September 8, 2008 / 1:15 PM / in 11 years

UPDATE 2-Oppenheimer: Brokers to underperform for more quarters

 (Recasts; adds details)
 Sept 8 (Reuters) - Oppenheimer’s Meredith Whitney expects at least four more quarters of pressured earnings at investment banks until businesses are right sized, while they battle major declines in revenue sources.
 “Up to now, brokers have been reluctant to pare back their expense bases/headcount largely because they didn’t view their earnings exclusive of multi-billion dollar writedowns as all that bad. This is about to change in our opinion,” analyst Whitney wrote.
 Wall Street banks, which have been roiled by billons of dollars of writedowns, are expected to post weak third-quarter earnings as trading volumes dip and M&A activity slows globally.
 The group now faces “negative operating leverage as these companies simply cannot cut expenses fast enough to offset revenue declines,” even as they continue to reel from falling asset prices and industry wide de-leveraging, Whitney wrote in a research note to clients.
 Since last summer, almost $2 trillion less liquidity has flowed through the U.S. capital issuance markets versus the same period year prior, Whitney said. August volumes were the lowest since December 2001 and represented the twelfth month of year-over-year declines in the past 13 months, she added.
 “The last time revenue and expenses were so mismatched was during 2001/2002,” Whitney said, adding that second quarter of 2008 was the first quarter when brokers uniformly experienced negative operating leverage exclusive of writedowns.
 The analyst said in 2001/2002, “it took four/five quarters for the brokers to downsize, (and) when they did, headcount declined by over 15 percent for the biggest brokers.”
 “Today, headcount is roughly 22 percent or 45,000 higher than trough levels reached in 2003, which we also note marked the point at which these stocks began to outperform again.” she said.
 The slowdown in business today is far more pronounced and protracted than it was in 2001/2002 and “this resize will be at least equally painful,” Whitney added.
 Whitney lowered her 2008 estimates for four large U.S. investment banks — Lehman, Merrill, Goldman Sachs and Morgan Stanley — citing higher writedowns, lower trading volumes, weak global equity markets and lower advisory and underwriting revenue.
 Whitney expects Lehman Brothers LEH.N and Merrill Lynch & Co MER.N to take a total writedown of $4 billion and $8.2 billion, respectively, in the third quarter, tied to residential-mortgage and commercial-mortage related positions, and leveraged finance exposures.
 The trading volumes for the equity markets and fixed income were weak in the third quarter of 2008 and the major global indices continue to be down more than 9 percent for the year, she said.
 “As Goldman Sachs (GS.N) revenues are relatively the most equity-linked of its broker peers, the fact that broad global equity market indices are all down double-digits will have a meaningful effect on the company’s earnings,” Whitney wrote.
 The analyst maintained her third-quarter estimates for Morgan Stanley (MS.N), but lowered her estimates for Goldman Sachs, Lehman and Merrill.
 The following table lists the estimate changes:
                   NEW     PRIOR     NEW       PRIOR     NEW
 Morgan Stanley    $0.81   $0.81     $4.20      $4.25    $4.15    $4.40
 Goldman Sachs     $1.55   $2.15     $12.82     $14.32   $14.00   $14.90
 Merrill Lynch    -$4.60  -$2.93    -$11.42    -$10.50   $1.27    $1.27
 Lehman Brothers  -$2.70   $0.23    -$6.67     -$3.70    $1.70    $1.80  (Reporting by Ratul Ray Chaudhuri in Bangalore; Editing by Himani Sarkar)   

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