Lehman Beats Estimates as Equities Offset Mortgages

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By Yalman Onaran

Sept. 18 (Bloomberg) -- Lehman Brothers Holdings Inc., the largest U.S. underwriter of mortgage-backed bonds, reported profit that beat analysts' estimates after limiting losses on home loans and leveraged-buyout financing.

Net income fell 3 percent to $887 million, or $1.54 a share, in the third quarter from $916 million, or $1.57, a year earlier, the New York-based company said today in a statement. The average estimate of 16 analysts surveyed by Bloomberg was $1.48 a share.

Chief Executive Officer Richard Fuld offset the slump in fixed income by reaping record fees from arranging mergers and boosting equity-trading revenue to more than $1 billion. Lehman said hedging helped cap losses on leveraged loans and mortgage holdings to $700 million, even after ``very substantial valuation reductions'' triggered by the global credit contraction.

``Lehman has done a better job of diversifying away from the fixed income and hedge fund dependency,'' said Peter Kovalski, who helps manage $12 billion, including Lehman shares, at Alpine Woods Investments in Purchase, New York. ``They have been investing more in their international business.''

European stocks and U.S. stock futures rose after Lehman released its earnings report. Lehman gained $1.18 to $59.80 at 8:44 a.m. in trading before the market opened in New York.

Revenue from fixed-income trading fell 47 percent to $1.06 billion in the quarter, while investment banking revenue gained 48 percent to $1.07 billion. Revenue from equities jumped 64 percent to $1.37 billion. Asset management and retail brokerage fees jumped 33 percent to $802 million. Revenue outside the U.S. accounted for 53 percent of the total, up from 48 percent in the second quarter.

First to Report

Return on equity decreased to 17 percent as of Aug. 31 from 21 percent a year ago.

Lehman is the first of the five biggest U.S. securities firms to post third-quarter profits. Morgan Stanley reports results tomorrow, followed by Goldman Sachs Group Inc. and Bear Stearns Cos. on Sept. 20. Merrill Lynch & Co.'s earnings will be published next month.

Lehman advised on $107 billion of corporate takeovers in the past three months, up 11 percent from a year earlier, and underwrote $5.5 billion of stock offerings, up 35 percent, data compiled by Bloomberg show.

General Electric Co. used Lehman for the sale of its plastic division to Saudi Basic Industries Corp. for $11.6 billion. Lehman also advised on Home Depot Inc.'s $8.5 billion sale of its construction-supply unit to a buyout group.

`Undervalued'

``Lehman's franchise has ample product and geographic diversification to offset some of the slowdown in mortgage and areas in credit such as leveraged lending,'' said UBS AG analyst Glenn Schorr in a Sept. 11 report to clients. ``Lehman's stock is undervalued relative to the long-term earnings power of the franchise.''

Lehman has declined 25 percent this year, the second-worst performance after Bear Stearns among the industry's five largest firms.

The subprime mortgage market ground to a halt after U.S. foreclosures rose to a record high in the second quarter. Lehman, which is cutting about 2,000 mortgage-related jobs, makes money lending to homeowners and packaging mortgages into bonds. Revenue from that business has dropped as investor appetite for such securities dwindled. Subprime home loans are made to borrowers with bad credit scores or heavy debt loads.

Expenses for the quarter included a one-time charge of $44 million for restructuring the mortgage business, Lehman said today. That lowered earnings per share by 6 cents.

`Credit Crunch'

Subprime losses spread to other credit markets in July as investors fled from high-risk, high-yield corporate debt to U.S. Treasuries. Lehman may have to fund $16 billion of loan commitments to leveraged buyouts at a loss because investors are reluctant to buy that type of debt, Citigroup Inc. analyst Prashant Bhatia estimated last month.

Sales of U.S. asset-backed securities, such as bonds that repackage subprime loans or credit card debts as well as collateralized debt obligations, fell 73 percent from a year earlier to $30 billion last month, according to estimates from analysts at Deutsche Bank AG.

``The corporate credit crunch will resolve itself over the next few weeks,'' said David Trone, an analyst at Fox-Pitt Kelton Cochran Caronia Waller LLC, in a Sept. 5 report. ``A big disconnect between market concerns and Lehman's actual experience continues.''

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