Sept. 18 (Bloomberg) -- Lehman Brothers Holdings Inc., the largest U.S. underwriter of mortgage-backed bonds, reported a smaller profit decline than analysts estimated after it limited losses on home loans and leveraged-buyout financing.

``The worst of this credit correction is behind us,'' Chief Financial Officer Chris O'Meara said in a conference call with analysts. Yields on many fixed-income assets now look ``attractive,'' and markets present ``trading opportunities,'' he said.

U.S. stocks rose, led by shares of investment banks, after Lehman reported a 3 percent decline in third-quarter profits and said that hedging in financial markets capped losses on leveraged loans and mortgage holdings at $700 million. Chief Executive Officer Richard Fuld's strategy of diversifying beyond fixed income produced record fees from arranging mergers and money management.

Net income declined to $887 million, or $1.54 a share, in the third quarter from $916 million, or $1.57, a year earlier, the New York-based company said today in a statement. The average estimate of 16 analysts surveyed by Bloomberg was $1.48 a share.

While fixed-income trading revenue fell 47 percent to $1.06 billion in the quarter, Lehman reported gains of at least 33 percent in equity trading, investment banking and money management.

Lehman shares gained 10 percent, the most in six years, after the Federal Reserve cut its benchmark interest rate. The stock climbed $5.87 to $64.49 in New York Stock Exchange composite trading.

Slowing U.S. Economy

Total revenue rose 3 percent to $4.3 billion. The firm generated more than half its revenue outside the U.S. for the first time, collecting 53 percent from overseas markets.

``Lehman has done a better job of diversifying away from the fixed income and hedge fund dependency,'' said Peter Kovalski, who helps manage $12 billion, including Lehman shares, at Alpine Woods Investments in Purchase, New York.

Lehman shares had declined 25 percent this year through yesterday, the second-worst performance after Bear Stearns Cos. among the industry's five largest firms.

The Fed took action after the two-year housing decline left a record number of Americans facing foreclosure and contagion from rising defaults on subprime mortgages threatened to slow the U.S. economy. The central bank lowered its target for overnight loans between banks to 4.75 percent today, the first cut in four years.

Market Storm

Lehman's bigger rival, Morgan Stanley, reports results tomorrow, followed by Goldman Sachs Group Inc. and Bear Stearns on Sept. 20. Merrill Lynch & Co.'s earnings will be published next month.

``Lehman's results show the remarkable capabilities of the investment banks to weather market storms,'' said David Easthope, an analyst at Celent, a Boston-based financial consulting firm.

Revenue from equities jumped 64 percent to $1.37 billion, and investment-banking rose 48 percent to $1.07 billion. The firm had a $1 billion backlog of investment-banking fees at the end of the quarter, according to O'Meara, the finance chief.

Asset management and retail brokerage fees increased 33 percent to $802 million. Return on equity decreased to 17 percent as of Aug. 31 from 21 percent a year ago.

Lehman said ``very substantial valuation reductions'' in its loan portfolio, triggered by the global credit contraction, were offset by hedges and increases in other assets.

Loan Commitments Drop

The $700 million writedown will be ``well received'' by investors, Wachovia Corp. analyst Douglas Sipkin said in a report today. The firm's bottom line was ``very impressive'' given the credit-market turmoil in July and August, he said.

Lehman ended the third quarter with $27 billion in lending commitments for leveraged buyouts, down from $44 billion at the end of the previous three-month period, according to O'Meara. The current figure includes $10 billion of new commitments.

The firm expects to lose more than $1 billion on the leveraged loans, even after scaling back in the third quarter, O'Meara said. Lehman is now demanding that private-equity firms make future loans more attractive to investors.

``If they have terms that work on the market, we're willing to do them,'' O'Meara said in an interview.

Credit-default swaps on Lehman fell about 15 basis points to 103 basis points, according to CMA Datavision in London. That means the cost to protect $10 million of Lehman bonds from default for five years fell to $103,000.

One-Time Charge

The subprime mortgage market ground to a halt after U.S. mortgages entering foreclosure rose to a record high in the second quarter. Lehman, which is cutting about 2,000 mortgage- related jobs, makes money lending to homeowners and packaging mortgages into bonds.

Revenue from that business has dropped as investor appetite for such securities dwindled. Lehman ended the quarter with $6.3 billion of subprime-mortgage assets, O'Meara said. Subprime home loans are made to borrowers with bad credit scores or heavy debt loads.

Expenses for the quarter included a one-time charge of $44 million for restructuring the mortgage business, Lehman said today. That lowered earnings per share by 6 cents.

Subprime losses spread to other credit markets in July as investors fled from high-risk, high-yield corporate debt to U.S. Treasuries. Lehman may have to fund $16 billion of loan commitments to leveraged buyouts at a loss because investors are reluctant to buy that type of debt, Citigroup Inc. analyst Prashant Bhatia estimated last month.

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

Last Updated: September 18, 2007 17:03 EDT