DBRS Morningstar Confirms Wells Fargo & Company at AA (low); Trend Revised to Negative

DBRS, Inc. (DBRS Morningstar) 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 Morningstar confirmed the ratings of its primary banking subsidiary, Wells Fargo Bank, N.A. (the Bank). The trend for all long-term ratings at the Company and all ratings at the Bank have been revised to Negative from 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
The Negative trend reflects the wide and growing scale of the economic disruption resulting from the Coronavirus Disease (COVID-19) pandemic, which is already pressuring Well Fargo’s earnings and asset quality and will likely continue to have a significant impact in future quarters. Nevertheless, unprecedented support measures have been put in place through monetary and fiscal stimulus, as well as relaxed criteria from regulators, which in our view, could help mitigate some of the negative impact of the crisis. However, should the crisis be prolonged, or if the recovery is muted, additional ratings pressure is likely.

The confirmation of Wells Fargo’s ratings reflect the quality and diversity of its underlying franchise. However, Wells Fargo is entering this economic downturn in a somewhat weaker position than some of its global peers, as it continues to grapple with the fallout originally stemming from the sales practices scandal and other missteps that first surfaced nearly four years ago. This includes managing under the asset cap that was imposed as part of the February 2018 Consent Order, as well as an elevated expense base, as it builds out its risk management infrastructure and absorbs other conduct costs. With the asset cap, the Company has a limited ability to grow the balance sheet and net interest income, which would help offset net interest margin compression in today’s challenging rate environment.

RATING DRIVERS
Given the Negative trend, an upgrade of the ratings is not currently anticipated. However, DBRS Morningstar would revise the trend back to Stable if the economic fallout from the coronavirus pandemic is not prolonged and remains manageable from a profitability and capital perspective. Conversely, a downgrade of ratings would arise from a sustained decline in profitability levels or a significant deterioration in asset quality.

RATING RATIONALE
Wells Fargo reported net income of $653 million in 1Q20, down from $2.9 billion earned in the linked quarter and $5.9 billion earned in 1Q19. The sharply lower earnings were primarily due to a substantial reserve build for potential credit losses, reflecting the impact of the coronavirus. Wells Fargo has enacted programs to provide support to its customers, employees and communities during this period. Through April 10, 2020, the Company had deferred $2.8 billion of principal and interest payments on loans serviced or held in portfolio.

The $4.0 billion provision for credit losses this quarter included a substantial reserve build for loans of $2.9 billion, as well as a $172 million provision expense for debt securities that included a $141 million reserve build. The reserve builds reflect forecasted credit deterioration due to the pandemic, credit weakness in the oil and gas portfolio from the recent sharp declines in oil prices, and loan growth. Quarterly net charge-offs (NCOs) of $909 million were higher from recent periods, although up just 6 basis points linked quarter to an annualized rate of 0.38%. However, NCOs will likely increase considerably going forward. The Company has identified certain loans, including commercial real estate, oil and gas exposures and other industries especially impacted by the economic slowdown, that require escalated monitoring in the current environment. While this portfolio is highly diversified with different levels of risk, it does collectively represent around 21% of the loan portfolio. The benefit from stimulus measures and forbearance programs should help moderate the pace of loss recognition though. DBRS Morningstar continues to view asset quality and credit risk management as key strengths of the Company and an area where the Company has historically outperformed peers.

While the Consent Order caps the size of Wells Fargo’s balance sheet at its size at YE17 (approximately $1.95 trillion based on a rolling two-quarter daily average), the Company has been effectively managing under this limit, although this is becoming more challenging in the current environment. Loans increased by $47.6 billion, or 5%, linked quarter as companies drew down their revolvers, boosting wholesale banking loan utilization in March to 48.6%, up 860 basis points linked quarter. Deposits grew 4% linked quarter, as some of the drawdown on credit lines remained parked at the Company.

Balance sheet trends remained favorable. 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. The Company is compliant with domestic Basel III liquidity coverage ratio rules and reported an average liquidity coverage ratio of 121% for 1Q20.

Capital metrics are sound, including an estimated CET1 ratio of 10.7% as of March 31, 2020, remaining above the Company's 10% internal target. Wells Fargo repurchased $2.9 billion common shares in 1Q20 before suspending its share repurchases program in mid-March.

Headquartered in San Francisco, Wells Fargo & Company, a financial holding company, reported $1.98 trillion in assets as of March 31, 2020.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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

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

The principal methodologies are the Global Methodology for Rating Banks and Banking Organisations, June 11, 2019 (https://www.dbrsmorningstar.com/research/346375/global-methodology-for-rating-banks-and-banking-organisations), DBRS Morningstar Criteria: Guarantees and Other Forms of Support, January 22, 2020 (https://www.dbrsmorningstar.com/research/355780/dbrs-morningstar-criteria-guarantees-and-other-forms-of-support), DBRS Morningstar Criteria: Rating Principal-Protected Market-Linked Securities, January 15, 2020 (https://www.dbrsmorningstar.com/research/355603/dbrs-morningstar-global-criteria-rating-principal-protected-market-linked-securities).

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The primary sources of information used for this rating include Company Documents and S&P Global Market Intelligence. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.

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

This rating is endorsed by DBRS Ratings Limited (DBRS Morningstar) for use in the European Union. The following additional regulatory disclosures apply to endorsed ratings:

Each of the principal methodologies/principal asset class methodologies employed in the analysis addressed one or more particular risks or aspects of the rating and were factored into the rating decision. Specifically, the Global Methodology for Rating Banks and Banking Organisations (June 11, 2019) was used to evaluate the Issuer, DBRS Morningstar Criteria: Guarantees and Other Forms of Support (January 22, 2020) was utilized to rate subsidiaries guaranteed by the Issuer and DBRS Morningstar Criteria: Rating Principal-Protected Market-Linked Securities (January 15, 2020) was used to rate select issuances of these types of securities.

The last rating action on this issuer took place on October 21, 2019, when all ratings were confirmed with a Stable trend.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are monitored.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

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

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

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