Roar of Rising Pay Muffles Bear Stearns' Gains

Bear Stearns (BSC) may have set a new low in the quest for easy earnings comparisons.

The New York-based brokerage Wednesday handily beat analysts' earnings estimates, posting second-quarter operating earnings of $1.18 a share. Investors applauded, sending the stock up $1.64 to $55.

More notably, Bear Stearns saw operating profits fall from a year ago even as revenue rose 3.6%. The culprit: A jump in compensation costs, stemming from an overseas expansion. The spiraling costs overshadowed a strong performance in fixed income, where revenue nearly tripled from a year ago, and could spell trouble in coming quarters, analysts say.

Knock Yourself Out

The clapping started after Bear Stearns crowed in its press release of a 53% jump in earnings. But the brokerage firm reached that number by applying a one-time charge to the year-ago numbers -- a charge that it excluded from its operating comparison when it reported earnings at this time last year.

Of course, Bear Stearns is far from the first firm to dress up its numbers by changing the mix. For instance, many financial services firms, such as J.P. Morgan Chase (JPM), have lately gotten in the habit of comparing results to the dismal fourth and first quarters, instead of the record-shattering comparable periods in 2000.

"The first thing I did is knock it right out," CIBC analyst Ken Worthington says of the year-ago charge. A Bear Stearns spokesman says the comparison is "apples-to-apples on a technical basis."

Bear Stearns posted operating earnings of $1.18 a share, beating the Thomson Financial/First Call consensus of $1.09 and falling from the year-ago operating earnings of $1.40. By adding a hefty 63-cent litigation charge back into year-ago results, Bear made its year-ago headline earnings comparison a more appealing 77 cents a share. The decline in operating results surprised some analysts, considering that revenue expanded as the bond business revived.

"It's unusual. You're supposed to get leverage out of higher revenue," says James Mitchell, banks analyst with Putnam Lovell. (Mitchell rates Bear Stearns hold and his firm has no underwriting relationship with brokerage firm.) Compensation costs rose to 54.3% of revenue in the second quarter from 52.9% in the first quarter. A Bear Stearns spokesman attributes the bulk of the rise to European expansion. But Mitchell says he is concerned that Bear's contracts could grow even costlier if key businesses such as equity trading fail to rebound.

"If the revenue falls, you don't have flexibility in the expense line," says Mitchell. "If revenue falls, earnings will fall faster."

Ace in the Hole?

One thing Bear certainly was entitled to boast about was the strength of its bond business. Thanks to Fed rate cuts, revenue in the firm's fixed-income business jumped 181% from a year ago, to $514.3 million. The company attributed the results to "superior results from mortgage-backed securities areas" and strong results from corporate bond, high yield, credit derivative and government bond trading.

As a much hoped-for rebound in equity markets continues at a slow and shaky pace, firms with sizable bond businesses, such as Bear Stearns and Lehman Brothers (LEH), have gotten a boost from the recently brisk business of underwriting and trading bonds. Lehman, for instance, chalked up much of Tuesday's 14% jump in second-quarter profits to the strength of its bond business.

Goldman Sachs (GS), on the other hand, posted a glum 24% decline in second-quarter results yesterday, as the once-fat fees from high-tech IPOs and merger and advisory fees have all but dried up.

Goldman Sachs was slipping $1.18 to $87 and Lehman was rising $2.35 to $74.85.

Profits at Bear's global clearing service and wealth management units dropped from year-ago levels, following the trend at other brokerage houses. Global clearing revenue fell 28% to $207.4 million, as weak equity market conditions contributed to reduced customer margin debt. And revenue in the wealth management business dropped 14% to $133.9 million.

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