Updated from 9:36 a.m. EDT

Wells Fargo ( WFC) made it clear on Thursday that its hefty writedowns of Wachovia's bad debt, combined with strong "traditional banking" business, has put the company ahead of competitors to boost profits as the economy begins to stabilize.

The San Francisco-based bank said it expects to report a first-quarter profit of $3 billion, or 55 cents per share on the back of stronger capital markets and new mortgage business. The expectation far exceeded the average analyst's guess of 23 cents per share, according to Thomson Reuters.

The news set off a market rally, with the Dow Jones Industrial Average soaring 200 points, led by financial stocks like Wells, Bank of America ( BAC), JPMorgan Chase ( JPM) and American Express ( AXP). Wells shares surged as much as 34% in early trading, but eased a bit as the morning wore on, recently trading up $3.89, or 26%, to $18.78.

CFO Howard Atkins attributed the profit boon to hefty writedowns on Wachovia's troubled loans more than improving credit-quality among consumers, although the firm has extended more than $225 billion of credit to U.S. taxpayers since early last October, when it received its $25 billion in bailout money.

"A lot of the losses from the Wachovia deal are behind us and we can now enjoy the benefits," Atkins said in an interview on CNBC.

Atkins also said the firm is "seeing some good signs" in California's housing market, which was among the worst hit by the home-value boom and bust. The trend applies not just to the refinancing boom taking place across the country, but with new buyers entering the market to buy homes at depressed prices.

Wells received $190 billion worth of mortgage applications during the first quarter, and approved 800,000 consumers to buy or refinance $100 billion worth of those requests.

There is "a lot of activity, particularly at the low end of the market," Atkins said.

Wells is not the first major bank to stun investors with statements of operating profitability, but it is the first to follow through with specific net earnings figures. The expected results include $372 million in preferred dividends Wells paid to the federal government in exchange for the preferred equity investment through the Troubled Asset Relief Program.

Wells CEO John Stumpf has said several times that the bank didn't need government funds, and could have raised private capital if necessary. Warren Buffett's Berkshire Hathaway ( BRK-A), which offered capital to Goldman Sachs ( GS) and General Electric ( GE) before the government stepped in with assistance, owns more than 7% of Wells Fargo. However, Stumpf said he accepted TARP funds at the behest of regulators to remove the stigma from other firms that needed aid more desperately.

On Thursday, Stumpf said in a statement that Well's "business momentum is strong, and we expect our operating margins to remain at the top of our peer group."

But despite the strong statements and market response, not all observers believed that Wells will sail through the remainder of the economic downturn unscathed. FBR Capital Markets analyst Paul Miller maintained an underperform rating on Wells shares, saying "we remain cautious based on what we don't know" about credit quality and accounting-rule changes and that net charge-offs seem "lite."

"We believe that credit quality materially deteriorated in the first quarter and that Wells Fargo is under-reserving for expected future losses," Miller wrote in a report Thursday.

However, Fox-Pitt Kelton analyst Andrew Marquardt countered that view, saying he expects the firm has already realized 62% of its ultimate losses vs. 20% for the rest of the banks he covers, on average. Marquardt maintained an outperform rating on Wells shares in an earnings preview note earlier in the day, saying its Wachovia acquisition will expand its reach and that legacy credit issues have mostly been addressed.

"We remain confident that Wells will continue to manage through this credit cycle better than most," he wrote.

Combined net charge-offs of Wells and Wachovia assets were $3.3 billion in the first three months of the year, on top of $6.1 billion in the previous quarter. The firm also added $4.6 billion to credit provisions, bringing the total allowance for future credit losses to $23 billion.

Additionally, Wells' move to slash its quarterly dividend to 5 cents from 34 cents will add $1.25 billion to common equity per quarter, starting in the current period. The company said it expects tangible common equity, a metric that has been closely scrutinized and debated as a measure of banks' financial health, to have been above 3.1% of tangible assets as of March 31. The metric is calculated in various ways, with some considering banks with TCE ratios above 3% to be healthy, and others considering 6% to be healthy, depending on what assets are factored in.

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