Monday, April 21, 2008

Analyst Whitney Thinks Wells Fargo Needs Reserves, Capital

By Ed Welsch, Dow Jones Newswires

NEW YORK -(Dow Jones)- While investors are now getting used to banks holding their hands out for capital reinvestments, they may be surprised if a consistent performer such as Wells Fargo & Co. (WFC) comes begging.

But that's exactly what may happen, according to Oppenheimer & Co. analyst Meredith Whitney.

Whitney believes that Wells Fargo is under-reserved by at least $4.5 billion as of Monday and will need to raise capital to restore its balance sheet this year and perhaps by even more in 2009. The analyst has won acclaim in recent months for her accurate calls that Citigroup Inc. (C) and Wachovia Corp. (WB) would have to cut their dividends.

A Wells Fargo spokeswoman wasn't immediately available to comment. Other analysts have pointed to the bank's continued exposure to consumer debt as a source of concern, but were generally comforted by the bank's diversification and the strength of its loan portfolios.

Shares of the San Francisco-based bank may take an especially harsh beating if Whitney's prediction turns out to be true, since investors are generally positive about the stock following its better than expected first-quarter results last week. Through Friday, Wells Fargo shares had risen more than 9% since the bank reported results on Wednesday. Shares were down 2.3% in pre- market trading Monday.

Whitney cut her estimate of Wells Fargo's 2008 profit to $1.20 a share from $ 2.15 a share, making hers the lowest estimate on the Street and leaving it well below the average estimate of $2.34 a share.

"Given our now dramatically below consensus estimates, we believe few if any are anticipating what we believe to be the inevitable consequence of Wells' current reserve position," she told clients in a research note Monday.

Whitney bases her estimates on a historical study of Wells Fargo's charge-off rates, which she says during the first quarter exceeded the bank's loan loss reserves for the first time since at least 1990. She assumes that credit conditions will continue to deteriorate, forcing the bank to increase its reserves to offset the growing number of charge-offs.

"If losses continue to accelerate past the 2Q, our well below Street estimates will prove too optimistic," she wrote.

A capital raise from Wells Fargo may also throw cold water on last week's rally, in which the broad stock market rose on mediocre but better-than-expected first-quarter earnings at banks including Wells Fargo and JPMorgan Chase & Co. ( JPM). The results also gave a boost to the broader S&P 500, which rose 4.7% last week, recovering from the shock of General Electric Co.'s (GE) earnings miss April 11.

Following Wells Fargo's earnings release Wednesday, Moody's Investors Service reaffirmed the bank's Aa1 credit rating, saying it "has avoided the market pitfalls that plagued its peers," but noted that "nevertheless it does hold an $ 83.6 billion home-equity portfolio."

Charge-offs on home-equity loans have been rising, leading to growing concern among bank investors. Whitney points out in her research that Wells Fargo changed its charge-off policy to 180 days from 120 days beginning in April, which she believes will only delay the reported increase in home-equity losses for a quarter. Wells Fargo said it shifted the policy in order to give debtors more time to deal with their financial problems and keep them in their homes.

Other analysts were also concerned that growing charge-offs at Wells Fargo and its change in the way it accounts for them, but many remained positive about the bank's prospects. "Although credit quality deteriorated in the quarter, we believe it is clear that Wells Fargo's residential real estate loan portfolios are generally performing better than those of other large banks," Bear Stearns said last week. Of 24 analysts tracked by Thomson Financial, 17 still issued recommendations on Wells Fargo equivalent to buy or hold, with 11 analysts at buy or strong buy.

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