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Analysts Question Wells' Loan-Loss Provision

The stock rose Wednesday, but some on the Street believes losses could be much steeper.

Wells Fargo's decision to set aside $1.4 billion for its most troubling loans may not be enough, analysts say.

The San Francisco bank said late Tuesday that it plans to record the

pretax provision in the fourth quarter and create a special fund to cover losses expected in about $12 billion worth of home-equity loans either purchased or originated through indirect channels, such as wholesale mortgage lending platforms and the correspondent channel.

Analysts wonder about the loss rates on the remaining $71.5 billion of home-equity loans that haven't been designated to the portfolio and why Wells Fargo only added a provision for their worst-performing loans.

"I'm just skeptical that the $1.4 billion is going to be enough over the next several quarters," says Christopher Mutascio, an analyst at Stifel Nicolaus, who has a hold rating on the company and cut his earning estimates for 2008 on Wells Fargo by 25 cents to $2.65 a share. "I'm not so sure that it's behind them. The loss rates in that non-liquidating portfolio are going to continue to rise," requiring Wells Fargo to continue to build its reserves.

Shares of the San Francisco bank surged 3% along with most of the financial sector Wednesday, in large part because of

Federal Reserve

Vice Chairman Donald Kohn's

dovish comments that boosted hopes for additional rate cuts.

Even so, Wells Fargo CFO Howard Atkins, speaking at an investor conference in New York on Wednesday, sought to assuage criticism like Mutascio's before it reached a crescendo.

"We are clearly not immune to the economic environment," Atkins said. "Our underlying business results have been good and at the high end of our peers."

Wells Fargo says that losses in this liquidating portfolio are expected to be about $1 billion over the course of 2008 and 2009 and that the loan writeoffs will lessen as the portfolio runs off.

Wells Fargo said most of the $71.5 billion in loans in its total home-equity portfolio were originated in the bank's retail branches. The bank has ceased originating wholesale home equity loans where the combined loan-to-value ratio of the first and second mortgage is above 90% of the loan or where the second mortgage is not behind a Wells Fargo first mortgage, the bank says. It will continue to originate home equity loans directly through its retail branches.

It has also ceased doing business in the correspondent channel.

"The loans represent the highest risk to Wells Fargo," Atkins said. The special provision reflects higher losses because "the further deterioration in the outlook" of the housing market.

Atkins' comments come just two weeks after Wells Fargo's CEO John Stumpf said the U.S. housing slump is the worst since the Great Depression and that problems will persist through 2008.

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Wells Fargo was considered one of the more protected banks in light of the mortgage crisis that has hammered rivals like

Countrywide Financial



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, because it didn't dabble in some of the problem areas hitting the mortgage sector these days -- most notably exotic teaser rates and other low-documentation mortgages, as well as subprime mortgage-backed securities and collateralized debt obligations, or CDOs.

But Betsy Graseck, an analyst at Morgan Stanley, wrote in a note that a continued economic slump could quickly make things much worse for Wells.

"We cannot rule out the possibility that given higher home value deterioration than expected, additional

home-equity line of credits could shift to the 90%+

combined loan-to-value ratio area, raising

Wells Fargo's special liquidation portfolio" she wrote.

Moody's Investors Service said on Wednesday that it was evaluating Wells Fargo's loss assumptions with regard to its retail mortgage originations. The rating agency expects to complete the review next month.

"Moody's current view is that the losses on the remaining $71.5 billion home-equity portfolio will be modest," primarily because the loans were originated through Wells Fargo's retail network, and the bank finances both the first-lien and second-lien mortgages in a majority of cases, it says.

However, "if Moody's determines that our current loss assumptions on the home equity may be too low, negative rating pressures would emerge," Senior Vice President Sean Jones said in a statement. "Because of the sharp deterioration in the credit performance of mortgage loans, we are testing our assumption on the expected losses within the higher quality portions of Wells Fargo's directly originated home equity and near prime mortgages."

Some observers viewed Wells Fargo's actions in a more positive light.

"The brokered third-party home equity loans were the area of greatest risk for them," says Frank Barkocy, the director of research at Mendon Capital Advisors and the former director at hedge fund manager, Keefe Managers. "What they have done is isolated this portfolio."

"Their own loan originations

are still in excellent shape," Barkocy says. "There is always the concern -- is this it? Have they captured everything? But at least they've taken aggressive actions and they are taking steps to more meaningfully address the issues."

"Just from the performance in the stock today. ... I think it is almost a breath of fresh air that someone is taking an aggressive stance," he says.