DBRS: Wells Fargo Reports Solid 3Q Results; Positive Operating Leverage

Summary:
• WFC’s quarterly net income of $5.8 billion increased on a linked quarter basis on higher revenue and lower expenses.
• The Company did not benefit from a reserve release this quarter as continued improvements in the quality of residential real estate were offset by higher commercial reserves reflecting deterioration in the energy sector. DBRS anticipates future reserve releases are likely to be sporadic due to both loan growth and the normalization of credit trends.
• Loans and deposits continued to grow steadily this quarter increasing 2% and 1% linked quarter, respectively.
• DBRS rates Wells Fargo & Company Issuer & Senior debt at AA with a Stable trend.

DBRS Inc. (DBRS) considers Wells Fargo & Company’s (Wells Fargo or the Company) 3Q15 results as solid. Specifically, (DBRS-adjusted) revenues increased Quarter-on-Quarter (QoQ), as generally positive business results were offset by a higher provision for loan losses. In DBRS’s view, overall results continue to validate the Company’s strong execution of its diversified business operating model that is primarily focused on commercial and consumer banking with significant sources of fee income.

Wells Fargo continues to consistently lead most of its large banking peers in financial performance including returns on assets and equity. The Company’s solid organic loan and deposit growth, strong and sustained earnings, and robust capital generation support its ratings level. Importantly, the Company has been able to achieve these strong and consistent results despite the ongoing headwinds of the challenging interest rate environment, increased regulatory and litigation expenses and significantly enhanced liquidity and capital requirements.

Core loans increased $17.1 billion, or 2% QoQ, including $354 million from the 2Q15 purchase of loans from GE Capital. Positively, the loan growth was broad-based driven by C&I and CRE, as well as first mortgage, auto, credit card and security-based lending on the consumer side. Earning asset growth, a higher day count partially offset by a one basis point decline in the NIM, drove a 1.7%, or $187 million, QoQ increase in net interest income.

Wells Fargo’s broadly diversified franchise generates almost half of its revenues from noninterest income sources. Noninterest income increased 4% QoQ, largely reflecting increased gains from equity investments, the positive accounting impact of debt related hedges (hedge ineffectiveness), as well as other items. This offset generally weaker QoQ underlying fee growth including a 7% decrease in mortgage banking income on lower origination volumes and commercial mortgage activity. Additionally, lower trust and investment fees, and seasonally lower crop insurance premiums were headwinds. Expenses were modestly lower QoQ, and the Company-calculated efficiency ratio of 56.7% for 3Q15 was improved from 2Q15’s 58.5% and remained inside the Company’s targeted efficiency range of 55% to 59%.

Wells Fargo’s liquidity and capitalization continue to be maintained at ample levels despite balance sheet growth and ongoing share buybacks and dividend distributions to shareholders, including $3.2 billion returned to shareholders in 3Q15. The Company reported an estimated Basel III fully phased-in (Standardized Approach) Common Equity Tier 1 ratio of 10.67% at September 30, 2015, a 12 basis point increase QoQ, which remains comfortably above the Company’s 10% targeted level.

Wells Fargo recently announced several acquisitions related to GE Capital, including $32 billion in assets from GE Capital’s Commercial Distribution Finance and Vendor Finance businesses, as well as other corporate finance loans & leases. Additionally, the GE Railcar Services acquisition will move Wells Fargo from the fifth largest to the second largest railcar and locomotive leasing company in North America. All acquisitions are expected to close in 1Q16 and will be neutral to modestly accretive in 2016. DBRS views these acquisitions of high quality assets and complementary businesses as consistent with Wells Fargo acquisition strategy.

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