Fitch Downgrades Wells Fargo's IDR to 'AA-'; Outlook Stable

NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded the long-term Issuer Default Ratings (IDRs) of Wells Fargo & Company (WFC) and subsidiaries to 'AA-' from 'AA'. Fitch has also removed WFC from Rating Watch Negative, where it was originally placed on May 15, 2009. The Rating Outlook is Stable. A complete list of ratings appears at the end of this release.

WFC faces continued significant pressure on asset quality in light of the extremely weak economic environment. The ratings also consider WFC's above average earnings capacity, derived primarily from its diverse community and mortgage banking activities, which has allowed WFC to provide for elevated loan losses and simultaneously build the reserve against future losses. Today, WFC reported another strong profit of $3.2 billion, despite a significant $700 million reserve build and the sizeable $565 million FDIC special assessment.

WFC's year-end 2008 acquisition of Wachovia Corporation effectively doubled its size and added significantly to its risk profile. On a consolidated basis, approximately 40% of WFC's loan portfolio is secured by residential first or second lien mortgages. Together with other consumer lending, approximately half of WFC's loan portfolio is exposed to U.S. consumers, a borrower group that has been very negatively impacted by reduced home prices and high unemployment. Through purchase accounting adjustments at the close of the transaction, WFC marked assets and loans acquired through Wachovia to fair value.

Significant write-downs were taken against the value of Wachovia's substantial Pick-A-Pay (option ARM) mortgages, considerable commercial real estate exposure and meaningful activities through various off balance sheet structures. Commercial real estate is anticipated to exhibit significant deterioration over the near to intermediate term. The significant write-downs taken at acquisition and legacy WFC's approach to commercial real estate are viewed as risk mitigants that are likely to buffer the impact to WFC as this asset class is further challenged.

Capital was stretched with the acquisition of Wachovia and continues to moderately lag peer levels. WFC issued $25 billion in preferred stock to the U.S. Treasury under the capital purchase program (CPP) in fourth-quarter 2008 (4Q'08). In the stress tests conducted by the bank regulators, the results of which were published in May 2009, the regulators indicated that WFC needed to add $13.7 billion in Tier I common equity. WFC raised the required capital by June 30, 2009 through the issuance of $8.6 billion in common shares, 2Q'09 retained earnings and the recapture of deferred tax assets, much of which arose as a result of the purchase accounting write-downs on Wachovia and, until recaptured, reduce common equity. Thus, capital ratios have improved materially since the Wachovia acquisition but remain below 'best in class' levels. Fitch believes that WFC is adequately capitalized, particularly given its solid funding and profitability, to manage through continued economic challenges ahead.

WFC's funding profile, considered by Fitch to be stable, is primarily core funded with deposits funding nearly two thirds of total footings. WFC also actively uses other wholesale funding sources including FHLB borrowings and 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. WFC's cost of funds compares favorably to peers, which helps drive its strong net interest margin. WFC actively manages liquidity at all levels of the organization.

The integration of Wachovia is proceeding as announced at acquisition. While every merger carries integration risks, WFC, under its current management team, has an excellent track record with acquisitions. WFC tends to take a deliberate approach to ensure smoother transitions and lower customer disruption when operations are consolidated. As a result, the major bank charters are not anticipated to be combined much before the end of 2009. Expected cost savings of approximately $5 billion annually are anticipated from consolidation of the two companies, primarily from administrative and back office consolidation as there is only branch overlap in six states.

Bilibala comments:
I think from negative to stable is a good news, regardless of the downgrade. Downgrade will have negative impact to Wells Fargo's cost of borrowing, but since Wells generate its fund mainly on zero interest deposit, therefore, the impact should be immaterial.