New York: Even after the record $8.4 billion (Rs33,012 crore) write-down for bad debts at Merrill Lynch & Co. Inc., the unprecedented ouster of three chief executives within five months and the elimination of $84 billion of market value at the five largest securities firms, Wall Street still is poised to report its second most profitable year.

And 2008 may be better.

“As the bombs are dropping and the mines are exploding, it’s a bit of a surprise," said Kenneth Crawford, who helps oversee $950 million at St. Louis-based Argent Capital Management Llc., which holds Morgan Stanley and Merrill shares.

The collapse of the subprime mortgage market derailed the careers of Merrill chief executive officer Stan O’Neal, Citigroup Inc.’s Charles O. “Chuck" Prince III and UBS AG’s Peter Wuffli. Together, those companies accounted for about 60% of the $45 billion of write-downs reported by the world’s biggest banks and securities firms so far this year. The industry already has cut 10,000 jobs.

Raring to go: In 2008, four of the five largest securities firms in the US are expected to post higher profits.

Analysts currently estimate the firms’ net income will reach $32 billion in 2008.

Goldman and Lehman will report their highest earnings ever this year, while profits will drop 42% at Merrill, 34% at Bear Stearns and 6% at Morgan Stanley. In 2008, analysts predict all the firms except Goldman will post higher profits. Goldman, led by CEO Lloyd Blankfein, will earn a Wall Street record $11 billion this year and then $10.5 billion in fiscal 2008, analysts estimate.

Reason for optimism

“When you look to next year, you’re back to earning money once these write-downs are taken," said Benjamin Wallace, who helps manage $750 million at Westborough, Massachusetts-based Grimes & Co. and owns Merrill and Morgan Stanley shares.

Les Satlow, who oversees $450 million at Cabot Money Management in Salem, Massachusetts, said he’s more bullish on prospects for investment banks than commercial banks.

“The securities firms have less exposure to the consumer and greater exposure to overseas capital markets, which have a reasonable chance of remaining solid," Satlow said.

Goldman and Lehman made more than half of their third quarter revenue outside the US, benefiting from faster growth in Asia and Europe. By contrast, Bank of America Corp. relies on the US for more than 80% of its revenue.

‘Significant dislocations’

Bank of America, JPMorgan Chase & Co. and Wachovia Corp., three of America’s four biggest banks, all reported on 9 November that fourth quarter results will be affected by difficult credit markets. Charlotte, North Carolina-based Wachovia said mortgage-related losses and reserves for bad loans may total $1.7 billion this quarter.

Bank of America, also based in Charlotte, said in a filing with the US Securities and Exchange Commission that “significant dislocations" in the debt markets will “adversely impact" the fourth quarter. JPMorgan, based in New York, said “further markdowns" for loans used to finance leveraged buyouts may occur “if market conditions worsen."

While revenue from fixed-income sales and trading is declining for most securities firms during the worst period for credit markets since Russia’s debt default in 1998, fees from investment banking, providing brokerage services to hedge funds and trading stocks are increasing, Bank of America analyst Michael Hecht wrote in a 5 November note to clients.

A record $3.6 trillion of mergers and acquisitions were announced this year, average daily trading on the Nasdaq Stock Exchange rose 10%, and equity market price swings measured by the Chicago Board Options Exchange SPX Volatility Index, or VIX, surged to the highest since 2003, creating trading opportunities.

Stock slump

“It’s not unrealistic to think there is improvement going forward," said Argent Capital’s Crawford, referring to the earnings outlook.

Grimes’s Wallace added that “not all of those positive drivers are going to come to an end right away."

This optimism comes during the biggest rout for Wall Street stocks since 2002.

Merrill, the world’s biggest brokerage, has dropped 43% this year in New York Stock Exchange trading, Bear Stearns has slumped 40%, Lehman has dropped 26% and Morgan Stanley has declined 20%. Goldman shares have advanced 6%. The 12-member Amex Securities Broker/Dealer Index is down 14%, the most since the 19% decline in 2002.

Dillon Read

The slide began after Zurich-based UBS, Europe’s biggest bank by assets, shut its Dillon Read Capital Management Llc. hedge fund unit in May because of losses on subprime mortgages. A month later, two hedge funds managed by Bear Stearns started receiving margin calls from lenders after bets on mortgage bonds and collateralized debt obligations, bonds backed by pools of other debt, went sour.

Wall Street executives remained sanguine. Lehman’s the then chief financial officer, Christopher O’Meara, told investors on 12 June that “subprime market challenges are and will continue to be reasonably contained." Bear Stearns CFO Sam Molinaro said on 14 June that the problem in subprime mortgage-backed bonds “hasn’t spilled into other areas of the market." David Viniar, Goldman’s CFO, also said 14 June that “there’s very little effect on other credit markets."

O’Neal and Prince

Merrill’s O’Neal called subprime defaults “reasonably well contained" on 27 June. A week later, UBS ousted Wuffli, 50, after almost four years in the job.

O’Neal’s 21-year career at Merrill ended last month when he lost the confidence of investors and the board of directors by disclosing write-downs that were almost double the firm’s forecast of just three weeks earlier.

The charges led to a $2.2 billion third quarter loss, the worst in Merrill’s history.

Prince, Citigroup’s CEO, stepped down 4 November after the largest US bank warned of as much as $11 billion of additional write-downs on subprime mortgages and related securities, on top of more than $6 billion of charges reported for the third quarter.

Morgan Stanley joined Merrill, Citigroup and UBS in booking losses on subprime mortgage-related assets. On 7 November, the second biggest US securities firm by market value after Goldman reported a loss of $3.7 billion in the two months ended 31 October. Prices for securities dependant on home loans to risky borrowers sank further than traders expected, cutting fourth quarter earnings by $2.5 billion, Morgan Stanley said.

The tumult followed the most profitable first half in Wall Street history, boosted by record merger and acquisitions, high-yield financing, commodities trading and stock market gains.

‘Polar opposite’

“The back half of the year has been the polar opposite," said David Killian, who helps manage $750 million, including Morgan Stanley shares, at Stoneridge Investment Partners in Malvern, Pennsylvania.

US banks and securities firms probably will mark down more than $50 billion of securities related to subprime home loans in the second half of 2007, said Michael Mayo, an analyst at Deutsche Bank AG in New York.

“Educated guesses are the best that can be done," Mayo said. “Nobody should be surprised to see whoever had big writedowns in the third quarter have more big writedowns."

Still, the business mix at the biggest securities firms is diversified enough for earnings to be strong in 2008, analysts estimate.

Merrill’s net income will climb about 60% to $6.9 billion next year, according to a survey of analysts by Bloomberg. Merrill generated about 43 % of its revenue from sales and trading last year, 12 % from investment banking and the rest from providing brokerage services and asset management, data compiled by Bloomberg show.

Visa IPO

Merrill was among eight investment banks hired last week by Visa International Inc. to help the biggest credit card company raise as much as $10 billion in the world’s largest initial public offering (IPO) announced this year.

“The IPO might send a signal to the market that it’s not all going to hell in a hand basket," said Marc Pado, chief market strategist at Cantor Fitzgerald LP in San Francisco.

Jeff Kearns in New York contributed to this story.