Wells Fargo & Co.'s surprisingly strong first quarter has not quieted worries that its reserves are too thin to absorb rising loan losses.

Even at $4.6 billion — or $1.3 billion higher than quarterly chargeoffs — the $1.3 trillion-asset San Francisco company's first-quarter provision may not be enough to cover credit costs, particularly losses on option adjustable-rate mortgages and other problem assets it inherited when it bought Wachovia Corp. last year, according to a team of Friedman, Billings, Ramsey & Co. Inc. analysts led by Paul Miller. In a note to clients issued last week, the analysts wrote that the provision should have been $6.25 billion.

Howard Atkins, Wells' chief financial officer, defended the provision in an interview Thursday and touted its $23 billion allowance. He said Wells has already absorbed many of the losses associated with the Wachovia acquisition.

"We believe our reserve is adequate," Atkins said. "We have already written off losses in Wachovia's riskier loan portfolio when we closed the acquisition in December, and therefore are experiencing lower losses right now."

Wells recorded a laundry list of Wachovia-related hits in the fourth quarter, including a $37.2 billion writedown tied to Wachovia's $93.9 billion portfolio of high-risk loans, a $1.2 billion net chargeoff on the pick-a-pay portfolio and $4.2 billion to build credit reserves.

The preliminary first-quarter results Wells released Thursday show that it is off to a better start this year. It expects to report a profit of $3 billion, or 55 cents a share, after paying preferred dividends to the Treasury Department and other investors. Wells cited better-than-expected mortgage revenue as the main factor.

The company also expects to report that its tangible common equity ratio as of March 31 topped 3.1%. The company's 85% reduction in its dividend, to 5 cents, announced March 6, should benefit retained earnings by adding $1.25 billion in additional common equity per quarter.

Atkins said his company would provide more details about asset quality when it posts its final first-quarter results April 22.

Like the Friedman Billings analysts, Joe Morford at Royal Bank of Canada's RBC Capital Markets, expected Wells' provision to be higher. His estimate was $5.5 billion.

"Nonperforming assets were noticeably absent from the pre-release, and they very well could be up materially, so that's a potential area of concern," Morford said, since the recent changes to mark-to-market accounting rules also may have affected the results. "The strong pretax, pre-provision run rate is very encouraging and should help Wells absorb higher credit costs."

In its preliminary results, Wells said it would report $20 billion of total revenue and $9.2 billion of pretax, pre-provision profits. The results were powered by "exceptionally" strong growth in the mortgage banking business. In the first quarter Wells originated $100 billion of mortgages, and its application pipeline grew 41% from a quarter earlier, to $100 billion.

Atkins said that about 25% of the mortgage volume was for purchase loans.

"That's actually pretty good news on the purchase side, so that's a fairly large amount of dollars involved for new mortgages," he said. The integration of Wachovia is "exceeding expectations" and generated about 40% of Wells' revenue for the first quarter.

Other analysts said Wells can manage any increased credit costs.

"I don't disagree that credit quality probably deteriorated further in the first quarter, but Wells Fargo is ahead of the curve in recognition of credit costs, because of purchase accounting," said Andrew Marquardt, an analyst with Fox-Pitt Kelton Cochran Caronia Waller, whose provision estimate was in line with Wells' announcement.

Wells expects $5 billion of annual cost savings from the acquisition, but Atkins did not specify the amount of merger-related costs the company would post for the first quarter. "We're finding that we're spending a little less money on the integration cost side, but we'll provide that" in the final results.

The announcement energized banking stocks, which have rallied in recent weeks on optimism that the economy is improving. Wells shares climbed 31.7% Thursday, to close at $19.71, and the KBW Bank Index climbed 20.1%.

But Stuart Plesser, an equity analyst at Standard & Poor's Corp. cautioned that Wells' results may not reflect wider conditions in banking. He said the same about Citigroup Inc.'s announcement that it turned a profit in January and February. Both companies had unique circumstances — the Wachovia acquisition in Wells' case and extra government backstops in Citi's case — that make them imperfect bellwethers for the industry as a whole, he said.

"I'm hesitant to look at these numbers and say, 'Wow, everyone is going to report numbers like these,' " said Plesser, who raised his full-year earnings estimate for Wells Fargo by 85 cents, to $2.07 a share. "I think a lot of what went on may be more Wells-specific than industry-specific, because of the acquisition."

He also said he is looking beyond Wells' mortgage results for clues about the company's health.

"There's no question the spreads in the mortgage business are attractive," Plesser said. "The real issue is how much the legacy assets are going to weigh on the provisions. It'll be interesting to see the commercial loans they picked up with Wachovia."

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