NEW YORK (MarketWatch) -- Analysts who cover broker Lehman Brothers Holdings Inc. watched closely from the sidelines Monday, loath to add to market speculation that the firm may be the next major brokerage to falter.

Maintaining investor confidence will be key to keeping Lehman LEH, afloat, at least for now, according to BMO Capital Markets analyst George Lazarevski.

"Similar to Bear Stearns, the greatest risk for Lehman Brothers is the risk that once speculation begins, it becomes a self-fulfilling prophecy, and no level of liquidity will be sufficient," he told investors Monday.

Lehman Chief Executive Richard Fuld said the Federal Reserve's decision to start lending directly to brokerage firms improves their liquidity. The Fed usually lends directly only to banks, but the central bank widened its reach in a historic move on Monday to include brokerages such as Lehman as well.

"The Federal Reserve's decision to create a lending facility for primary dealers and permit a broad range of investment-grade securities to serve as collateral improves the liquidity picture, and from my perspective, takes the liquidity issue for the entire industry off the table," Fuld said in a statement.

“ 'It's not clear whether Lehman is in trouble, but I don't think there's a fire there.' ” — Harvard Business School

Unlike banks, brokerage firms don't have a base of retail customers who deposit cash into accounts, and until Monday they didn't have access to the Fed as lender of last resort. That makes them more vulnerable to the waxing and waning of risk appetite in capital markets.

They also rely on the confidence of clients and counterparties to keep trading with them. When rival Bear Stearns Cos. BSC, -10.00% lost that confidence last week, the firm's business quickly unraveled, pushing it into the arms of JPMorgan Chase & Co. JPM, -0.84% and the Fed. See related story.

Everyone's nervous

Similar concerns roiled Lehman shares Monday, although experts tried to limit the damage by speaking carefully, hoping not to make matters worse for the firm.

"Just commenting on it seems to give it more credence," said Samuel Hayes, the Jacob H. Schiff professor of investment banking, emeritus, at Harvard Business School. "It's not clear whether Lehman is in trouble, but I don't think there's a fire there."

Shares of Lehman Brothers recovered more than half of their earlier losses of more than 40%, and ended the day off about 19%. The move was still the biggest one-day drop in Lehman shares since the firm went public in 1994, and reflected just how nervous investors are after being rattled by an 11th-hour bailout of Bear.

The roller-coaster ride experienced by Lehman showed how volatile the market can be, some analysts said, a major worry just days after the storied Bear Stearns was taken down.

"If market participants begin to fear that another bank is facing a liquidity crisis, we could see another collapse," wrote Morningstar analyst Ryan Lentell in a research note.

"Rumors of problems at Bear gained traction because of the bank's exposure to the residential-mortgage market, which has been in turmoil," he said. "The investment banks all have exposure to these asset classes, and as fear over further price declines in any one asset class escalates, it could lead to a run on another bank."

Options traders are making big bets that Lehman stock will drop an additional 24% by Thursday, when March options expire, Dow Jones Newswires reported. Traders also are betting that the shares will continue to plummet over the next month.

But Deutsche Bank DB, -1.89% analyst Mike Mayo said Monday that fears of a Bear Stearns-like meltdown for brokerage Lehman Brothers are overblown.

"Lehman is not Bear," he commented, adding that Lehman has more liquidity, more support from counterparties, a more-diversified franchise and a "seasoned and experienced" chief executive.

"While there is a chance that we have not factored in all the needed write-downs, we believe that this difference creates a reasonable margin of safety," Mayo wrote in a research note.

Deutsche Bank maintained its "buy" rating on the stock. Other market players were not so optimistic about the broker.

Early Monday, Moody's Investors Service trimmed its outlook on the investment bank's debt rating, heightening concerns about liquidity. The ratings agency affirmed its A1 rating on the senior long-term debt of Lehman but lowered its outlook on the ratings to stable from positive.

Moody's said its ratings action "recognizes that Lehman has navigated quite well to date through persistently volatile and challenging financial markets, the sharp marketwide decline in valuations across numerous asset classes, tight global-liquidity conditions and the strong headwinds facing Lehman's (and other securities firms') core-earnings drivers."

"However, these conditions have decreased the upward pressure on Lehman's rating, and therefore a positive outlook is no longer warranted," according to Moody's.

UBS also downgraded Lehman to neutral on concerns that the bank will see further trouble in the capital markets.

If the current losses hold throughout Monday's session, it would easily be the stock's biggest one-day percentage drop since they started publicly trading in May 1994.

Previously, the biggest one-day percentage drop for Lehman shares was 18.6% on April 14, 2000, in the thick of the dot-com meltdown.

Rival brokerages Morgan Stanley MS and Goldman Sachs Group GS, -1.14% also saw their shares significantly lower in premarket trading -- down nearly 7% and nearly 8%, respectively.

Another shoe to drop?

Touching off the shivers on Wall Street, J.P. Morgan agreed to buy struggling brokerage Bear Stearns for $236 million, or $2 a share, in an unprecedented rescue supported by the Federal Reserve. The Fed also moved to cut the discount rate to 3.25%. See related story.

Market rumors have pegged Lehman as the next investment house to face the same type of withering scrutiny that Bear Stearns came under last week. How well Lehman will survive such a storm remains to be seen, several analysts said.

"The concern is that every Wall Street firm will be viewed in light of the Bear Stearns sale price," Robert Brusca, chief economist at Fact and Opinion Economics, said Sunday evening.

“ 'As fear over further price declines in any one asset class escalates, it could lead to a run on another bank.' ” — Ryan Lentell, Morningstar

Other analysts seconded that opinion, saying that without going into too many specifics about Lehman's core businesses, it is easy to see why the firm will face greater obstacles in the near future.

"There is no question that they are a well-managed shop, but this problem is much larger than Lehman," said Mark Williams, who teaches finance at Boston University School of Management and used to be an official at the Federal Reserve.

"The Fed actions were great for Bear Stearns, but they didn't address the whole industry," he added. "Bernanke is going to need to act a lot less like a quarterback and a lot more like a facilitator."

Williams commented that without further intervention from the Fed, only the strongest institutions will survive because the market is "gruesomely efficient" in deciding who will survive on the capital markets.

But investor confidence and access to liquidity are only some of the obstacles Lehman may face. "During a crisis of confidence, earnings, book value and liquidity don't matter much," Citigroup analyst Prashant Bhatia wrote in a note Monday. "Client and counterparties vote with their money, and if confidence breaks down rapid deterioration will likely follow."

These are problems endemic to the industry, analysts said. "Wall Street CFOs have known for over 20 years that the loss of confidence is a life-threatening risk for a securities firm," Sanford Bernstein analyst Brad Hintz told investors.

"It is not bad trading decisions or credit losses that end the life of one of these institutions; rather, it is the inability to roll over debt when it comes due," he said. "As such, liquidity risk has remained the Achilles heel of the securities firms."

But Lehman faces different challenges than its rival firms due to its large mortgage operations and broader exposure. "Company-specific risks include subpar performance in trading-related businesses, declining business performance as a result of losing talent, risk management and lack of financial liquidity in the event of shock-type events," Bhatia said.

The firm already has been feeling the fallout from that lack of confidence. The firm had a scare this weekend after published reports Sunday said that the Development Bank of Singapore was discontinuing all transactions with the bank. However, both parties said Monday that those reports were false.

“ 'Client and counterparties vote with their money, and if confidence breaks down rapid deterioration will likely follow.' ” — Prashant Bhatia, Citigroup

Lehman got some good news Friday, when it announced that a new credit facility was "substantially oversubscribed." The bank replaced its existing three-year credit facility with a $2 billion committed unsecured facility.

It said it was particularly encouraged by the large number of banks that participated in the facility -- more than 40 -- and by the actions of co-leaders J.P. Morgan Chase and Citigroup Inc. C, -2.12%

"We are extremely pleased with the success of the syndicated facility and view this as a strong signal from the market and our key bank relationships," said Paolo Tonucci, Lehman's global treasurer.

Citigroup analysts rated Lehman shares as "high risk" Sunday, saying the bank is particularly vulnerable to the macroeconomic environment, including "the strength of the economy and strength of the operating environments for investment banking, trading, origination and global financial asset values."

The market echoed those worries, with analysts looking ahead to when Lehman reports first-quarter financial results before the market opens Tuesday.

Analysts surveyed by Thomson Financial have been expecting earnings of 72 cents a share, on average, with revenue pegged to drop more than 60% from a year earlier.

Some analysts remain bearish on the stock, worried about continuing write-downs and the state of global credit markets worldwide. Oppenheimer & Co. analyst Meredith Whitney, for one, slashed her first-quarter profit estimate for Lehman to 50 cents a share.

Analysts also are anticipating that revenue will fall 34% to $3.35 billion for the quarter.

Messy quarterly reports

Indeed, analysts and market players surveyed by FactSet Research expect all four of the largest U.S. investment banks to have suffered mightily in the first quarter, with earnings for Morgan Stanley, Goldman, Bear Stearns and Lehman to have been halved from the same period last year.

But Lehman has attempted to stay ahead of the curve when planning for 2008, trimming its operations wherever it can and investing heavily in a well-publicized risk-management team.

The broker also cut nearly 4,000 jobs in the last year and now has around 28,600 employees. The bank has said it aims to trim its total workforce by 5% globally in the next 12 months.

The trend to downsize has been a major theme for the nation's five largest investment banks, with both Goldman Sachs streamlining its work force and Morgan Stanley laying off more than 2,000 workers this year.

As part of that downsizing, published reports said Monday, Lehman has shut down its European credit-strategy team in London -- including reassigning David Brickman, who was head of European credit strategy, as well as Ben Bennett, previously director of European credit strategy.

Despite some market stabilization Monday, Hintz said that Sanford Bernstein is advising clients to stay out of the brokerage arena, at least for now.

"We would not recommend getting into the large-capitalization names at this time. The unfortunate events at BSC will lead to sharply increasing funding pressure on the other four large-capitalization brokers in the near term," he commented. "Although [Morgan Stanley, Goldman Sachs, Bear Stearns and Lehman] have strong capital bases and capable corporate treasuries and repo desks, investing in the brokers now is a bet on a recovery of confidence in credit markets that are experiencing the worst turmoil in several decades. "

It is a lesson other corporate executives need to take to heart, Boston University's Williams said. "If executives think they can just stand up and say everything is OK until things get better, then they are wrong. Everything is not OK. They need to have a broader plan."