Bad news, Bear: Profit sinks 61%

LONDON (CNNMoney.com) -- Bear Stearns' chief financial officer, attempting to restore confidence in the investment bank after a steep drop in quarterly profit, said Thursday he expects a return to more favorable conditions next year.

The liquidity crisis, along with a broad repricing of risk in the credit markets, posed an "extremely challenging" operating environment that resulted in disappointing third-quarter results, Samuel Molinaro said in a conference call with analysts via Webcast in London.

But Molinaro stressed that the bank's underlying business is sound and is likely to get back to more normal levels once the liquidity situation improves. Market dislocations tend to run a quarter or two, and customers may start feeling more comfortable using leverage "sometime in 2008," he said.

Bear Stearns posted a sharp decline in net income for the third quarter - a period during which two of its hedge funds heavily invested in subprime securities blew up, helping to fuel a global credit storm.

Despite the weak results, which missed Wall Street analysts' estimates, Bear (Charts, Fortune 500) shares rose about 3 percent in midday trading.

"Everyone knew Bear Stearns had to mark down a substantial portion of its assets and that certain core businesses were going to be impacted. That was nothing surprising," said Punk, Ziegel & Co. analyst Dick Bove.

The company took a $200 million loss related to the Bear Stearns Asset Management High-Grade hedge funds. It also booked $700 million in writedowns related to mortgage assets and private equity loan commitments that lost value during the credit crunch.

New York-based Bear said quarterly net income for the period ended in August sank 61 percent to $171.3 million, or $1.16 a share, from the year-earlier period. Revenue fell to $1.3 billion from $2.13 billion last year.

Investors have been closely watching earnings from brokerages this week to see how they've fared during the tumultuous summer, keeping a particular focus on how they're marking so-called "level three" assets whose value has become uncertain amid the turmoil in the credit markets.

Level three assets include those that aren't heavily traded, such as mortgage-backed securities, as well private equity investments. Since they aren't highly liquid, Wall Street firms rely on their own models to value them.

Molinaro attempted to ease concerns on this front, saying the company's level three assets only accounted for about 4 percent of Bear's assets as of the end of May.

Bear, a leader in the business of packaging home loans into tradable securities, saw its business slow significantly in the wake of the mortgage meltdown.

Fixed-income revenue fell 88 percent during the quarter to $118 million, or about 9 percent of total revenue. In the same period last year, fixed income accounted for about 44 percent of Bear's total revenue.

Equities revenue climbed about 53 percent to $719 million, while investment banking revenue fell nearly 9 percent to $211 million.

Bear's earnings contrasted sharply with those of rival Goldman Sachs (Charts, Fortune 500), which also reported on its financial picture Thursday. Goldman said many of its businesses were "challenged" during the quarter, but the celebrated Wall Street firm posted a surge in revenue and profit.

On Wednesday, Morgan Stanley (Charts, Fortune 500) posted disappointing third-quarter earnings and said it took $940 million in markdowns related to loans. Earlier in the week Lehman (Charts, Fortune 500) reported $700 million in writedowns, although it still managed to top Wall Street's expectations.

Bear has taken a beating from the turmoil in financial markets. Its stock has lost about a third of its value since hitting a high of $172 a share in January of this year.