UPDATE 2-Goldman to face tough warrant talks - Bernstein

(Adds details, background; updates stock activity)

June 11 (Reuters) - Goldman Sachs (GS.N) and Morgan Stanley (MS.N) will have to face challenging negotiations with the U.S. Treasury regarding valuation of warrants they sold, Bernstein Research said, and cut its 2009 profit estimates for the two companies.

However, the companies, which were allowed to repay $10 billion in TARP money, can now focus on their core businesses and take full advantage of the trading opportunities that the recovering capital markets provide, Bernstein analysts led by Brad Hintz said. [ID:nWNAB8796]

"We continue to believe both firms will book strong revenues in fixed income sales and trading as improvement in the credit markets and fewer competitors provide a unique earnings opportunity for both Goldman and Morgan Stanley," Hintz said in a note to clients.

The long-term outlook for both these firms is favorable, as when corporate earnings pick up, equity underwriting markets will reopen and this high-margin revenue source will come back, boosting companies like Goldman and Morgan Stanley, Hintz said.

Goldman Sachs, Morgan Stanley and eight other top U.S. banks won clearance on Tuesday to repay $68 billion in taxpayer money given to them during the credit crisis, a step that may help them escape government curbs on executive pay.

The U.S. Treasury said banks repaying bailout funds also can repurchase warrants that the government holds in their firms "at fair market value," and many of the approved banks said they intended to do so.

The warrants give the government the right to buy common stock at a predetermined price for up to 10 years and were intended to give taxpayers a chance to share in the profits of healthy banks.

Bernstein said Goldman Sachs will be the clear winner during a credit recovery and normalization of the fixed income market, and given the firm's business strategy and capital strength, it is poised to take advantage of improving market conditions.

"With liquidity returning to the market, the post Lehman panic now history, and Goldman's competitors either under the strict government oversight of TARP or focused on strategic shifts away from the institutional businesses, we rate Goldman Sachs Outperform," the analysts said.

Separately, Fox-Pitt Kelton raised its second-quarter profit estimates on Goldman Sachs, citing better-than-expected underwriting activity and some principal investment gains. [ID:nWNAB8820]

Shares of Goldman were down 61 cents at $146.07, while Morgan Stanley shares were up about a percent at $29.54 in Thursday morning on the New York Stock Exchange. (Reporting by Anurag Kotoky in Bangalore; Editing by Gopakumar Warrier)