Commentary: So Many Securities Firms, So Little Security

It was another dismal week on Wall Street despite improving markets. Salomon Brothers Inc. said it would cut its staff and get out of the retail brokerage business. Goldman, Sachs & Co., which has been laying off scores of investment bankers, reported a capital decline from $2.26 billion last year to $1.84 billion this year. CS First Boston announced it would cut or redeploy as many as 1,000 of its 6,500 employees, shutter its municipal-bond department, and exit the Japanese equities business. "Everyone is walking around on eggshells," says one CS First Boston executive.

The main cause of the numerous rounds of bloodletting on Wall Street since last fall is the Great Bond Market Crash of 1994. Its impact has proved far more pernicious than analysts predicted. That Salomon, Goldman, and CS First Boston are hurting most is no surprise: All three firms have large institutional bond operations that got battered when the Federal Reserve began sharply raising interest rates last February. All got caught with large bond inventories that fell in value and suffered big trading losses. Says one Street executive: "Fixed income is like a big flywheel for these firms. When it's hot, its gigantic. When it's not, they're stuck with the expenses."

"JUST THE BEGINNING." And the pain could continue if interest rates rise again: more layoffs, curtailed expansion plans overseas, jettisoning of more marginal businesses. "If the environment doesn't improve, this will be just the beginning of the Street's restructuring," says Perrin Long, a Brown Brothers Harriman & Co. analyst.

The underlying problem is the expenses that were built up during three years of stellar bond-market profits. Firms became stuck with unwieldy cost structures that far outstrip revenues, which have fallen dramatically with the slowdown in underwriting and trading. "The Street has to start looking more closely at its infrastructure costs," says John J. Mack, president of Morgan Stanley & Co.

CS First Boston is a perfect example. The firm plans to reduce expenses by close to 20% to offset a big drop in fixed-income profits. Insiders say that while its muni business generated $20 million in profits in 1994, the unit isn't profitable enough and isn't a core business. "We don't really expect any significant improvement near-term in market conditions," says Maynard Toll, a CS First Boston spokesman. "It's not prudent to maintain an expense base that was built up during a bull market."

Salomon Brothers left the private-client business for similar reasons: It wasn't an important enough area. But Salomon's main problem is that it is too dependent on bond trading and lacks the diversified revenue stream of a Merrill Lynch & Co. or Morgan Stanley. "Salomon Brothers does not have the ballast, such as large money management, custodial services, or correspondent clearing, that helped stabilize some competitors' earnings," says a Salomon spokesman.

Securities firms with strong retail equity businesses, by contrast, are doing well. Charles Schwab & Co.'s stock has risen 25% this year. Earnings for 1994 were up 15%, to $135.3 million, on the strength of mutual-fund fees, which spiked 59%, to a record $156.8 million. "The retail firms that haven't been exposed as much to the bond losses last year" are doing a lot better than those that have, says Schwab spokesman Hugo W. Quackenbush.

CONTRARIANS. The stock of Baltimore-based Alex. Brown & Sons Inc., which was up 22% in 1994, has soared another 22% this year, thanks to investment banking and retail commissions. Although St. Louis-based A.G. Edwards Inc. increased its roster of brokers in 1994 from 5,100 to 5,400 brokers, Chairman Benjamin F. Edwards III says: "We've been able to maintain profit margins at 10% or slightly above, and we haven't let anybody go or shrink by attrition."

Several New York houses bucked the bad-news trend as well. Donaldson, Lufkin & Jenrette Inc. had its third-best year in 1994 and has hired real estate bankers from Goldman Sachs and more than 20 emerging-market traders from Bankers Trust. Morgan Stanley says it has avoided layoffs and nabbed mortgage-backed traders from Goldman Sachs. But competitors believe shrinkage at Morgan Stanley is inevitable. Severely reduced bonuses, disclosed to Morgan Stanley employees on Feb. 14, led staff to dub the event "the Valentine's Day Massacre." But, hey, at least they still have jobs.