Aug. 25, 2004 -- LONDON -- Just as European investment banks prepare for what's expected to be a slow autumn in their dealing rooms, they face the unappealing pressure of rising personnel costs.

Operating costs at the three major European investment banks -- Credit Suisse Group, Deutsche Bank AG and UBS AG -- fell during the second quarter, analysts at Keefe, Bruyette & Woods said in a recent note. However, staff compensation as a percentage of revenue, a key measure of efficiency, rose at all three banks, especially at the Credit Suisse First Boston investment bank, according to Keefe Bruyette.

CSFB and, to a lesser extent, Deutsche Bank are facing a conundrum: As they try to keep up with UBS, how can they build market share in key areas like equities trading and high-yield bonds without blowing a hole in their budgets?

With emerging investment banks, such as the one at HSBC Holdings PLC, providing stiff competition for top recruits, analysts say things will get worse before they get better.

"Compensation/revenue ratios have improved over the last few years, initially from staff cuts and then recently from high fixed-income trading revenues," said Matthew Clark, banks analyst at Keefe, Bruyette. "We expect the improvements are largely over."

The question of costs is likely to pop up with increasing frequency during the second half, as analysts zero in on cost ratios -- the percentage of revenue eaten up by salaries, bonuses and other operating costs -- as a key benchmark of a bank's performance. In general, analysts start to worry when a bank's cost ratio moves beyond 75%. Right now, the warning lights are flashing at CSFB, following the recent departure of CSFB Chief Executive John Mack, renowned for his cost-cutting.

The cost ratio at CSFB's institutional-securities unit jumped to 91.2% in the second quarter, from 77.5% in the first. That compares with 74% at Deutsche Bank and 76.6% at UBS's investment bank.

And good bankers are getting more expensive. Although pay scales and bonuses vary widely, bankers estimate that new managing directors -- typically bankers with at least eight or nine years' experience -- can now earn more than $1 million, or more than €800,000, annually, including bonuses.

CSFB's net profit shrank to 430 million Swiss francs ($343.7 million or €279.1 million) in the second quarter from 759 million francs in the blowout first quarter.

The bank's wealth and asset-management unit more than doubled its bottom line, helped by gains in its private-equity portfolio. But that good performance masked the poor results at CSFB's other business, institutional securities, where revenue plunged 22%, while expenses were just 8% lower from the previous quarter. Profitability at the institutional-securities division also plummeted, pushing down CSFB's return on average allocated capital by half. The return on allocated capital measures profitability generated on capital made available to CSFB by its parent group.

CSFB said it is hiring "selectively." Analysts expect CSFB to ramp up hiring of bankers in Europe and Asia, where the bank has pledged to expand the successful parts of its franchise, such as mortgage-backed securities, distressed debt and private equity.

But the bank will have to make investments at a time when CSFB itself admits prices for "talent," or investment-banking professionals, are rising rapidly.

"If you look at the investment-banking industry, you see more hiring drove up prices, what you often see at the end of a bull market," Oswald Gruebel, chief executive officer of Credit Suisse Group, said when the bank reported second-quarter earnings.

CSFB management says that a substantial increase in its equity capital-markets group and mergers-and-acquisitions expertise in the first quarter is its most marked spate of hiring for this year.

Deutsche Bank says it is adding staff this year, but that its hiring is selective.

UBS has spent the past two years carefully bulking up, in part by poaching bankers from rival firms, though it also continues to hire selectively. "What we accomplished in 2001 and 2002 was to attract triple-A bankers, the deal makers of 1999 and 2000, who were miserable at their firms, as they had been told to fire some of their best people, cut back and write off loans," said Ken Moelis, co-head of UBS's investment-banking operations. "You start to think, 'I'm up for doing something else.' "

UBS, having already completed much of the hiring CSFB and Deutsche Bank are now being forced to do, isn't planning any large-scale hiring for the third and fourth quarters.

"In investment banking, we are focusing on putting more resources into a strategic-solutions group, such as tax and restructuring expertise," said Mr. Moelis.

Gerry Rawcliffe, managing director at Fitch Ratings in London, said costs can start rising quickly if banks go after entire teams of bankers and analysts, rather than individuals.

"Obviously the current employers of those teams will be bidding relatively aggressively to keep them on board," Mr. Rawcliffe said. "But I don't think there's any evidence that we will see an immediate return to the excesses we saw in the 1990s."

CSFB's new CEO, Brady Dougan, said that though the investment bank wants to level the playing field in terms of compensation, it won't offer multiyear guarantees for external hires, as was common practice at CSFB in the late 1990s. That practice, part of a free-spending culture at the bank, prompted the now-departed Mr. Mack to make unflattering comparisons between CSFB and a casino.

As part of its effort to control costs, CSFB says it won't lavish money on its businesses that look set to be unprofitable over the long term.

"Certainly, we would be prepared to lose market share rather than hang in there and kill ourselves," Mr. Gruebel said.