Wells Fargo’s record profit: Good omen or anomaly?

Are U.S. banks back?

No big bank was supposed to utter the words “record” and “profit” in the same sentence this year. But Wells Fargo said today it earned about $3 billion for the first quarter — its highest income ever, and twice what analysts predicted.

The unexpected peek into the bank’s official results, which will be released in two weeks, was a welcome sign of improvement in one of the most troubled and critical industries in the U.S. economy.

Money is cheap and mortgage applications are surging, thanks in large part to unprecedented efforts in Washington to breathe life back into the financial industry. The government has been pumping money into the financial system, slashing interest rates, and buying and guaranteeing more types of assets than ever before. As a result, cash poured into Wells Fargo & Co. and loans streamed out, indicating a strong pickup in the most important source of business for any bank.

Other banks across the U.S. are likely gaining, too, from near-zero borrowing costs and the resuscitation of the mortgage business. If more banks see a similar burst in business offset their loan losses, the panic over the fate of the banking industry that upended the stock market in the past year could dissipate.

“The mindset is: The banks cannot do well,” said Richard Bove, banking analyst at Rochdale Securities. “But the banks are in a stronger position than anyone expected.”

Wells Fargo’s surprise profit is also another good indicator for the overall economy. Stocks soared on the news Thursday — not just banks, but also technology, homebuilding, and transportation companies. That’s because if banks are stable, more loans can be made. And when people can borrow, they can spend.

An important caveat, though, is that Wells Fargo is somewhat of an anomaly. The San Francisco-based bank, first of all, has simply gotten bigger — Wells Fargo roughly doubled in size after completing its acquisition of Wachovia Corp. on Jan. 1.

More importantly, the company has long been among the heartiest of the big banks. Because it did not get as risky in its investments or as loose in its lending standards, loan loss rates at Wells Fargo are lower than at many of its peers.

Most analysts are still predicting quarterly losses for banks like Citigroup Inc. and Morgan Stanley, which also release their results later this month. They will likely be weighed down by the souring debt and exotic credit products on their books that have gotten into trouble.

“Banks are not all going to show the same type of robust earnings that Wells did,” Bove said. “Loan losses are going to go up. That’s a definite for the industry.”

Wells Fargo’s own chief financial officer even warned against getting too excited about the results.

“It’s premature to conclude the economy has turned,” said CFO Howard Atkins in an interview with The Associated Press.

Atkins did say the bank was seeing a clear benefit from the government’s actions to bring interest rates down. “All I can tell you is, we’re seeing a lot of business.”

Here’s a closer look at the drivers behind Wells Fargo’s record profit:

— CHEAP MONEY. Think a 4.8 percent interest rate for a 30-year mortgage is good? Try 0.2 percent — that’s what banks are paying to borrow from each other through the Federal Reserve.

Where it might have cost a bank $4 in interest for every $100 it borrowed a year ago, it now costs less than $1 to borrow the same amount of that money. Banks’ borrowing costs have fallen more than consumer borrowing costs have (especially when you consider credit card rates, which are largely rising).

Still, much of the reduced cost of borrowing is being passed on to consumers to help generate new business. Which is why …

— MORTGAGE APPLICATIONS ARE RISING. Wells Fargo said it completed about $175 billion in loan commitments during the first quarter and received $190 billion in mortgage applications. That volume is a 64 percent jump from the final quarter in 2008. More than 40 percent of that volume came in March — a sign that improvement might spill into the second quarter.

While about three-quarters of Wells Fargo’s mortgage activity was just customers refinancing loans to lock in better rates, about a quarter came from consumers purchasing new homes, Atkins said. Purchasing activity is about the strongest since the housing market collapsed in 2007, he said.

— BANKS ARE SITTING ON PILES OF CASH. Wells Fargo was one of hundreds of banks given federal funding last fall to spur lending. The Treasury Department gave the bank $25 billion.

Most relatively healthy banks have also been able to attract more deposits as customers worry about other banks collapsing, or pull money out of riskier investments like stocks to avoid losses. Wells Fargo didn’t provide details about first-quarter deposit growth, but said consumer and small business checking accounts were growing.

— LOAN LOSSES WERE LOW. Dubiously low, to some analysts. Wells Fargo said charge-offs totaled $3.3 billion, down sharply from the combined charge-offs of $6.1 billion at Wells Fargo and Wachovia in the fourth quarter.

Paul Miller, bank analyst at the investment bank Friedman Billings Ramsey, projected Wells Fargo’s first-quarter charge-offs would total $4.9 billion.

Loan losses are widely expected to be banks’ biggest obstacle in 2009 — unlike in 2008, when it was write-downs due to plunging demand for exotic debt instruments.

Losses on various types of loans from mortgages to credit cards to commercial real estate could peak at different times, Calyon Securities analyst Mike Mayo noted Monday, so banks may have to navigate through multiple downturns.

Mayo predicted that the industry-wide default rate on loans will rise to 3.5 percent by the end of 2010 — exceeding the default rate during the Great Depression, and leading to total losses between $600 billion and $1 trillion over the next three years.

Related Topics: Banking, Wells Fargo & Co.