Credit crisis sours securities industry outlook

IRVINE, Calif. — Credit market turmoil has soured the outlook for the securities industry through next year.
The fallout from the subprime-mortgage mess continues to roil much of Wall Street’s product origination and trading side.
Late last month, Brad Hintz, an analyst at Sanford C. Bernstein & Co. LLC in New York, reduced by 10% his estimate of 2008 fixed-income sales and trading revenue for the industry.
As a result, in his report, he cut 2007 and 2008 earnings estimates for The Bear Stearns Cos. Inc. and Lehman Brothers Inc. by about 7%, Goldman Sachs & Co. by 5%, and Merrill Lynch & Co. Inc. and Morgan Stanley by 3% to 4%.
As a unit of Alliance Capital Management LP, Sanford C. Bernstein manages about $107 billion for high-net-worth clients.
According to Richard Bove, an analyst at Punk Ziegel & Co. in New York, the assets of brokerage firms are overstated on the balance sheets. “Firms can’t value what they own, so we think the [brokerage firm] stock prices are overstated,” he said.
Mr. Bove has “sell” ratings on Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch and Morgan Stanley, all of New York.
Because of the bursting of the “debt capital market bubble, the industry will have a lot more difficult time meeting the earnings they’ve achieved in the last couple years,” he said. And Mr. Bove doesn’t think that the steadier retail business will blunt the impact.
Merrill Lynch, for example, relies more on trading profits than in the past, he said.
Furthermore, Mr. Bove expects that the retail business will be negatively affected by fewer investment-banking deals and less demand for structured products, as well as slowing sales of credit products sold by retail brokers.
“I don’t think demand for those [structured] products are high now,” he said, and “if you can’t do investment-banking deals, then the highest-priced products are not available [for firms] to sell.”
Structured products are a “little bit more complicated than most people can understand, so the [credit market dislocations] pose a problem for the big [investment banks],” said Dennis Zank, president of Raymond James & Associates Inc. in St. Petersburg, Fla.
‘Aligning nicely’
Despite the subprime-mortgage quagmire and liquidity crisis, the retail business looks positive over the longer term, observers said.
“It seems to me everything is aligning nicely with the demographics in the industry,” Mr. Zank said. “There is strong demand from baby boomers for what we do, and to some extent, there is a diminished supply of financial advisers,.”
Brokers, many of whom are baby boomers and are looking to retire, often face health issues that make work difficult, Mr. Zank said.
“When you combine all that with fewer firms’ training [new brokers], it paints a pretty good picture for the business,” he added.
“A lot of people don’t use financial advisers, but a lot are going to [consider it]” once they retire, said Patrick O’Shaughnessy, a brokerage industry analyst at Morningstar Inc. of Chicago.
The demand for advice should “grow pretty substantially over the long term,” he said.
“The full-service [firms] have done a reasonably good job of shifting to assets under management” and away from transactional business, Mr. O’Shaughnessy added. “Even if we see a slowdown in trading volume, they may not be impacted that much.”
Although fee-based accounts may help even out revenue, Mr. Bove warned, managed assets have “started to see increased priced competition.”
Mr. Hintz noted in his report that retail brokerage and asset management in the United States remain strong, and that corporate-mergers-and-acquisitions businesses in Europe and the United States are “booming.”
In addition, “improved risk management … will likely allow the brokerage firms to weather the market disruption … more successfully than the industry did in 1998” after the Russian default crisis, he wrote.
But Mr. Bove thinks that the industry will face a head wind for a while. “I think it’s going to take quite a few quarters to work through the debt issues,” he said.
Observers also expect that client nervousness will affect recruitment activity because brokers are loath to change firms when their clients are anxious about their investments.
But the recruitment deals offered to established brokers remain strong.
Wall Street needs a good retail base for its other lines of business, such as banking, mutual funds, syndicate and alternative investments, Mr. Zank said.
“All of these [other businesses] start with the retail client,” he said.
List: Wirehouses, regionals and discount brokers ranked by retail reps