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Wells smells

Instead of a stress test, maybe we need a "smell" test for the banks. Today, Wells Fargo "surprised" Wall Street by saying it's expecting a record profit for the first quarter. There may be logical explanations for this, but something doesn't smell quite right.

Wells says mortgage applications were a big driver of revenue in Q1, both new loans and refinancing. From Bloomberg:

Wells Fargo reported $100 billion in mortgage loans during the quarter, and said second-quarter originations are likely to be strong.

"There is a lot of activity at the lower end of the housing market," Chief Financial Officer Howard Atkins said in a telephone interview. "We are a lot closer to the bottom."

I can buy being "closer" to the bottom, but I question how much closer and how far away the bottom is. What about the 600,000 foreclosed homes being held back from the market (as I pointed out yesterday)?

Wells says it's benefiting from so many mortgage companies going under. Atkins: "Margins are better because of the competitive situation. A lot of the irrational players are out of the market."

I'm still buying it. Makes sense. Wells also bought Wachovia at the end of last year and those Wachovia branches accounted for 40% of Q1 revenue.

But Wells has about $1.3 trillion dollars in assets on its balance sheet. More than half of those came from Wachovia, including $122 billion in ARM mortgages. And that's where the stench is coming from.

Did Wells use the new relaxed accounting rules to make the books look better? I guarantee you they did. Banks now have much more latitude in determining the value of "toxic" assets.

Wells is in better shape than some of the other big banks and might be able to sell some of those assets in the PPIP.

But if the mark-to-market rules hadn't been changed, I wonder whether Wells would really smell this rosy.

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