Wells Fargo and US Bancorp said lending profits are being squeezed by low interest rates, but improving credit quality helped both banks post higher-than-expected fourth-quarter earnings.

The banks reported substantial improvements in nonperforming loans and reduced the funds set aside to cover bad loans. They also said their loan books were expanding, a possible sign of economic recovery as companies and individuals borrow more.

But analysts and investors shrugged off the signs of credit improvement and focused on the fact that low interest rates make it harder for banks to make a profit from borrowing short-term and lending longer-term.

There was also some hangover from Goldman Sachs Group Inc , whose quarterly profit tumbled on declining trading revenue, reinforcing fears that banks still face a highly volatile climate.

Shares of Wells Fargo, the No. 4 U.S. bank, were down 1.6 percent at $31.95 in morning trading. Shares of U.S. Bancorp, the fifth-largest U.S. commercial bank by assets, were down 2.7 percent at $26.57.

You want to own the big money-centered banks that have a little bit of exposure to everything, like a JPMorgan, a Wells to a certain extent, and Bank of America, said Keith Davis, bank analyst and principal at money manager Farr, Miller & Washington in Washington.

I would stick with the big, diversified money-centered banks that have a number of levers to pull to combat what is going to be a very difficult environment going forward, with the regulatory overhangs and the weak loan growth and net interest margins coming in.

US Bancorp posted a 61 percent jump in net income as the regional bank released $25 million in loan loss reserves. The reserve release was its first since the financial crisis began in 2008.

The bank's earnings per share of 49 cents beat analysts' average estimate by 3 cents, according to Thomson Reuters I/B/E/S.

Wells Fargo posted a 21 percent increase in fourth-quarter profit, helped by an $850 million reserve release.

The bank said earnings rose to $3.4 billion, or 61 cents a share, meeting analysts' expectations.

Citigroup also took a large reserve release in its fourth quarter, raising concerns among analysts about the quality of the quarterly results.

Hudson City Bancorp also reported results on Wednesday, beating expectations but warning that net interest margins in 2011 may decline from 2010 fourth-quarter levels. Hudson shares sank 6.1 percent in morning trade.

(Reporting by Joe Rauch and Jonathan Spicer; writing by Ben Berkowitz; Editing by Lisa Von Ahn and John Wallace)