Lehman net falls less than expected

NEW YORK (Reuters) - Lehman Brothers Holdings Inc LEH.N said on Tuesday quarterly earnings fell 3.2 percent on writedowns linked to mortgages and leveraged loans, but its shares rose as the results beat expectations and the investment bank said the worst of the credit correction was over.

The results soothed investors concerned that the widening U.S. subprime mortgage and credit crisis would wallop investment bank earnings. Shares of Goldman Sachs Group Inc

(GS.N) and Morgan Stanley (MS.N) also gained, on hopes their earnings reports later this week will also be strong.

"People were expecting considerably worse. Everybody was expecting bigger writedowns, given Lehman's exposure to the fixed income markets," said Lee Delaporte, director of research at Dreman Value Management, which has $22 billion of assets under management.

Lehman Brothers, traditionally seen as a U.S. bond house, has worked to bolster businesses including asset management and merger advisory, and now generates more than half its revenue outside the United States.

That diversification likely prevented the bank's results from being even weaker this quarter, analysts said. Bear Stearns Cos Inc, BSC.N which also reports earnings this week, is less diversified, and its shares edged lower.

Lehman said its earnings were $887 million, or $1.54 a share for the fiscal third quarter ended August 31, compared with $916 million, or $1.57 a share in the same quarter last year.

Analysts had on average expected earnings of $1.47 a share before exceptional items, according to Reuters Estimates.

Total net revenue rose 3 percent to $4.3 billion, but fixed income sales and trading revenue declined 47 percent to $1.1 billion.

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Lehman said it wrote down some $700 million of residential mortgage positions and loan commitments, after accounting for gains in its hedges, and said the outlook for credit looks better.

"Barring any unforeseen circumstances, we feel that the worst of this credit correction is behind us," said Lehman Chief Financial Officer Chris O'Meara on a conference call with investors.

Lehman's bonds rose relative to Treasuries, and its shares rose $2.38 to $60.95 in afternoon trading on the New York Stock Exchange.

But shares of the fourth largest U.S. investment bank are still down more than 20 percent since the beginning of the year, more than twice the decline for the overall sector.

Investors are concerned about Lehman's exposure to U.S. subprime mortgages. The company said earlier this month that it was shuttering BNC Mortgage, its subprime lending business, but Lehman still has mortgage assets whose value may decline.

Lehman also has billions of dollars of exposure to leveraged buyout deals--about $27 billion of commitments to deals, down from $44 billion at the end of last quarter, O'Meara said.

Shifting the risk from those assets to investors may be difficult.

"The key point to ask is how much is still on the books that they didn't address yet," said Robert Lutts, president and chief investment officer at Cabot Money Management in Salem, Massachusetts, adding that it is too soon to buy investment bank stocks.

Even with the writedowns, the company's book value per share rose to $38.29 from last quarter's $37.15.

Lehman's shares trade at about 1.6 times their book value, while last year the company's shares were more than two times their book value. That valuation may not be compelling until the price-to-book ratio is closer to 1.25 or 1.5 times, said Blake Howells, director of research at Becker Capital Management in Portland, Oregon.

Return on average common equity, a measure of how effectively the company generates profits from its net assets, was 17.1 percent, down from 21 percent in the same quarter last year.

(Additional reporting by Tim McLaughlin, Joseph A. Giannone, and Neil Shah)