(Reuters) - Wells Fargo, the biggest U.S. mortgage lender, reported a better-than-expected 14 percent rise in first-quarter net profit as it set aside less money to cover bad loans.

Net income applicable to common shareholders rose to $5.60 billion, or $1.05 per share, in the quarter ended March 31 from $4.93 billion, or 92 cents per share, a year earlier, the fourth-biggest U.S. bank said on Friday.

Analysts on average had expected the bank to earn 97 cents per share, according to Thomson Reuters I/B/E/S.

Chief Executive John Stumpf said that capital levels continued to strengthen at the fourth-biggest U.S. bank, which also cut costs in the quarter.

Wells Fargo's mortgage business, which provides nearly one in five U.S. home loans, continued to suffer from a drop in refinancing activity. Income from mortgage banking fell to $1.5 billion from $2.8 billion in the first quarter of 2013.

For the week ending April 4, applications for refinancing fell to their lowest share of total mortgage applications since July 2009, according to the Mortgage Bankers Association.

Wells Fargo's new home loans fell to $36 billion in the quarter from $109 billion a year earlier and $50 billion in the fourth quarter.

February was the worst month for new home loans since at least 2000, according to Black Knight Financial Services.

Wells Fargo had $27 billion of mortgage applications in the pipeline at the end of the quarter, down from $65 billion at the end of the fourth quarter.

Wells Fargo's net income got a lift from a drop in the amount it set aside to cover bad loans as the housing market and the overall economy stabilized.

The bank released $500 million from its loan loss reserves, higher than the $200 million released a year ago but less than the $600 million released in the fourth quarter.

Wells Fargo is experiencing historically low loan losses. Its net charge-off rate was 0.41 percent in the latest quarter, down from 0.47 percent in the fourth quarter and 0.72 percent in the first quarter of 2013.

Total lending rose 4 percent to $826.4 billion, while total revenue fell slightly to $20.6 billion from $21.3 billion a year earlier.

Wells Fargo posted big gains from its equity investments, which earned $847 million in the quarter, about 7.5 times the $113 million it earned a year earlier.