DBRS Confirms Wells Fargo & Company Issuer Rating at AA (low); Trend Stable

DBRS, Inc. (DBRS) confirmed the ratings of Wells Fargo & Company (Wells Fargo or the Company), including the Company’s Long-Term Issuer Rating of AA (low). At the same time, DBRS confirmed the ratings of its primary banking subsidiary, Wells Fargo Bank, N.A. (the Bank). The trend for all ratings is Stable. The Intrinsic Assessment (IA) for the Bank is AA, while its Support Assessment remains SA1. The Company’s Support Assessment is SA3 and its Long-Term Issuer Rating is positioned one notch below the Bank’s IA.

KEY RATING CONSIDERATIONS
While Wells Fargo continues to grapple with the fallout stemming initially from the sales practices scandal that surfaced two years ago, as well as the asset cap implemented in conjunction with the February 2018 Consent Order, the Company has maintained its strong market share in a number of businesses across its franchise. This is most recently evidenced by 2018 FDIC deposit market share data which shows Wells Fargo maintaining its strong number three U.S. deposit market share with year over year deposit growth. Earnings have also remained solid, despite the heightened regulatory and litigation expenses, although at a lower level than the Company usually operates. However, DBRS views renewed efforts to control expenses, including a recently announced reduction in headcount, will lead to improving operating results. However, as Wells Fargo’s efforts to resolve its operational issues plays out publicly, negative headlines are likely to remain an overhang. Recognizing the issues facing the Company, last year DBRS downgraded the Company’s Issuer Rating from AA to AA (low).

RATING DRIVERS
Over the intermediate term, DBRS currently sees limited positive rating drivers given the Company’s outstanding operational, legal, and regulatory issues. Conversely, negative rating implications could arise from any new notable missteps, or if the Company’s ongoing regulatory and reputational issues lead to a sustained decline in profitability levels or a perceived impairment in franchise strength. Additionally, a noted deficiency in risk management practices or a worse than peer deterioration in asset quality, especially as a result of weak underwriting or an increase in risk appetite, could have negative rating implications.

RATING RATIONALE
Despite the impact of heightened litigation and remediation expenses, DBRS considers Wells Fargo’s recent operating results as remaining solid with ample capacity to absorb these costs. Wells Fargo leads many of its large global banking peers in financial performance, although some of these peers have closed the gap in recent periods. The Company does have an expense and headcount reduction program in place and has been rationalizing its sizeable branch network and exiting non-core businesses, all of which should lead to improving results and efficiency ratio.

Wells Fargo’s revenues are highly diversified across products and geography. For 2Q18, revenues were down a modest 2% linked quarter, reflecting lower non-interest income largely due to a drop in market sensitive revenue and a decline in mortgage banking revenue. Despite the shrinking balance sheet, net interest income increased linked quarter, partially driven by a nine-basis point improvement in the net interest margin. Expenses were down 7% linked quarter on lower litigation accruals and seasonally lower personnel expenses.

The Company’s February 2018 consent order caps the size of its balance sheet at its size at YE17 equating to approximately $1.95 trillion. The Company has been effectively managing under this limit by curtailing certain products. In 2Q18, Wells Fargo’s total assets declined by $35.7 billion from 1Q18, primarily due to declining cash and short-term investments reflecting the purposeful run-off of certain deposit balances. Loans also declined linked quarter on lower auto, legacy consumer real estate and commercial real estate loans, partially reflecting loan sales and prior decisions to tighten underwriting standards in certain loan portfolios. Positively, Wells Fargo reported an uptick in C&I loans. Initially expecting a $300 to $400 million adverse impact to earnings from the asset cap (less than 2% of annual net income), the Company now expects this number to be substantially lower. At the end of 2Q18, DBRS estimates that the Company was operating well-below the asset cap, providing substantial room for loan growth to support current and new customer growth opportunities.

DBRS continues to view asset quality and credit risk management as key strengths of the Company and an area where the Company is expected to outperform peers. Wells Fargo is able to react quickly to changing fundamentals in its loan portfolio and adjust underwriting accordingly. Reflecting the current benign credit environment, the Company has reported declining non-performing assets for nine consecutive quarters.

Funding is considered robust. Indeed, the Company has a proven ability to grow and fund its balance sheet with deposits. Additionally, Wells Fargo has ready access to wholesale funding in a variety of markets. Given its balance sheet and business mix, Wells Fargo is less reliant on market-based funding sources than some of its peers. Short-term borrowings represented $104.5 billion, or just 6% of total assets as of June 30, 2018. The Company is compliant with domestic Basel III liquidity coverage ratio rules and reported an average LCR of 123% for 2Q18.

DBRS views the Company’s capital position as sound. Capital levels remained relatively stable and above Wells Fargo’s 10% target with a Basel III CET1 ratio of 12% at June 30, 2018. The Company received a non-objection from the Federal Reserve for its 2018 capital plan, which includes sizeable gross buybacks of up to $24.5 billion, as well as a 10% increase in the common stock dividend in the 3Q18. Wells Fargo returned approximately $4.0 billion to shareholders in 2Q18, equating to a net payout ratio of approximately 84%. With estimated total loss absorbing capacity (TLAC) of 23.6% at 2Q18, the Company already exceeds the expected TLAC required minimum of 22%, which will become effective on January 1, 2019, creating an estimated buffer of approximately $20 billion.

Headquartered in San Francisco, Wells Fargo & Company, a financial holding company, reported $1.88 trillion in assets as of June 30, 2018.

The Grid Summary Grades for Wells Fargo are as follows: Franchise Strength – Very Strong/Strong; Earnings Power – Very Strong/Strong; Risk Profile – Very Strong/Strong; Funding & Liquidity – Very Strong/Strong; Capitalisation – Very Strong/Strong.

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

The applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (July 2018), DBRS Criteria: Guarantees and Other Forms of Support (January 2018), DBRS Criteria: Rating Principal Protected Market-Linked Securities (February 2018), which can be found on our website under 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.

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

Lead Analyst: John Mackerey, Vice President – Global FIG
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG - Global FIG
Initial Rating Date: 10 December 1999
Last Rating Date: 20 September 2017

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

For more information on this credit or on this industry, visit www.dbrs.com.