“The LA Times reports on the Wells Fargo “sneak peek” of their first quarter earnings today.  One big reason for the surprise was the bank’s allowance for loan losses (we added the emphasis):

“The big surprise for analysts was Wells’ first-quarter provision of $4.6 billion for potential loan losses — a huge amount, to be sure, but markedly lower than Wall Street had expected.

For example, FBR Capital Markets number crunchers had projected a set-aside of $6.25 billion for losses. In a skeptical note to investors, FBR — which has a “sell” rating on Wells — said, “We believe that credit quality materially deteriorated in the first quarter and that Wells Fargo is under-reserving for expected future losses.”

In a Bloomberg interview (hat tip ML-implode.com),  Wells Fargo  CFO,  Howard Atkins responded to a question about the loan loss reserve by simply stating it was adequate:

“Obviously if the economy continues to deteriorate we’ll have to have another look at [loan loss provisions], but as of this moment in time we think 23 billion [total provision] is an adequate reserve.”

Mr Atkins is asked in the interview about the effect of the new mark to market rules recently allowed by FASB.  He says the effect from these changes were “nominal”.  What he does NOT say is important here. He doesn’t say the effects were something like ” not material” or “negligible”.  A fairly close transcript of what he actually says is:

“… the new mark to market rules from FASB still require banks to write down the credit portion of any marks on their portfolios and in fact we did that in the quarter – our earnings actually reflected a negative from writing down some of these securities portfolios but, overall the benefit from that was not that great.”

Was the benefit “great enough” to amount to the  $1.65B difference from what analysts expected in the provision for loan and security losses?  Listen at about minute 7.20 below and see what you  think…

We think it is clear in the interview (and so does ML-implode.com) that changes in MTM rules enabled virtually all of the “surprise” earnings of 55 cents versus the expected 23 cents.

Mr Adkins also said earlier  in the interview that a large portion of income for the quarter was derived from fees on new mortgages, but that about 75% of that volume was from refinancing which can be expected to be nonrecurring.  In a March 30 opinion given to Bloomberg,  Paul Miller, an analyst with FBR, documents his expectations for the surge in mortgage fee income for banks and its non-recurring nature:

“Banks and lenders with “stronger trading and mortgage fee income” will see a benefit in their first-quarter profit that will “not be sustainable” as the broader economy continues to deteriorate.”

The Pragmatic Capitalist says of these earnings shenanigans:

“I expect to hear very similar reports from all of the big money center banks.  Stay flexible and patient.  I am certain that this sort of noise will create an incredible short opportunity in the coming month.”