Dow Jones Newswires -- April 8, 1999
1Q Recovery Seen For Capital-Markets Investment Banks
By Lynn Cowan
NEW YORK (Dow Jones)--After two quarters of poor earnings, investment banks that focus on the capital markets are expected to show improved year-over-year results for the earnings period that ended in March.
A healthy rebound in the debt market and improved trading revenue appear to be two key factors that should help many capital-markets oriented firms top their results from the first quarter of 1998, analysts say.
Early indicators from Lehman Brothers Holdings Inc. (LEH) and Morgan Stanley Dean Witter & Co. (MWD) - two Wall Street companies that end their quarters a month ahead of the usual January-to-March first quarter - show trading revenue rising above last year's levels, a good indicator for the remainder of the Street. At the same time, U.S. debt-underwriting volume for the quarter rose to $564.8 billion compared with $549 billion a year ago, according to Securities Data Co. U.S. equity-underwriting volume continued to lag, at $37.4 billion compared with $43.8 billion.
"(Earnings) will be far better than the third quarter and a lot better than the fourth quarter of 1998," said Keefe Bruyette & Woods Inc. analyst Hal Schroeder. "We're moving back toward levels of the first half of 1998," a period of great profitability for the industry.
Investment banks that don't contain a significant retail brokerage arm, such as Bear Stearns & Co. (BSC), are considered capital-markets focused; those with a large brokerage staff that caters to individuals, such as Morgan Stanley Dean Witter, aren't.
When the stock market became rocky last autumn and debt markets stalled, capital-markets firms couldn't rely on the steady stream of commission revenue that retail brokers used to balance some of their trading and underwriting downturns. Two quarters of earnings releases followed that were lower than the corresponding periods a year earlier, though the fourth quarter's results were better than the third's for capital-markets firms.
This time around, several firms are expected to show year-over-year improvement. A First Call Corp. analyst survey sees Bear Stearns earning $1.15 a diluted share, compared with $1.10 a year ago, and Hambrecht & Quist Group Inc. (HQ) earning 63 cents a diluted share, compared to 60 cents a year ago. Los Angeles-based Jefferies Group Inc. (JEF) is seen earning 74 cents a diluted share, compared with 75 cents a year ago.
"The best way to characterize the industry right now is that it is picking up steam," said Financial Service Analytics analyst Michael Flanagan.
Follows Good Results From Lehman, Goldman
Lehman Brothers, which ended its quarter in February, already posted earnings of $1.57 a diluted share, compared with $1.44 a share a year ago, while Goldman Sachs & Co., a private partnership that is planning to go public this year, said it earned $1.188 billion pretax, a 16% increase from the 1998 quarter. Although both firms are on different reporting schedules than the majority of investment banks, the months included in their quarters this year are considered more comparable than the past two periods, when results varied widely from August through November.
Lehman's capital-markets executives said their world has improved considerably since September, when traders first began to experience the effect of emerging countries' problems, and debt markets were hit with liquidity problems. But both equity and debt investors continue to favor large-cap, highly recognizable companies, so smaller issuers still have some trouble tapping both the debt and equity markets.
"We're not back at July levels, but we're a long way off the wide spreads we saw in the fall," said Jim Merli, head of Lehman's U.S. fixed income syndicate. "Generally speaking, the higher-quality, large-cap frequent borrower names are almost back to where they were. The less highly recognized names, less frequent borrowers are still lagging, although they've gained a considerable amount of ground.'
Not all companies are going to beat their year-ago numbers. Donaldson Lufkin & Jenrette Inc. (DLJ) is expected to earn 69 cents a diluted share, compared with $1 a year ago, adjusted for a stock split in May; Friedman Billings Ramsey Group Inc. (FBG) is expected to break even this quarter, compared to earnings of 31 cents a diluted share last year.
Arlington, Va.-based Friedman Billings was among the hardest hit by last fall's turmoil, and has gradually been edging back to profitability after two quarters in the red, the result of trading losses and a slowdown in initial public offerings. In the first quarter of 1998, FBG was the top-ranked underwriter of initial public offerings, according to Securities Data Co.'s statistics; this year, it didn't even crack the top 25 list.
In DLJ's case, the firm won't see the same rebound in trading revenue and proprietary investments that some of its peers have experienced, analysts say. The company lost $187.7 million in principal transactions owing to trading losses in the third quarter of 1998, a 211% decline from a year earlier. By comparison, Bear Stearns' trading and proprietary investments line remained profitable during the same period, declining 50%. DLJ's rebound from its loss is expected to be slower not only because it was more severe, but because the firm has been more risk-averse in its trading strategies, analysts said.
"They're very cautious about the inventory at risk. Trading profits will rebound dramatically but not to the extent of Lehman, Merrill or Morgan Stanley, because they're not on the same trading platform. They don't have the same level of exposure,' said Putnam Lovell de Guardiola & Thornton analyst Dean Eberling. "The biggest swing factor this quarter will be a rebound in trading profits."
Eberling and other analysts are debating how long the rebound can be sustained. Eberling said there are so many factors affecting firms' return on trading, from technology to competition, that it may be hard to continue showing significant improvement in that area. Merrill Lynch & Co. analyst Judah Kraushaar said a portion of the industry's stronger trading revenue will result from activity in the debt market, which could slow down in the months ahead.
"One question I have is, If we are in a disinflationary world, how can debt be created on a sustained basis at an accelerated pace?," Kraushaar said. "I think if things settle down beyond the first quarter, there's still some risk that ongoing levels of trading and investment banking revenues (from fixed income) could be lower than where they peaked last year."
- Lynn Cowan 201-938-5293; lynn.cowan@dowjones.com
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