NEW YORK - Moody's Investors Service on Wednesday upgraded its bank financial strength rating on Wells Fargo & Co by one notch, citing an improved capital position after the bank's earnings beat expectations.

Moody's raised the bank financial strength rating to C from C-minus.

It also upgraded Wells Fargo's non-cumulative preferred stock rating by two notches to Ba1, the highest junk grade, from Ba3, and downgraded its junior subordinated debt by two notches to Baa2, the second-lowest investment grade, from A3.

The latter rating changes reflect a new method put into effect on Tuesday for rating subordinated debt and preferred shares. Under the changes, Moody's said it is ending the assumption that such instruments would benefit from government support.

The bank's deposit rating remains unchanged at Aa2 and the holding company's senior debt is unchanged at A1.

The outlook on the bank financial strength rating is positive, which indicates another upgrade is likely over the next 12 to 18 months.

Wells Fargo has improved its capital position after leveraging itself noticeably by acquiring Wachovia last year, Moody's said in a statement.

In addition to an $8.6 billion equity issuance earlier this year, it has generated $5.7 billion of capital internally in the first nine months of 2009, the rating agency said.

The increased capital is an important credit issue because it provides a cushion against the large credit costs that we think Wells Fargo will have to absorb over the coming quarters, Moody's senior vice president Sean Jones said in a statement.

Residential mortgages and commercial real estate exposures make up nearly 60 percent of Wells Fargo's loans, and we expect losses in these sectors to grow well into 2010, he said. (Reporting by Dena Aubin; Editing by Leslie Adler)