Despite Wells Fargo's (NYSE:WFC) rosy earnings pre-release last Friday, which sent shares popping like a champagne cork, the California lender's shareholders may be in for a nasty hangover. While it's clear that the banking environment was hugely favorable in the first quarter, Wells' balance sheet could still reveal enormous toxic exposures -- to the tune of $120 billion in potential losses, according to one analyst.

What's $50 billion between friends?
On Monday, KBW (NYSE:KBW), an investment bank focused on the financial services industry, published a note stating that Wells Fargo will require an extra $50 billion in common equity if it is to repay the TARP investment and achieve a reasonable capital cushion.

The analyst's $120 billion loss estimate is based on an economic scenario that looks pretty severe, but far from implausible, with the economic downturn lasting through the first quarter of 2010, and unemployment peaking at 12%. Under those conditions, the KBW analyst estimates that Wells will need $50 billion in order to achieve a tangible common equity ratio of 4.5% by the end of 2010 (after repayment of the government's $25 billion TARP investment).

Wells Fargo isn't top of this table
As the following table shows, Wells has a ways to go before it meets that bar -- and catches up to the upper echelon of its peers:

Bank

Tangible Common Equity Ratio (on Dec. 31, 2008, unless otherwise noted)

Goldman Sachs (NYSE:GS)

4.6%* (Mar. 27, 2009)

US Bancorp (NYSE:USB)

4.5%

Morgan Stanley (NYSE:MS)

3.3%* (Nov. 30, 2008)

Wells Fargo (NYSE:WFC)

>3.1% (Mar. 31, 2009)

Citigroup (NYSE:C)

3.0%**

Bank of America (NYSE:BAC)

2.8%

Source: Standard & Poor's Capital IQ.
*Estimated. **Prior to the common shares/preferred stock exchange.

Shareholders: Buckle up!
Faithful readers will be aware that I have had concerns about Wells Fargo for some time. At the end of January, I suggested that the bank had yet to fully recognize losses in its loan portfolio. I continue to think that is the case; consequently, shareholders (a group I'm part of) should expect significant volatility in results (and share price) over the coming year. I'll be eagerly anticipating the details of the company's full first quarter earnings release on April 22nd -- they'll definitely merit investors' careful consideration.

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