Sizing Up Wells Fargo's Surprise

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Bart Narter, senior vice-president of the banking group at consulting firm Celent, says banks have seen a "flight to quality" by customers. "When your competitors are doing poorly, it's easier for you to do well," Narter says.

A key problem for Wells Fargo's competitors has been huge losses on their balance sheets from both bad loans and toxic investments. Analysts have had difficulty predicting these charges, which have decimated financial sector profits.

In a note Apr. 9, FBR Capital Markets (FBR) analyst Paul Miller worried Wells isn't setting aside enough for future credit losses.

"We believe that credit quality materially deteriorated in the first quarter and that Wells Fargo is under-reserving for expected future losses," Miller said.

Only full, detailed first-quarter results may assuage Miller's worries. But other analysts and investors were less concerned.

Benefited by Taking Big Losses Late in '08

First American Funds analyst Alan Villalon notes that accounting rules allowed Wells Fargo to book large losses late last year as part of its acquisition of Wachovia. And, at least so far, he says Wells Fargo seems to have done a good job anticipating the losses that were coming from Wachovia's portfolio. "The fear was that the Wachovia acquisition was going to deteriorate more than expected," Villalon says. Apparently, that hasn't happened.

Standard & Poor's equity analyst Stuart Plesser says Wells Fargo has been "one of the more conservative" banks in planning for future losses. Plesser upgraded Wells Fargo from a hold to a buy rating, saying he no longer worries as much about the bank's ability to build up capital to cover future losses. Plesser said: "With this kind of earnings power, they can build [capital] back up without having to go back to the private markets or go to the government" for more funding. (S&P, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP).)

Thus, Wells Fargo has benefited by taking big losses early, and it should benefit in the future from strong earnings at a time when many other financial institutions are reporting losses. According to Thomson Reuters (TRI), analysts expect financial sector earnings to drop another 49% this earnings season from a year ago.

"We're Being Good Corporate Citizens"

These days, financial institutions can't worry about just the state of their businesses, but also what's going on in Washington. Congress and the public have strongly criticized banks for taking billions in bailout money from the U.S. taxpayer, but not boosting lending.

It's clear that Wells Fargo, like its rivals, is feeling some political heat. But Wells Fargo seems determined to divert the spotlight away from itself. In its announcement, Wells Fargo Chief Financial Officer Howard Atkins directly addressed this issue. "Our commitment to serving credit-worthy consumer, small-business, and commercial customers has continued throughout the credit crisis, and, in fact, accelerated during the quarter, and we're providing significant support to U.S. homeowners," Atkins said in a statement.

Wells Fargo lent more than $225 billion since early October, the bank said, "nine times the amount received from U.S. taxpayers through the U.S. Treasury Capital Purchase Program investment." Wells Fargo also paid $372 million in dividends to the U.S. Treasury in the first quarter.

Wells Fargo is "trying to make a point of saying, 'We're being good corporate citizens here,'" Narter says. In an overheated political climate, "they're saying, 'Don't pick on us.'"

Ahead of Other Banks' Earnings Reports

Why did Wells Fargo make this announcement now? Villalon, of First American Funds, believes Wells Fargo wanted to get ahead of both other banks' earnings reports as well as the results of the U.S. Treasury's "stress tests" of banks. Expected this month, the tests were designed to assess how bank balance sheets would handle tough economic conditions. Wells Fargo's message, Villalon says: "We're not those guys. We're different."

Now the pressure is on other banks to prove that they're not different from Wells Fargo. Banks will want to show they're sharing in Wells Fargo's success, not contrasting it.

Steverman is a reporter for BusinessWeek's Investing channel.