The subject behavior may occur if the custom wallpaper was a JPEG (.jpg) file. The registry path to the wallpaper is pointing to a file that does not exist.
To resolve this behavior:
1. Copy / Paste the following to a FixWP.reg file:
Windows Registry Editor Version 5.00
\[HKEY_CURRENT_USER\Control Panel\Desktop\]
"Wallpaper"="%USERPROFILE%\\Local Settings\\Application Data\\Microsoft\\Wallpaper1.bmp"
"OriginalWallpaper"="%USERPROFILE%\\Local Settings\\Application Data\\Microsoft\\Wallpaper1.bmp"
2. Right-click the FixWP.reg file and press Merge.
3. Confirm your request.
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