Analyst Whitney sees Wall St. pain ahead

NEW YORK (Reuters) - While Goldman Sachs Group (GS.N) and Morgan Stanley (MS.N) insist their conversion to bank holding companies will not lead to drastic changes, Oppenheimer & Co analyst Meredith Whitney said she expects the transition to be very painful.

Whitney, who last year predicted the woes now gripping banks, said on Monday revenue and profit at the investment banks will lag as they slim down and reorganize their mix of businesses. Operating like a commercial bank will require painful adjustments, she said.

"They've said they won't look very different. It's hard for me to see that," Whitney said at the Reuters Global Finance Summit. "That is a very different experience than what they are communicating to the Street, in terms of regulation, regulatory scrutiny, expenses, red tape, inefficiencies. The list goes on and on."

The big Wall Street firms have global reach and strong management. Yet these two brokers, which became banks during the market's September meltdown to reassure anxious investors, do not have experience operating under tougher Federal Reserve standards, Whitney said.

Goldman and Morgan Stanley face a tougher environment, where the extension of credit through capital markets and asset-backed securities goes back to its original form, which was traditional lending backed by deposits. And as traditional banks, companies need to hold more capital.

"You get a much more boring business, where returns are a lot lower," said Whitney, whose star has risen in the past year as her bearish views have proven accurate.

GOLDMAN PLUNGES

Pessimism sank shares of Goldman and Morgan Stanley on Monday. Goldman plunged 12 percent to $68.94, its lowest level in more than five years, while Morgan Stanley fell 10 percent to $14.27.

"There's nobody who has seen Goldman lose money. That's a shock," Anton Schutz, president and chief investment officer of Mendon Capital, told the Reuters summit in a later session.

In the past week, a growing chorus of analysts has forecast that Goldman will report its first quarterly loss since going public in 1999. Investors are struggling to value Goldman's stock as the bank reduces leverage and trading risk.

"If you want to try to value these companies on book value, how much is Goldman going to lose? What is book after projecting a loss this quarter?" he said.

Goldman's stock price has been under pressure all year, even as the firm avoided major losses from the credit crunch. As Lehman Brothers collapsed in September, Goldman converted to a bank, raised $6 billion through a stock offering, and sold $5 billion of preferred shares to Warren Buffett's Berkshire Hathaway (BRKa.N).

Later, Goldman agreed to a $10 billion injection from the U.S. Treasury.

Schutz observed that Goldman continues to trade at a higher price relative to its liquidation value. That has prompted some investors to pair a short position against Goldman with a long position on another, cheaper bank.

RESIZING

Looking ahead, Goldman and Morgan Stanley face wrenching changes as they shed assets and businesses to create a stronger balance sheet, dial down risk and shrink leverage. Those changes will create companies that generate lower returns, Whitney said.

"We have an industry that was intermediated by the broker industry now get re-intermediated by the banks. That's a seismic (shift)," she said. "That means there is less capital around. So the industry just shrinks."

And as revenue falls, investment banks will be forced to slash expenses. Whitney forecasts job cuts as deep as 25 percent to 30 percent over the course of 2008 for the biggest banks.

"The industry has to re-size. You take a shadow banking system that magnified revenue on an exponential basis. That shadow system has completely disappeared," she said.

Whitney argues that Wall Street's potential to generate revenue has fallen back to the levels last seen in the 2001 or 2002 market slump, yet its expenses remain elevated at 2006 and 2007 peak market levels.

"Banks that thought they had cryptonite power all of a sudden come back to earth," she said. "That's costly and humbling and disruptive."

(Reporting by Joseph A. Giannone; editing by John Wallace)