictive about mass layoffs than laws in the U.S., making severance standards higher here and cuts more expensive.

Rule changes enforced after the 2008-09 global financial crisis also require paying more compensation to bankers in restricted stock units that vest over time, rather than in the form of immediate cash bonuses.

If markets rebound quickly next year, the way they did in 2009 after the crash that began in late 2008, it could force any bank that culls now to pay up later to fill its coverage holes. To lure anyone, a bank would likely have to pay for the restricted stock its hires will give up by moving – and that’s on top of the severance packages the bank paid out to get lean in the first place.

Severance standards can also complicate the timing of culls, executives say. One capital markets head stressed that many bankers at his firm doubled their pay in each of the past two years, often to more than $1-million. Because severance paid now would be based on that elevated pay level, investment banks may choose instead to keep staff, but slash compensation to little more than base salaries, which are often around $200,000 for senior people.

If staff don’t like it, they can try to find a job somewhere else in a tough market. “We just paid record amounts the last two years. Why would you fire people now?” the executive said.

Cutthroat? Yes. But that’s also capital markets.

Canadian firms are also lucky in that there isn’t much fat to trim. Because pandemic deal flow was so absurdly high, everyone was busy, and that made it much harder to poach talent during the boom. Hiring last over the past 18 months was “so tricky,” said Bill Vlaad, a leading Bay Street recruiter.

Canaccord’s deal flow skyrocketed during the pandemic, yet the head count in its Canadian capital markets arm currently sits around 280 people, according to filings, almost the same number of people this division employed in 2019.

While hiring was tough, banks also saw some defections, which created job vacancies. With the tech sector on fire, overworked capital markets employees and lawyers were enticed to leave by stock options handed out by startups.

Burnout was another big factor affecting head count. Some junior staff straight up quit, despite the lucrative pay, because they were sick of the work. A junior banker’s job is a monotonous grind even in the best of times, with a focus on editing spreadsheets and recycling PowerPoint presentations. Without traditional perks such as fancy closing dinners and vacations paid for by lavish compensation, the job lost a lot of its lustre and not even $350,000 salaries were worth it.

Bay Street law firms, meanwhile, had junior to mid-level employees poached by rival U.S. firms, which were desperate for warm bodies and paid outsized compensation. To recruit, they often paid signing bonuses worth US$100,000 or more, plus perks such as U.S.-dollar pay and a promise to be able to work remotely.

It is entirely possible leaders making the hiring and firing decisions on Bay Street are far too Pollyannaish about it all. Even if they want to hold the line for very logical reasons, those with publicly-traded stocks may feel pressure to cut expenses because investors demand it – just like tech companies.

But, as of now, the situation is akin to the broader economy. Aggressive rate hikes have shocked the system, and it takes time for the fallout to truly be felt.