NEW YORK (Bloomberg) — Lehman Brothers Holdings Inc., led by its strength in bond trading, reported a 22 percent increase in fourth-quarter profit and ended the year with a record $4 billion in earnings.Net income climbed to $1 billion, or $1.72 a share, the highest ever for the three months ended November 30, from $823 million, or $1.38, a year earlier, the New York-based company said in a statement yesterday. The earnings exceeded the average estimate of $1.68 a share in a Bloomberg survey of 16 analysts.

Lehman, the fourth-largest US securities firm by market value, increased earnings at a slower pace than competitors Goldman Sachs Group Inc. and Bear Stearns Cos. Growth was led by a 31 percent gain in revenue from fixed-income sales and trading. Fees from investment banking rose five percent, reversing a third- quarter decline.

“Lehman’s business domestically and internationally is firing, particularly on the fixed income side,” said Tom Jalics, an analyst at National City Bank, which manages about $32 billion in client accounts, including Lehman shares. “The market may be a little disappointed with yesterday’s 3 or 4 cent gain, but it’s going to be good at the end.”

Lehman chief executive officer Richard Fuld spent the past five years trying to reduce the firm’s dependence on the fixed- income markets. In fiscal 2006, equities sales and trading, asset management, brokerage services, mergers and acquisitions and stock underwriting accounted for 44 percent of Lehman’s revenue, up from 41 percent in the year-ago period and the highest since 2001.

Shares of Lehman fell 29 cents to $76.08 at 4:02 p.m. in New York Stock Exchange composite trading.

Revenue from equity sales and trading rose 22 percent to $900 million in the fourth quarter, compared with $2.14 billion in revenue from bond trading.

Total revenue for the quarter increased 23 percent to $4.53 billion. Return on average common equity, a measure of how well a company reinvests its earnings to generate additional profit, was 22.3 percent in the quarter, up from 20.9 percent a year earlier.

For the full year, Lehman’s net income climbed 23 percent, as revenue rose 20 percent to $17.6 billion.

Analysts underestimated Lehman’s earnings by an average 9.9 percent for the past five quarters. New York-based Goldman exceeded the average fourth-quarter estimate by almost 7 percent.

Lehman’s stock has gained 19 percent this year, the worst performance among the five biggest U.S. securities firms. Goldman has surged 57 percent. Morgan Stanley is up 40 percent, Bear Stearns Cos. 38 percent. Merrill Lynch & Co. shares increased 34 percent. Last year Lehman’s stock was the top performer.

Revenue from investment banking rose in the fourth quarter to $858 million. Investment management revenue surged 26 percent to $640 million.

Lehman underwrote $2.86 billion of initial public offerings during the fourth quarter, up 47 percent from the same period in 2005, data compiled by Bloomberg show. Lehman was one of the four investment banks that managed last month’s $1.32 billion IPO of Hertz Global Holdings Inc., the car-rental company.

At the end of fiscal 2006, Lehman’s merger and acquisition pipeline had $348 billion, compared with $236 billion a year ago, Chief Financial Officer Chris O’Meara said in a conference call today. The debt underwriting pipeline had $58 billion, compared with $51 billion at the end of 2005. The equity underwriting pipeline is down to $17 billion from $19 billion, O’Meara said.

Mergers and Acquisitions

The firm also advised on $78 billion of corporate takeovers completed during the quarter, 19 percent less than a year earlier, according to Bloomberg data. Lehman is the eighth-ranked adviser on M&A deals announced this year, down from seventh in 2005.

The slip in the global league tables was partly due to the surge in banking activity this year in Asia, where Lehman is still building its franchise, O’Meara said. The firm has been investing in Asia and Europe, and the fruits of those investments will be coming “gradually” in coming years, he said.

In trading, Lehman’s custom products include options contracts that let investors speculate on the volatility of an underlying asset and exchange-traded funds that are linked to different stock market indexes.

“Brokers are enjoying growth in their earnings because they don’t just trade stocks and bonds anymore,” said James Ellman, who manages more than $100 million at Seacliff Capital LLC and holds Lehman shares. “There are so many derivative products that trading revenues keep rising.”

Lehman has traditionally ranked among the three largest underwriters of securities backed by mortgages in the U.S. A housing slowdown has reduced applications for new mortgages and refinancings, shrinking the pool of loans available to be packaged into bonds.

During the quarter, Lehman sold $41 billion of residential mortgages packaged into bonds, which was an increase from the previous quarter, O’Meara said. The amount securitised was slightly lower than a year earlier, he said, without giving comparable figures. Sales of mortgage loans were “flat” in the fourth quarter, O’Meara said.

Lehman earned 37 percent of its 2006 revenue from outside the US, compared with 36 percent last year. Non-U.S. revenue rose 21 percent to a record $6.5 billion, the firm said.

Lehman paid Fuld, 60, a stock bonus of $10.9 million for 2006, part of $35.9 million in grants it handed out to the firm’s top six executives. Those figures don’t include salaries or cash bonuses.

Compensation Costs

The firm’s total compensation costs were 49.3 percent of net revenue in the quarter and the full year. The ratio was up from 48.7 percent in the fourth quarter of last year and unchanged from the 2005 average.

Lehman’s compensation ratio has been higher than its rivals’ over the past five years, averaging 50.1 percent through 2005, compared with 49.5 percent at Merrill Lynch and 41.8 percent at Morgan Stanley.