The I-Banks Ain't Done Yet: Lehman's Earnings

As the market has continued to hurtle forward through the first half of 2007, results for Lehman Brothers' (NYSE: LEH  ) second quarter suggest that the major brokerage houses have been able to keep up, despite some roughing up at the hands of the residential housing market.

For the quarter, the firm reported diluted earnings per share of $2.21, up 31% from $1.69 in the second quarter of last year. The reported EPS was also a good 20% higher than Wall Street analysts' projections for the quarter. Revenue was likewise up nicely to $5.5 billion, a 25% bump from May 2006.

In a remark released with the earnings, Lehman's CEO, Richard Fuld Jr., tipped his hat to the firm's commitment to "diversified growth." He was specifically referring to the fact that nearly half of Lehman's revenue for the quarter came from outside the U.S., but the results also spoke to the diversity and strength of the firm's multiple business segments.

Not surprisingly, the residential mortgage market provided some drag on Lehman's results. Despite strong demand in some credit areas, its fixed-income capital markets segment (i.e. bond trading) was down 14% year over year. More than balancing this out, though, was a stellar performance from its equity capital markets, which nearly doubled from May 2006 and led to an overall 17% increase for the capital markets segment. The equity capital markets business produces its results from activity from customers such as hedge funds, as well as the firm's proprietary trading.

Lehman's two other segments, investment banking and investment management, also performed well and increased revenue 55% and 30%, respectively, year over year. Investment banking had the recently robust debt markets to thank for much of its performance, as debt origination revenue was up 87% and provided nearly half of the investment banking revenue.

For those concerned about the way the major investment banks are financing themselves, the report from Lehman provided little comfort. The firm's leverage ratio, which is total assets divided by shareholder equity, has continued to increase and finished the quarter at 28.6, up from 25.4 in the second quarter of 2006. Its net leverage ratio -- which uses tangible shareholder equity and excludes some low-risk assets such as cash and equivalents from the numerator -- is likewise up, from 13.8 last year to 15.5 currently.

Barring firm-specific missteps, the results from Lehman likely bode well for the other investment banks that are on deck to report second-quarter earnings. We will hear from Goldman Sachs (NYSE: GS  ) and Bear Stearns (NYSE: BSC  ) later this week, and then Morgan Stanley (NYSE: MS  ) will follow next week.

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Fool contributor Matt Koppenheffer does not own shares of any of the companies mentioned. The Fool's disclosure policy has never once been caught with its pants down. Of course, it doesn't actually wear pants ...


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