Lehman Takes Smaller Hit Than Expected

Lehman Brothers Holdings Inc. (LEH), the No. 4 investment bank, on Tuesday said third-quarter profits fell less than expected, as strength in stock trading and investment banking offset losses from the struggling mortgage market.

The report provided investors a crucial first glimpse at how Wall Street fared in the fallout from the mortgage crisis, which started when borrowers with poor credit began defaulting at a sharply higher rate earlier this year. Optimism about the financial sector pushed shares of investment banks higher, with Lehman up $1.27 to $59.89 at the market open.

"First take: the quarter could have been worse," Deutsche Bank analyst Mike Mayo said in a note to clients.

Lehman Brothers — the first of four to report results this week — said quarterly profit fell 3.2 percent to $887 million, or $1.54 per share, from $916 million, or $1.57 per share, a year earlier.

Stronger investment banking and retail brokerage fees pushed revenue up 3.1 percent to $4.31 billion. Those stronger businesses helped to compensate for a $700 million hit from "substantial valuation reductions" in mortgage-backed bonds and other investments.

The results topped Wall Street projections for a profit of $1.47 per share on $4.23 billion of revenue, according to analysts polled by Thomson Financial. However, analysts lowered their earnings expectations by about 16 percent over the last month as Wall Street remained uncertain about how much exposure Lehman had to decaying credit and mortgage markets.

"Despite challenging conditions in the markets, our results once again demonstrate the diversity and financial strength of the Lehman Brothers franchise, as well as our ability to perform across cycles," said Chairman and Chief Executive Richard Fuld in a a statement.

Fuld, who has led Lehman Brothers since the bank was spun off from American Express Co. in 1994, has tried to transform the company from a bond house into a full-service investment bank. The company has also made a big push overseas, which accounted for 53 percent of total revenue during the third quarter.

The expansion was well-timed: The U.S. credit markets descended into distress this summer, dragged by a mortgage industry suffering from decaying credit quality. Analysts were braced for steep losses during the quarter, but had hoped the big Wall Street investment banks were able to compensate through their diverse mix of businesses.

The mortgage meltdown has had ripple effects through Wall Street, pinching demand for some of the investment banks' best-selling products. Mortgage-backed bonds, collateralized debt obligations and asset-backed commercial paper are all much tougher to sell now.

Lehman Brothers undertook major cutbacks in its mortgage business this year, shuttering its subprime mortgage lending arm, BNC Mortgage, and laying off about 2,500 people. Lehman recorded a $44 million charge related to the BNC shutdown this quarter.

The biggest hit taken by Lehman was in fixed-income trading, which declined 47 percent to $1.06 billion during the quarter. The investment bank did not disclose how far the valuations have slipped for some of its asset-backed securities, including bonds that repackage subprime loans.

Advising on deals pushed investment banking revenue up 48 percent to $1.07 billion.

And, Lehman also recorded its second best quarter ever for stock trading, where revenue jumped 64 percent to $1.37 billion. Much of this growth was led by international stock markets and fees charged for giving advice. Asset management and retail brokerage fees gained 33 percent to $802 million.

Investments entrusted to the bank reached a record $275 billion from $207 billion a year earlier, despite some deterioration in the company's stock portfolio.

Lehman is the first of the five biggest U.S. investment banks to post third-quarter profits. Morgan Stanley reports results on Wednesday, followed by Goldman Sachs Group Inc. and Bear Stearns Cos. on Thursday. Merrill Lynch & Co. will report its third-quarter results in October.