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ERROR: type should be string, got "https://www.wsj.com/articles/SB955756581606615117\nBy Andrew Bary\nUpdated April 17, 2000 12:01 am ET / Original July 19, 2019 6:47 am ET\nT he plunge in the Nasdaq threatens to pinch the profits of many securities firms by reducing the monstrous trading in technology stocks and by prompting a decline in margin borrowing, which has become an important earnings source on Wall Street, especially for online brokers that lack the diversified revenue stream of full-service firms like Morgan Stanley Dean Witter and Merrill Lynch.\nSanford Bernstein analyst Steve Galbraith told clients last week that a \"deleveraging of the system\" would profoundly affect what he calls \"pure-play retail brokerage\" firms -- online brokers.\nMargin loans, made to buy stocks, have mushroomed in recent months as aggressive investors have sought to magnify potential profits from surging technology shares and other highflying issues. Margin debt stood at a record $265 billion in February, up 46% from October, and 75% higher than the $151 billion of February 1999. Data due next week could show another rise in March.\nThe sharp increase in margin loans has prompted calls for the Federal Reserve, which regulates them, to tighten rules that for more than 25 years have let investors buy stock by paying 50% of the price in cash and borrowing the rest.\nMargin lending is a low-profile and lucrative business. It's estimated that securities firms earn interest spreads of 2.5 to 3 percentage points on margin loans. Brokerage clients pay 7%-10% for these borrowings, depending on the size and importance of their accounts. Online brokers have correctly bet that their clients will focus on commissions, which average just $15 per trade, and not on margin interest.\nGalbraith estimates that margin lending accounts for an average of 20% of the revenues of the major online brokers, including E*Trade Group , Ameritrade , DLJdirect , TD Waterhouse and Charles Schwab (see accompanying table). Some firms don't provide exact figures on the size of their margin loans and their margin-related revenues. But they do report net interest revenues. Margin income is a big component of interest revenues.\nMargin lending makes up considerably more than 20% of the operating profits of the online brokers, although reported profits generally are minimal, owing to heavy marketing expenses. Schwab is the exception; it has substantial earnings. E*Trade, the No. 2 online broker, reported earnings of less than a penny a share in the March quarter, while Ameritrade said its profits totaled two cents a share in the period.\nDick Bove, an analyst at Raymond James & Associates, says margin lending is the major source of profits for many online brokers.\nThe first-quarter profit reports from Ameritrade and E*Trade demonstrate the beneficial impact of surging margin borrowing. Ameritrade's net interest income rose to $38.8 million from $14.4 million in the March 1999 quarter, while E*Trade's tripled, to $96 million, and made up almost 25% of its net revenues. Ameritrade and E*Trade customers are particularly heavy users of margin, with Galbraith estimating that such debt has accounted for more than 10% of customer stock holdings at the two firms, compared with 1.5% for the overall stock market. The growth in net interest revenues has been notable at Schwab, but not as dramatic as at E*Trade and Ameritrade. Schwab's interest income rose 55%, to $203 million, in the fourth quarter from the level a year earlier, as the company's margin debt outstanding grew to $16.9 billion, up from $9.6 billion. Schwab has yet to report first-quarter profits.\nOne of the bullish arguments for the online brokers is their growing margin revenues, but Galbraith argues that the trend is in danger of reversing. The stock prices of most major online brokers, as the accompanying charts show, are well below their peaks in early 1999 despite strong revenue and account growth. The declines reflect concern about increased competition from full-service firms, fear that the pool of attractive untapped clients is shrinking and the prospect of further downward pressure on commissions.\nThe first-quarter reports from E*Trade and Ameritrade, however, offered no signs that these issues were blunting growth. Trading exploded, with E*Trade reporting that total transactions in the quarter jumped 237%. The firm said it added a net 603,000 new accounts in the period, bringing its total to 2.6 million. That's a quarterly rise of 30%, a huge increase in a supposedly saturated market. Given the sharp increase, the cost of attracting each new account fell sharply at both E*Trade and Ameritrade -- a bullish development.\n\"These companies proved that they could increase their accounts by mindblowing amounts,\" Bove says. \"The question is whether this represents a frenzy at the top of a market or a longer-term trend.\" A skeptical Bove believes account growth rates and trading could slow markedly in the quarters ahead. Galbraith predicts that margin lending is apt to drop. \"The reversal in growth in margin-related income that we would expect, given Nasdaq declines, should highlight the perils of putting long-duration valuations on these earnings streams,\" Galbraith wrote last week. By \"long-duration\" valuations, he means high price/earnings multiples.\nSchwab, which fell 15 1/4 to 39 7/8 last week, trades for 40 times projected 2000 profits, while E*Trade is expected to post a slight loss for its fiscal year ending in September. Galbraith has an \"underperform\" rating on both stocks, and doesn't rate the other big online brokers.\nGalbraith says it's a stretch to assign a P/E of 40 to a company like Schwab that still relies heavily on retail trading and lending, while institutional brokers command far lower multiples. Lehman Brothers , an institutional firm, has seen its shares fall 11% this year, to 75 5/8, and trades for seven times estimated 2000 profits. Bear Stearns , another primarily institutional broker, stands at 39 5/8, having badly trailed its peers in the past year. It trades for around seven times earnings. Morgan Stanley Dean Witter and Goldman Sachs , which possess market-leading global underwriting and investment banking franchises, lately have come under pressure after large early-year gains. Morgan Stanley, which dropped 16 13/16, to 67 3/4, last week, trades for around 14 times estimated 2000 profits. Goldman, which fell 16 1/4, to 86 1/4, on the week, leaving it way below its recent high of 128, also has a P/E around 14.\nReferring to margin lending, Galbraith said: \"Ascribing 40 P/Es to what could almost be considered subprime-lending operations seems overly optimistic.\"\nHe and others believe that Wall Street is policing margin lending well enough to avoid outright losses on the loans despite the recent plunge in large numbers of highflying stocks. When stocks drop sharply, individuals who borrowed to buy them are subject to margin calls, forcing them to put up more money or see their holdings liquidated.\nOne indication of tightening standards is that many brokers either don't allow certain stocks to be bought on margin or require stricter maintenance margins, which means brokers move more quickly to demand additional collateral when stocks fall.\nGalbraith notes that E*Trade has tighter-than-normal margin restrictions on over 500 stocks and that Ameritrade has such curbs on nearly 700. DLJdirect says it won't make margin loans against about 400 volatile stocks, including Exodus Communications , Ariba , Internet Capital Group and Palm .\nE-mail comments to editors@barrons.com\nIf the Nasdaq stays down, brokers who depend on margin loans could be squeezed"