March 15 (Bloomberg) -- Bear Stearns Cos., the biggest U.S. underwriter of mortgage bonds, said first-quarter profit rose 8 percent as higher revenue from trading derivatives and debt of troubled companies overcame a slowing market for home loans.

Net income climbed to $554 million, or $3.82 a share, in the three months ended Feb. 28, from $514 million, or $3.54, a year earlier, the New York-based company said today in a statement. Earnings exceeded the average estimate of 12 analysts surveyed by Bloomberg by 4 cents a share, the smallest margin in at least six quarters.

Bear Stearns, which gets about half its profit from the debt market, said revenue from bonds climbed 27 percent, dwarfing gains from trading stocks and advising on mergers and acquisitions. It was held back by a decline in residential mortgages, echoing comments made yesterday by Lehman Brothers Holdings Inc., the second-largest investment bank for securities backed by home loans.

``Bear has been more conservative than most other mortgage originators and securitizers, so it's not as badly affected,'' said Guy-Max Delphin, a Boston-based analyst at Fortis Investments, which manages $153 billion and holds Bear Stearns shares. ``Meanwhile, they're doing great with other fixed-income products.''

Residential mortgage-related revenue decreased in the quarter, ``reflecting weakness in the U.S. residential mortgage- backed securities market,'' Bear Stearns said. The firm underwrote $21 billion of mortgage-backed bonds in the quarter, 28 percent lower than a year earlier, Chief Financial Officer Samuel Molinaro said in a conference call with analysts.

Subprime Holdings

The ratio of subprime loans in the firm's mortgage business was about 3 percent, Molinaro said. While he expected about a 30 percent decline in the amount of subprime loans made this year, there's still demand from investors for such mortgages made under tougher standards, he said.

Shares of Bear Stearns rose after Molinaro's comments on subprime mortgages. The stock finished with a gain of $3.21, or 2.2 percent, to $148.50 in New York Stock Exchange composite trading. The shares have declined 8.8 percent this year, compared with a 5 percent drop in the 12-member Amex Securities Broker/Dealer Index.

Credit derivatives and distressed debt helped the credit business post record net sales, the firm said. Derivatives are financial instruments derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in the weather or interest rates.

Defaulted Debt

The credit business performed well ``across the board,'' Molinaro said in an interview. Trading of all types of credit derivatives has been rising in European and U.S. markets, he said.

``Credit spreads are very tight,'' he said. ``There's been a lot of customer activity in both cash and synthetic credit products.''

Bear Stearns had more ``favorable outcomes'' on its distressed debt purchases, adding to revenue, Molinaro said. There wasn't an increase in companies going bankrupt, he said.

Lehman, Bear Stearns's largest Wall Street rival in the mortgage market, and Goldman Sachs Group Inc., the biggest U.S. securities firm by market value, have reported record first- quarter earnings.

Mortgage `Weakness'

Lehman also said yesterday ``weakness'' in the mortgage market limited revenue growth and its profit exceeded analysts' estimates by the smallest margin in at least six quarters. Profit at Goldman, which said it has limited mortgage risks, beat analysts' most-bullish predictions by 19 percent.

The company's return on equity was 18.3 percent in the first quarter, compared with 20.1 percent a year earlier.

Fixed-income revenue at Bear Stearns, which includes mortgage-bond underwriting and bond trading, rose to $1.1 billion in the first quarter. Revenue from equity sales and trading climbed 3 percent to $500 million.

Chief Executive Officer James Cayne's push in investment banking resulted in Bear Stearns winning higher fees from advising on mergers and share sales during the first quarter. Investment-banking fees increased 3 percent to $303 million. Excluding merchant banking revenue, which fell, investment banking revenue would be up 20 percent, the firm said. The decline in merchant banking resulted from one-time gains a year ago when some of the investments in the portfolio were sold at a profit, CFO Molinaro said in the interview.

Takeover Advice

Bear Stearns advised on takeovers valued at $57 billion that were completed during the latest quarter, rising from $35 billion a year earlier, data compiled by Bloomberg show. Equity underwriting rose to $2.1 billion from $844 million.

``The strong investment-banking backlogs from last year are helping in the first half,'' said Matthew Albrecht, a New York- based analyst at Standard & Poor's, who has a ``hold'' rating on Bear Stearns shares. ``The mortgage downturn hasn't hurt much yet, but if the situation is prolonged, then it will.''

Revenue from clearing services, which includes the money Bear Stearns makes serving hedge funds, gained 5 percent to $276 million. The firm is the top ``prime broker'' in the U.S. based on total assets of the hedge funds it serves. The gains in prime brokerage revenue were partially offset by clearing revenue for retail clients, CFO Molinaro said.

Buying Lenders

Bear Stearns bought lenders in the U.S. and the U.K. to supply mortgages to customers with the worst credit histories. The loans are then packaged into securities and sold to investors. Late payments on U.S. subprime mortgages rose to a four-year high of 13.3 percent at the end of last year, according to the Mortgage Bankers Association. More than 20 lenders have closed or sought buyers since the start of 2006, according to Bloomberg data.

The firm held $1.3 billion of ``residuals,'' the parts of mortgage securities that are the highest-yielding, at the end of November, company filings show. The value of the residuals on the company's balance sheet will remain about the same by the end of this year, while the ratio of subprime in the mix will decline, CFO Molinaro said.

``Bear's exposure to subprime mortgages through residuals should have no more than a 5 percent adverse effect on earnings,'' wrote Fox-Pitt, Kelton Inc. analyst David Trone in a March 1 note. ``The company hedges at least some of its credit risk, although it is unclear how much.''

Molinaro said the mortgage position was ``well-hedged,'' without providing details.

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

Last Updated: March 15, 2007 16:45 EDT