June 12 (Bloomberg) -- Lehman Brothers Holdings Inc., the first of Wall Street's biggest firms to report second-quarter earnings, said profit rose 27 percent to a record as a rally in stocks fueled equity trading and investment-banking revenue increased.

Net income climbed to $1.27 billion, or $2.21 a share, in the three months ended May 31, from $1 billion, or $1.69, a year earlier, New York-based Lehman said in a statement. Earnings exceeded the highest estimate of 16 analysts polled by Bloomberg.

Equity-trading revenue almost doubled and underwriting fees increased 76 percent, as Chief Executive Officer RichardFuld reduced the firm's dependence on fixed-income markets by expanding abroad and making bigger bets for its own account. Lehman and its four largest rivals have more opportunities to profit because the U.S. Securities and Exchange Commission is loosening restrictions that tied up capital they use to trade.

``They did extraordinarily well during the quarter,'' said Carl Salvato, who helps manage $400 million at Great American Companies in Tampa, Florida. ``They've diversified away from fixed income toward equities, and increased their international exposure.''

Shares of the company rose 38 cents, or 0.5 percent, to $76.06 in composite trading on the New York Stock Exchange at 4 p.m. The Standard & Poor's 500 Index fell 1.1 percent.

Lehman's revenue climbed to a record $5.51 billion from $4.41 billion a year earlier. The firm generated 48 percent of that total from non-U.S. sources, up from 40 percent in the first quarter and 37 percent last year.

Fixed-Income Decline

Demand for prime-brokerage services and derivatives, as well as proprietary bets, drove equity-trading revenue to $1.7 billion, an all-time high, Lehman said. Asset-management revenue rose 33 percent to a record $460 million.

Lehman, the biggest U.S. underwriter of mortgage bonds, said revenue from fixed-income trading, which includes bonds, currencies and credit derivatives, fell 14 percent to $1.89 billion.

``Continued weakness in the U.S. residential mortgage business'' contributed to the decline in fixed-income revenue, Lehman said in the statement.

Rising delinquencies in the subprime mortgage market haven't spread to other areas, Chief Financial Officer Christopher O'Meara said on a conference call with investors. The firm saw some improvement in subprime loan pricing near the end of the quarter, O'Meara said.

Return on Equity

Return on equity, a measure of how effectively the firm reinvests earnings, rose to 25.8 percent compared with 23.7 percent last year. The firm added 1,233 people to its headcount during the quarter, bringing the total to 28,323.

Wall Street firms are borrowing more and taking bigger risks on higher-returning investments since the SEC eased capital requirements last year. Lehman's leverage ratio, or total assets relative to shareholders' equity -- has risen to about 28.6 from 26 in 2006.

``Lehman still has room to increase leverage and boost earnings further,'' said Brad Hintz, a New York-based analyst at Sanford C. Bernstein & Co., who formerly served as Lehman's chief financial officer.

Investment-banking revenue rose 55 percent to $1.15 billion. Lehman, the fourth-largest securities firm by market value, arranged $5.5 billion of stock offerings in the second quarter, 20 percent more than a year earlier, including the initial public offering of David Einhorn's Greenlight Capital Re Ltd.

O'Meara said the firm had a $30 billion backlog of equity deals at the end of the second quarter.

Merger Work

Lehman's fees from arranging mergers and acquisitions increased 14 percent to $277 million. The firm advised Woonsocket, Rhode Island-based CVS Corp. on its $21 billion purchase of Caremark Rx Inc., which was completed in March, and helped a group led by billionaire Haim Saban arrange their $12 billion purchase of Univision Communications Inc.

The backlog of M&A transactions at the end of last quarter was $584 billion, O'Meara said.

``The pleasant environment for Lehman and the others continues,'' said Michael Holland, who helps manage about $4 billion at New York-based Holland & Co. ``Capital markets have been good, and they're generating fees from investment-banking and asset management.''

Credit Suisse analyst Susan Katzke raised her earnings estimate for 2007 to $7.95 per share from $7.20 after earnings were released. Analysts on average expect earning per share this year of $7.36.

Goldman, Bear Stearns

Analysts are less bullish about earnings for Goldman Sachs Group Inc. and Bear Stearns Cos., which both post second-quarter results on June 14. Goldman probably will report a 2 percent drop in net income and Bear Stearns may say profit fell 9 percent, according to analysts' estimates compiled by Bloomberg.

Goldman ranks as the biggest U.S. securities firm by market value, followed by Morgan Stanley and Merrill Lynch & Co. All the firms are based in New York.

Shares of Lehman dropped 3.1 percent this year through yesterday, the third-worst performance after Bear Stearns and Merrill of the 12 members in the Amex Securities Broker/Dealer Index, reflecting concern about rising delinquencies in the mortgage market. Lehman, like Wall Street rival Bear Stearns, underwrites and purchases mortgage loans, and then packages them into securities.

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

Last Updated: June 12, 2007 16:12 EDT