(Adds analyst comments, background and updates share movement)
May 19 (Reuters) - Citigroup slashed its earnings outlook for Wall Street investment banks, Goldman Sachs Group Inc (GS.N), Lehman Brothers Holdings Inc LEH.N and Morgan Stanley (MS.N), citing a tough operating environment.
The second quarter has seen lower client-related trading volumes, little banking activity, losses related to ineffective hedging and reversals of gains on fair valuing liabilities, analyst Prashant Bhatia wrote in a note dated May 16.
Bhatia, who is the latest in a growing line-up of Wall Street analysts to cut estimates on U.S. investment banks, said he expects significant asset sales related to leveraged loan inventory, and commercial and residential mortgages as a result of a greater degree of liquidity in the marketplace.
"We expect the brokers may take some losses to exit concentrated positions," he said, adding that although the operating environment appears to have improved considerably this month, it will not offset the weakness seen in March and April.
Second-quarter results could be a catalyst for restoring investor confidence that the worst of the markdowns have been taken and that balance sheets have been considerably de-levered and significantly de-risked, Bhatia said.
The analyst rates Lehman and Morgan Stanley "buy," and Goldman Sachs "hold."
He cut his target on Morgan Stanley stock to $70 from $75.
Goldman Sachs shares fell nearly 1 percent to $185.77 in morning trade on the New York Stock Exchange. Shares of Lehman were down nearly 1 percent to $43.27, while Morgan Stanley shares were down 37 cents to $46.84.
The Amex Securities Broker-Dealer Index .XBD, which includes Lehman and Morgan Stanley, has fallen 16 percent this year as the effects of the subprime mortgage crisis, credit crunch and housing slump reverberate. The following table lists the estimate changes made on Wall Street investment banks: COMPANY Q2 EPS VIEW FY'08 EPS VIEW RATING
Current Prior Current Prior Goldman Sachs $3.70 $4.71 $17 $18.50 Hold Lehman Brothers $0.05 $1.66 $3.50 $5.25 Buy Morgan Stanley $0.75 $1.66 $4.25 $6.35 Buy (Reporting by Tenzin Pema in Bangalore; Editing by Jarshad Kakkrakandy)