Fitch Affirms Wells Fargo & Company's LT IDR at 'AA-' Following Large Regional Bank Review
The rating action follows a periodic review of the large regional banking group, which includes BB&T Corporation (BBT), Capital One Finance Corporation (COF), Comerica Incorporated (CMA), Fifth Third Bancorp (FITB), Huntington Bancshares Inc. (HBAN), Keycorp (KEY), M&T Bank Corporation (MTB), MUFG Americas Holding Corporation (MUAH), PNC Financial Services Group (PNC), Regions Financial Corporation (RF), SunTrust Banks Inc. (STI), US Bancorp (USB), Wells Fargo & Company (WFC), and Zions Bancorporation (ZION).
Company-specific rating rationales for the other banks are published separately, and for further discussion of the large regional bank sector in general, refer to the special report titled 'Large Regional Bank Periodic Review,' to be published shortly.
KEY RATING DRIVERS
IDRs, VRs, AND SENIOR DEBT
The affirmation reflects the company's superior earnings profile, solid and consistent management team, and strength of its franchise across many business lines.
Over the past several years, WFC's financial performance has been very strong despite a challenging economic and interest rate environment. WFC continues to post solid levels of net income, with return on assets (ROAs) well in excess of the large regional average. WFC's superior earnings performance is a core strength for the company, and a positive rating driver that differentiates it from its peers.
Fitch attributes WFC's superior earnings profile to its proven cross-sell strategy, low funding costs, efficient cost structure, and a diversified business model by geography and product type that has proven resilient over time. Further, Fitch assumes that WFC has been able to benefit post-financial crisis from a flight to quality.
WFC continues to report very strong levels of net income, in spite of considerable margin compression over the past couple of years, more so than other large regional peers. Somewhat explaining this, WFC has reported the highest level of deposit growth, which has left the company with an excess amount of liquidity, only to be reinvested into lower yielding assets. This excess cash represents a significant resource available for the company to invest into earning assets as rates rise.
Fitch views WFC's deposit franchise as currently undervalued in this low-rate environment. As deposit rates have fallen from pre-crisis levels, the benefit to WFC from its low cost of funding has compressed. The differential in funding costs has narrowed as all the large regional banks have all been able to continually lower deposit costs. When interest rates rise, WFC will likely be able to maintain lower funding costs relative to peers, helping to maintain superior profitability metrics in a higher interest rate environment.
WFC's management team is also viewed very favorably by Fitch. There has been a great deal of stability in the executive management ranks, with little turnover. Fitch views this as a competitive strength as the company's strategic direction and corporate culture remains consistent, and less vulnerable to swings in strategy. WFC's stated strategic objectives are clearly articulated, and achievable. Even during a challenging interest rate environment, the company is able to easily meet its three financial targets for ROA, return on equity (ROE) and the efficiency ratio, which are 1.3% to 1.6%, 12% to 15%, and 55% to 59%, respectively.
Fitch views no company as immune to operational issues or losses, though WFC has emerged relatively unscathed from the financial crisis, especially relative to similarly sized peers. Fitch attributes WFC's greater immunity to risk management failures and lack of outsized legal charges that have plagued the bigger banks to its long-tenured senior management team and strong corporate risk culture.
WFC's franchise is considered the strongest of the large regional banks, with leading market shares in many sectors and asset classes. WFC has the second most deposits in the U.S., and is a leading lender in many products, including mortgage origination and servicing, small business, commercial real estate, automobile, and middle-market commercial & industrial (C&I). WFC is also the second largest debit card issuer, second largest private student lender, third largest full-service retail brokerage (based on financial advisors), and fourth largest wealth management provider (based on AUM). This franchise provides the company with economies of scale that are difficult to replicate, and allows the company to effectively compete with any bank given the breadth of its product offerings.
In terms of WFC's financial profile, asset quality continues to improve, while capital and liquidity remain good. WFC's credit risk metrics have improved alongside the industry. WFC's nonperforming asset (NPA) ratios remain elevated and above regional bank peer averages. Much of the weaker relative performance is due to a large balance of mortgage-related accruing troubled debt restructurings (TDRs). Despite higher NPA levels, NCOs are roughly in line with peer averages. Fitch expects loan losses will increase from currently unsustainably low levels for WFC, as well as the industry, especially under a higher interest rate environment. However, higher provisioning should not materially impact WFC's financial profile given its earnings strength.
Although WFC is one of the largest participants in the energy-sector, overall O&G loans represent less than 2% of total loans. WFC indicated that its loan loss reserves incorporate potential losses on WFC's oil and gas exposures.
WFC's capital profile is considered solid, relative to its risk profile, capital generation capabilities, and target payout ranges. The Common Equity Tier 1 under Basel III Advanced Approach, fully phased-in, was 10.55% at June 30, 2015, well above the fully phased-in requirement of 9%, which includes the recently announced 2% G-SIB capital surcharge.
Fitch expects that WFC will maintain a capital cushion over the 9% requirement to insulate the company from volatility in unrealized losses and the valuation of the MSR asset. There is also uncertainty with regard to the inclusion of the capital surcharge in CCAR stress testing. As such, Fitch believes that WFC will likely carry a higher level of capital than some of its large regional peers over the long term, who do not have a G-SIB surcharge.
In terms of the finalized U.S. Basel III supplemental leverage ratio (SLR) rule issued on April 8, 2014, WFC easily meets the holding company requirement with an estimated fully phased-in SLR of 7.8% at June 30, 2015. Fitch expects that WFC will be able to meet a long-term debt requirement when the regulatory rules are announced; however, the requirement to maintain a higher level of debt than its business model needs may modestly impact profitability and could lead to incremental risk taking.
WFC is primarily deposit funded, with core deposits representing 75% of total funding sources as of June 30, 2015. WFC also actively uses wholesale funding sources, including short- and long-term debt. Debt maturities are well distributed, and significant liquidity is held in the form of cash and liquid assets at both the parent company and the banks. Furthermore, there is a limited reliance on short-term borrowings, with federal funds purchased, securities sold under agreements to repurchase, commercial paper, trading liabilities, and other short-term borrowings, at approximately 9% of total funding as of June 30, 2015, well below similarly-sized banks, though higher than the large regional peer average.
The parent's liquidity is considered solid, as the firm strives to maintain its parent liquidity position such that it has the ability to stay out of the wholesale markets for a minimum of 12 months at any given point in time. WFC's high credit ratings have helped it gain universal acceptance in virtually all global capital markets on very favorable terms, and Fitch anticipates that WFC will continue to be able to easily issue debt to meet upcoming debt maturities and other requirements.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
WFC's subordinated debt is notched one level below its VR of 'aa-' for loss severity. WFC's preferred stock is notched five levels below its VR, two times for loss severity and three times for non-performance, while WFC's trust preferred securities are notched two times from the VR for loss severity and two times for non-performance. These ratings are in accordance with Fitch's criteria and assessment of the instruments non-performance and loss severity risk profiles and have thus been affirmed due to the affirmation of the VR.
LONG- AND SHORT-TERM DEPOSIT RATINGS
The uninsured deposit ratings of Wells Fargo Bank, N.A. and Wells Fargo Bank Northwest are rated one notch higher than Wells Fargo Bank's IDR and senior unsecured debt because U.S. uninsured deposits benefit from depositor preference. U.S. depositor preference gives deposit liabilities superior recovery prospects in the event of default.
WFC's international subsidiary, Wells Fargo Bank International's deposit ratings are at the same level as senior debt ratings because their preferential status is less clear and disclosure concerning dually payable deposits makes it difficult to determine if they are eligible for U.S. depositor preference.
HOLDING COMPANY
WFC's VR is equalized with those of its operating companies and banks, reflecting its role as the bank holding company, which is mandated in the U.S. to act as a source of strength for its bank subsidiaries. VRs are also equalized reflecting the very close correlation between holding company and subsidiary failure and default probabilities.
SUBSIDIARY AND AFFILIATED COMPANY
Fitch upgraded the IDRs of Wells Fargo Bank N.A. and Wells Fargo Bank Northwest N.A. to 'AA' in May 2015, The Rating Outlooks are Stable. The upgrade of the banks' ratings to a notch above the parent reflects the expected implementation of total loss absorbing capital (TLAC) requirements for U.S. Global Systemically Important Banks (G-SIBs) and the presence of a substantial debt buffer in the holding company.
The VRs remain equalized between WFC and its material operating subsidiaries. The common VR of WFC and its operating companies reflects the correlated performance, or failure rate between the WFC and these subsidiaries. Fitch takes a group view on the credit profile from a failure perspective, while the IDR reflects each entity's non-performance (default) risk on senior debt. Fitch believes that the likelihood of failure is roughly equivalent, while the default risk given at the operating company would be lower given TLAC. All U.S. bank subsidiaries carry a common VR, regardless of size, as U.S. banks are cross-guaranteed under the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA).
Wells Fargo Canada Corp., Wells Fargo Bank International, and Wells Fargo Securities International Limited are wholly owned subsidiaries of WFC or Wells Fargo Bank, N.A. Their IDRs and debt ratings are aligned with WFC reflecting Fitch's view that these entities are core and integral to WFC's business strategy and operations. Their IDRs and ratings would be sensitive to the same factors that might drive a change in WFC's IDR.
SUPPORT RATING AND SUPPORT RATING FLOOR
WFC has a Support Rating (SR) of '5' and Support Rating Floor (SRF) of 'NF'. In Fitch's view, the probability of support is unlikely. IDRs and VRs do not incorporate any support.
In May of this year, Fitch downgraded the SR and SRF for Wells Fargo Bank, N.A. and Wells Fargo Bank Northwest in line with Fitch's view of sovereign support. The SR and SRF reflect Fitch's view that senior creditors can no longer rely on receiving full extraordinary support from the sovereign in the event that WFC becomes non-viable. Also, implementation of the Dodd Frank Orderly Liquidation Authority legislation is now sufficiently progressed to provide a framework for resolving banks that are likely to require holding company senior creditors participating in losses, if necessary, instead of or ahead of the company receiving sovereign support.
Wells Fargo Bank International has a support rating of '1', which is an institutional support rating, and indicates that there is a high probability that WFC would provide support to Wells Fargo Bank International, which is domiciled in Ireland.
RATING SENSITIVITIES
VR, IDRs, AND SENIOR DEBT
Given that WFC's ratings are already at the top of the globally rated bank universe, Fitch views limited potential for an upgrade.
Conversely, failure to maintain earnings at above peer levels will pressure WFC's ratings, as its earning profile is one of the key rating drivers. The strength of the earnings stream provides for solid capital generation capabilities, which will help absorb unexpected losses.
Market-sensitive revenues, which include gains and losses on equity investments, trading activities, and debt securities, combined with investment banking fees, have averaged around 6.5% of total revenues for WFC over the past year. Fitch expects that capital markets-related revenues will remain relatively modest in the context of overall earnings; however, an outsized reliance could impact ratings given the general volatility and risks associated with capital markets revenues.
WFC's ratings may also be sensitive to any outsized risks that company may take as it relates to a higher implied cost of capital given the company's G-SIB capital surcharge. However, given the bank has a superior earnings profile and a strong risk culture, Fitch views this risk as low likelihood.
To date, litigation-related costs have been very manageable. While WFC does not disclose actual litigation reserves (similar to many of its peers), the high end of the range of reasonably possible potential litigation losses in excess of the company's liability for probable and estimable losses was $1.4 billion at June 30, 2015, considered very modest in the context of annual pretax pre-provision revenues of roughly $35 billion. Fitch anticipates that any FHA-related fine that may ultimately get assessed will be manageable in the context of WFC's superior earnings profile, and that WFC will comply with the outstanding items from the mortgage servicing amended Consent Order. However, any material outsized legal, regulatory or operational-related charges may adversely impact ratings.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The ratings for WFC and its operating companies' subordinated debt, trust preferred securities, and preferred stock are sensitive to any change to WFC's VR.
LONG- AND SHORT-TERM DEPOSIT RATINGS
The long-and short-term deposit ratings are sensitive to any change to WFC's long- and short-term IDR.
HOLDING COMPANY
Should WFC's holding company begin to exhibit signs of weakness, demonstrate trouble accessing the capital markets, or have inadequate cash flow coverage to meet near-term obligations, there is the potential that Fitch could notch the holding company IDR and VR from the ratings of the operating companies.
SUBSIDIARY AND AFFILIATED COMPANY
Given that WFC's and the banks' VRs remain equalized, Wells Fargo Bank N.A.'s ratings are broadly sensitive to the same considerations that might affect WFC's VR.
The IDRs and ratings of Wells Fargo Canada Corp., Wells Fargo Bank International, and Wells Fargo Securities International Limited are sensitive to the same factors that might drive a change in WFC's IDR.
Wells Fargo Securities International Limited's Rating Outlook is Positive. The Positive Outlook reflects the agency's belief that the internal TLAC of material international operating companies will likely be large enough to meet Pillar 1 capital requirements and will then be sufficient to recapitalize them. A one-notch upgrade is likely once Fitch has sufficient clarity on additional disclosure on the pre-positioning of internal TLAC and its sufficiency in size to cover a default of senior operating company liabilities. Sufficient clarity may, however, take longer to come through than the typical Outlook horizon of one to two years.
SUPPORT RATING AND SUPPORT RATING FLOOR
Since WFC's Support and Support Rating Floors are '5' and 'NF', respectively, there is limited likelihood that these ratings will change over the foreseeable future.
Additionally, due to the linkage in ratings between WFC and Wells Fargo Bank International, if Wells Fargo Bank International were to become less strategically important to WFC, its ratings may be impacted.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Wells Fargo & Co.
--Long-term Issuer Default Rating (IDR) at 'AA-'; Outlook Stable;
--Senior debt at 'AA-';
--Subordinated debt at 'A+';
--Preferred stock at 'BBB';
--Short-term IDR at 'F1+';
--Commercial paper at 'F1+';
--Short-term debt at 'F1+';
--Market-linked securities at 'AA- EMR';
--Viability at 'aa-';
--Support at '5';
--Support floor at 'NF'.
Wells Fargo Bank, NA
--Long-term IDR at 'AA'; Outlook Stable
--Long-term deposits at 'AA+';
--Market-linked securities at 'AA+ EMR';
--Senior debt at 'AA';
--Subordinated debt at 'A+';
--Short-term IDR at 'F1+';
--Short-term deposits at 'F1+';
--Short-term debt at 'F1+';
--Viability at 'aa-';
--Support at '5';
--Support Floor at 'NF'.
Wells Fargo Bank Northwest, NA
--Long-term IDR at 'AA'; Outlook Stable;
--Long-term deposits at 'AA+';
--Senior debt at 'AA';
--Short-term IDR at 'F1+';
--Short-term deposits at 'F1+';
--Viability at 'aa-';
--Support at '5';
--Support Floor at 'NF'.
Wachovia Bank, N.A.
--Long-term deposits at 'AA+';
--Senior debt at 'AA';
--Short-term deposits at 'F1+';
--Subordinated debt at 'A+'.
Wells Fargo Canada Corp.
--Long-term IDR at 'AA-'; Outlook Stable
--Short-term IDR at 'F1+';
--Senior debt at 'AA-';
--Short-term debt at 'F1+'.
Greater Bay Bancorp, Inc.
--Senior debt at 'AA-'.
Wachovia Corporation
--Commercial paper at 'F1+';
--Senior debt at 'AA-';
--Subordinated debt at 'A+';
--Preferred stock at 'BBB'.
Wells Fargo Real Estate Investment Corporation
--Preferred stock at 'BBB+'.
Wells Fargo Bank International
--Support at '1';
--Long-term deposits at 'AA-';
--Short-term deposits at 'F1+'.
Wells Fargo Securities International Limited
--Long-term IDR at 'AA-'; Outlook Positive;
--Short-term IDR at 'F1+'.
SouthTrust Bank
--Senior debt at 'AA';
--Subordinated debt at 'A+'.
First Union National - Florida
--Subordinated debt at 'A+'.
Wells Fargo Capital II, X
Wachovia Capital Trust II
Central Fidelity Capital Trust I
Corestates Capital II, III
First Union Capital II
--Preferred at 'BBB+.'
Wachovia Capital Trust III
--Preferred at 'BBB.
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