Bond Bull Market Boosts Bear

Updated from 10:45 a.m. EST

Bear Stearns' ( BSC) solid fourth-quarter earnings had little impact on the company's stock or its sector Wednesday, as investors worried that the results aren't representative of the group.

Bear reported a 23% jump in earnings, beating analysts' estimates by a wide margin as strong bond trading results and heavy cost-cutting helped the firm overcome a 60% slide in investment banking revenue.

Shares of the New York-based investment bank rose 0.23% to $61.99 while the Philadelphia Banking index fell 1.4% to 758. Both Bear Stearns and the brokerage sector have seen an impressive run since early October, with Bear up almost 18% and the sector up 24%.

"It was a spectacular performance," said Brad Hintz, an analyst at Sanford Bernstein. "It's even more spectacular when you consider that the rally in fixed income didn't occur until halfway through the quarter."

Bear said revenue from bond trading was a big contributor to its results, surging 40% to $463.9 million, as tighter credit spreads benefited the high grade, distressed and credit derivatives business.

Bear has the second-largest exposure to fixed income on Wall Street, with only Lehman Brothers ( LEH) being more exposed, according to Hintz. "In this kind of environment, Bear Stearns is going to coin money," he said.

Ahead of the Pack

For other Wall Street firms, however, the results aren't expected to be nearly as strong. Morgan Stanley ( MWD) and Goldman Sachs ( GS) have more exposure to equity underwriting, which remained weak in the quarter. Bear Stearns said revenue from investment banking plunged almost 60% in the fourth quarter to $93.3 million amid fewer merger transactions and equity underwriting opportunities.

Last quarter, Bear Stearns posted impressive results, with earnings climbing 22%, while Lehman and Morgan said third-quarter results plunged 37% and 13%, respectively. But Goldman said earnings rose 12%. All three brokers report their fourth-quarter results Thursday.

Jeffrey Harte, an analyst at Sandler O'Neill, said other brokerage stocks aren't reacting to Bear's results because a large chunk of its profits in the quarter came from cost-cutting.

During the quarter, compensation costs as a percentage of net revenue rose to 50.2%, compared to 46.7% last year. But for the full year, these expenses were down to 48.9% from 51.5% in 2001. Meanwhile, noncompensation expenses as a percentage of net revenue fell 25.3%, and were down 9.3% for the full year.

"Revenue rebounded but profit came more from cost-cutting than I expected it to," said Harte. "If they'd beaten the consensus that strongly on strong revenues, you'd probably see the whole group going up."

Total revenue at Bear rose 0.6% to $1.13 billion from $1.12 billion, last year. Analysts surveyed by Thomson Financial/First Call had expected the firm to post revenue of $1.19 billion in the quarter.

Net income jumped to $190.5 million, or $1.36 a share, compared to $154.9 million, or $1.08 a share, in the same period last year. The results include a markdown of $33.9 million related to a decline in the value of its merchant banking investment Aeropostale. The numbers also beat consensus estimates of $1.23 a share.

Although Bear said mortgage-backed securities slowed a bit in the quarter, analysts said this isn't yet a concern. "As the yield curve flattens, the origination of mortgages is going to drop off. But they're still going to have a lot of mortgages in the pipeline," Hintz said.

Hintz added that Bear should continue performing well over the next couple of quarters as fixed income remains strong. He also noted that Bear is "reasonably well leveraged" to a pick up in the equity market, although it would naturally underperform its peers if stocks were to stage a meaningful comeback.

David Trone, an analyst at Prudential Securities, raised his 2003 earnings estimates by 20 cents to $5.45 a share Wednesday but offered some words of caution. "Bear's fiscal 2002 result of $5.57 has been impressive, in both absolute and relative terms, but we continue to expect their earnings to decline in 2003, while peers should have strong increases," he said, adding that the strength in fixed income is "unsustainable."

On a conference call Wednesday, Chief Financial Officer Sam Molinaro said he has seen no evidence yet that M&A activity is improving. "The reality has been that the M&A backlog continues to be relatively weak," he said. "Unstable equity markets have continued to hold individual investor activity at low levels."

Molinaro also indicated that the firm might be interested in acquiring the securities clearing unit Pershing from Credit Suisse First Boston.

"It potentially could be a very nice addition to our business mix and make our fully disclosed business even that much more formidable in the market," he said. "The obvious benefits would be scale advantages and the ability to achieve significant cost reductions between the two companies."

Pershing, which is the second-largest "clearing" firm in the country, has processed about 10% of New York Stock Exchange trades in recent years. Clearing firms execute trades and mail out trade confirmations, among other things.

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