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TEXT-S&P says Wells Fargo & Co ratings unaffected by Q3 results

(The following statement was released by the rating agency)

Oct 12 - Standard & Poor's Ratings Services today said its ratings on Wells Fargo & Co. (WFC; A+/Negative/A-1) are unaffected by the company's strong third-quarter results.

WFC generated $7.5 billion in pretax income, up 22.3% from the same quarter in 2011, which represents a strong 35.4% pretax margin, compared with 31.3% last year. Third-quarter results benefited from continued strong mortgage performance, which we expect to continue into the fourth quarter, and a $767 million reserve release, up from $400 million in the second quarter. The material increase in reserve releases was largely due to the write-off of already reserved for loans resulting from the Office of the Comptroller of the Currency (OCC)'s new accounting guidance on Chapter 7 bankruptcy borrowers. Without this change, reserve releases would have declined to $200 million in the third quarter. We expect modest reserve releases to continue in the coming quarters.

WFC's expense reduction is on track, in our view. The efficiency ratio improved to 57.1% from 59.5% in third-quarter 2011, and the company is within its efficiency target of 55%-59%. The completion of the Wachovia Corp. integration benefited improvements in efficiency.

The net interest margin (NIM) slipped a greater-than-expected 25 basis points (bps) to 3.66% from the second quarter. This decrease resulted largely from lower variable income, as well as higher levels of cash and short-term investments--due to strong deposit growth--and lower interest rates and the run-off of higher-yield investments and loans. We expect continued downward pressure on the NIM over the next few quarters.

Credit quality continues to improve but is not yet back to pre-crisis levels. Excluding write-offs due to the new accounting rules, the net charge-off ratio would have fallen to 0.92% from 1.15% last quarter. With the new write-offs, the rate is 1.21%. Reported total nonperforming assets were 3.2%, unchanged from last quarter and only marginally affected by the new accounting guidance. Although the Purchase Credit Impaired (PCI) portfolio could still pose incremental credit risk in the event of a recession, it continues to perform better than we initially expected, and recent improvements in home prices help mitigate the risk.

Core loans were up 1.8% in the third quarter compared with the previous quarter, primarily because the company retained $9.8 billion in mortgages rather than securitizing these assets and buying them back as lower-yield mortgage-backed securities. This activity highlights the challenge of dealing with margin pressure in attempting to find suitable investments with higher yields as deposits continue to grow. Average core deposits increased 7% (annualized) for the year and 7% (annualized) for the quarter. We expect WFC to continue to look for asset acquisitions to boost loan growth.

Estimated Basel I Tier 1 common equity eased 2 bps to 10.06% during the third quarter and is up 72 bps from a year ago. The company reported an estimated Basel III Tier 1 common ratio of 8.02%, up 24 bps from the previous quarter. Over time, we believe WFC will continue to increase capital in anticipation of Basel III while prudently returning capital to shareholders. In addition to the regular dividend, the company repurchased 25.5 million shares (including a forward purchase agreement to settle in the fourth quarter), and it did not redeem any higher-coupon trust preferred securities.

The negative rating outlook on WFC reflects the outlook on the U.S. sovereign rating given the extraordinary government support we incorporate into our issuer credit rating on WFC. If we were to lower the U.S. sovereign rating by one notch to 'AA', we would also lower the issuer credit rating on WFC because we would remove the one notch of support we currently factor into the rating. Similarly, we could revise our outlook on WFC to stable if we were to revise our outlook on the U.S. sovereign rating to stable. Otherwise, we view WFC's fundamental credit trends as stable.

(Caryn Trokie, New York Ratings Unit)

((Caryn.Trokie@thomsonreuters.com; 646-223-6318; Reuters Messaging: rm://caryn.trokie.reuters.com@reuters.net))

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