Wells Fargo projects record $3 billion Q1 profit, lifts stocks

— -- Investors starved for good news from banks finally got a signal that the beleaguered industry might finally be leaving its worst troubles behind.

Thursday, Wells Fargo wfc said it not only turned a profit in the first three months of 2009, but also expects to set a record for quarterly earnings with net income of $3 billion from increased activity in its capital markets and mortgage business.

The results were double analysts' expectations and spurred a big rally in bank shares. Wells Fargo jumped 32% to $19.61, Bank of America leapt 35% to $9.55, JPMorgan jpmrose 19% to $32.75, and Citigroupc gained 13% to $3.04. The strength spilled over into the broad market, helping send the Dow Jones industrials up 246 points to a two-month high of 8083.

As one of the USA's top five banks, and the No. 2 mortgage lender behind BofA bac, Wells Fargo's better-than-expected results suggested that upcoming earnings reports from other major financial institutions might also contain positive surprises.

Investors will scrutinize the results for clues that the financial system is stabilizing, which would be a key factor in helping the U.S. stage an economic recovery. Next week, heavyweights Citigroup, JPMorgan and Goldman Sachsgs report first-quarter results. Already, the CEOs of Citigroup, JPMorgan and BofA have raised hopes by saying they were profitable in the first two months of the year.

Well Fargo's results show that homeowners took advantage of low rates. The bank saw $100 billion in new mortgages in the quarter, with more than 450,000 people purchasing or refinancing homes. Mortgage applications rose 64% from the fourth quarter of 2008 to $190 billion.

"It's a good start," says Ben Wallace, analyst at Grimes & Co., which owns shares of both JPMorgan and Wells Fargo. But Wallace cautions that these results don't mean that the banks have engineered a turnaround yet.

That's because the economic downturn is still in full sway, and the credit markets aren't back to normal levels despite the government's massive injections of capital to stimulate lending. At the same time, losses from credit cards, construction and commercial real estate loans are starting to mount and could continue through 2010, says Mike Mayo, banking analyst at Calyon Securities.

On top of all that, the banks still have the cloud of the "stress test" that the government is conducting to determine if they are strong enough to withstand the pressures of a weak economy going forward and whether they need more help from taxpayers in the form of bailout money.

"Once you get through earnings, all eyes zero in on the stress test," says Jason Goldberg, banking analyst at Barclays Capital.