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IPO woes could pressure brokerage results
SNL Financial (March 19, 2003)

Large investment banks learned in 2002 that they no longer could rely on a robust initial-public-offering market to supplement quarterly profits. In the first quarter of 2003, an already anemic market for equities underwriting slowed further still, presenting an ominous outlook for activity in the coming months.

According to data released by the Securities Industry Association, February was the slowest month for equities underwriting in at least the last two years. With no IPOs scheduled for pricing at this point, the slump promises to continue through March and April.

The four large investment houses that are scheduled to release results for the first fiscal quarter of 2003 on March 19 and 20 have been able to pull a variety of levers to maintain and, in some cases, increase quarterly earnings. Strong fixed-income activity, which provided a boost to fourth-quarter results, again appears to have had a positive bottom-line impact. Continuing expense-reduction programs have also smoothed quarterly results. But none of the four institutions set to release results is expected to produce both sequential and year-over-year growth in earnings per share.

Although total underwriting rose 2.6% to $435.4 billion during the first two months of 2003, fixed-income securities, not equities, have been responsible for the favorable comparison. Strength in underwriting of asset-backed securities is primarily responsible for the higher activity. A total of $170.3 billion in asset-backed debt was underwritten in January and February, up 20.4% from 2002, according to Securities Industry Association data. In 2002, $1.1 trillion in asset-backed debt was underwritten, representing 43% of all U.S. corporate underwriting activity. The prior year, asset-backed securities represented less than a third of all underwriting activity. Traditional corporate debt underwriting has slipped 0.9% year to date, but that decline is sharply below the double-digit plunges recorded in most other areas of underwriting. Common-stock and preferred-stock issuances have tumbled 28.6% and 61.6%, respectively. Traditional IPOs and follow-on offerings have plunged 80.2% and 29.5%, respectively.

Only $154 billion worth of equity was underwritten in 2002, making it the slowest year for such activity since 1998.

The outlook for future activity looks bleak. Within the last 30 days, five IPOs have been withdrawn, while only two have priced, according to IPOExpress. The number of deals in the pipeline is frighteningly small. Likely as a result of geopolitical concerns - "Iraq paralysis" as Prudential Securities analyst David Trone calls it - there are no IPOs scheduled for pricing at this point, according to IPOExpress, and only one company, reinsurer AXIS Capital Holdings Ltd., has filed for an IPO in the last month.

Financial institutions have helped keep the IPO market afloat during the first two-and-a-half months of 2003. Seven of the eight underwritten IPOs priced so far in 2003 have involved banks, thrifts, mortgage lenders or insurance companies. But that stream of activity is also running dry. Insurance companies and insurance brokers completed 20 IPOs, raising an aggregate of $13.97 billion, over the last 24 months. Now, only AXIS has an IPO in registration. It is seeking to raise as much as $517.5 million, which would rank as the 14th-largest insurance IPO on record.

Analysts point to a number of factors - seasonal strength in interest-rate derivatives, narrowing of credit spreads, strength in mortgage-backed securities and war-related volatility in currencies and commodities - for solid fixed-income activity. But, said Putnam Lovell NBF analyst James Mitchell, the first quarter might be "the high-water mark" for such activity in 2003.

It "appears to us that many of the main drivers of fixed income trading are firing on all cylinders, which we believe could drive fixed income trading revenues meaningfully higher this quarter," he said in a report. "In fact, we believe fixed income trading revenues will be strong enough to allow the brokers to beat consensus estimates for the first quarter of 2003."

But, Mitchell said, fixed-income-related revenues "will fall from very strong first-quarter levels," and will combine with a slow recovery in equity-related capital-markets businesses to make for more difficult conditions.

"In other words, we expect the top line at most firms to fall from first-quarter levels for the remainder of 2003," Mitchell said. "Although we believe companies may be able to offset this challenging revenue outlook with lower compensation levels and additional headcount reductions, the investment banks are unlikely to effect such changes quickly enough to offset the decline in revenues that we foresee."

Of the four companies scheduled to release results this week, only Bear Stearns Cos. is expected to generate favorable year-over-year earnings comparisons, though it is projected to fall short of its stunning fourth-quarter profits. The Thomson First Call consensus estimate for Bear Stearns' first-quarter earnings is $1.35 per share, up 6 cents from the first quarter of 2002, but down 15 cents from the fourth quarter. Lehman Brothers Holdings Inc. is expected to grow earnings by 29 cents per share sequentially, but the consensus estimate of 98 cents is a penny short of year-ago profits. Morgan Stanley & Co., estimated to generate earnings of 62 cents per share, reported first-quarter profits of 76 cents per share a year ago. Goldman Sachs Group Inc. reported earnings of 98 cents per share in the first and fourth quarter of 2002. It is projected to earn 96 cents in the first quarter of 2003.

Estimates for all but Morgan Stanley have been tweaked higher in the last 30 days. Some analysts said Morgan Stanley could be the most likely of the four to miss the consensus view as a result of volatility associated with its credit-card business. Bear Stearns, meanwhile, is more highly recommended by analysts than others in the group because of its recent propensity to exceed earnings estimates. In three of the past four quarters, the company has beaten the consensus by 20% or more.

The gloomy environment has not deterred investors from increasing positions in the four companies' stocks. Shares of all but Bear Stearns outperformed the 6.9% increase in the S&P 500 in the seven-day period ended March 17, and the SNL Institutional Broker/Dealer Index gained 8.3% during that time.

Bear Stearns is the first of the four companies set to release results. It is scheduled to do so before the market opens on March 19. The company will hold a conference call at 10 a.m. Eastern time the same day to discuss its results. The call may be accessed by dialing (800) 692-4690. On March 20, Lehman, Morgan Stanley and Goldman will conduct conference calls at 9 a.m., 10 a.m. and 11 a.m., respectively.



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