Last week, the Federal Reserve announced that it would restrict dividend payments for large banks after conducting the 2020 version of its stress test. Not only will banks not be able to increase their dividends at this time, but the payment of any dividend depends on an average of four quarters of each bank’s net income.
Many of the stocks of large banks have already announced plans to keep their dividends at current levels in the third quarter, including Bank of America (NYSE: BAC), JPMorgan Chase (NYSE: JPM)and Citigroup (NYSE: C). However, the remaining member of the “big four” – Wells Fargo (NYSE: WFC) – Didn’t exactly give income investors good news.
Image source: Wells Fargo.
Wells Fargo dividend cut: what we know
Wells Fargo will pay a reduced dividend in the third quarter. We don’t know yet how much it will be, and the bank is likely waiting to see how its second-quarter earnings come out before making that determination.
As almost exclusively a commercial bank (as opposed to an investment bank), Wells Fargo is setting aside more than most in anticipation of pandemic-related credit losses. In the first quarter, Wells Fargo increased its reserves by $ 3.1 billion, causing earnings to drop from $ 0.73 to just $ 0.01 per share.
CEO Charles Scharf recently said, “We expect our second-quarter results to include an increase in the credit loss reserve substantially greater than the increase in the first quarter.” If this is the case, it is likely to push Wells Fargo’s net income into negative territory. Given that the Fed dividend rule is based on the previous four quarters of earnings, it is not difficult to see why a quarterly dividend cut of $ 0.51 per share will be necessary.
For reference, the bank’s earnings per share in the third and fourth quarters of 2019 were $ 0.92 and $ 0.60, respectively. Therefore, unless the bank’s reserve build-up is astronomically large in the second quarter, it will continue to have a positive average profit of four quarters per share, and therefore be able to pay some level of dividend.
Should investors be concerned?
First, keep in mind that the stress tests used by the Federal Reserve are designed to assess a worst of cases And even in the worst proven COVID-19 recession, Wells Fargo remained adequately capitalized. However, due to the bank’s massive accumulation of loss reserves in the first quarter, and the expected additional accumulation in the second, it appears that net income will be under pressure to the point that it will not be possible to keep the current dividend under the Federal Reserve rule. .
Second, it is likely to be a temporary cut, and it will still result in quite impressive dividend yields. At the current stock price, Wells Fargo is yielding approximately 8%, so even if you are forced to cut your dividend in half, it will still be a relatively high paying dividend stock.
The bottom line is that while this is certainly a disappointment for income investors, there is no reason to worry about Wells Fargo as a business. This is no the Great Recession, and the bank has more than enough capital to weather tough times.
