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Lehman's Precursor of Things to Come


To me these numbers seem to be indicating that the difficult market environment is starting to take its toll, but it might be too early to tell.


Editor's Note: This article was written by Steve Zausner, who runs the Vicis Capital London office and has a background as a derivative/credit analyst.

This morning, Lehman (LEH) reported fiscal 2Q06 EPS of $1.69 5 percent above the Street estimate. Commissions, Asset management and Principal Transaction revenues drove the upside in revenues. In total, revenues beat estimates by roughly 7%. On the expense side, the comp ratio came in at 49.3%, in line with forecasts and the prior quarter.

  • Segment results were mixed: Capital Markets and Investment Management were stronger, banking was weaker: First, Investment Banking revs dropped 11% Q/Q as debt underwriting decreased 30%, but equity underwriting rose 5% and M&A jumped 8%. Second, Capital Markets revenues increased 1% Q/Q due to a 5% rise in fixed income (strong results in all products – credit, munis, real estate, mortgages,and interest rates), offset by a 7% fall-off in equities (however improved results in prime brokerage and derivatives). Finally, Investment Management revenues increased 2% Q/Q. Specifically, Private Investment Management revs grew 16% (to a new record), while Asset Management revs declined 6%. Assets under management rose 5% to $198 billion, with 43% equities (down from 44% Q/Q), 28% FI (down from 30%), 19% MM (up from 17%), and 9% alternative assets (flat Q/Q).

  • Pretax Margin and ROE Decline Q/Q: For the fiscal second quarter, pretax margin was 34.0%, versus 34.8% in the prior quarter and 31% in the year ago period. Additionally, the firm reported a 23.7% ROAE for the quarter, versus 26.7% in 1Q06 and 18.2% in 2Q05. Book value rose $1.07 per share (4%) to $31.08 per share.

Bottom-Line: Nothing Special, could be a precursor for worse to come. All in all, LEH numbers were solid today with no real surprises, but, the divot in margins is worrisome. To my thinking, the decline in pretax margin and ROE shows that it is not as easy to make money as it used to be (possibly more worrisome, the drop in ROE can be indicating real problems in the trading business-that they are starting to commit more capital to make less returns). Also, for the most part, results were below the record 1Q06 numbers. To put it all in context, however, 2Q06 was the firm's second best quarter in history.

To me these numbers seem to be indicating that the difficult market environment is starting to take its toll, but it might be too early to tell.

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Steve Zausner has a position in LEH

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