Bank shares to underperform debt: JPMorgan

FRANKFURT (Reuters) - Shares in European banks, hit hard by subprime-related writedowns, are likely to fall further and look set to underperform banks' fixed-income securities, JPMorgan said on Wednesday.

The industry is facing a period of adjustment that will lead to smaller balance sheets, increased credit losses and lower earnings," the U.S. investment bank said in a European credit research note focused on the financial sector.

Some "secondary banks" might go under, likely causing problems in the wider sector, JPMorgan said.

"The equity market appears to have set itself up for more disappointment," it said. "... The current rally is likely to be very similar to October last year and, therefore, likely to be relatively short lived."

The DJ Stoxx European bank index rose 20 percent between March 17 and April 2. It has given up some gains since and was trading 13 percent above the mid-March trough -- a 43-month low -- on Wednesday at 1045 GMT (6:45 a.m. EDT).

In October, the index jumped almost 7.5 percent in just over a week but shed all those gains before the end of the month.

"The equity market has gotten too optimistic over the short-term rally in spreads. Banks fund in cash, not CDS," JPMorgan said, pointing to credit default swaps (CDS), which are derivatives that price the risk of an issuer not repaying debts.

The benchmark iTraxx Crossover CDS index has fallen by almost 100 basis points from a record-high set in early March, a move seen by some market watchers as a sign of recovery in credit markets, on which banks rely for funding.

But CDS indices spreads are not representative of bank funding levels, JPMorgan said, adding that "deep-seated problems" remained.