Brokerage results to show crisis far from over

By Joseph Giannone - Analysis

NEW YORK (Reuters) - The chief executives of Wall Street's largest investment banks in April all assured investors the worst of the credit crisis was safely behind them. Wishful thinking.

Instead, markets that brought down Bear Stearns in March continued to tumble last month, ensuring dismal second-quarter results from Morgan Stanley (MS.N), Goldman Sachs Group Inc (GS.N) and Lehman Brothers Holdings Inc LEH.N. The highly anticipated numbers, to be announced in the coming two weeks, will reveal that their struggles have just begun.

"It is pretty grim. A lot of the (securitized) products that Wall Street created over the last decade have either gone away or have been significantly reduced in size," said money manager Timothy Ghriskey, co-founder of Solaris Group.

Investors will be looking to see whether three of the four largest U.S. investment banks successfully shed their risky assets, reduced expenses and fortified balance sheets slammed by the slumping mortgage market and break-down in corporate finance.

Research analysts forecast yet another quarter of falling profits from tumbling real estate and mortgage values, a dearth of merger activity and another round of write-downs on assets buffeted by volatile markets. Moreover, some hedging strategies designed to offset trading losses backfired.

The hottest spotlight will be on Lehman, which is fending off accusations from activist hedge fund manager David Einhorn that it manipulated first-quarter results as well as speculation that it will be forced to raise as much as $5 billion to offset a steep second-quarter loss.

According to Reuters Estimates, analysts' average profit forecast for Lehman has fallen to break-even and, on an operating basis, a loss of 29 cents per share. A month ago, analysts had forecast net income of $1.13 a share.

Goldman Sachs, meanwhile, is expected to post a 27 percent drop in net income from the year-ago period, while Morgan Stanley's profit is seen falling 56 percent.

PULL IN HORNS

Banks have written off some $350 billion of mortgages and other assets hit by the credit crisis, sold large stakes to foreign governments and slashed jobs. These measures, and unprecedented access to Federal Reserve credit lines, raised optimism that banks were starting to turn the corner.

Yet regulators and investors are pushing banks to pull in their horns by reducing leverage -- the proportion of total assets over their equity -- and paring back risk. Banks during the latest quarter have been unloading mortgages, corporate loans and other securities at big discounts.

"It's a credit cycle and some issues have to work their way through," said Robert Patten, a veteran banking analyst at Morgan Keegan. "The Fed is clearly focused on solvency, safety and soundness, urging every bank to raise capital, cut their dividend and get through this period."

Accordingly, most investors have steered clear as banks navigate the storm.

Over the past year, Lehman shares have lost more than half their value and Morgan Stanley's have dropped 43 percent, while Goldman has seen its shares shed 25 percent. In Friday trading, the Securities broker dealer index fell 4 percent.

Wall Street's ongoing exposure to the credit crunch only leaves their earnings, and shares, poised for more declines.