Faced with the threat of another bruising year, Wall Street has turned to the booming corporate bond market to bail itself out. And it appears to be working -- at least for now.

Revenue from bond underwriting and fixed-income trading desks fueled a first-quarter earnings surge at many Wall Street securities firms, and similar results are expected from the brokers in the second quarter. Also, when you factor in all the dollars that Wall Street firms are saving after eliminating 83,000 jobs in the past three years, it's proving to be a recipe for success that investors appreciate.

This year the Amex Securities Broker/Dealer Index is up 26%, far outpacing the 11% gain in the S&P 500.

But some analysts caution there are signs that the bond business could run out of steam in the second half of the year. And that could put a crimp in Wall Street earnings in the third and fourth quarters, if other lines of investment-banking work don't start to rebound soon. The market for new equity offerings remains ice cold, and no one seems ready yet to pull the trigger on a big corporate merger.

In fact, May was one of the worst months for corporate deal-making in more than a decade. Prudential Securities bank analyst Michael Mayo described merger-and-acquisition activity as "still abnormally low" in a recent report, meaning there's very little investment-banking business for Wall Street firms. Meanwhile, the downsizing on Wall Street continues as firms keep shedding investment bankers and stock analysts.

But for now, it's smooth sailing on Wall Street on the earnings front, as low interest rates drive investors away from low-yielding U.S. Treasuries and toward corporate bonds that pay higher returns. So while corporations may find it difficult to raise money by selling stock, they are finding a ready market for high-yield junk bonds, or hybrid securities like convertibles -- bonds that convert into stock at predetermined prices.
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Junk Bonds Jump

Indeed, this year the biggest gains have been in the junk bond market, where Wall Street firms have underwritten 181 debt offerings for a total dollar value of $49.7 billion, according to Thomson Financial. By comparison, at this time last year, the Street had pumped out 138 junk bond deals with a total value of $32.4 billion.

The convertible bond market also has been active, with 103 deals coming to market for a total dollar value of $41 billion, according to Morgan Stanley's Convertbond.com tracking service. A year ago, there were 77 deals that raised $39 billion.

May was a particularly active month, with 48 convertible bond deals coming to market, as companies rush to get their financing in place before the summer doldrums set in. On Wall Street, May and June traditionally are two of the busiest months for investment bankers, as companies look to get new offerings and deals done before everyone heads for the beach.

"When rates are this low, it's going to drive the junk bond market," said Sean Egan, president of Egan Jones Ratings, a credit rating service.

Still the feverish market for bonds isn't necessarily translating into soaring fees for Wall Street firms, and that could be cause for concern down the road. In fact, Thomson Financial reports that the combined $2 billion in fees that Wall Street has generated from bond-underwriting work is slightly less than the $2.1 billion in fees investment banks raked in during the first five months of 2002. In other words, many firms are just treading water.

The main reason the booming business in bonds isn't corresponding into a revenue bonanza for Wall Street is due to the fierce competition for banking business in these lean economic times. And all that competition is leading firms to do something almost unheard of on Wall Street -- trim underwriting fees on some deals.

This year the average banking fee on a typical convertible bond deal is 2.6% of the offering's total value. Last year, according to Thomson Financial, the average fee was 2.9%. Banking fees reportedly have come down on other bond deals, too.

"There's an eagerness on the part of the bankers to get deals done," said Richard Peterson, chief market strategist for Thomson Financial. "They are willing to sacrifice a little fee production to get a relationship going."

Merrill Cashes In

In terms of banking fees, Merrill Lynch ( MER) stands in first place, taking in $392 million in fees from all bond-underwriting deals, according to Thomson. That's a big jump for Merrill, which last year stood in eighth place in fee revenue. Nipping on Merrill's heals is Citigroup ( C), which has taken in $321 million in banking fees from its bond work this year.

The big loser? That's J.P. Morgan Chase ( JPM), which has seen its bond-underwriting fees tumble this year to $154 million from $329 million.

But underwriting tells only one part of the bond story. That's because Wall Street firms also are cashing in on a surge in fixed-income trading revenue this year.

Indeed, Bear Stearns ( BSC), Goldman Sachs ( GS) and Morgan Stanley ( MWD) all reported better-than-expected first-quarter earnings because of gains on trading bonds. ( For Morgan Stanley's second-quarter earnings report released Wednesday, click here.) In particular, Wall Street has done a brisk business in trading mortgage-backed securities, which have been a hot commodity due to a surge in mortgage refinancings.

But there's also a growing concern that the brisk activity on Wall Street's fixed-income trading desks may be beginning to slow and the rest of year won't be as lucrative as the first half.

"Revenue for fixed-income trading has peaked," said Brad Hintz, a Sanford Bernstein brokerage analyst, who expects that to force analysts to reduce third- and fourth-quarter earnings estimates for some Wall Street firms.
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And despite the recent surge in the stock market, few Wall Street analysts are ready to predict a revival in stock trading, or other lines of investment banking, such as corporate merger advisory work. The latest numbers offer little proof of an imminent revival in corporate deal making.

There's even some indication that the folks who work on Wall Street aren't convinced that the industry has turned the corner. A recent survey by Wall Street Services, a financial services staffing firm, found that 52% of the people who work on Wall Street don't expect to get a bonus this year.

That kind of pessimistic thinking doesn't bode well for investors who have been heralding the start of a new bull market.

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