Financial Stocks Take a Beating

Brokerages are set to report earnings, and analysts expect more bad news.

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The sorry fate of Bear Stearns is undoubtedly a body blow for an industry that's been on the ropes for much of the past nine months. If the financial sector doesn't right itself soon, it could be a knockout.

Brokers and banks continue to watch financial share prices plummet after JPMorgan Chase agreed to buy Bear Stearns, the fifth-largest U.S. investment bank, for a meager $2 a share. The deal, which included emergency financing provided by the Federal Reserve, is the latest rout amid continuing fallout from shaky subprime lending that sparked the current credit crisis and continues to paralyze large chunks of the lending market. Bear's shocking sale price illustrates just how difficult it is to value any major financial institution during this crisis. It traded at $30 on Friday.

The greatest menace now is of more failures, near or actual—and that the one just witnessed at Bear will eventually be remembered as the first domino of many.

This week, America's biggest brokers and investment banks are set to report earnings. It is an unenviable position. Expect more pain to be added to the estimated $400 billion in estimated losses already anticipated in the wake of last year's collapse of the residential real estate market.

So what should we expect from those earnings calls? "Significant writedowns," says Frank Scaturro, a vice president at Thomson Financial. "It's daunting, but they may be freer now with all this acrimony already in the marketplace."

At the same time, all of Wall Street will be watching to see if the Fed's efforts to keep capital flowing have had the desired effect. The Fed helped finance the JPMorgan-Bear deal, cut rates on direct loans to commercial banks, and agreed to let primary dealers borrow in exchange for a "broad range" of collateral. The hoped-for impact will be a recovery in lending.

"I think we're at the crescendo of this crisis," says Dick Bove, a veteran bank analyst at Punk, Ziegel. "Basically, over the next three to four days, all of the guarantees the Fed has provided are going to be tested. If the Fed is able to maintain the stability of the market, then the tests will satisfy the sellers, and we'll go back to a more normal functioning in the financial markets."

If not, there's little room to hope for any good news in the sector. Rumors of trouble are already flying at some of the best-known names on Wall Street, especially those firms with large exposure to the subprime market. Shares of Lehman Bros. were down 19 percent Monday even after its CEO Richard Fuld said in a statement that the Fed's weekend decision to lend directly to primary dealers "takes the liquidity issue for the entire industry off the table." Goldman Sachs, Merrill Lynch, and Morgan Stanley all fell by a smaller margin.

Worse off were the likes of National City and Washington Mutual, where subprime exposure is a larger worry. Their shares plunged more than 42 percent and 12 percent, respectively. Following the Bear announcement, analysts at Oppenheimer predicted financials could drop 50 percent more.

Also, despite Fed intervention, more bank failures are expected. Merrill Lynch has said that consolidation among big banks could be massive and that "Bear Stearns' demise should probably be viewed as the first of many." Analysts note that in the 1989-91 downturn, a quarter of financial sector companies merged, were acquired, or went bankrupt. So far, only about 7 percent of the sector has disappeared this time.

Looking ahead, Bove says some traditional banks could benefit as the market improves, gaining traction, thanks to market share gains from larger rivals in the brokerage sector that have fallen victim to the credit crunch. Analysts at Keefe, Bruyette & Woods see opportunity in the government-sponsored lenders like Fannie Mae and Freddie Mac down the road, provided they can raise capital and expand their investments.

But neither expects a hefty rebound in the sector for some time. Given Monday's market turmoil, ongoing credit-related losses, and future expectations that the government will step in to regulate the financial sector with a heavier hand, there's little reason to predict banks will stop weaving soon.


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  • Kirk Shinkle

    Kirk Shinkle is a senior editor for U.S. News Money and manages the Best Funds portal. Follow him on Twitter @KirkS or email him at kshinkle@usnews.com.