Two major investment banks, Lehman Brothers and Goldman Sachs, reported first-quarter earnings last week. While the two banks may have beaten analysts' estimates for the period's performance, both acknowledged significant RMBS losses and credited client activity with buoying their fortunes.
Lehman Brothers reported net revenues of $262 million for its fixed-income capital markets segment, a drop of 88%, caused by deterioration in the market for residential mortgages, commercial mortgages and acquisition finance. During the same period last year, the bank cleared $2.2 billion in net revenues, according to the statement about its first-quarter results.
Goldman Sachs reported $1 billion in net losses on residential mortgage loans and related securities. It also said that net revenues in its underwriting business segment were $509 million, about 40% lower than the first quarter of 2007, mainly because of lower net revenues in debt underwriting.
"The decline in debt underwriting was primarily due to a decrease in leveraged finance and mortgage-related activity, reflecting difficult market conditions," the company said in a statement.
For Lehman Brothers' part, the results reflect the impact of what was a very difficult market environment, Erin Callan, CFO of Lehman Brothers said during a conference call.
The investment bank's results were highly anticipated, given the news about the collapse of Bear Stearns, which presented Lehman Brothers with fierce competition on several fronts of asset securitization and fixed-income investment banking.
"It is fair to say that we have great sympathy for our colleagues at Bear Stearns. We are very sad about what happened at that organization," Callan said. Still, she said, there is so much more fallout from the current capital markets that it was hard to focus on the potential upside for Lehman Brothers.
Although Callan declined to discuss whether it might take advantage of Bear Stearns' particular situation to take more market share, she did say that, in general, the company was well positioned to ride out the current cycle.
"We still don't anticipate negative market risks abating anytime soon, and we have planned accordingly," Callan said. "Our clients are active and our strategy to take up share is paying off."
As for its other capital markets results, weaker demand for fixed-income investment banking led to lower underwriting activity in that segment, but the company's mark-to-market adjustments also materially impacted results, Callan said. Despite the ongoing volatility in the capital markets, however, the company highlighted two positive developments that helped it sustain some buoyancy during its first quarter: strong trading and robust client activity across its credit markets.
Spread movement on several securities asset classes underscored the market conditions, said Callan. Certain classes of asset-backed securities widened out to levels of 140 basis points over their benchmarks, while triple-A MBS paper ballooned to 135 basis points over and triple-A CMBS paper widened out to 180 basis points, she said.
For 2008, Lehman said it expects fixed-income originations to decline by about 6%, owing to fewer securitizations and less merger-and-acquisition activity. This reflects the company's modest expectation for investment banking activity for 2008. Lehman Brothers and Goldman announced their results shortly after the Federal Reserve announced that it would extend $200 billion in liquidity to primary dealers via the term securities lending facility. Still, one analyst wanted to know how Lehman would handle its leverage levels, especially in a virtually illiquid environment.
While acknowledging that there were fewer liquid buyers available now than there were six months ago and that Lehman residential mortgage position was large, Callan said the company would continue to reduce its leverage levels and get comfortable with its large position hedging its remaining holdings.
As for how the recent downgrade of $360 billion in securities might affect its regulatory capital requirement, Callan said that 80% of its securities were rated double-A and triple-A. Further, she said: "our capital ratios did not fall materially since the end of the last quarter."
Overall, the holding company saw its net income drop to $489 million, a 57% decrease from net income of $1.15 billion in the same quarter a year ago.
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