Wells Fargo Ups Loan Reserves, Reduces Estimate on Earnings

In a sign of worsening woes for California banks, Wells Fargo & Co. said Tuesday that its second-quarter earnings will be sharply lower than expected because of a big boost in its reserves for possible loan losses.

Wells Fargo, the nation’s 10th-largest bank with $56 billion in assets, said it would report net earnings of only $15 million, compared to net income of $152 million in the first quarter and $232 million in the second quarter of last year.

The company attributed the drop in earnings to a $350-million increase in its loan-loss reserves. These reserves--which are deducted directly from earnings--are to cover deteriorating commercial loans and those for leveraged buyouts.

Some bank analysts, who were surprised by the size of the reserves, expressed concern that Wells did not include provisions for potential losses on commercial real estate loans, a growing area of concern, particularly in Southern California.

“More substantial problems could arise in the large commercial real estate portfolio, which accounts for 30% of loans,” said Standard & Poor’s Corp., a New York-based credit rating agency that downgraded Wells Fargo’s debt Tuesday.

The announcement sent the stock of the San Francisco-based banking company plummeting for the second day in a row. The stock, trading on which was briefly halted in the morning, dropped $6.50 to $74. On Monday, it declined $6.375.

The news also dragged down the shares of other California banks with hefty loan portfolios; Security Pacific was off $1.375 to $23.25, First Interstate declined $2.25 to $34, and BankAmerica dropped $1.50 to $35.875.

Wells Fargo’s stock price had risen in recent months amid investor hopes that it would avoid the real estate problems of banks in Texas and New England. The stock also gained favor because of the confidence shown in the bank by renowned investor Warren E. Buffett, who holds a nearly 10% stake in Wells Fargo stock.

Wells Fargo said it would increase the loan-loss reserves in the quarter ended June 30 after a review of its loan portfolio by federal regulators. The additional provision brings its total reserve to more than $1 billion, compared to $905 million at the end of March.

Wells Fargo, which at the end of March had $48.4 billion in loans outstanding, said it is placing about $400 million in commercial loans in the non-performing category, even though the payments on principal and interest are current. About half of those, it said, are loans made to companies that financed buyouts with debt. The company said it expects actual loan losses in the second quarter to be about $180 million, up from $67 million in the first quarter.

“We see some potential distress,” said Rod Jacobs, Wells’ vice chairman and chief financial officer, in an afternoon briefing with reporters. “We’re trying to be prudent. Our actions reflect our current state of knowledge about the portfolio and the economy.”

He declined to speculate about possible future bombshells, saying “provisioning will be a quarter-to-quarter event.”

But analysts expressed concern about Well Fargo’s exposure to commercial real estate loans. The commercial real estate market is especially soft in Southern California, where two-thirds of Wells Fargo’s commercial real estate loans are concentrated.

Wells Fargo is California’s largest commercial-property lender and nationally is second only to Citicorp in that category. Commercial real estate loans account for nearly a third of Wells Fargo’s portfolio, whereas leveraged-buyout loans make up 7%.

“They still haven’t really taken the hit on real estate, which lies ahead,” said Michael Murphy, a prominent San Francisco short seller whose Overpriced Stock Service newsletter has been forecasting a financial catastrophe at Wells for some time.

He called their exposure in commercial real estate “pretty horrendous” and predicted that the stock would drop to “the $45 area as people realize how bad things are.”

If the company had not made the loan-loss provision, Jacobs said, earnings would have exceeded $160 million for the quarter. In last year’s second quarter, the company made $164 million, not counting a one-time gain related to the establishment of a joint venture with a Japanese securities firm to manage pension funds in Japan.

S&P; said the announcement and concerns about potential future problems prompted it to downgrade about $3.6 billion in Wells Fargo debt and preferred stock. S&P; said the action reflected its “view that bad loans will keep rising substantially at least through year’s end.”

Fitch Investors Service, another New York rating firm, said it put $2.15 billion in Wells Fargo debt on watch, with the likelihood that the rating will be lowered.

“Regulators forced the hand here is the way I read the tea leaves,” said Fred W. DeBussey, an analyst with Fitch who said he was “surprised” by the high level of new non-performing assets.

Donald K. Crowley, with the San Francisco investment firm of Keefe Bruyette & Woods, said he has reduced his full-year 1991 earnings estimate for Wells to $8 a share from $11.70 and his 1992 projection to $10.50 a share from $12.15.

He added that “we’re not getting much guidance from the company about the outlook.”

Carl E. Reichardt, chairman and chief executive, said the increase in bad loans reflects national economic trends. “There is some evidence of an upturn in the economy, but we remain cautious and expect continued pressure on the loan portfolio at this point in the business cycle,” he said.

Investors in recent weeks had been bidding up the prices of bank stocks as they anticipated that lower interest rates and signs of economic recovery would put banks on better footing. Wells stock, which had languished last fall at about $50 a share after dropping from $86, had climbed back to that loftier level.

Part of the resurgence was on the strength of Wells Fargo’s successful attempts to soothe investors’ concerns by emphasizing management’s good track record and its prudent approach to lending. But the company’s announcement appeared to raise questions about it credibility.

Bank Stocks Slip Daily closes for June, price per share Wells Fargo Tuesday: $74.00., down $6.50 Security Pacific Tuesday: $23.25, down $1.38 First Interstate Tuesday: $34.00, down $2.25 Bank of America Tuesday: $35.88, down $1.50