News: Analysis & Commentary: Market Turmoil
Financial Services: No Ordinary Downturn
The current slump is hurting IPOs and could cause layoffs
What started as a modest decline in the Nasdaq prior to the third quarter's earnings season has greatly accelerated in recent weeks. And the downturn has cast an especially powerful hex on the financial services industry. Fees from technology and telecommunications initial public offerings and high-yield bonds that propelled brokerages to astronomic heights have begun to tank. And if the market remains weak, depressed trading volumes and more limited equity gains on in-house portfolios could eat further into earnings. Shares of the financial giants are now off by as much as 30% since their highs in September.
In this market, analysts expect the breakneck expansion seen by investment banks and asset managers to slow. The consensus: Brokers and asset managers' earnings will grow by 31% this year--only half their 60% gain in 1999--and drop to 8% for 2001. "They are in a downward slope," says Chuck Hill, research director at First Call Corp.
The implications go well beyond tanking shares. Further industry consolidation, such as the recently announced merger of J.P. Morgan & Co. and Chase Manhattan Corp., could be halted altogether. Eventually, layoffs could kick in. And in a market no longer eager to embrace fledgling companies, on Oct. 17, Chase announced disappointing earnings after its venture-capital unit, Chase Capital Partners, posted losses of $25 million.
The first earnings alarm bell rang on Sept. 21 when Morgan Stanley Dean Witter missed its third-quarter estimates. It lost millions on high-yield bonds--the most profitable commercial paper on Wall Street.
Warning signs have since shown up elsewhere: Goldman, Sachs & Co. estimates that brokers' fees on debt issues in September were 17% lower than the 2000 average as the market for once highly profitable junk bonds dried up. Investment banks' initial public offering proceeds that month were about half the level of those in prior months. As a result, Salomon Smith Barney analyst Guy Moszkowski lowered fourth-quarter estimates for Goldman Sachs, Morgan Stanley Dean Witter, and Bear Stearns by 11%, 9%, and 7%, respectively.
That may be conservative. Trouble is, investment banks' fees are too hooked on the technology, media, and telecom equity issuances investors now shun. For instance, the much-anticipated IPO of AT&T's wireless unit was recently postponed. Merrill Lynch & Co. estimates that such offerings now account for 60% of all brokers' equity underwriting worldwide, up from 26% in 1996. And at Goldman Sachs, Salomon Smith Barney, Morgan Stanley Dean Witter, and Donaldson, Lufkin & Jenrette, the sector represents 75% or more of high-yield bonds.
So far, though, the shakeout hasn't been as bad to the consumer-oriented side of the Street: online brokers and mutual-fund companies. Shares in T. Rowe Price Associates Inc., Federated, and other mutual-fund firms haven't tumbled as sharply as those of big brokers or investment banks. And shares of online brokers had already been under pressure because of increased competition and lower trading commissions.LIMITED IMPACT. As their problems grow, however, investment banks are scrambling to diversify into nontech real estate and energy deals. It may not last forever, but for now, the strategy works: On Oct. 17, Merrill Lynch beat Street estimates by posting a 53% increase in third-quarter earnings partly because of its lower exposure to telecom issues.
But in a concentrated industry whose mainstay is underwriting, such efforts will have limited impact if the market stays down. In 1995, five investment banks handled about 40% of IPOs. Now, the top five handle as much as 75% of the deals. All will get hurt in a prolonged slowdown.
Continued market troubles could also put downward pressure on Wall Street salaries and jobs. "Whenever the markets slow down on a sustained basis, there will be layoffs," says Richard G. Lipstein, a managing director of the financial services search practice at Gilbert Tweed Associates. Of course, Wall Street has survived market mayhem before. But there are sure to be more scary moments ahead.By Emily Thornton in New York, with Geoffrey Smith and Louise LeeReturn to top