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3 Investment Banks Post Strong Profits

Lehman, Morgan Stanley see gains amid July's bond losses. Goldman takes hit in fixed-income trading.

September 24, 2003|Josh Friedman | From Reuters

Investment banks Morgan Stanley and Lehman Bros. Holdings Inc. weathered the summer's losses in the bond market, reporting strong third-quarter results Tuesday. But rival Goldman Sachs Group Inc. took a hit.

All three firms reported higher earnings for their fiscal third quarters, which ended July 31, although Goldman Sachs said revenue from fixed-income, commodity and currency trading fell sharply.

Both Lehman and Morgan Stanley said their profits for the quarter more than doubled from a year earlier. Bond trading revenue, which has carried the industry during a long investment banking slump, rose sharply and remained strong compared with the second quarter.

Bankers are hoping that businesses such as stock trading, advising companies on mergers and acquisitions, and underwriting of initial public offerings -- which fueled revenues during the late 1990s stock rally -- will rebound before the three-year boom in the bond market dies down.

Investors had been waiting to see how fixed-income trading teams fared during the biggest sell-off in Treasury bonds since 1994. Bond yields, which had been at four-decade lows, suddenly shot higher in July.

Banks were forced to quickly buy and sell securities for clients and their own proprietary accounts to protect against the surge in interest rates. The heavy trading that resulted was an opportunity to either make or lose money, depending which way traders bet.

Lehman said that revenue from principal transactions, which include trading, totaled $1.2 billion in the third quarter, down only slightly from $1.28 billion in the second quarter.

Lehman "appears to have sidestepped potential losses in what was clearly a treacherous bond market period," said Merrill Lynch analyst Guy Moszkowski in a research note. The firm "took advantage of the huge order flow driven by the tumult."

Morgan Stanley made even steeper gains, with its principal transactions rising to $2.1 billion from $1.6 billion.

Goldman Sachs, however, said revenue from commodity and currency trading was down 37% from a year earlier and down 48% from the second quarter. The firm has set itself apart from competitors by allowing its fixed-income traders to make riskier bets and make more trades on the firm's account.

That approach led to record fixed-income revenue in previous quarters, but backfired this time around, analysts said.

David Viniar, Goldman's chief financial officer, said the firm was caught with large trading positions in mortgage-backed bonds and currencies when interest rates began to tumble.

"Maybe we could have sold sooner or hedged better," Viniar said. "Because of that, our results could have looked better."

Goldman shares dropped $3.60 to $89.06 on Tuesday, while Lehman's shares gained 69 cents to $70.90 and Morgan Stanley added $1.18 to $52.33, all in New York Stock Exchange trading.

Executives at all three firms said they expected equity underwriting and mergers and acquisitions to rebound gradually along with the economy.

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