Bonuses on the way - but hold off the Porsche

It's bonus time in the City - and last year's stock market rally is promising the biggest payout in years. Confidence has returned after three years of falling share prices, as investment banks start to make money again. And with fewer people around to share the spoils after countless rounds of redundancies, expectations are high for this year's seasonal jackpot.

Bonuses provide a major incentive for those in the Square Mile. They are paid to traders, fund managers and research analysts - anyone who has played an active role in generating profits for the company. In a good year, they are worth many multiples of a year's basic salary. The payout is determined ultimately by how well an individual has done, but it is influenced, too, by the company's performance.

US investment banks such as Morgan Stanley, Goldman Sachs, Merrill Lynch and JP Morgan, which are reputed to be among the City's highest payers, have already told their staff how much their bonuses are going to be. The word is that they're pretty good. Top analysts are said to be walking off with more than £500,000, while £1m payouts are thought to be commonplace among the top traders.

"There are rumours that bonuses at Morgan Stanley and Goldman Sachs are up by 30 per cent," said one investment banker. One fund manager who was told about his bonus last week was all smiles, saying: "Bonuses are well up on last year. They've come in much better than expectations." The biggest prize is thought to have gone to a derivatives trader at Goldman Sachs, who is reported to have received more than £30m, a record payout for the City.

But bankers who haven't received their bonuses should hold off ordering their Porsches: they could yet be disappointed. Paul King, a recruitment consultant at CNA International, said: "Bonuses will be up on last year, but they won't be fantastic. People have reason to be optimistic, but it's nothing like the heady days of the dot-com boom."

Another City headhunter said: "Expectations are higher than reality. I've heard that some people's bonuses are up by 30 or 40 per cent, but these are likely to be the exceptions rather than the rule. I would say that a 10 or 20 per cent increase would be normal."

It's not all good news. Bond traders, who generated the bulk of profits during the stock market downturn, won't be seeing a massive increase. While other bankers were being sacked or had their bonuses slashed during the bear market, bond traders continued to earn large payouts, in many cases receiving seven-figure sums. Corporate financiers, who earn fat fees advising on deals, won't be getting much of a rise, either. Despite the recovery in share prices, the market has yet to see the kind of buoyant activity in mergers, acquisitions or new issues which would justify big rewards.

Equity traders and fund managers, who have benefited most from the rising stock market, are set to get the biggest bonanzas. Bonuses are likely to be particularly generous for those involved in the Japanese and Asian markets, which saw the most dramatic moves in share prices.

But even the highest achievers in London won't be counting on instant riches. Companies are aware that they run the risk of losing their best staff if they pay their bonuses in one lump sum. People would jump ship to a competitor as soon as they cashed in. Increasingly, bonuses are paid over a length of time, typically three years, with greater rewards weighed towards the end of the lock-in period. And while the bulk of the payments are made in cash, bonus packages usually include an allocation of shares, which people can't sell for three years.

More immediately, bonuses are up against another debilitating factor: dollar weakness. A City headhunter said: "The key thing about bonuses at the moment is the weaker dollar. All the US investment banks - Goldman Sachs, Merrill Lynch, Lehman Brothers, Morgan Stanley, JP Morgan, Citigroup - pay their bonuses in dollars. Let's say your bonus was raised by 10 per cent. This is all very well, but it translates into a minimal increase when converted into sterling."

Some banks such as Morgan Stanley and Goldman Sachs set their bonus payments in November when the sterling-dollar exchange rate was as low as $1.66. Unfortunately for their UK employees, bonuses are converted into sterling only on the day of payment, which is likely to be this month or in February. With the dollar currently languishing at $1.82 against the pound, this means that the sterling value of these bonuses have fallen by almost 10 per cent in less than two months. Perhaps that Porsche could wait another year, after all.