Wells Fargo Faces Some Rough Sledding

An avalanche of loan problems makes Wells Fargo the most likely superregional candidate for a ratings downgrade, according to Moody's Investor Service.

So far, however, the rating agency has not placed Wells on CreditWatch, the first formal step in a review process.

A further downgrade, from A2, depends on the size of the loan-loss reserve Wells takes in the fourth quarter.

Leery of tipping the scales, Moody's analyst Christopher Mahoney offered only a vague outlook. "If this comes out awful, it could be a concern," he said.

Fitch Reduces Some Ratings

Loan problems recently convinced another rating agency, Fitch Investors Services, to cut-credit ratings on two outstanding debt issues.

Fitch also expects further deterioration before the situation improves.

Any doubt cast on the bank's credit quality is a bad sign, since lenders will demand stiffer interest premiums.

Like its peers, Wells has issued debt this year and will probably have to raise more to satisfy regulators.

Recently, the bank issued $200 million in five-year subordinated notes.

Wells also raised $239 million through a sale of preferred stock in October.

Concentration in California

With three fourths of its commercial loan portfolio concentrated in California, Wells faces more pressure than superregionals in less depressed regions.

Worse still, real estate loans make up about 57% of the commercial loan portfolio, the highest percentage among 12 regional banks with the largest stock market capitalization.

Regulators are poring over the real estate portion of Wells' portfolio, leading some close observers to anticipate a bigger loss reserve than the $200 million Wells took in the third quarter.

Nominal Profit Possible

Meanwhile, the bank should earn between $350 million and $400 million from operations in the fourth quarter -- before it records reserves against investment losses.

If losses don't exceed operating earnings, Wells may be able to report a nominal profit and keep its capital intact.

Even if loan-loss reserves hit $1 billion, analysts estimate that Wells will not be forced to go to the capital markets to raise equity.

Some Shrug It Off

With a loss at $1 billion, the common-equity-to-assets ratio would still be above 4%, and within regulatory compliance.

Some analysts shrug off the significance of big loan losses.

"Even at $1 billion, the loss would not be crippling in the long term," said Raphael Soifer, an analyst with Brown Brothers Harriman in New York.

Mr. Soifer said investors are not concerned this year's fourth quarter, but with the bank's performance over the next two years.

In the long term, Wells is expected to rebound. Analysts said the fundamental earnings power continue to be strong.

It is the most efficient bank in west, with an overhead ratio seven percentage points better than BankAmerica.

After downgrading 90 banking companies in 1990, and some 40 this year, Moody's thinks banks may have reached the bottom in their debt ratings.

Pressure Across the Board

While acknowledging that Wells is the most vulnerable to a ratings downgrade, Moody's said that each of the 12 banks has some soft spots.

Regulators view Fleet/Norstar Financial Group Inc., for example, as a survivor -- but it must work through real estate problems in the New England area, which is overbuilt.

In a recent report on 12 superregional banks, Moody's said Wells Fargo has a favorable long-term outlook.

But in the near term, all banking companies face pressure on their ability to generate capital through retained earnings.

Regulators appear to be softening their stance on loans, giving banks a better chance to keep loans off the nonperforming status and shore up their balance sheet without bulking up loan-loss reserves.

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