Goldman Sachs Group Inc's first-quarter earnings are expected to benefit from the increased use of derivatives by European clients seeking ways to hedge risk, according to an internal report seen by Reuters.

Revenue at Goldman's investment bank in Europe increased by 8 percent from the year-ago period to $476 million, the report said.

A big driver was derivatives that clients, corporations and financial institutions used to hedge bets in the stock and fixed-income markets.

Overall client-driven derivatives revenue was up 142 percent year-to-date in Goldman's Europe division, helping to offset declines in more traditional investment banking businesses, like mergers and acquisitions.

The figures suggest that steps taken by European regulators to stabilize capital markets have been effective and have set the stage for stronger-than-expected quarterly results for Wall Street investment banks.

The figures also suggest that U.S. banks are benefiting from stress among European competitors that have had to step back from the market and reduce risk-taking in the midst of the sovereign debt crisis.

On a conference call last week to discuss quarterly results, Jefferies Group Inc Chief Executive Richard Handler said a number of larger foreign players who have had ambitions of being global are choosing to go back to their respective countries to basically satisfy their regulators and the rating agencies. That is a situation, he said, that creates an opportunity for U.S. competitors to gain market share.

Goldman's derivatives gains were driven by clients adjusting their balance sheets for counterparty credit risks, as well as European financial institutions seeking capital gains, said a source familiar with the results who spoke on condition of anonymity because the figures are not public.

Goldman spokesman Michael DuVally declined to comment on the figures.

Goldman does not break out its European results individually in quarterly reports. Instead, it reports revenue for Europe, Middle East and Asia, which delivered $2.87 billion of revenue and $1.09 billion in pre-tax earnings for the first quarter of 2011.

Analysts have been lifting their estimates for Goldman in recent weeks thanks largely to improved market conditions.

Analysts expect Goldman to earn $3.25 per share for the first quarter, on average, according to Thomson Reuters I/B/E/S, up from an estimate of $2.89 per share 30 days ago. The figure compares with adjusted earnings of $4.38 a year ago, excluding a one-time cost of redeeming preferred stock.

(Reporting By Lauren Tara LaCapra; Editing by Alwyn Scott, Steve Orlofsky, Gary Hill).

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