For commercial banks that pushed into investment banking during the bull market, the current downturn is emerging as the first test of their commitment to the highly volatile securities business.
At a minimum, analysts say, the market tumult will cut revenues at bank investment banking units. And some banks may be forced to lay off some of the underwriting talent they acquired through pricey deals for securities firms.
"All you can safely say is that revenue assumptions in the initial models have been thrown out of the window," said Harold Schroeder, a bank equity analyst with Keefe, Bruyette & Woods Inc.
"But if bank executives have done their homework, it should not be a surprise to them that the securities industry is volatile."
Over the past 18 months about a dozen banking companies bought investment banking firms, paying top dollar to enter Wall Street-dominated businesses like underwriting and selling initial public offerings and high- yield bonds.
At the same time, a record number of banking companies set up so-called section 20 units, bringing the number of banks with permission to underwrite securities to 45. Of these, 34 are authorized to deal in corporate stocks and bonds.
Thanks to a soaring stock market, these new activities emerged as major sources of fee income for banks during the first half of this year. But as the world's markets stumble, the contribution underwriting units will make to their parent banks is expected to slow dramatically.
Making matters worse for commercial banks, many have focused their securities ambitions on the IPO and junk bond markets-two sectors that have come to a grinding halt in recent weeks.
To be sure, no one expects banks to quit the securities business at the first sign of trouble. They are still eager to offer "one-stop shopping" and to add more sources of fee income to their revenue mix.
But market turmoil and layoffs on Wall Street have cast a pall of uncertainty over bank underwriting units.
At BankBoston Corp., which closed its $400 million acquisition of Robertson Stephens from BankAmerica Corp. last month, vice chairman Paul Hogan said it is clear that underwriting revenues would decrease as markets swoon. But BankBoston may be able to make up for the dip in other ways.
"What's bad for the underwriting business may be good for the commercial banking business," he said. Shut out of the stock or bond markets, Robertson Stephens' clients could turn to BankBoston's lenders for funding, he explained, providing a different stream of revenue for the bank.
Still, layoffs are expected at many securities underwriters, whether they are owned by commercial banks or by Wall Street giants. Just Tuesday, Merrill Lynch & Co. said it would cut 3,400 jobs-5% of its work force of 65,000-in "response to reduced, near-term revenue opportunities in certain markets."
Industry watchers say for underwriters, the situation is only going to get worse. "In November and December, too many people are going to chase too few deals," one consultant said. "People are cutting their hiring budgets by 50%."
Ultimately, how banks respond to this scenario will depend on how they entered the securities business in the first place.
Banks that bought established securities firms, such as Bankers Trust Co. and BankAmerica Corp., may find it easier to pare back their staffs than those that built their underwriting businesses internally, such as Chase Manhattan Corp., some said.
Executives at firms like NationsBanc Montgomery Securities, BT Alex. Brown, and BancBoston Robertson Stephens have been through market downturns before, these observers explained. Therefore they have the skills they need to make decisions about layoffs, resource allocations, and other crucial issues.
"If you bought it you have a critical mass already in place, and you have managers that can make a careful assessment" of a firm's position, said Samuel Hayes, a professor of finance and investment banking at Harvard Business School.
"If you've built it internally, it's a lot less predictable how the unit will respond and react" to market volatility.
Moreover, if big Wall Street firms announce staff cuts, banks with brand-name securities shops will not look out of step if they make similar moves, Mr. Hayes added. Banks that built their businesses internally are more likely to be perceived as leaving the market altogether if they begin to pare staff.
"If they have a 5% cut in what they bought, they can hide behind the skirts of what others are doing," Mr. Hayes said. A handful of sales and traders have already been let go from Bankers Trust's Alex. Brown unit in Baltimore.
But some say layoffs can be risky, even for banks that bought well-known underwriters.
"Most of the securities firms that have been acquired over the last year are relatively small. If the bank started dismantling them, they might fracture the culture," Mr. Schroeder said.
Even as some firms cut jobs, others are expected to take advantage of the down market to pick up investment bankers at reasonable prices. Executive recruiters say that many talented people-not just low producers- are laid off during down cycles. And some who do not lose their jobs will be disappointed by their bonuses and therefore more open to making a move.
"There will be a lot of opportunity," said Keith Macomber, an executive recruiter with Sullivan & Co. "Some people will be unhappy with their bonuses this year and will decide to leave."
Mr. Macomber predicted that bank executives would look back a year from now and view this period as a good time to lure quality investment bankers.
BankBoston's Mr. Hogan agreed, adding that he has already been contacted by a number of job seekers. "This gives us the opportunity to be selective," he said.