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Moody's Affirms Wells Fargo Ratings, Outlook Down to Negative

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Moody's Investors Service, a rating arm of Moody's Corporation (MCO - Free Report) , affirmed all the ratings of Wells Fargo (WFC - Free Report) and its subsidiaries. The Wall Street biggie’s senior unsecured debt rating is affirmed at A2.

Wells Fargo Bank, N.A., the main bank operating entity’s long-term deposit rating has been affirmed at Aa2 andlong-term senior unsecured debt rating at Aa2. The bank’s counterparty risk assessment is Aa1(cr)/Prime-1(cr). Further, the deposit ratings of Aa1/Prime-1 and a stand-alone baseline credit assessment (BCA) of a2 have been affirmed.

However, the rating firm’s outlook for the bank has been downgraded to “negative” from “stable”. "The outlook change reflects Wells Fargo's slower than anticipated pace in resolving its legacy governance, oversight, compliance and operational risk management deficiencies", said Allen Tischler, senior vice president.

"Although Wells Fargo's years-long remediation efforts are progressing, the slow pace weighs on its expense base, further undermining its earnings potential against the backdrop of challenging operating conditions resulting from the coronavirus pandemic outbreak", he added.

Ratings Affirmation & Rationale Behind the Downgrade

Moody’s affirmed Wells Fargo's ratings on the bank’s strong underlying credit strengths, including conservative risk profile, diversified loan portfolio and strong liquidity. Further, despite Wells Fargo's compliance and operational issues tarnished reputation and significantly weakened the profitability, the rating firm maintained the ratings on strong balance sheet fundamentals.

Nevertheless, the continued impact of the coronavirus pandemic on the US economy is likely to deteriorate the credit quality, keepingthe bank’s capitalization under pressure, per Moody’s. Specifically, tangible common equity to risk-weighted assets (TCE/RWA) capital metric will be affected on weakening asset quality. Moreover, Wells Fargo's capitalization is anticipated to be weakened in the second half of 2020 despite improved profitability.

Therefore, Wells Fargo's actions on capital management, which include an 80% reduction in common stock dividend and suspension of share buybacks, are considered to be in the bank’s favor by the rating agency. Moreover, despite regulatory issues and tarnished image, the company has been able to appoint experienced staff, increasing its credit strength.

Moody's expects the bank to gradually revive from its existing challenges,applying stronger operational risk and compliance management along with improved governance. However, the coronavirus pandemic has pushed the same until at least 2021, including the Federal Reserve's consent order restrictions with the asset cap as well. Moreover, lingering uncertainty over the resolution of Wells Fargo’s challenges, including regulatory issues, heightened expenses and decrease in capital, might weaken the credit profile, per Moody’s, supporting its negative outlook.

On the profitability front, along with an uncertain economic environment, expected lower net interest income and elevated loan loss provisions, Wells Fargo's expense profile remains weak. Notably, work pressure of remedial measures taken for legacy compliance and governance failures led this to happen. For the first half of 2020, the bank recorded 78% cost/income ratio, being one of the highest amongst US banks. Yet, pre-sales scandal, the bank targeted and achieved a cost/income ratio in the mid- to high-50s.

Therefore, Moody’s believes Wells Fargo's new management team’s outlined plan of reducing costs in the years ahead, working at the historic level of operating efficiency, is consummated, the agency’s additional negative rating pressure can be limited. However, downward rating pressure on Wells Fargo will be increased if Moody’s view on Wells Fargo’s operating efficiency and profitability metrics are not likely to be significantly rebound in 2021 and beyond.

Conclusion

The banking giant was caught in a number of litigations over several malpractices, which came into the spotlight. Also, the asset cap put on the bank by the Fed has disappointed investors so far. Moreover, the pressure of expense management remains concerning. Therefore, it is going to be a long and expensive journey for Wells Fargo till it gets all the dust settled.

Currently, the company carries a Zacks Rank #4 (Sell).

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The company’s shares have plunged 54.3% so far this year. This is way below other big banks such as JPMorgan (JPM - Free Report) and Bank of America (BAC - Free Report) . Also, it is below the industry’s decline of 33.6% during the same time frame.

 

 

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