Rating Downgrade For Wells Fargo

Following its earnings release on July 22, 2009, Wells Fargo & Co.’s (WFC) long-term issuer default ratings were downgraded by Fitch Ratings to AA- from AA. The rating agency was prompted by the negative trends in asset quality as a result of ongoing economic turmoil.

According the rating agency, the acquisition of Wachovia has significantly increased the risk profile of the merged company. Almost half of Wells Fargo’s loan portfolio is now exposed to U.S. consumers, who are suffering from falling home prices and high unemployment.

However, considering its capacity to deliver above average earnings from its diversified nature of banking activities, Fitch removed WFC from a negative rating watch. The outlook now is stable.

The agency expects a substantial deterioration in commercial real estate in the coming months. However, it believes that significant write-downs and Wells Fargo’s strategies will greatly minimize the risk.

Wells Fargo’s second quarter 2009 earnings after payment of preferred dividends came in at $2.58 billion, or $0.57 per share, compared to $1.75 billion, or $0.53 cents per share in the prior-year quarter. The earnings were substantially ahead of our estimate as well as consensus.

We think that WFC is relatively well positioned compared to its peers (Comerica Inc. (CMA), Fifth Third Bancorp (FITB), KeyCorp. (KEY), US Bancorp (USB) and BB&T Corp. (BBT)) as it benefited from a larger share in the mortgage markets after acquiring Wachovia and also from the demise of some smaller players. However, higher credit losses resulting from continued deterioration in the housing markets will impact earnings in the coming quarters. Also, the combined entity’s large exposure to mortgage/real estate loans and the integration costs associated with the merger will continue to impact earnings throughout 2009.

Thus, we are maintaining our Hold recommendation on the shares.

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