* Bank posts quarterly profit of $4.9 billion
* Tops analysts' estimates on EPS, misses on revenue
* Net interest margin falls on low rates
By Rick Rothacker and Jed Horowitz
Oct 12 (Reuters) - Wells Fargo & Co's third-quarter profit jumped 22 percent as the largest U.S. mortgage lender benefited from a surge in home loan refinancings.
The No. 4 U.S. bank by assets has expanded in mortgage lending while others such as Bank of America Corp have pulled back. It said it expects the lending boom to continue as the housing market shows signs of recovery and borrowers take advantage of low interest rates pushed by the Federal Reserve.
"It feels like it is going to last at least a few quarters and obviously we hope it does," Chief Financial Officer Tim Sloan told analysts in a conference call.
Wells reported third-quarter earnings per share of 88 cents, topping analysts' consensus estimate of 87 cents, as compiled by Thomson Reuters I/B/E/S. But the bank missed revenue estimates and a key banking measure dropped more than expected, sending its shares down in New York Stock Exchange trading.
Net interest margin - the spread between what the bank pays on deposits and earns on loans - fell to 3.66 percent from 3.91 percent in the second quarter, a bigger drop than it warned of last month.
Banks are experiencing shrinking margins as older loans with higher interest rates are paid down and they find fewer places to invest growing deposits.
"The margin came in much worse than we expected, but mortgage banking was better," Keefe, Bruyette & Woods analyst Frederick Cannon wrote in a note to clients. "Overall, this was a slight beat this quarter, but the margin matters more."
Wells Fargo executives urged investors to focus on the bank's overall profit rather than the shrinking margin. Chief Executive John Stumpf said the bank is also rapidly boosting fee income by selling products and services that do not depend on interest rates for loans.
"Overall revenue is up 8 percent this year," Stumpf said, while deposit growth is strong and bad loans and other expenses are declining. "Those are pretty good numbers."
Sloan said the bank's net interest margin could remain under pressure through next year.
The bank reported record net income of $4.9 billion on total revenue of $21.2 billion on the same day that JPMorgan Chase & Co also reported results to kick off the bank earnings season. JPMorgan, the largest U.S. bank, said profits rose 34 percent to a record $5.71 billion.
Wells shares were off 3.2 percent at $34.05 in afternoon trading on the New York Stock Exchange. The KBW Bank Index of large banks, which includes Wells Fargo, was off 2.8 percent.
HOLDING ONTO MORTGAGES
Wells Fargo has emerged from the financial crisis as the dominant U.S. mortgage lender, making about one in three U.S. home loans and tripling the volume of its closest competitor, JPMorgan.
In the quarter, Wells wrote $139 billion in mortgages versus $89 billion a year ago, but up only slightly from $131 billion in the second quarter. The bank's decision to stop making loans through brokers cost it about $8 billion in volume, Sloan said in an interview.
The bank typically sells most of the loans it makes to investors such as Fannie Mae and Freddie Mac . But this quarter, executives decided to hold onto $9.8 billion in loans that were eligible to be sold to the mortgage finance companies.
The move cost the bank about $200 million in fee income during the quarter, but in the long run executives said the loans would yield more than the mortgage-backed securities they could have bought. The bank expects to add more mortgages to its portfolio in the fourth quarter.
Sloan said the loans will not materially affect interest rate or credit risk at the bank, given the size of its overall loan portfolio. The bank can also sell the loans in the future if it wants, he added.
While mortgages have boosted the bank's bottom line, they have also produced some headaches.
The U.S. Attorney in Manhattan this week filed a lawsuit accusing the bank of recklessly underwriting government-insured home loans. The bank has denied the allegations. [ID: nL1E8L9HPF]
The bank also continued to set aside more money to cover investor demands to buy back soured mortgage loans it sold during the housing boom. It added $462 million to those reserves in the third quarter, down from $669 million in the second quarter but up from $390 million a year ago.
TOTAL LOANS UP
Total loans increased by $7.4 billion, or about 1 percent, from June 30, to $782.6 billion.
The additional $9.8 billion in mortgages that the bank held instead of selling drove most of the increase. Wells Fargo also had increases in auto, credit card, student and commercial loans.
The executives touted improvements in credit quality. The bank set aside less money for future loan losses than it charged off in the third quarter - a sign it believes credit quality is improving. Some of the third-quarter loan losses resulted from new regulations that will not have an effect in future quarters.
Wells bought back 17 million shares of its own stock in the quarter, plus an additional 9 million under a contract that settles in the fourth quarter.
Stumpf said the bank is looking forward to the next round of annual stress tests in which the bank can ask the Federal Reserve for permission to increase share buy-backs and dividends.
Banks submit their capital plans in the first quarter.
"We are really focused on getting more capital back to our stockholders," he said.