Wells Fargo ( WFC) reported an expected drop in third-quarter earnings Wednesday, though results beat expectations on higher net interest margin and "tremendous" growth in deposits.

The San Francisco-based bank reported net income dropped 24% to $1.64 billion, or 49 cents per share, from $2.17 billion, or 64 cents per share, a year earlier, reflecting an industry-wide deterioration in loan performance. Results also include $646 million in charges for investments in the failed investment bank Lehman Brothers, as well as in mortgage finance giants Fannie Mae ( FNM) and Freddie Mac ( FRE), which were taken over by the government last month.

Wells Fargo's net interest margin rose to 4.79% from 4.55%, however, as revenue climbed 5% to $10.38 billion from $9.85 billion. Chief Financial Officer Howard Atkins attributed the rise to double-digit growth across several businesses, including asset-based lending, commercial banking, credit cards, mortgage banking, insurance, international and wealth management. Wells also saw a "tremendous inflow" of deposits as customers veered away from instability in the equities and debt markets.

Analysts had expected earnings of 41 cents per share on revenue of $10.96 billion, on average, according to Thomson Reuters.

Wells shares slipped 1.3% to $33.09 in recent pre-market trading.

Despite the better-than-expected results, Wells Chief Credit Officer Mike Loughlin acknowledged that the "current credit cycle continues to be challenging" and that "several consumer loan portfolios remain under stress. Wells charged off nearly $2 billion in loans due to poor performance last quarter, reflecting 1.96% of its portfolio, compared with 1.01% a year earlier. The company also boosted credit reserves by $500 million, raising the total allowance for future credit losses up to $8 billion.

Loughlin noted that consumers have been affected by declining home values, higher energy costs and rising unemployment. "Until conditions improve in the residential real estate and liquidity markets, we will continue to hold more nonperforming assets on our balance sheet as it is currently the most economic option available," he said.

Indeed, credit conditions have deteriorated dramatically during the quarter, as the banking sector lost many of its key players. Besides the fall of Lehman, Fannie and Freddie, Merrill Lynch ( MER) rushed into the arms of Bank of America ( BAC). Soon after, the nation's largest thrift, Washington Mutual failed, with its branches and deposits acquired by JPMorgan Chase ( JPM) for a mere $1.9 billion.

More recently, Wells announced that it would step in to acquire Wachovia ( WB), sparking a tense battle with Citigroup ( C), which had agreed to acquire the smaller thrift, with the government's stamp of approval. Citi is now suing Wells for billions of dollars because of the failed deal, though it is not blocking the transaction.

Wells President and CEO John Stumpf said the company has "great anticipation and confidence" about completing the deal by the end of the year.