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Wells Fargo's Boring Beat

Wells Fargo's first-quarter profit beat Wall Street expectations but the margin was modest compared to the rest of the money-center banks.



) -

Wells Fargo's

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earnings report: Yawn.

On Wednesday, the firm beat expectations by a measly 3 cents per share vs. outsized results from competitors. It also asserted that -- yeah, guys -- credit has "turned the corner," although its nonperforming assets and allowance for future losses climbed.

This was due in part to integration costs and a shift of

off-balance sheet loans onto Wells' books, thereby increasing credit costs. The bank's top-line results also suffered from an easing of the mortgage- refinancing wave that propelled growth for the past year.

To be fair,

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Bank of America

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, which all reported before Wells Fargo, had set the bar pretty high. JPMorgan kicked off the season for money-center banks, saying its profit had surged 55%, with CEO Jamie Dimon issuing glittery comments about the country's economic outlook. Bank of America -- a barometer of both the financial market and economy, due to its size and scale -- built further upon that success and optimism. And


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then stunned the market on Monday, reporting a $4.4 billion profit and encouraging signs about its restructuring.

The Street had been expecting Citi to simply break even. If the ugly stepchild of money-center banks could beat by that much, then

Wells Fargo -- which has been trouncing estimates for the past year --

had to

have something fantastic up its sleeve, right? Well, not so much.

For anyone who has been paying close attention to Wells' results, the quarter wasn't entirely surprising. The firm didn't pile on its expected integration costs up front at the time of its Wachovia acquisition. Instead, it is meting them out over time as the process continues. Though costs had been below internal estimates for awhile,

the rebranding process is finally in full swing, and costs seem to be ticking up a bit.

Secondly, Wells Fargo had a whole lot of assets held off-balance sheet --

more than were held on-balance sheet at some point -- along with a whole lot of bad loans from the Wachovia portfolio. Despite the bank's best efforts to sell or wind down hundreds of billions of dollars' worth of off-the-books assets, and although it didn't have exposure to worrisome credit-card trusts held off the books as Bank of America did, Wells Fargo still had to add $693 million to its allowance for loan losses, and charged off $123 million worth.

At the same time, and partly as a result, Wells' nonperforming loans climbed by 12% from the previous quarter, to $27.3 billion. NPAs now stand at more than 4% of Wells' overall loan book. Accordingly, the bank's allowance for near-term credit losses climbed even higher.

Wall Street still seems to be sorting out the numbers. The stock initially fell in premarket action, but it's recovered and pushed into positive territory after the open. It was recently changing hands at $33.55, down 14 cents. The session's range so far has been between a low of $32.57 and a new intraday 52-week high of $34.25. Shares were up about 25% year-to-date through Tuesday's close, so there was reason for optimistic investors to see short-term dips as a buying opportunity. Volume was already above 34 million, on pace to exceed the issue's three-month trailing daily average of 44.1 million.

On the bright side, Wells Fargo stated pretty explicitly that it believes the credit firestorm has been snuffed out: "We believe quarterly provision expenses and quarterly total credit losses have peaked," said chief credit and risk officer Mike Loughlin. That peak seems to have passed

in the third quarter.

So, even though Wells Fargo is preparing for more losses ahead, and credit quality appears to be further deteriorating, the bank's overall provision expense -- the losses it expects to ultimately sustain -- has come down by $781 million over the past six months. Wells Fargo didn't build any additional reserves, and its charge-offs declined last quarter.

Furthermore, Wells Fargo's capital ratios may be stronger than ever, all having increased the past several periods due to capital-raising and internal revenue generation. The company's Tier 1 ratio now stands at a hearty 10%. It's not a bad thing to have ample powder in the keg at the start of an economic recovery, just as credit costs are abating.

Lastly, the most problematic loans from the Wachovia acquisition are becoming less sticky. That's both a factor of time -- the most toxic have already defaulted and been written off -- as well as

the bank's initiatives to keep borrowers current and in their homes until the economy improves.

Management acknowledged that loan demand remained "soft" and hedging results weren't quite as strong as the past few quarters. But CEO John Stumpf indicated that while Wells Fargo may have been treading water last quarter, his team is identifying opportunities to take hold of, once the recovery gets under way. It's worth noting that all of Wells Fargo's business lines -- community banking, wholesale banking, and its capital markets-wealth management division -- were profitable.

"We're encouraged by signs of improvement in the credit cycle, and by the savings and cross-sell opportunities we're realizing as more Wachovia bank stores convert to Wells Fargo," Stumpf said.

Wells earned $2.5 billion, or 45 cents per share, last quarter, on $21.5 billion worth of revenue. Analysts had expected the bank to earn 42 cents per share on revenue of $21.7 billion, on average. You might look at it as Wells under-delivering on top-line estimates, or as Wells being able to squeeze more profit out of less than what the experts assumed. A stunning quarter it was not, but

the bank still beat.

-- Written by Lauren Tara LaCapra in New York