Sept. 20 (Bloomberg) -- Bear Stearns Cos., the securities firm hit hardest by the collapse of the subprime mortgage market, reported its biggest profit decline in more than a decade.

Third-quarter net income dropped 61 percent to $171 million, or $1.16 a share, in the three months ended Aug. 31 from $438 million, or $3.02, a year earlier, the New York-based firm said today in a statement. Profit fell short of analysts' estimates.

Bear Stearns, led by Chief Executive Officer James ``Jimmy'' Cayne, said revenue from fixed-income sales and trading slumped 88 percent amid ``extremely challenging'' market conditions. The failure of two Bear Stearns hedge funds, which bet on mortgage securities, saddled the firm with $200 million of losses. Investors spooked by the July meltdown fled high-risk, high-yield debt, freezing global credit markets.

``The worst is definitely behind us,'' Bear Stearns Chief Financial Officer Samuel Molinaro said today in a conference call with investors.

Lehman Brothers Holdings Inc. and Morgan Stanley fared better during the quarter because Bear Stearns depends more on the U.S. for profits. Goldman Sachs Group Inc., the biggest securities firm, said today that profit surged 79 percent, after the sale of a power company boosted revenue.

Cayne and his team ``are facing up truthfully to what's going on and working their way through it,'' said Peter Goldman, a managing director at Chicago Asset Management LLC, which owns about 46,000 Bear Stearns shares. ``There was never any question'' that the firm might have to record losses from the turmoil in U.S. debt markets.

$700 Million Writedown

Revenue fell 38 percent to $1.33 billion in the third quarter from $2.1 billion last year. Return on equity dropped to 5.3 percent from 16 percent a year earlier, trailing Lehman's and Morgan Stanley's 17 percent.

Bear Stearns wrote down the value of mortgage assets and leveraged loan commitments by $700 million, after using financial-market hedges to mitigate the loss, according to Molinaro. The firm had $7 billion of commitments to leveraged buyouts at the end of the quarter, $2 billion of which were funded, he said.

Lehman said Sept. 18 that it also capped losses on leveraged loans and mortgage investments at $700 million, net of hedging.

Bear Stearns and its rivals may benefit after the U.S. Federal Reserve lowered its benchmark short-term interest rate by a half-point to 4.75 percent. The Sept. 18 cut reduced the cost of financing trades and loans for the securities industry.

Hostile Environment

``If there's a market turn, Bear Stearns has the most upside to go because its share price has dropped so much,'' said Matt Albrecht, a New York-based equity analyst at Standard & Poor's who recommends selling Bear Stearns shares.

Bear Stearns, founded in 1923, was battered as the number of U.S. home loans entering foreclosure rose to a record in the second quarter. About 30 percent of Bear Stearns's fixed-income revenue comes from mortgages and related securities, according to estimates from Sanford C. Bernstein & Co. analyst Brad Hintz. The firm doesn't provide a breakdown for mortgage-related revenue.

``They're going through an environment that's designed as badly as they could imagine,'' said Hintz, who has a ``market perform'' rating for the stock. ``Fixed income will recover slowly, and along with that their earnings will too, but it will take time.''

The Bear Stearns hedge fund collapse led to the ouster of Co-President Warren Spector on Aug. 5. Spector, 49, was viewed by analysts as the most likely successor to the 73-year-old Cayne. The funds caused $200 million of losses and ``expenses'' in the quarter, the firm said.

Hedge Fund Defections

Some hedge fund clients of Bear Stearns's prime brokerage defected to other firms during the turmoil, reducing debt balances in the unit to $85 billion at the end of August from $108 billion in the previous quarter, Molinaro said today. The departures halted in mid-August and some customers have returned, he said.

Employees haven't fled and morale remains ``very good,'' Molinaro said. Headcount, up 396 to 15,516 at quarter-end, will ``likely be trending downward'' for the rest of the year because of cuts in the mortgage origination business, he said. The firm will evaluate whether more reductions are needed next year.

Shares of Bear Stearns dropped 29 percent this year, the worst performance of the five biggest U.S. investment banks. The stock fell 18 cents to $115.46 in New York Stock Exchange composite trading today.

Share Buyback

``Bear Stearns is in the worst shape on Wall Street because it has the most exposure to fixed income and least to international markets,'' said Albrecht of Standard & Poor's. ``Their reliance on the mortgage market isn't going to help as that market continues to roil.''

The company's board approved a plan to buy back up to $2.5 billion of shares, including $1 billion from the open market. The firm bought $1.3 billion of stock under the previous plan to repurchase as much as $2 billion.

Morgan Stanley, the world's second-biggest securities firm by market value, reported a 7 percent drop in profit from continuing operations yesterday, a steeper decline than analysts estimated, because of losses on loans for leveraged buyouts and a decline in fixed-income trading revenue.

Goldman Sachs said today that net income rose to $2.85 billion, or $6.13 a share, from $1.59 billion, or $3.26, a year earlier. Earnings beat analysts' estimates, the seventh straight quarter that Goldman has surpassed expectations. Merrill Lynch & Co., the third-largest, publishes results next month. All the firms are based in New York.

Third-quarter revenue from equity sales and trading climbed 53 percent to a record $719 million. Investment-banking fees fell 9 percent to $211 million. Clearing, which includes providing brokerage services for hedge funds, rose 30 percent to a record $332 million.

To contact the reporter on this story: Yalman Onaran in New York at yonaran@bloomberg.net.

Last Updated: September 20, 2007 17:08 EDT