Wachovia Previews Broker Q1 Earnings; Lowers Estimates (BSC, GS, LEH, MS)

Wachovia released a research report this morning previewing the first quarter for several of the largest investment banks in the U.S.: Bear Stearns (NYSE: BSC), Goldman Sachs (NYSE: GS), Lehman Brothers (NYSE: LEH) and Morgan Stanley (NYSE: MSG). The firm currently has a Market Weight rating on the Brokers sector.

Wachovia believes "weak volumes and market valuations" will likely "make Q1 one of the worst quarters for investment-banks collectively in years." The firm expects a group return on equity of 9%-11%.

While valuations on investment banks such as Bear Stearns, Goldman, Lehman and Morgan Stanley are at 5-year lows, Wachovia believes that this decline is appropriate with the markets current expectations for weaker returns. On the other hand, the firm notes that it still sees long-term value in the sector, but cannot become more aggressive until balance sheets are cleaned up, along with the general economic environment.

According to Wachovia, several factors that bode negatively for the major brokers include: a 90% drop in high yield issuance, an 85% decline in U.S. IPO's and a 41% drop in international IPO's.

While Lehman is currently the only broker that Wachovia has an Outperform rating on, the firm also believes that Goldman has positioned itself to recover faster than its peers when the market turns around. Wachovia feels out of the major brokers, including Merrill Lynch (NYSE: MER), that Lehman and Goldman are the best long-term investments and believes they will remain flexible and be able to invest at a critical point.

Wachovia points out that Lehman Brothers is currently trading at a 5-year low of 1.25x book value. Over the last year, Lehman grew book value by 16%, compared to declines of 26%, 11%, and 8% for
Merrill, Morgan Stanley, and Bear Stearns, respectively. Furthermore, since 2001, Lehman has placed itself at the high-end of brokers, growing its book value by 16%, compared to 3%, 10% and 16% for MER, MS and BSC, respectively.

Wachovia expects Lehman to "trade a discount until the bear market in bonds ends." The firm called Lehman's tale a "show me story".

The firm lowered its Q1 and FY08 EPS estimates on each of the major brokers:

• Bear Stearns Q1 down from $2.54 to $1.36, FY08 down from $10.64 to $7.39.
  
• Goldman Sachs Q1 down from $5.84 to $2.94, FY08 down from $20.86 to $17.14
  
• Lehman Brothers Q1 down from $1.70 to $1.04, FY08 down from $6.92 to $5.52
  
• Morgan Stanley Q1 down from $1.47 to $0.84, FY08 down from $5.88 to $4.22

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