updated 9/13/2006 11:22:38 AM ET 2006-09-13T15:22:38

Lehman Brothers Holdings Inc. on Wednesday delivered third-quarter profit above analysts’ expectations as Wall Street’s No. 4 securities firm relied on trading gains to make up for a slowdown in investment banking activity.

The New York-based financial services firm said it was snared by challenging market conditions and signs the economy is moderating. The slow summer quarter not only curbed trading activities from the first half’s blistering pace, but dampened demand for merger advisory and initial public offerings.

Chairman and Chief Executive Richard Fuld, who in the past year has expanded the firm from its traditional roots as a bond house into more lucrative businesses, was still able to lead Lehman to its 16th straight quarterly profit. Although investment banking was weaker during the period, Fuld surprised Wall Street with equity trading gains despite a quarter that’s particularly punishing for stocks.

“Market conditions during the third quarter were clearly more challenging than during the first half of the year,” Fuld said in a statement. “However, despite the market environment and the typically slower activity of the summer months, these results are our best third-quarter results ever.”

Indeed, Lehman reported net income applicable to common stock of $899 million, or $1.57 per share, compared with $864 million, or $1.47 per share, a year earlier.

Stronger performance from Lehman’s equities capital markets business, along with the usual strength gleaned from fixed income, pushed revenue up 8 percent to $4.18 billion from $3.85 billion last year. The company’s investment banking business, which helped power earnings during a record first half, saw revenue decline 11 percent from last year.

The numbers still came in ahead of Wall Street predictions for earnings of $1.49 per share on revenue of $4.01 billion, according to analysts polled by Thomson Financial.

Analysts lowered projections for U.S. investment banks several times during the quarter, fearing the industry wouldn’t be able to compensate for a sharp decline in global stock markets and slowing economic growth.

Goldman Sachs Group Inc. on Tuesday reported that better-than-expected investment banking returns helped profit beat expectations, and reports are due out in the coming days from rivals Bear Stearns Cos. and Morgan Stanley Inc. Investors are looking for any signals corporate confidence has not waned, and that the big stock deals that helped profits soar during the first half will return in the current quarter.

The most-watched business among the Wall Street firms has been investment banking, where Lehman reported revenue dropped 11 percent to $726 million. The firm’s investment management division’s revenue sank 18 percent to $605 million.

However, Lehman Brothers said its pipeline of new deals remains at record levels. Fuld has hired dozens of investment bankers within the past year to beef up the business, and brought on former Lazard Freres & Co. veteran Felix Rohatyn to help orchestrate it.

The capital markets business, which includes equity and debt sales and trading, reported a 13 percent increase in revenue to $2.85 billion from $2.53 last year.

Equity trading jumped 31 percent to $837 million, with strength coming from its prime brokerage business. Lehman battled a major slowdown in trading during the period as major U.S. stock indexes began to erode in late May on concerns about interest rates, and only started to rebound last month.

The firm’s fixed income division, which contributes about two-thirds of the capital markets revenue, posted a 6 percent revenue increase to $2.01 billion.

Lehman Brothers, whose shares have been among the worst performing of its Wall Street rivals, rose in early trading on the New York Stock Exchange.

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