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Goldman Sachs Group Inc., Morgan Stanley, Merrill Lynch & Co. and Bear Stearns Cos., four of the five largest securities firms, will earn less than expected through next year after a rout in U.S. subprime mortgages, according to Lehman Brothers Holdings Inc.
Lehman analyst Roger Freeman trimmed his share price estimates for Goldman to $214, for Morgan Stanley to $81, for Merrill to $106 and for Bear Stearns to $142 in a note sent to clients today. He cut his third- and fourth-quarter and 2008 earnings estimates for the New York-based firms.
``Third-quarter earnings will be significantly impacted by the dislocation in the credit and asset-backed and mortgage markets,'' New York-based Freeman said in the note. He has an ``equal-weight'' rating on Goldman and Morgan Stanley, the two biggest U.S. securities firms by market value, and an ``overweight'' rating on Merrill and Bear Stearns.
Wall Street firms have posted three straight years of record earnings, fueled by fixed-income trading. Defaults on U.S. housing loans to subprime borrowers with poor credit histories have reached a 10-year high, driving down the value of bonds backed by mortgages and prompting a global slide in stocks.
Goldman, Morgan Stanley, Lehman and Bear Stearns end their fiscal third quarter tomorrow and are scheduled to report results next month. Merrill Lynch, the third-biggest U.S. securities firm after Goldman and Morgan Stanley, will finish its quarter at the end of September.
Worse than 1998
Two days ago, Merrill Lynch analyst Guy Moszkowski, cut his stock recommendation on Lehman, Bear Stearns and Citigroup Inc. to ``neutral'' from ``buy,'' citing a likely slowdown in revenue from investment banking. Standard & Poor's said yesterday that business conditions for securities firms are worse than in the second half of 1998, after Russia defaulted on its debt. S&P predicted that revenue from investment banking and trading could fall 47 percent in the last six months of the year.
``We believe 1998 is a relevant comparison period because it was also characterized by a liquidity crisis in an otherwise pretty favorable economic and corporate earnings environment,'' Lehman's Freeman wrote today.
The 12-member Amex Broker/Dealer Index had fallen 9.5 percent this year through yesterday. At 9:51 a.m. in New York Stock Exchange composite trading, Morgan Stanley was down 1.9 percent to $60.02, while Goldman declined 1.3 percent to $171.45. Merrill stock slipped 1.2 percent to $72.21 and Bear Stearns fell 0.6 percent to $106.47. Lehman dropped 1.1 percent.
Time to Buy
Analysts still expect the firms to earn more than they did last year. The average estimate of analysts surveyed by Bloomberg News is for earnings per share at Goldman, Morgan Stanley, Lehman Brothers and Bear Stearns to rise in the third-quarter from a year earlier.
For Douglas Ciocca, who helps manage about $1.4 billion at Renaissance Financial in Leawood, Kansas, the drop in stock prices and earnings estimates make the shares more attractive. He owns stock in Goldman, Morgan Stanley and is considering buying shares in Merrill Lynch, which he said could win customers as investors seek guidance amid declining markets.
``It makes sense to consider initiating positions in these companies with the appropriate time frame,'' he said in an interview today. ``Down markets are really good for our business -- Merrill is going to gather a lot of assets.''
`Wall of Worry'
Earnings from most divisions at the banks are likely to be little changed next year, with ``slight increases'' in equities and fixed-income trading and from faster-growing economies, Lehman's Freeman wrote. ``We admittedly have limited conviction about 2008 ourselves sitting here at the end of August with a wall of worry to climb between now and October,'' he wrote.
Freeman halved his third-quarter estimate for Bear Stearns to $1.45 a share from $3.28. He cut his estimate for Goldman to $4.26 from $4.47, for Merrill to $1.74 from $1.90 and for Morgan Stanley to $1.43 from $1.80.
Two Bear Stearns hedge funds collapsed in the past two months because of bad subprime-mortgage bets. Goldman, the world's second-largest hedge fund manager, was forced to put $2 billion of its own cash into one of its funds and waive some fees after it lost money.
Lehman Brothers and Bear Stearns are the fourth- and fifth- biggest U.S. securities firms.