Thu Jul 29, 2004
By Jane Merriman

LONDON, July 29 (Reuters) - Europe's main investment banks are set to suffer from a decline in fixed income revenues in the second quarter, but also from weakness in equities and mergers activity that was supposed to compensate for the long-expected bond slowdown.

The banks with major investment banking operations such as Deutsche Bank (DBKGnDE: Quote, Profile, Research) , Credit Suisse (CSGN.VX: Quote, Profile, Research) , UBS (UBSN.VX: Quote, Profile, Research) and BNP Paribas (BNPP.PA: Quote, Profile, Research) report second-quarter results in the next two weeks.

They could see a 20 to 25 percent drop in fixed income revenues in the second quarter versus the first, but equities revenues are likely to be down by just as much, according to analysts' estimates.

Uncertainty about the economic outlook and the speed of U.S. interest rate rises have put a damper on equities and M&A activity after a strong start to the year.

"Investment banking revenues and profit numbers could be substantially lower in the second quarter than in the first quarter, because both fixed income and equities trading has been poor," said Vasco Moreno, head of European banks research at Keefe, Bruyette & Woods.

He sees overall European fixed income revenues in second quarter down 24 percent, and equity trading down 17 percent quarter-on-quarter.

A three-year boom in bond sales and trading, which delivered record profits for many of the investment banks, has come to an end with the rise in U.S. interest rates.

U.S. investment banks have already set the tone, with Merrill Lynch (MER.N: Quote, Profile, Research) and J.P. Morgan Chase (JPM.N: Quote, Profile, Research) reporting weaker second-quarter figures. They were hit by a sluggish June, which suggested the traditional summer slowdown had started early.

"Contrary to many expectations, the equities business slowed down even more quickly than the debt sales and trading business," said Kinner Lakhani, banks analyst at ABN AMRO. "This has raised concerns that there will be no smooth handover from the debt to equities business."

Fixed income is expected to continue a graceful decline, while equities and M&A could stay in no man's land over the third quarter, analysts said.

HEDGE FUNDS

The banks could also suffer fallout from a lacklustre performance at hedge funds in the past three months.

"Hedge funds are a major customer group of investment banks, so when they suffer investment banks suffer," Credit Suisse First Boston said in a research note.

Hedge funds are big clients for the banks' equities and bonds sales and trading businesses as well as prime brokerage operations.

CSFB said hedge funds' performance was down by 0.5 percent over the past three months, possibly as a result of lower equity market volatility.

CSFB's strategy after the ousting of Chief Executive John Mack will be in the spotlight, while at Deutsche Bank, which reports results on July 30, the fixed income slowdown is set to hit revenues, plus there are concerns about rising costs, analysts said.

The revenue downturn at the banks has already been discounted in share prices. UBS, Credit Suisse and Deutsche Bank are currently trading on a multiple of about 10 times 2005 earnings, according to one analyst's estimates.

"That's a very low multiple relative to where they normally trade, which is more like 14/15 times," he said. "The low valuation says the market thinks analysts have to cut more from their forecasts - that earnings estimates are too high."

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