DBRS Downgrades Wells Fargo & Company Issuer Rating to AA (low); Trend Stable

DBRS, Inc. (DBRS) has downgraded the long-term ratings for Wells Fargo & Company (Wells Fargo or the Company), and its related entities, including the Company’s Long-Term Issuer Rating to AA (low) from AA. The trend on all ratings is now Stable. The Intrinsic Assessment (IA) for Wells Fargo Bank, N.A. (the Bank) was lowered one notch, to AA from AA (high), 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.

The one-notch rating downgrade reflects operational and management missteps at the Company and resultant reputational damage stemming from ongoing issues surrounding the Company’s sales practices, as well as practices impacting other consumer-related areas. Simply, over a number of years, some retail customers received, and were potentially charged for, unrequested or unnecessary products, evidencing a lack of controls, including the inability to properly monitor employees engaged in sales-related activities, an initial lack of management intervention, as well as issues surrounding controls and monitoring of third-party vendors. As the Company works to address the issues, expenses have been elevated and revenue growth in some areas has softened. Additionally, negative headlines are likely to remain an ongoing risk, as the Company faces heightened regulatory scrutiny, litigation, as well as additional investigations and the ongoing challenge of evolving the culture of the organization. Hence, a degree of uncertainty still hangs over the Company. Despite the downgrade, Wells Fargo remains among DBRS’s highest rated banks reflective of its highly scaled and diversified franchise, predictable and varied earnings, strong capital levels and ample liquidity as commensurate with its ratings and Stable trend.

Since the initial sales practice issue was brought to light in September 2016, the Company has been proactively investigating and working to address the issue and DBRS notes that the settlement amounts and customer remediation have remained a highly manageable number. Subsequently, other issues have been identified in the Company’s indirect auto lending platform and mortgage lending practices. Wells Fargo recently completed an expanded third-party review covering a wider time period and identified an additional $2.8 million in refunds to be paid for customers. Additionally, the Company recently agreed to a preliminary class action settlement of $142 million for claims dating back to 2002. The Company’s ongoing mitigation efforts include outreach to affected customers and stakeholders, enhanced oversight, increased transparency, process enhancements and personnel changes.

DBRS notes the added expense of third party monitoring and quality assurance, as well as control and risk oversight, have added to the Company’s expense base and pushed the efficiency ratio above the Company’s targeted 55% to 59% range. Most recently, Wells Fargo reported an efficiency ratio of 61.9% for 1H17.

DBRS notes that Wells Fargo faces its challenges from a position of strength, which is reflected in its very strong ratings. Despite growing expenses and a worsening efficiency ratio, the Company continues to outperform many global peers. The Company’s sizeable exposure to the U.S. housing market that consists of its large mortgage servicing and origination platform, as well as its substantial on-balance sheet mortgage portfolio, are also considered in DBRS’s ratings.

Wells Fargo’s national franchise includes the largest U.S. branch network, the second largest U.S. deposit market 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 notes however, that the Company’s still relatively modest, although growing, presence in capital market businesses compared to other large banks leaves it less exposed to the volatility and risk inherent in those businesses.

DBRS considers Wells Fargo’s recent operating results as remaining strong. Wells Fargo leads many of its large banking peers in financial performance, although some of these peers have closed the gap in recent periods. The Company does have an expense reduction program in place and has begun to rationalize its sizeable branch network. In DBRS’s view, the Company’s generally consistent results validate the soundness of its diversified operating model that is primarily focused on commercial and consumer banking with significant sources of fee income. Overall, the Company reported higher net income of $11.3 billion in 1H17 as compared to $11.0 billion in 1H16, largely as a result of higher net interest income and a lower provision for credit losses.

Asset quality trends continue to be relatively benign with Wells Fargo benefitting from appreciation in real estate valuations, as well as an improving economy. Additionally, net charge-offs remain very low, although likely at unsustainable levels. The Company’s residential real estate exposure is a sizeable one-third of total loans and leases, but is highly diversified by both geography and product type.

Funding is considered robust. Indeed, the Company has a proven ability to grow and fund its balance sheet with low-cost deposits that comprised over two-thirds of its balance sheet, as of June 30, 2017. Wells Fargo also has ready access to wholesale funding in a variety of markets. Debt maturities are well distributed, and significant liquidity is held in the form of cash and liquid assets at both the parent company and bank level. Wells Fargo maintains a high level of liquidity with approximately $554 billion in cash, short-term investments and available for sale investment securities, as of June 30, 2017, representing 29% of total assets. The Company is compliant with domestic Basel III liquidity coverage ratio rules and reported an average LCR of 124% for 2Q17.

DBRS views the Company’s capital position as sound. Capital levels have kept pace with balance sheet growth despite ongoing capital management activity. The Common Equity Tier 1 under Basel III Standardized Approach, fully phased-in, was 11.59% at June 30, 2017, well above the fully phased-in requirement of 9%, including the 2% G-SIB capital surcharge.

Headquartered in San Francisco, Wells Fargo & Company, a financial holding company, reported $1.93 trillion in assets as of June 30, 2017.

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.

RATING DRIVERS
DBRS currently sees limited upside ratings potential given the Company’s outstanding operational, legal, and regulatory issues. Conversely, higher than expected litigation costs or additional operational issues leading to a sustained decline in profitability levels or franchise impairment could have negative rating implications. Moreover, a notable increase in risk appetite, or worse than peer deterioration in asset quality, could also have negative rating implications.

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

The applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (May 2017), DBRS Criteria: Guarantees and Other Forms of Support (February 2017), DBRS Criteria: Rating Principal Protected Market-Linked Securities (February 2017), 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: 2 August 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.