LONDON -- Global banking groups could face a 70 percent decline in pretax profits from investment banking and trading in the second half of this year compared with the first, as the credit crunch hits earnings, according to a report Wednesday from ratings agency Standard & Poor's Corp.
S&P said it has conducted a "harsh but plausible" stress test for investment banks' earnings, observing that the current environment for securities firms bears many similarities to 1998.
"Once again, we see sharp falls in stock markets following a strong run, a jump in volatility, sizable losses at some large hedge funds, higher risk premia on bank debt, a liquidity crunch and rumors of banks and broker-dealers getting into difficulties," the report said.
But S&P acknowledged that the causes of the 1998 and 2007 market drops were distinct. Current market volatility has been sparked by rising delinquencies on U.S. subprime mortgages, while the problems of 1998 followed a sovereign default by Russia in August that year.
S&P said that it would regard six months of volatility as "testing but manageable" within current ratings for the large securities firms. Many capital markets businesses are part of diverse financial groups, which could help to cushion the effect of a decline in revenue.
"We estimate that the aggregate 70 percent decline in pretax profit at the (investment banking) divisional level would be diluted to 40 percent at the consolidated group level," S&P said.
It said that net effect would be greatest at the firms with the heaviest exposure to capital markets, like Goldman Sachs Group Inc., Bear Stearns Cos., Lehman Brothers Holdings Inc. and Deutsche Bank AG.
But still favorable fundamentals mean that an extended downturn is unlikely, S&P said. It added that, faced with a decline in revenue, the securities industry will be paying less to its staff thanks to variable compensation arrangements.