Deutsche loss, earnings worries hits banks, hold Europe shares in check

* FTSEurofirst 300 down 0.1 pct

* Deutsche heads for biggest one-day drop in 10 months

* High market valuations need to be justified by earnings growth

By Toni Vorobyova

LONDON, Jan 20 (Reuters) - European equities steadied on Monday, pegged back from 5-1/2 year highs by a retreat in financial shares after a surprise loss from Deutsche Bank (Xetra: DBK.DE - news) .

It was the first of the region's lenders to report fourth quarter earnings.

Deutsche - which had not been due to release results until Jan. 29 - fell 4.0 percent after unveiling a fourth quarter loss of 1.15 billion euros ($1.56 billion) due to heavy litigation and restructuring costs, as well as weakness in fixed income trading.

Debt sales and trading revenues fell 31 percent, year-on-year, raising concerns about performance at other banks with a large fixed income business. Underscoring the problems in that area, a source told Reuters that Swiss bank UBS will begin outsourcing its fixed income trading platform to two technology groups in an attempt to save costs.

The STOXX Europe 600 Banking Index dropped 0.7 percent , making it by far the worst performing sector.

"The figures of Deutsche Bank are surprising and there is no end to be seen, and therefore we are kind of critical about the conditions of the banking sector," said Oliver Roth, head trader at Close Brothers Seydler.

"I think we have seen the bottom of the crisis, but I don't see the end of the crisis. Therefore I see much more potential in other sectors than banks."

The impact, however, was felt more broadly, with Deutsche's loss following on from a profit warning from oil major Shell (LSE: RDSB.L - news) last week and adding to concerns that the earnings season will not deliver the strong results needed to justify high equity valuations and to enable further market gains.

"The market is trading on valuations which are getting closer to levels where any sort of earnings disappointment is going to be increasingly problematic," said Ian Richards, strategist at Exane BNP Paribas.

European equities are trading at around 13.6 times their expected 12 month earnings - around their most expensive in nine years, according to Thomson Reuters Datastream.

The pan-European FTSEurofirst 300 index was steady at 1,345.05 points by 1135 GMT, holding below last week's 5-1/2 year peak of 1,346.23 points.

The DAX lagged other regional bourses, down 0.2 percent as Deutsche's drop took 19 points off the German index. The move put Deutsche on track for its biggest one-day fall since March 2013, with Volumes at 148 percent of the 90-day daily average by mid-session, even as activity more broadly was subdued due to a public holiday in the United States.

On average, European companies could miss fourth quarter earnings consensus by 1.5 percent, according to StarMine SmartEstimates, which focus on the up-to-date predictions form historically most accurate analysts.

However, with SmartEstimates predicting a 3.9 percent year-on-year drop in fourth quarter earnings, the bar has been set relatively low for any possible upside surprises.

"On balance, we think this season will be an improvement in terms of earnings surprises compared to the third quarter season. Most of this expected improvement is because consensus revised down earnings estimates very substantially while the economic backdrop remained broadly unchanged," analysts at Goldman Sachs (NYSE: GS-PB - news) said in a note.