DBRS Confirms Wells Fargo & Company Senior Debt at AA; Trend Stable

DBRS, Inc. (DBRS) has today confirmed its ratings for Wells Fargo & Company (Wells Fargo or the Company) and its subsidiaries, including Wells Fargo’s Issuer & Senior Debt rating of AA and Short-Term Instruments rating of R-1 (middle). The trend on all ratings remains Stable. The rating action follows a detailed review of the Company’s operating results, financial fundamentals and future prospects.

DBRS views Wells Fargo’s highly successful franchise, predictable and diversified earnings stream, consistent and effective management, corporate culture and operating strategy, strong capital levels and ample liquidity as commensurate with its Issuer & Senior Debt ratings of AA and Stable trend. The Company continues to outperform most peers in an industry operating environment generally characterized by elevated expense levels and revenue growth challenges. The Company’s sizeable exposure to the U.S. housing market including its large servicing and origination platform as well as its on-balance sheet mortgage portfolio including a significant level of loans in a junior lien position are also considered in DBRS’s rating. Given the Company’s superior ratings level and a willingness to take on managed risk in order to achieve respectable returns on capital, DBRS therefore sees the upside ratings potential as limited.

Wells Fargo’s diverse national franchise includes the largest U.S. branch network, the second largest U.S. deposit share, leading shares in residential mortgage origination and servicing and top tier positions in middle market and small business lending, auto finance and debit card issuance. DBRS remains mindful that the Company’s market share leadership positions and size as the fourth largest bank in the U.S. by assets places Wells Fargo under heightened regulatory and media scrutiny. DBRS notes however, that the Company’s relatively modest presence in capital market businesses enables it to avoid the volatility and risk inherent in those businesses in addition to heightened regulatory oversight.

DBRS considers Wells Fargo’s recent operating results as solid, especially considering the difficult operating environment facing banks. Indeed, Wells Fargo consistently leads most of its large banking peers in financial performance and has been able to generate good organic loan and deposit growth, strong earnings, and sustained record profitability that are supportive to its ratings level. Underpinning the ratings is the Company’s ability to produce robust quarterly revenues, income before taxes and provisions (IBPT) and net income consistently. While earnings have generated a solid level of return as measured by return on assets (ROA) and return on equity (ROE), the Company has benefitted from a significant level of reserve releases, as credit quality has improved, benefitting the bottom line. Quarterly provisions, which peaked at $6.1 billion during 3Q09, were a mere $325 million in the most recent quarter, or just 4% of IBPT.

For 1Q14, Wells Fargo produced record net earnings (to common stock) of $5.6 billion; up 4.4% quarter-on-quarter (QoQ) and 13.7% year-on-year (YoY), as a tax benefit, strong equity investment gains, lower expenses and a lower credit loss provision more than offset the decline in net interest income in the linked quarter. The net interest margin has remained under pressure in the current rate environment as well as added pressure from strong deposit growth and increased liquidity positions in anticipation of new regulatory requirements. Additionally, as the mortgage refinance boom has ebbed, mortgage banking income declined 3.8% QoQ and 46% YoY. The strong rise in servicing income over the past year from an improved MSR valuation and economic hedge gains, however, has partially offset a decline in production revenue. Additionally, the Company has exhibited good expense discipline including right-sizing the mortgage banking expense base to reflect the decline in production. For 1Q14, expenses declined 1.1% QoQ and 3.6% YoY while the improved efficiency ratio of 57.9% (60bps QoQ improvement) was within the Company’s targeted expense range.

Asset quality trends continue to improve for Wells Fargo primarily driven by appreciation in real estate valuations as well as an improving economy. By virtue of real estate lending comprising 56% of its loan portfolio (per regulatory data), the Company would be susceptible to accelerated losses if real estate valuations were to weaken significantly. That said, Wells Fargo’s exposure to real estate is highly diversified geographically and by product type. The Company has also taken steps to reduce the risk level of residential mortgage loans it retains in portfolio. For instance, newer loans have a higher FICO score, lower loan to value and are more likely to be in a first lien position than the pre-crisis consumer real estate portfolio. Most recently, the decision to eliminate the origination of interest-only home equity lines of credit (HELOCs) except in cases where the borrower has other significant assets was announced. Another significant part of the loan portfolio includes the Commercial and Industrial (C&I) book, which represents about 18% of the loan portfolio (per regulatory data). This portfolio continues to show improving asset quality with low levels of net charge-offs (NCOs) (0.07% of average loans in 1Q14) and declining levels of nonaccrual loans (0.34% of loans in 1Q14) Additionally, the Company’s non-strategic/liquidating loan portfolio continues to ramp down.

DBRS views the Company’s capital position as sound. Specifically, capital levels have steadily grown over the past year despite ongoing capital management activity and balance sheet growth. On March 26th, 2014, the Federal Reserve Board announced that it had no objection to the Company’s 2014 Capital Plan, which included a proposed 16.7% dividend increase to $0.35 per share and an increase in share buybacks. The Company also published its fully phased-in Basel III (advanced approach) Common Equity Tier 1 ratio of 10.07% as of March 31, 2014, which is above their well-capitalized requirement.

Funding is considered robust with the Company’s ability to grow and fund its balance sheet with deposits a rating strength. This was evidenced by 8% YoY deposit growth in the most recent quarter. Also noteworthy is that the loan to deposit ratio continues to improve as the rate of deposit growth has exceeded loan growth. Wells Fargo maintains a high level of liquidity with over $242.5 billion in cash and equivalents, as of March 31, 2014, representing 16% of total assets. Including available for sale securities, liquid assets represent almost one-third of the balance sheet. While there is still some uncertainty around the final Basel III liquidity rules, DBRS believes that given Wells Fargo’s balance sheet structure, it will be well-positioned to meet future liquidity requirements.

Wells Fargo & Company, a financial holding company headquartered in San Francisco, reported $1.55 trillion in assets as of March 31, 2014.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (June 2012). Other applicable methodologies include the DBRS Criteria – Support Assessments for Banks and Banking Organisations (January 2014) and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (December 2013). These can be found at: http://www.dbrs.com/about/methodologies.

The primary sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: William Schwartz
Rating Committee Chair: Roger Lister
Initial Rating Date: 10 December 1999
Most Recent Rating Update: 7 February 2013

For additional information on this rating, please refer to the linking document under Related Research.