Dark clouds gather on Wall Street
The nation's brokerages kick off the earnings season next week. Analysts are betting that there will be plenty of bad news to go around.
NEW YORK (CNNMoney.com) -- When the nation's biggest brokerage firms reported disappointing quarterly earnings in October, many on Wall Street were hoping that the darkest days of the credit crisis were behind them.
Now, with less than a week before the start of the next earnings season, analysts and investors are betting that this quarter's results could be just as bleak.
"I expect the numbers to be terrible," said Matt Kelmon, president and portfolio manager at the Kelmoore Strategy Funds, whose firm owns shares of a number of Wall Street firms.
Since the last quarter, few encouraging signs have emerged about the health of brokerage firms. Meanwhile, stock investors have remained on edge, the credit markets frozen shut and the nation's economic picture uncertain.
As a result, Wall Street analysts have been slashing their earnings estimates on firms like Morgan Stanley (Charts, Fortune 500) and Bear Stearns (Charts, Fortune 500), both of which are expected to post steep losses in December after warning last month they would take multi-billion dollar writedowns this quarter.
As of midday Friday, neither firm had said when it would release its fourth-quarter report.
Merrill Lynch (Charts, Fortune 500), the nation's largest brokerage, will not report results until January. To date, Merrill has among been the hardest hit by the credit crunch, having suffered an $8 billion loss on mortgage securities last quarter, which prompted the exit of its CEO Stanley O'Neal.
While all five firms' results will be closely scrutinized, much of the focus will be on Morgan Stanley and Bear Stearns.
Last month, Morgan Stanley became the latest firm to reveal massive losses, saying it would take a $3.7 billion hit in the fourth quarter because of its subprime mortgage exposure. One week later, Bear Stearns said it would take a $1.2 billion writedown due to its subprime assets and collateralized debt obligations.
Investors will again be paying close attention to how they value these so-called "level three" assets like mortgage-backed securities, which aren't highly liquid, said Lehman Brothers analyst Roger Freeman.
So far this year, banks have booked or announced more than $36 billion in writedowns as they try to value these securities.
"Just as in the third quarter, the markdowns will be very closely watched," said Freeman. "The question is are those marks going to be worse, the same or better."
During the month of November, a number of ABX indexes, which serve as a benchmark for securities backed by home loans issued to borrowers with weak credit, suffered declines suggesting that some of these securities could be worth even less than originally anticipated.
Even though Morgan Stanley and Bear Stearns will likely suffer the most from these securities, firms like Lehman and Goldman won't be immune from the broader market conditions.
Investment banks are no longer enjoying the type of dealmaking activity of recent years. The credit crisis has virtually stamped out debt and equity underwriting.
Buried within these troubling results, however, will be some good news, analysts argue. Some of the fourth quarter's weakness will be offset by growth in firms' rapidly expanding overseas businesses and results in their trading divisions.
"Despite the recent challenges in the mortgage and credit businesses, trading volume was robust," J.P. Morgan Chase analyst Kenneth Worthington wrote in a research note published this week.
Analysts and investors will scrutinize the outlook these firms give as they enter fiscal year 2008. Most analysts are leaving the door open to the possibility of more writedowns, warning it will take some time before brokerages return to the days of record-setting profits.
"It will take some time for these companies to recover and re-establish their record results," Punk, Ziegel & Co.'s Richard Bove wrote in a recent research note. "There will be earnings disappointments and inability to regain record profits for what may be 12 to 18 months."