NEW YORK (CNN/Money) -
Lehman Bros. had a bang-up first quarter and it looks like it wasn't alone.
Two of its Wall Street brethren -- Bear Stearns and Morgan Stanley -- will report their results later this week and are likely to have done just as well.
Lehman Bros. (LEH: Research, Estimates) reported earnings of $2.21 per share, versus $1.15 a year earlier, and well above the $1.67 per share that analysts surveyed by First Call were expecting.
The company's results showed revenue growth in almost all key areas, particularly stock and bond trading, echoing projections from analysts about how the brokerages would do in a quarter challenged by declines in stocks, but continued strength in bonds.
"I expect the numbers to be very good for all the banks," said Kenneth Worthington, a financial analyst at CIBC World Markets who covers the sector. "We're in the sweet spot right now where fixed income isn't deteriorating that much and equity markets are holding up."
Worthington said that even the current eight-week period of declines in equities has not been a negative for the brokerages because increased volatility means increased trading activity. In addition, the surge in the fixed income market has been a major boon for the Wall Street banks during the quarter.
The fixed income market soared in the first quarter of 2004 -- as it did in the fourth quarter of 2003 -- as investors sought to find a safe-haven place to put their money on the heels of some less-bullish than hoped for economic news. The continued low interest rate environment -- due in part to the still-lagging labor market and lack of inflation worries -- has also made fixed income more attractive to investors.
"Analysts have been raising estimates over the last three or four weeks as they've realized that fixed income was stronger than expected in the quarter," said Jeffery Harte, a financial analyst at Sandler O'Neill & Partners who covers the companies.
"The first quarter is seasonally always the strongest, but coming off the huge year we had in '03, people figured it (fixed income) would be fine, but nothing great," Harte added. "But it's done much better than expected, and that's important for these banks."
As such, the rise in Lehman's fixed income revenue was unsurprising, and likely means Bear Stearns and Morgan Stanley registered similar gains, as well, said Reilly Tierney, an analyst at brokerage Fox-Pitt, Kelton who covers the sector.
What surprised analysts was that equity trading revenue was a lot stronger than had been expected. Lehman reported investment banking revenue that was at a 3-year high, with a dip in bond underwriting revenue being compensated for by a gain in stock underwriting revenue.
Lehman's upbeat quarter was particularly important, the analysts said, because the bank is not as well-diversified as the other two.
On Wednesday, Bear Stearns (BSC: Research, Estimates) is expected to report earnings of $2.05 per share, three percent more than the $2 it earned a year earlier. In the fourth quarter, the company reported earnings per share that rose 61 percent from the year-earlier period.
On Thursday, Morgan Stanley (MWD: Research, Estimates) is expected to say it earned 96 cents per share, up 17 percent from the 82 cents per share it earned a year earlier.
Although analysts said it was not likely that the Federal Reserve would raise the Fed funds rate this year, they did acknowledge there was concern that the fixed income boom would have to edge back in 2004, particularly in the second half of the year. The Fed funds rate, an overnight bank lending rate, currently stands at 1.0 percent, a low for more than 40 years. It is expected to remain there when the central bank's interest rate setting meeting ends Tuesday.
Susan Roth, an analyst at Credit Suisse First Boston who covers the sector, wrote in a recent note that the stronger-than-expected fixed income surge in the first quarter, and a good start to underwriting revenue and M&A activity in 2004, led her to raise estimates on the individual stocks and the sector as a whole.
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Roth noted that her firm's overall 2004 estimates account for increases in trading volume, equity underwriting and M&A that are closer to the historical average than in 2003, and an inevitable slowdown in fixed income.
If the stock market remains volatile, or turns higher after this two-month correction eases, brokerages can still do well, Harte said, even in a rising interest rate environment, with M&A and other segments benefiting, but he acknowledged that if the stock market should register a serious setback, that would hurt the Wall Street banks.
Tierney said that it is too early to call the two-month stock market pullback anything more than a correction, and that the IPO pipeline remains strong, and nothing has been cancelled of yet, leading him to believe the recovery is still in progress.
Harte said he would be looking for all the companies to say that M&A activity is continuing to accelerate, as it has in the last quarter.
"Underwriting revenues and M&A activity picked up as 2003 progressed; 2004 is off to a strong start," Roth wrote in a recent note.
She thinks that Goldman Sachs and Morgan Stanley should benefit from revenue and earnings accrued through investment banking. In December, Morgan Stanley beefed up its banking team to prepare for an expected rise in investment banking business in 2004.
Starting off the new quarter on a positive note, on Tuesday, French bank BNP Paribas said its U.S. division BancWest will buy Community First Bankshares (CFBX: Research, Estimates) for $1.2 billion in cash. Lehman Bros. and BNP's own bankers advised on the deal.