Bank of America

(BAC) - Get Report

said first-quarter earnings rose 11% from a year ago thanks to strength in its consumer-lending and credit card businesses, which offset a slide in mortgage banking.

The Charlotte, N.C., bank earned $2.68 billion, or $1.83 a share, in the first quarter, up from $2.42 billion, or $1.59 a share, last year. The latest quarter doesn't include FleetBoston, which the company acquired on April 1. It does include a charge of $285 million, or 16 cents a share, related to a settlement paid in the mutual fund probe, and a charge-off of $106 million in bad loans to


, the scandal-tarred Italian milk and food company.

Analysts had been forecasting earnings of $1.80 a share in the latest quarter for BofA, which temporarily is the nation's second-largest bank behind


. The bank will once again fall back into third place once the merger of

J.P. Morgan

(JPM) - Get Report


Bank One

(ONE) - Get Report

is completed.

Overall revenue rose 7% to $9.69 billion, reflecting net interest income of $5.97 million, up 11% from a year ago, and noninterest income of $3.72 billion, up slightly from a year ago. Expenses rose 15% from a year ago to $5.42 billion. Excluding the impact of the mutual fund settlement, expenses rose 9%, driven by an increase in revenue-based employee incentives and benefits costs.

The gain in interest income reflected higher interest rates, consumer and middle market commercial loan growth, and domestic deposit growth, partially offset by lower large corporate and foreign loan balances. Commercial loan growth was modest at best, rising just 4% from a year ago.

Noninterest income reflected improvements in equity investments, card income, investment and brokerage services, service charges and investment banking income. The bank continued to report fewer bad loans on its books, with nonperforming assets falling to their lowest level since 1999.

Mortgage banking income declined 48% from a year ago, driven by a slowdown in refinance activity, something that's likely to continue with interest rates expected to move higher. The mortgage operation recorded a $275 million writedown resulting from faster prepayment speeds due primarily to the low interest rate environment and changes in other assumptions.

But the bank also made money by repositioning its balance sheet for higher interest rates by selling debt securities for a gain of $495 million.

In early trading, shares of BofA were trading down $1.20, or 1.5%, to $79.30.

Bank stocks have been selling off the past few weeks in the anticipation that the Federal Reserve may have to move soon to raise interest rates to fend off a rise in inflation. Fear of a resurgence in inflation will likely be fanned again today with news from the Labor Department that consumer prices rose more than expected in March.

Higher interest rates tend to be bad for financial stocks because they makes some of their investments in mortgage-backed securities less valuable. Higher rates also discourage corporate bond underwriting and make it more expensive for consumers to take out mortgages.

But a slight rise in rates would be a welcome relief to banks like BofA, which have seen their net interest margins squeezed by historically low interest rates. Low rates have reduced the profitability of bank lending operations because banks have little room to arbitrage the difference between their own borrowing costs and the interest rates they can charge borrowers.

"One thing we've said about the banks is that they make a lot of money in the deposit business," says Peter Nerby, a senior credit analyst at Moody's Investor Service. "They make a huge amount of money from arbitraging deposits ... and they've been concerned about low interest rates because it makes the arbitrage more difficult."

In combining with Fleet, BofA now has nearly $1 trillion in assets and 180,000 employees. But bank executives said they plan to eliminate about 12,000 employees as part of the merger.