Updated from 12:15 p.m. EDT

Wells Fargo

(WFC) - Get Report

met Wall Street's quarterly earnings expectations but warned Tuesday that current estimates of its annual earnings are too high.

For the second quarter, the San Francisco-based financial services company reported net income of $1.04 billion, or 63 cents a diluted share, compared with $931 million, or 55 cents a share, in the year-ago quarter. Wall Street analysts polled by

First Call/Thomson Financial

had predicted 63 cents a diluted share.

Investment gains and trust fees compensated for margin pressure from rising interest rates, the company said. The net interest margin was 5.55%, compared to 5.69% in the comparable quarter last year.

The company is "on track to meet our aggressive cash earnings per share targets established at the time of the merger," said Richard Kovacevich, its chief executive, referring to the $32 billion merger with

Norwest

announced in June 1998. He said the cash earnings target is $2.91 a share. "However, GAAP (generally accepted accounting principles) earnings per share are expected to be reduced by approximately 6 cents per share."

The company has made more than 20 acquisitions since the merger, which it valued using purchase accounting, Kovacevich said. As a result, the company's balance sheets are overflowing with goodwill, the intangible assets like employee morale that have no independent or liquidation value.

Goodwill, also called going-concern value, cannot be included under GAAP, on which the predictions of Wall Street analysts are based. The company must take periodic charges to square the books, but it did not include all of those charges in previous estimates of its earnings. The process, called amortization, will reduce annual earnings by 38 cents a diluted share instead of the 32 cents the bank predicted at the time of the Norwest merger.

Analysts polled by First Call/Thomson Financial currently expect Wells Fargo to post annual earnings of $2.56 a diluted share. Based on the $2.91 cash earnings target and the 32-cent amortization target, the bank's internal GAAP earnings target was $2.59, according to Larry Haeg, a company spokesman. In other words, the bank now says it will miss Wall Street's annual earnings expectations by 3 cents a diluted share.

"I'm not really concerned about it. The bank's operating trends are solid," says Adam Levy, an analyst on the

(FSFSX)

Invesco Financial Services Fund, which owns shares in Wells Fargo.

In the quarter, Wells reaped a 1.89% return on assets and a 19.04% return on common equity, even as higher interest rates have pressured traditional lenders. The

Federal Reserve

has boosted interest rates six times, or a total of 1.75 percent, since June 1999 .

Wells Fargo finished down 1 5/16, or 3%, at 42 1/16.

The company, which has $234 billion in assets and nearly 5,300 branches, said it has integrated 70% of its products and systems "without any significant customer issues."

In 1996, Wells Fargo won an $11.3 billion bid for

First Interstate

of Los Angeles. But problems began when the banks tried to physically merge. Wells Fargo's computer systems broke down, and the bank lost deposits and incorrectly withdrew money from some accounts. It closed hundreds of branches and cut 7,000 jobs as customers fled.

Kovacevich said the company has earned more business from current customers and attracted new ones through the current integration. He credited employee's "hard work, dedication and customer focus" for that.