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Cut, Slash, Slice, Trim, Chop


Industry Outlook 1991: SECURITIES

CUT, SLASH, SLICE, TRIM, CHOP

This will be the year of the incredible shrinking securities industry. Expect some brokerage firms to be acquired, others to drop lines of business, and many to lay off more workers. "There's another 10% to 15% in head-count reduction yet to come," predicts Richard B. Fisher, chief executive of Morgan Stanley & Co.

Cutting 20,000 people on top of the 20,000 who were dismissed in 1990 won't be pleasant for Wall Street. But brokerages are still working off the fat they accumulated during the roaring `80s. In those giddy years, firms built massive staffs and costly infrastructures to handle the bull market's volume and takeover business. Many jumped into all kinds of nontraditional areas to provide a range of services to a wider variety of customers. In retrospect, "the `80s were terrible for this industry," says Jean-Louis Lelogeais a principal at Booz-Allen & Hamilton Inc.

SMOKESCREEN. Among other things, the industry never recovered from the stock market crash of October, 1987. That slide erased profits for the year and sent return on equity for brokerages plummeting. Merger-and-acquisition activity in 1988 and 1989 masked the slump in the industry's core businesses, such as underwriting of equity and debt. As a result, overhead stayed high even as return on equity fell. Restructuring didn't begin in earnest until 1990, when M&A volume dropped by a third. "The securities industry is now entering its fourth year of recession," says Jeffrey M. Schaefer, an economist for the Securities Industry Assn. (SIA).

Signs of hard times will continue to mount in 1991. The largest brokerage stocks were down about 9.5% in 1990. Average daily trading volume on the New York Stock Exchange was 157 million shares, a drop from 166 million shares during 1989. And 1990 was the first year since 1974 that industry revenues fell. The SIA estimates that brokerage revenues were $53 billion in 1990, down from $60 billion in 1989. With profits scarce, the industry's return on equity was about zero last year. If some overcapacity is wrung out, 1991 could produce a modest 3.5% return. But there is no guarantee of that. "The theme for 1991 is: Will the pall lift?" says George L. Ball, chief executive of Prudential-Bache Securities Inc.

One by-product of overcapacity will be more acquisitions. In fact, the latest game on Wall Street is betting on who will buy whom. The most frequently mentioned domestic buyer is Sanford I. Weill, who heads Primerica Corp., which owns Smith Barney, Harris Upham & Co. Potential foreign buyers could include Nomura Securities Ltd. and other foreign firms with Wall Street investments. The most-rumored candidates for the auction block are PaineWebber Group Inc. and Pru-Bache.

Another possibility is that large companies that have brokerage firms, such as Equitable Life Assurance Society, owner of Donaldson, Lufkin & Jenrette Inc., or Sears Roebuck & Co., which owns Dean Witter Reynolds Inc., may decide to combine their brokerage operations. For example, Sears could take a minority interest in Primerica as a way of combining Dean Witter and Smith Barney.

Financial reform legislation this year could speed consolidation in the industry by inviting more bidders into the fray. Under the Glass-Steagall Act of 1933, banks can't own brokerages. But if Congress removes this barrier, admittedly a long shot, even healthy regional brokerages could be snapped up by stronger domestic banks. Merrill Lynch & Co., the last large American retail brokerage firm whose stock is publicly traded, might even turn out to be a prime target for a deep-pocketed foreign bank.

Another way securities firms may economize this year is by eliminating certain lines of business. Pru-Bache, for example, said in November that it is drastically slashing investment banking activities. Other brokerage houses are sure to follow, since there are still too many bankers chasing too few deals, especially in a recession.

TEAMING UP. More brokers will also try joint ventures to cut costs. Shearson Lehman Brothers Inc. and Pru-Bache are talking about combining their back-office operations, which provide the computer support to process transactions. With the growth of volume and new products in the 1980s, they and others added far too much data-processing capacity, which now needs to be wrung out. As many as 1,000 employees could be trimmed from Pru-Bache's back office alone if a joint venture is reached with Shearson, estimates Perrin H. Long, an analyst at Lipper Analytic Securities Corp.

Meanwhile, the industry is pinning its hopes on several promising areas. Asset management, both for institutional and retail clients, is being hailed as a replacement for M&A revenues. Money-management fees are low compared with advisory fees on transactions, but they provide far steadier earnings. Merrill Lynch, for one, now has $109 billion in assets under management, largely from retail investors.

And such funds are growing. Merrill's cash-management accounts and mutual funds, for example, are attracting some of the dollars that are flowing out of the beleaguered thrift industry, says Merrill's Jerome P. Kenney, executive vice-president for strategy and research. Foreign exchange trading and derivative products, such as Nikkei put warrants, which allow investors to bet on a decline in the Japanese stock market, are growing profit centers.

Optimists also see the Street's bread-and-butter underwriting business rebounding in 1991. Issuance levels of equity and municipal bonds have been low for so long, they argue, that an uptick could come as companies and state and local governments return to the capital markets. John L. Steffens, executive vice-president of the private client division at Merrill, expects a tough first half but an upturn in profits after that. By then, perhaps, a leaner, chastened Wall Street will have relearned what it forgot in the 1980s: Reckless growth and profits don't mix.Leah Nathans Spiro in New York


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