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Wells Played, Mr. Fargo


WFC will likely exceed earnings expectations in 2009.

To me, the most important words in the Wells Fargo (WFC) announcement this morning were:

"By immediately writing down loans and securities at Wachovia through purchase accounting adjustments at close, we have already significantly reduced the risk of loss to tangible common equity. Since these losses have already been recognized, our future earnings will be higher and therefore tangible common equity can now grow faster."

The English translation is: "We trashed the Wachovia balance sheet as much as the accountants would allow, so that post merger, we can exceed earnings expectations in 2009."

And my guess is that at least for the next few quarters, they can and will. And with their "voluntold" reduction in common dividends, tangible capital should grow.

But as I offered the other day, accounting is all about the timing of losses, not the cash flows on loans. And merger reserves -- like the ones Wells took -- and mark-to-market accounting, accelerate the timing whereas accrual accounting tends to drag it out over time.

The question for Wells, and all financial services firms, is whether the losses they've already taken have been enough to carry them through to the recovery. And with Wells currently trading below book value, I expect that there will be investors who are willing to bet they will.

As someone who has emphasized the importance of financial staying power, I'd suggest that it's far too early to declare victory. At the same time, I can understand the reason for hope, particularly given how firms such as Wells may have played the accounting game to a T.

Wells played, Mr. Fargo.
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