The top U.S. securities regulator has questioned Wells Fargo & Co (WFC.N) over its accounting for a roughly $20 billion (16 billion pounds) portfolio of troubled loans.
In a letter sent in September that became public on Tuesday, the Securities and Exchange Commission (SEC) asked the bank's controller, Richard Levy, to explain how Wells Fargo went about valuing the portfolio, which it acquired primarily by buying Wachovia.
The SEC's questions, which may represent another headache for Wells Fargo following a sales scandal, relate to assumptions the bank made in determining how to value the loans. On a portfolio of so-called "Pick-a-Pay" mortgages, for example, the discussion focussed on metrics such as borrower credit score and loan-to-value.
Those valuation assumptions affect Wells Fargo's earnings in that, when banks acquire distressed assets, they must value them in a way that involves some guesswork about whether the loans will be repaid. The values can rise or fall significantly over time, depending partly on the accuracy of the guesswork, which in turn can lead to gains or losses.
In recent months, stock analysts at firms including Keefe, Bruyette & Woods and Credit Suisse have raised questions about whether Wells Fargo's earnings are supported by underlying business growth or accounting manoeuvres.
In a Sept. 23 note, Credit Suisse's Susan Katzke said the bank's "shares were pressured by debatable earnings quality," even before a sales scandal erupted on Sept. 8, hammering its stock.
"There is this sense they are managing earnings and the way you can manage earnings is if you interpret accounting in beneficial ways at the appropriate moments," said Charles Peabody, analyst at Compass Point Research & Trading. "I don't think that is necessarily a bad thing. The problem is that when you get on that treadmill it's hard to get off it."
Wells Fargo's Levy responded to the SEC's questions in detail in an October letter. His response included tables showing how and why values changed over time.
In correspondence the next month, the SEC's senior assistant chief accountant, Stephanie Sullivan, said the agency had completed its review.
Valuing such loans "is challenging, and that is the answer that Wells Fargo is offering," said Judy Beckman, an accounting professor at the University of Rhode Island.
Spokesmen for the SEC and Wells Fargo declined to comment.
The SEC regularly questions companies on their earnings reports. The regulator sent 2,905 such letters to companies during the 12 month period ended June 30, according to a report from Ernst & Young.
In September regulators ordered Wells Fargo to pay $190 million in fines and restitution to settle charges its employees created as many as 2 million deposit and credit card accounts without the consent of customers.
The bank faced more trouble on Tuesday when it was the only major U.S. bank that failed to convince regulators it could go bankrupt without causing a major market disruption.
(Reporting by Dan Freed in New York; Editing by Lauren Tara LaCapra)