The Last Two Investment Banks Fight for Position

By Heather Landy
Special to The Washington Post
Wednesday, September 17, 2008; Page D01

NEW YORK, Sept. 16 -- With one competitor in bankruptcy and two others married off to commercial banks, senior executives at Goldman Sachs and Morgan Stanley rushed to defend the prospects for what has fast become an endangered species on Wall Street: the stand-alone investment bank.

The dramatic reshaping of the finance industry on Monday had analysts and investors wondering by Tuesday whether the firms, the last of their breed, could remain independent.

The concerns were heightened by evidence of weak demand for traditional investment-banking services. Third-quarter revenue from merger advising fell 56 percent at Goldman Sachs and 40 percent at Morgan Stanley compared with the year-ago period. Debt and equity underwriting fees fell by nearly a fifth at both firms.

But while the pie may be smaller, so is the number of big firms angling for a slice. And that bodes well for the firms that are still around once the business recovers, said David Viniar, Goldman Sachs's chief financial officer.

"If there are more opportunities and fewer competitors, that will help our market shares and our pricing power," Viniar told analysts on a previously scheduled conference call to discuss the firm's third-quarter results.

Morgan Stanley had been planning to hold its third-quarter conference call Wednesday, but it moved the event up a day so that its chief financial officer, Colm Kelleher, could put to rest what he called "ridiculous rumors" being repeated in the market.

"I wanted to highlight the strength and robustness of Morgan Stanley, its diversification and its strengths," he said in explaining the decision to reschedule. "I think it's very important to get some sanity back into the market."
Concerns about rising borrowing costs fueled speculation on Wall Street this week that investment banks, which rely heavily on debt to finance their activities, may need to acquire big, stable bases of bank deposits to regain the confidence of lenders.

Viniar dismissed the notion, arguing that banking regulations prevent deposits from being used to fund most of the businesses Goldman Sachs is in.

"There is some small portion of our business that probably could be funded by bank deposits," he conceded. But most of it could not, he said.

As a result, even full-service banks such as Citigroup and J.P. Morgan Chase have to access the long-term-debt markets to fund their non-bank businesses, he added.

"We think it's not about the model; it is about the performance of the company, and the model that we are in has allowed us and helped us to perform as well as we have," Viniar said.

But Goldman, seemingly coated in Teflon at the start of the credit crisis while rival firms floundered, finally showed signs of vulnerability in the third quarter.

Earnings in the three months ended Aug. 29 fell 70 percent from the corresponding period of 2007, to $845 million, and the company took $1.1 billion of write-downs, primarily for mortgage-related loans and investments.

"The issues in the mortgage and credit markets have affected all financial institutions," Viniar said. "We have not emerged completely unscathed during this process."

Morgan Stanley's third-quarter profit fell to $1.43 billion from $1.53 billion. Revenue inched up 1 percent, to $8 billion.

Mortgage-related write-downs at Morgan Stanley totaled $640 million for the quarter.

The finance chiefs of both firms said hedging and other risk-reduction strategies had minimized exposure to potential losses stemming from Monday's Chapter 11 filing by Lehman Brothers and the financing crisis that has devastated the insurance giant American International Group.

Kelleher said he viewed Morgan Stanley's engagement last month to advise the Treasury Department on the handling of the troubled mortgage giants Fannie Mae and Freddie Mac "as a testament to the strength of our investment-banking franchise."

He also said the firm was "well-equipped" to ride out the crisis in confidence that led to the reshaping of Wall Street.

"I'm absolutely convinced that when the fear comes out of this market and confidence returns, you will get much more sensible funding levels," he said when an analyst on the call asked for his outlook.

The final question on the call, about derivatives known as credit default swaps, came from Roger Freeman, the brokerage analyst at Lehman.

"Hey, Roger," Kelleher said when the operator announced that Freeman would be put on the line. "Nice to hear from you."