Flying High Once Again : Wall Street Bounces Back ...
Even in the best of times, predicting the future health of the stock brokerage industry is a dicey proposition.
It is an industry whose three main revenue streams--commissions, trading profits and underwriting fees--are inextricably linked to two imponderables: the performance of the stock market and the level of interest rates.
Now, as brokerage firms come off their best first half since before 1987’s stock market crash--with estimated pretax earnings of more than $2.25 billion--the inherent uncertainty has been heightened by the fragility of the current economic recovery and the apparent stall of the Dow Jones industrial average just under 3,000.
“Everybody wants to believe that the good times will continue to roll,” said John Keefe, a brokerage analyst at Lipper Analytical Securities Corp. “But most people also realize that the first quarter was as strong as it was because of two people, Alan Greenspan (chairman of the Federal Reserve Bank, who eased interest rates) and Saddam Hussein (the Iraq leader who forced the shooting war against his country).”
As a result, caution--not celebration--is the watchword among brokerage firms both large and small. With the stock market struggling, trading volume down and the hot new-issues market cooling off, “the bloom is off the rose,” said Thomas W. Strauss, president of Salomon Bros. Inc. “People are already talking nostalgically about the first quarter” when profits hit $1.5 billion.
Expense controls remain tight. “Typically, you bounce back fast and firms scramble to add people,” said Jerome P. Kenney, executive vice president for corporate strategy of Merrill Lynch & Co. “This time, we’d like to hold the line (on expenses) to better assess the extent of the recovery.”
Seth Gersch, managing director for administration of Montgomery Securities in San Francisco, agreed that the first half was great, but added: “I think business is going to start to get slower. The window for doing financings is beginning to close. The appetite for stocks is down and prices are up.”
The hesitant economic recovery also is leading to paralysis in capital markets. After a spectacular first half, “People are still trying to figure out if the economy is coming back and when, and what that means for rates. They don’t feel compelled to do anything now,” said Grant Kvalheim, managing director and head of Merrill Lynch’s capital markets desk.
Individual firms will not discuss their results for the second quarter ended June 30, but most analysts figure the industry as a whole posted pretax profits of between $750 million and $1 billion. That compares to a strong $1.5 billion in the first quarter.
Unlike the first quarter, when trading profits and commission revenues swelled, the biggest windfall in the second quarter came from the flood of underwritings of debt and equity issues. While the second-quarter profit is off significantly from the previous quarter, it is still a welcome turnaround from full year 1990, when the industry posted a pretax loss of $162 million--the first industrywide loss in 17 years. (National full-line firms posted an even more dismal pretax loss of $678 million in 1990.)
The 1990 results culminated a harrowing four-year period in which one industry job in every five disappeared and big name firms such as Drexel Burnham Lambert plunged into bankruptcy and virtually ceased to exist. Though most officials are comfortable that an industry turnaround has begun, they continue to emphasize cost controls.
Even in the midst of the first quarter rebound, the industry’s work force, which had shrunk from a peak of 262,000 to 210,000, was cut by another 1,000 employees, said Jeffrey Schaefer, research director at the Securities Industry Assn., a trade group. Most of the decline represented “downsizing that had been set into motion before the first quarter, and some of that will continue,” Schaefer said.
“There may be more cutbacks ahead in (depressed) junk bond and mergers-and-acquisitions areas,” he added, although statistics for second-quarter industry employment haven’t yet been compiled.
Job cutbacks aren’t the only way brokerage firms are saving money. In 1989, for example, Paine Webber Group moved its entire retail operation from New York across the Hudson River to New Jersey.
Observers predict that strategic pruning of unprofitable businesses will be the rule rather than the exception during the 1990s. “In the 1980s, there was this embarrassment of riches. Brokers weren’t forced to confront the issue of which of their businesses made money and which didn’t,” added Keefe. Products proliferated, personnel multiplied and revenues climbed to the skies.
As a result, according to Strauss and other industry officials, the brokerage business--like other financial service industries such as banking and insurance--remains plagued by overcapacity.
Mergers and other consolidations will continue, he said, and firms will continue to rationalize operations by exiting unprofitable or marginally profitable businesses.
“Last year, a lot of people were asking themselves some very basic questions: ‘Are we in the right businesses? Can we justify being in all these product lines?’ ” said Strauss.
Those questions, which were put aside in the ebullient first-quarter Gulf War-related boom, are beginning to re-emerge. “A lot of people put those strategies in the closet during the first quarter,” said Strauss. “Now, they are going to be dusted off.”
Merrill Lynch’s Kenney agreed. “Competitive pressures will remain brutal” as a result of overcapacity, he said.
Still, Keefe, ticking off such high-profile collapses as Drexel, L. F. Rothschild and E. F. Hutton, said “I think most of the failures are out of the way.”
“Certain firms will leave certain businesses,” he said, continuing the pattern set by Prudential Securities’ withdrawal from investment banking and Dean Witter Reynolds’ retrenchment to focus on retail brokerage.
Nor can Wall Street bank on hugely successful new products, such as junk bonds, which powered the industry in the 1980’s. “I don’t see any new blockbusters,” said Kenney. And the hugely profitable merger and acquisitions business “is still pretty quiet,” Strauss said.
New York Stock Exchange trading volume, one of the most closely watched barometers for assessing the industry’s health, fell about 11% in the second quarter compared to the first quarter, to an average of 172 million shares a day.
“The offset to that, from a profitability standpoint, was that new-issue volume in the second quarter was huge,” said Tom Davis, Merrill Lynch managing director for equity transactions.
Though Davis predicted that May will turn out to have been the peak month for what he termed “the frenetic new-issues activity,” he said the market is far from dead.
“Reasonably sized deals are still getting done,” he said. “We just priced an IPO (initial public offering) of 7,250,000 shares of Kaiser Aluminum for $14 a share. That’s about $100 million, in round numbers. Assuming overall market conditions hold, you will see good but not frenetic (new-issues) activity in the third quarter.”
And industry boosters point out that, even at 172 million shares a day, the second quarter volume performance was solid compared to the average daily volumes of 158 million, 166 million and 162 million in 1990, 1989 and 1988, respectively.
Said the SIA’s Schaefer: “I don’t want growth in the second half as much as I want the second half to be as good as the first half.”
But fundamentally, said Merrill Lynch debt chief Kvalheim, the current malaise on Wall Street may well reflect that of Main Street. Both, he said, are pondering reports of an economic recovery--yet searching in vain for evidence of it.
“I don’t talk to any companies who say their business is any better than it was,” he said. “I just talk to people who say business has bottomed and who hope it is coming back.”
THE BOTTOM LINE
Here are pretax profits (losses) by quarter for New York Stock Exchange member firms since the October, 1987, crash.
NYSE Members Revenue Segments
Other securities related revenues, mainly interest income, merger/acquisition and private placement fees, accounted for nearly one-third of the total 1990 revenues for New York Stock Exchange member firms doing business with the public.
In billions 1 Commissions $8.9 2 Trading Gain 13.2 3 Underwriting (financial) 3.2 4 Margin interest (on collateral) 3.1 5 Mutual fund sales 1.7 6 Fees, account supervision 2.2 7 Commodities 1.7 8 Other securities related 17.4 9 Other unrelated 2.9
Source: Securities Industry Assn.
