S&P cuts Goldman, Lehman outlooks

"We believe that negative rating outlooks are broadly appropriate for the independent securities firms ... Our current expectation is that net revenues could decline 20 percent to 30 percent year-on-year [adjusting for write-downs]."

from a Standard & Poor's report by managing director Scott Sprinzen and analyst Diane Hinton

Standard Poor's Corp, in a continuing sign of loss of confidence in investment banks' eroding profitability, put Goldman Sachs Group Inc and Lehman Brothers Holdings Inc on negative outlook on Friday.

Although the rating agency didn't change ratings on Goldman's AA- and Lehman Brothers' A+ senior debt, it brought its view of the likelihood of a precipitous decline in profits at the firms during the next few quarters to the same negative levels it had previously assigned to Merrill Lynch & Co and Morgan Stanley.

The outlook changes are appropriate in spite of the fact that recent actions by the Federal Reserve have instilled confidence in the capital markets, S&P added.

A negative outlook implies a one-in-three likelihood of a rating downgrade over an intermediate period of about two years, S&P said.

"We believe that negative rating outlooks are broadly appropriate for the independent securities firms, reflecting the potential for a more substantial decline in profitability from capital market activities," S&P said in a report whose principal authors are managing director Scott Sprinzen and analyst Diane Hinton.

"Our current expectation is that net revenues could decline 20 percent to 30 percent year-on-year," adjusting for write-downs, the report said.

Moody's Investors Service continues to rate Goldman Sachs and Lehman with stable outlooks, and has no plans to respond to S&P's change.

"We remain comfortable with the outlooks," senior vice president and lead securities industry analyst Peter Nerby said.

Investment have written down more than US$100 billion of securities and loans since the middle of last year, and are still finding it difficult to sell the assets to large investors.

The 20 percent to 30 percent decline in profitability will erode investment banks' "margin of safety" this year, but S&P said it expects to sustain current debt ratings because of the Fed's move last week to let investment banks borrow directly from the central bank at low rates against some of their battered securities.

"Nonetheless, we see some possibility, were there to be persisting capital markets turmoil and sharply weakening economic conditions, that financial performance could deteriorate significantly more than we now assume, which would call the current ratings into question," S&P said.

During a conference call, Sprinzen said S&P expects to decide within 30 days on whether or not to change Morgan Stanley's AA- rating. The firm, in many ways, has the best business diversity of the five large investment banks, he added.

However, the "virtual collapse" of Bear Stearns Cos last week "highlights the extent to which securities firms are exposed to capital market sentiments and explains the Federal Reserve's actions to support the US securities industry directly," S&P said. The Fed arranged for JPMorgan Chase & Co to buy Bear, which S&P rates BBB, at a fire-sale price of US$2 a share and guaranteed the bank against US$30 billion of losses on Bear Stearns' problem assets.

Lehman's model is closer to Bear Stearns' and less diversified than the other three firms, but Lehman's funding capability and liquidity are among the strongest on Wall Street, Sprinzen said. Lehman and Morgan Stanley in their fiscal first-quarter earnings earlier in the week demonstrated strength across their businesses, while Goldman -- the most profitable broker -- had higher write-offs than in the past. Merrill Lynch doesn't report its first-quarter results until April.

Indeed, S&P has no great concerns in the near -- or even long -- term about profitability or funding for Goldman or Lehman and is relatively confident about core businesses at most firms.

"We are not saying there is some fundamental flaw or business disadvantage compared to what we've seen before," Sprinzen said.

However, he repeated that the capital-markets environment remains so volatile and uncertain that the agency's across-the-board caution on investment banks is justified.

"We don't feel it hurts to have negative outlooks even on the best-positioned players," he said.