Uneasy Signs at Lehman

Profit beats estimates, but housing weakness takes a toll.
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earnings squeaked past estimates, but early signs of weakness from mortgage-related products showed through.

Lehman's profit rose to $1.1 billion, or $1.96 a share, for the quarter ended Feb. 28, up from the year-ago profit of $1.83 a share. Revenue rose 13% to $5.04 billion.

Analysts were hoping the company would make $1.95 a share on $4.97 billion of revenue.

Principal transactions jumped 18.6% from a year earlier to $2.92 billion, while Lehman's capital markets business brought in $3.5 billion of revenue, up 15% from a year ago.

While the equities business had strong results, jumping 42% from growth in execution and prime brokerage services, the fixed-income side showed signs of weakness. Revenue inched higher by 3% from a year earlier and just 1.4% from the fourth quarter to $2.1 billion.

The brokerage firm said "record" results in credit products and "strong performance" in real estate were offset by "declines in securitized products due to weakness in U.S. residential mortgage sector and in interest rate products."

Revenue from investment management rose 20% from a year earlier to $695 million.

Lehman has been bulking up on its alternative asset-management offerings. The firm announced on Tuesday that it had purchased a 20% stake in the hedge fund D.E. Shaw, which provides a variety of alternative and long-only products.

"We suspect that Lehman has negative marks on its subprime mortgage inventory, weaker originations, and worse securitizations, mitigated by gains from hedging," writes analyst Mike Mayo of Prudential Equity Group. "We expect the conference call to shed more light on the subprime mortgage business, which will likely remain a drag on the company's revenues, especially given an increase in problems since quarter-end."

But Lehman "showed that it can meet expectations despite big fall-out in subprime mortgages," he writes. "While questions remain about the ongoing drag, the quarter showed that this business is not terribly large in the scheme of Lehman's company." He rates the company overweight.

Investors will be leery to hear what Lehman's management team says about the subprime sector during a conference call Wednesday morning. Shares of Lehman sank 90 cents, or 1.2%, to $71.10 in premarket trading.