Moody's Investors Service on Wednesday cut Wells Fargo's senior debt rating to 'A1' from 'Aa3', its senior subordinated debt rating to 'A2' from 'A1', and the banking giant's junior subordinated debt rating to 'A3' from 'A1'.
The rating agency cut Wells Fargo's preferred stock rating to 'B2' from 'A2.' Wells Fargo's short-term rating was affirmed at 'Prime-1.'
Wells Fargo Bank N.A.'s rating for deposits was lowered to 'Aa2' from 'Aa1', and its 'Prime-1' short-term rating was affirmed. Moody's bank financial strength rating, or BFSR, on Wells Fargo Bank N.A. was lowered to 'D+' from 'B.'
All ratings have a stable outlook except for the BFSR and preferred stock rating, where the outlook is "developing" because of concerns that tight equity markets may spur U.S. government support for the San Francisco-based banking giant, which has assets of $1.3 trillion.
"The downgrades of the BFSR and the preferred stock ratings reflect Moody's view that Wells Fargo's capital ratios could come under pressure in the short-term, increasing the probability that systemic support will be needed," said Moody's.
The rating actions come as Moody's recalibrates some of the weights and relative importance attached to certain rating factors within its current bank rating methodologies. Capital adequacy, in particular, is taking on increasing importance in determining BFSRs in the current environment. Meanwhile, debt and deposit ratings are expected to reflect higher support assumptions for systemically important institutions during this global financial crisis.
The downgrade of Wells Fargo's BFSR to 'D+' from 'B' reflects the increased probability of systemic capital support due to Moody's view that Wells Fargo's capital ratios could fall to comparatively low levels.
"The BFSR is driven by Wells Fargo's capital challenges, which are made more acute because U.S. banks' access to the equity market is shut or very limited at best," said Moody's. "This increases the likelihood of a capital initiative by the U.S. government to support Wells Fargo. The BFSR is intended to express an opinion about the likelihood of such an event."
Wells Fargo's comparatively low capital ratios -- especially its tangible common equity ratio -- result from its acquisition of Wachovia. In Moody's opinion, the amount of equity that Wells Fargo raised was modest in comparison to the amount and quality of assets it acquired from Wachovia.
Moody's does not expect Wells Fargo to generate sizable amounts of capital until the second half of 2010, at the earliest. "Wells Fargo will need to take provisions and merger expenses -- predominantly in 2009 and into 2010 -- against those Wachovia assets that were not marked down on Dec. 31, 2008," according to the rating agency.
Also, a challenging housing market and higher unemployment will result in higher loan-loss provisions for the legacy Wells Fargo portfolio, and additional charges beyond Wells Fargo's lifetime loss estimate of approximately 29% against the legacy Wachovia option-ARM portfolio cannot be ruled out.