Broker Stocks Outlast Skeptics

Right now, of course, it's hard to see any headwinds for the brokerage sector.

The merger-and-acquisition machine is going at full tilt. This week's proposed $67 billion mega-deal between AT&T(T Quote - Cramer on T - Stock Picks) and BellSouth(BLS Quote - Cramer on BLS - Stock Picks) is likely to spawn copycat deals in the telecommunications industry. As they say on Wall Street, the M&A pipeline -- deals in the works -- is pretty full.

Bond and stock underwriting also is going strong. The total dollar value of underwriting in the three-month period ending in February was $867 billion, up 15% over the same period a year ago, according to Thomson Financial.

In fact, analysts are expecting even bigger earnings gains for the brokers in the second quarter, including Morgan Stanley.

But some worry that in the competition between Wall Street firms to emerge as the leader in M&A and underwriting, imprudent risk is being assumed.

Allen Puwalski, senior financial analyst with the Center for Financial Research & Analysis, says Wall Street banks, in order to win corporate business, are making ever larger commitments to lend money to those companies. He says some of these loans could come back to bite a Wall Street firm in a market downturn.

"These transactions lead to good league table placement now, but they could lead to future credit hits,'' says Puwalski.

At the end of the day, league table rankings are nothing more than bragging rights for Wall Street. That's because traditional investment banking fees are accounting for an ever-diminishing portion of Wall Street earnings. Since the bull market began in earnest, the main earnings-driver at Wall Street firms has been revenue from proprietary trading -- in-house trading of bonds, stocks and commodities.

Over the past three years, Wall Street traders have shown a great knack for making big profits in any kind of interest rate environment, but profits from trading are hard to predict, and it's inevitable that a firm will stumble. The unpredictability of trading revenue is one reason analyst estimates for brokerage stocks are so often wrong.

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