Wells Fargo & Co., the most valuable U.S. bank and largest mortgage lender, dropped 4% in New York trading after reporting a record third-quarter profit that was marred by narrower profit margins.

The bank fell $1.42 to $33.76 at 9:31 a.m., the most since June, after posting a 22% rise in net income to $4.94 billion, or 88 cents a share, from $4.06 billion, or 72 cents, a year earlier, according to a statement from the San Francisco- based company. While record-low rates spurred homeowners to refinance, boosting the mortgage unit, that also led to less interest income on the bank’s loans and other investments.

Chief Executive Officer John Stumpf, 59, has taken market share in U.S. mortgages, where the bank accounted for 1 in 3 home loans at midyear. That helped blunt the impact of lower interest rates as older, higher-yielding investments expired and the bank said it took more cautious stance by reinvesting in shorter maturities.

“Loan growth is slow and net interest margins are falling,” Jennifer Thompson, a bank analyst at Portales Partners LLC, said in an interview before the results were released. “The more fee-income business you have, the better off you are at this point in the cycle because the spread business is under pressure.”

More Revenue

Mortgage banking helped offset a 0.25%age point decline in the net interest margin, the difference between what the bank makes on loans and pays for funds, to 3.66%, the bank said. The margin was 3.91% at the end of June.

The drop exceeded guidance from Chief Financial Officer Timothy Sloan, who said Sept. 11 the third-quarter margin might narrow by about the same as last year’s 0.17 percentage point.

“While the economic and interest-rate environments continue to present challenges for us and our industry, our diversified model and focus on our customers continued to produce strong quarterly results,” Sloan said in the statement.

Revenue advanced 8.1% from a year earlier to $21.2 billion and was little changed from the second quarter. Mortgage banking income rose to $2.81 billion, up 53% from last year’s third quarter, according to the company. The total declined $86 million from the second quarter. Wells Fargo said guidance from regulators compelled the bank to write down the value of some performing consumer loans.

Mortgage Rates

The average fixed rate on a 30-year mortgage fell to 3.38% Sept. 26, according to Bankrate.com. Nationwide originations probably climbed 33% in the third quarter from a year earlier to $412 billion, according to estimates from the Washington-based Mortgage Bankers Association.

Mortgages have also brought U.S. banks more than $84 billion in costs tied to shoddy home loans and foreclosures since the start of 2007, according to data compiled by Bloomberg.

Wells Fargo was sued by the U.S. for hundreds of millions of dollars in damages this week over claims the bank made reckless mortgage loans that defaulted and caused losses for a federal insurance program. The conduct spanned more than a decade, according to a statement from U.S. Attorney Preet Bharara. Wells Fargo denied any wrongdoing and said it will vigorously defend itself.

Wells Fargo shares had gained 28% this year through yesterday, bringing the firm’s market value to about $186 billion, the highest for any U.S.-based bank. Berkshire Hathaway Inc., run by billionaire Warren Buffett, is the biggest stockholder with more than 7% of the common shares, according to data compiled by Bloomberg.

Analysts and investors are looking for signs that banks will be able to produce a sustained and more diverse stream of revenue in a U.S. economy that’s expanding at less than 2% annually. The 25 largest commercial banks held $4.13 trillion in loans and leases in the week ended Sept. 26, a 0.7% gain from the end of June, according to the Federal Reserve. Commercial and industrial loans climbed 3% over the same period to $794 billion, central bank data show.

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