DBRS Confirms Wells Fargo & Company Senior Debt at AA; Revises Trend to Negative

DBRS, Inc. (DBRS) has today confirmed its ratings for Wells Fargo & Company (Wells Fargo or the Company) and its subsidiaries, including the Company’s Issuer & Senior Debt rating of AA and Short-Term Instruments rating of R-1 (middle). The trend on all Long-Term ratings has been revised to Negative from Stable while all Short-Term Instruments ratings remain Stable (see rating chart for additional details). The rating actions follow the ongoing developments surrounding the Company’s sales practices where, over a number of years, some retail customers received, and were potentially charged for, unrequested products. These developments also evidence a lack of controls, including the inability to properly monitor employees engaged in sales-related activities, and the neglect of management to more forcibly address the issues earlier.

The Negative trend recognizes the ongoing reputational damage stemming from details of the Company’s sales practices being made public. Moreover, negative headlines are likely to remain an ongoing risk, as the Company faces several class-action lawsuits, as well as additional criminal investigations. Given its relatively high rating level, DBRS has limited tolerance for any further adverse impact to Wells Fargo’s franchise strength and/or earnings power, both of which are key underpinnings of Wells Fargo’s credit profile and overall credit ratings. DBRS will continue to monitor the impact and severity of the reputational damage, success at mitigation efforts, as well as changes to its compensation structure, all of which may curtail the Company’s growth prospects.

While the September settlement with the Consumer Financial Protection Bureau, the Office of the Comptroller of the Currency, and the Office of the Los Angeles City Attorney, was immaterial ($185 million, plus $5 million in customer remediation, both of which had been previously accrued), the settlement does highlight a major management misstep for the Company, which had come through the financial crisis relatively unscathed, and calls into question management oversight of a key business line. Furthermore, Wells Fargo’s practice of “cross-selling” banking products was viewed as a key strength of the Company’s sales culture, as it deepens its relationships with customers and boosts fee income, an activity that will likely now be hindered, as Wells Fargo adjusts its compensation structure and transitions its culture. DBRS also notes that the settlement includes added regulatory oversight, which has the potential to drive increased regulatory and compliance costs. Wells Fargo must provide various written plans to the regulators that should help prevent this kind of activity going forward, and these plans will be reviewed regularly to confirm the Company is meeting its timeline for implementation. This effort includes the added expense of third party monitoring and quality assurance, as well as control and risk oversight, all of which will add to the Company’s expense base and will keep the efficiency ratio at the high-end, or above, the Company’s targeted range 55% to 59%. Most recently, Wells Fargo reported an efficiency ratio of 59.4% for 3Q16.

The Company’s ongoing mitigation efforts include outreach to affected customers and stakeholders, enhanced oversight, increased transparency, process enhancements, and personnel changes, which included the abrupt retirement of Chairman and CEO John Stumpf, Mr. Stumpf, who ultimately viewed continuing on in the CEO role as a distraction, was replaced as CEO by Tim Sloan, a long-time Wells Fargo veteran and already president of the Company and heir apparent. The Board has also commenced an independent investigation of the retail banking sales practices and related matters, which should lead to improved Board oversight of the Company and management.

At this early point, there appears to be limited impact to revenues, although there have been reports of various clients suspending business activities with Wells Fargo. Moreover, the Company is facing numerous lawsuits and will continue to get increased regulatory and political attention, which may also adversely impact performance. Related to its efforts to improve transparency, the Company has been monitoring and disclosing customer activity, as well as any crossover impact of other business lines. This monitoring did show typical September traffic to branches and call centers, although consumer checking accounts openings and credit card applications declined.

DBRS notes that Wells Fargo faces these serious challenges from a position of strength. Indeed, the Company just reported its 16th consecutive quarter of at least $5 billion of earnings, including record loan and deposit balances in 3Q16, generated from a diversified and resilient business model.

Headquartered in San Francisco, Wells Fargo & Company, a financial holding company, reported $1.94 trillion in assets as of September 30, 2016.

RATING DRIVERS
If the Company is able to demonstrate that it can still grow new accounts, loan and deposit balances, while maintaining top quartile profitability metrics, DBRS would likely revert the trend back to Stable. Conversely, if the reputational damage results in loss of customers and elevated expenses that weaken returns, the ratings would likely be downgraded.

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

The applicable methodologies are Global Methodology for Rating Banks and Banking Organisations (July 2016), DBRS Criteria: Support Assessments for Banks and Banking Organisations (March 2016), DBRS Criteria: Rating Bank Capital Securities - Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2016), DBRS Criteria: Rating Market-Linked Securities (March 2016) and DBRS Criteria: Guarantees and Other Forms of Support (February 2016), 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.

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

Lead Analyst: John Mackerey
Rating Committee Chair: Roger Lister
Initial Rating Date: December 10, 1999
Most Recent Rating Update: June 23, 2016

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