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Wells Fargo Confirms Robust Earnings

Wells Fargo on Wednesday confirmed its preliminary report of record first-quarter profits, citing a booming mortgage business and strong interest margins.

Updated from 12:30 p.m. EDT

Wells Fargo


succeeded on Wednesday in convincing some of Wall Street's doubting Thomases that its earnings were as robust as initially reported, but worries persisted that economic headwinds may stifle future results.

Wells reported a first-quarter profit of $2.38 billion, or 56 cents per share, which translated into $3.05 billion when excluding preferred dividends. Its bottom line sailed 19% from the year-ago period when it posted a profit of $2 billion, or 60 cents per share. The earnings per share figure was higher in the earlier period, because there were fewer shares outstanding.

The official results confirmed Wells'


on April 9, which sent its shares up more than 31% that day. Wells was up much of Wednesday, but closed down 3.4% to $18.18 amid broad declines in bank shares following

Morgan Stanley's


weak report.

In prepared comments, CEO John Stumpf and CFO Howard Atkins sought to allay


that results were artificially boosted by mark-ups on Wachovia assets that were heavily written down in the fourth quarter. They also sought to give the impression that strong earnings generation lessened the firm's need for additional capital.


We believe a company that is building capital through retained earnings at a high and consistent rate like Wells Fargo is a more strongly capitalized bank than a bank with the same point-in-time capital ratios that is losing money or has volatile earnings," Atkins said.

The ever-scrutinized tangible common equity ratio at Wells climbed to 3.28% from 2.86% at the end of last year. Atkins attributed capital strength to several factors: Wells' "diversified business model" -- an attribute he touted several times -- as well as its strong operating margins; synergies from the Wachovia acquisition; and the fact that a huge portion of risk was wiped from Wells' books last quarter.

The firm estimates that Wachovia's full integration will retain an additional $5 billion in cost savings each year, as will its decision to slash the common dividend by 85%.

Wells took advantage of a low interest-rate environment that has made interbank borrowing cheaper and spurred a housing market resurgence of sorts. It also benefitted from a "flight to quality" as more consumers opted to stash cash in bank accounts rather than equity markets.

Wells posted a net-interest margin of 4.16%, which represents the difference between its price of borrowing and the price it charges to lend. Core deposits grew 6% on an annualized basis from the end of 2008, at $756.2 billion on March 31. Checking and savings deposits were up 31%.

In terms of lending, the San Francisco-based bank extended $175 billion in credit last quarter through loans, mortgages and mortgage securities purchases. The firm made $101 billion in mortgage originations to 450,000 refinancers and entry-level homebuyers entering a market of cheap houses and low interest rates.

Stumpf was braggadocious about Wells' strength, attributing its results to prudent lending in the boom times and market-share gains as competitors remain distracted by bad loans. After its acquisition of


, Wells now serves one in three U.S. households and services one in every six mortgages.

"The best way to generate capital is to earn it," Stumpf said in a statement. "This has long been the hallmark of our company .... We are open for business and we're gaining wallet share and market share, as we've always done in economically challenging times, because we make fewer mistakes than our competitors in the so-called 'good times' and have fewer problems to fix."

Atkins also asserted that Wells' net-interest margin, as well as deposit growth, were "the highest among our large bank peers," while its nonperforming asset ratio was the lowest.

But there was no denying that asset deterioration occurred, and that related losses may continue to climb as the economy rights itself. As Chief Credit Officer Mike Loughlin pointed out, perhaps obviously, "As long as the U.S. economy remains weak, losses on the combined portfolio will increase."

Wells posted a provision expense of $4.6 billion last quarter, which included $3.3 billion in charge-offs and a $1.3 billion build to reserves for future losses. Nonperforming loans accounted for 1.25% of total loans, up 46 basis points.

Atkins said the $23 billion in credit reserves that Wells posted in the first quarter "fully covered" projected losses over the next year. He also said that while less-impaired loans may fall further, Wells effectively erased the riskiest risk from its books by writing down Wachovia's most troubled loans by $37.2 billion last year.


The remaining balance of the impaired portfolio -- with $58 billion in total -- had virtually no remaining loss content at year-end," Atkins said. "To repeat: the estimated life of loan loss content related to the designated impaired portfolio was removed from our balance sheet at year-end and we are confident that as long as there is no additional deterioration, future losses have been eliminated."

While saying it is "too early to call a turn in credit," Atkins added that the mega-writedowns on Wachovia loans will provide a

"substantial" benefit

once conditions improve and those assets can be marked up further.


were circumspect about the initial results, which blew away their estimates by a long shot. But on Wednesday, even some of the most cynical had good things to say.

R. Scott Siefers, an analyst with Sandler O'Neill struck a more bullish tone in a report on Wednesday, calling it a "strong" quarter, with core earnings at 48 cents per share, when stripping out unusual items -- "a few times higher than we had expected it to be prior to the pre-release."

Siefers maintained a hold rating, saying he has "mixed feelings," and doesn't expect shares to sail much higher given the recent rally. He also cited an outlook for a continued climb in credit costs, as well as the unlikelihood that huge benefits from the first-quarter mortgage boom will be sustained over the long-term.

Nonetheless, "the company is printing good profitability at a time when much of the industry is struggling under a mountain of losses," Siefers writes. "Also, purchase accounting treatment from the

Wachovia transaction affords the company a large degree of flexibility that others lack."