Lehman Beats Estimates, Limits Losses on Mortgages

Sept. 18 (Bloomberg) -- Lehman Brothers Holdings Inc., the largest U.S. underwriter of mortgage-backed bonds, reported a smaller profit decline than analysts estimated after it limited losses on home loans and leveraged-buyout financing.

``The worst of this credit correction is behind us,'' Chief Financial Officer Chris O'Meara said in a conference call with analysts. Yields on many fixed-income assets now look ``attractive,'' and current markets present ``trading opportunities,'' he said.

U.S. stocks rose, led by shares of investment banks, after Lehman reported a 3 percent decline in third-quarter profits and said that hedging in financial markets capped losses on leveraged loans and mortgage holdings at $700 million. Chief Executive Officer Richard Fuld's strategy of diversifying beyond fixed income helped Lehman reap record fees from arranging mergers and money management.

Net income declined 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.

Revenue from fixed-income trading fell 47 percent to $1.06 billion in the quarter, while investment-banking revenue rose 48 percent to $1.07 billion. Revenue from equities jumped 64 percent to $1.37 billion. Total revenue rose 3 percent to $4.3 billion.

Overseas Growth

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. The firm had a $1 billion backlog of investment banking fees at the end of the quarter, O'Meara said.

Asset management and retail brokerage fees increased 33 percent to $802 million. The firm collected 53 percent of its revenue outside the U.S., the first time overseas markets accounted for more than half.

``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.''

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

Lehman shares rose $2.19, or 3.7 percent, to $60.81 at 1:05 p.m. in New York Stock Exchange composite trading. They had declined 25 percent this year through yesterday, the second-worst performance after Bear Stearns Cos. among the industry's five largest firms.

Slowing U.S. Economy

All face the prospect of slowing U.S. economic growth, as a two-year housing decline worsens, according to David Berson, chief economist of Fannie Mae, the largest mortgage buyer. The number of Americans who may lose their homes to foreclosure more than doubled in August from a year earlier because subprime borrowers with adjustable-rate mortgages saw their monthly payments rise, RealtyTrac Inc. said today.

Lehman's bigger rival Morgan Stanley reports results tomorrow, followed by Goldman Sachs Group Inc. and Bear Stearns on Sept. 20. Merrill Lynch & Co.'s earnings will be published next month.

``Lehman's results show the remarkable capabilities of the investment banks to weather market storms,'' said David Easthope, an analyst at Celent, a Boston-based financial consulting firm.

Lehman said ``very substantial valuation reductions'' in its loan portfolio, triggered by the global credit contraction, were offset by hedges and increases in other assets.

Loan Commitments Drop

The $700 million writedown will be ``well received'' by investors, Wachovia Corp. analyst Douglas Sipkin said in a report today. The firm's bottom line was ``very impressive'' given the credit-market turmoil in July and August.

Lehman ended the third quarter with $27 billion in lending commitments for leveraged buyouts, down from $44 billion at the end of the previous three-month period, according to O'Meara, the finance chief. The current figure includes $10 billion of new commitments, he said.

Credit-default swaps on Lehman fell about 15 basis points to 103 basis points, according to CMA Datavision in London. That means the cost to protect $10 million of Lehman bonds from default for five years fell to $103,000.

Credit-default swaps were conceived to protect bondholders against default and pay the buyer face value in exchange for the underlying securities should a company fail to adhere to its debt agreements.

One-Time Charge

The subprime mortgage market ground to a halt after U.S. mortgages entering foreclosure 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. Lehman ended the quarter with $6.3 billion of subprime-mortgage assets, O'Meara said. 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.

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.