Wells Fargo's Beat Rings Hollow

(Includes updated stock price.)

Despite Wells Fargo's ( WFC) huge profit beat and a pronouncement that the firm had surpassed its stress-test capital mandate, investors sent its stock down on worries about escalating credit problems.

Shares of the San Francisco-based bank were down 2.8% at $24.63 in recent trading.

Wells reported net income of $3.17 billion, or 57 cents per share, up 81% from the previous year. Its revenue surged 18% to $22.5 billion on strong growth in traditional consumer lending, mortgages, investment banking and other areas that have also helped major competitors like Bank of America ( BAC), JPMorgan Chase ( JPM) and Citigroup ( C).

The average analyst expected the firm to post 34 cents per share in profit, on revenue of $20.5 billion, according to Thomson Reuters. The highest earnings estimate was 50 cents per share and the highest revenue estimate was $21.7 billion.

CFO Howard Atkins also said the firm has boosted Tier 1 capital levels by more than the $13.7 billion required by the Federal Reserve's stress test. "We have exceeded this requirement by $500 million," Atkins said, through an $8.6 billion stock offering, better-than-expected revenue, tax gains and other means.

But investors focused instead on a sharp rise in non-performing assets . Wells' book of troubled loans climbed to $18.3 billion, or 2.23% of all loans, up from $12.6 billion, or 1.5%, at the end of March.

Not surprisingly, the bank's commercial and commercial real-estate loans had the most problems, with the nonperforming variety up to $7.6 billion, or 2.28% of that loan book, from $4.5 billion, or 1.3% the previous quarter.

In a pre-recorded conference call, CFO Howard Atkins attributed most of the increase to technicalities. When Wells acquired Wachovia last year, it wrote down the troubled bank's impaired loans and removed them from the NPA formula. Because of a "low starting point" of $92 million at Dec. 31, the loans were expected to move back to NPA status, most of which occurred during the second quarter.

Atkins was quick to point out that "not all NPAs result in a loss," while he and other executives pointed out Wells' vast modification efforts to improve loan performance. Still, the significant rise in NPAs, along with Wells' $4.4 billion worth of charge-offs, which represent 2.11% of loans, up from $3.3 billion, or 1.54% last quarter, clearly spooked investors about troubles ahead.

Wells added $700 million to its credit reserves, bringing its total allowance for credit losses over the next year to $23.5 billion.

"We expect credit losses and nonperforming assets to increase," Chief Credit Officer Mike Loughlin said in a statement.

Loughlin and Atkins also pointed out that the firm is seeing moderation in loan-loss growth, and stabilization in early-stage delinquencies due to de-risking actions over the past two years. But Atkins noted that "this trend may not continue," and depends largely on unemployment and real-estate values.