As banks prepare to report earnings, Wells Fargo (NYSE:WFC) will draw some of the most intense scrutiny. Although the bank passed the Federal Reserve’s annual stress test in June, they told it that it will have to cut its dividend. Investors in Wells Fargo stocks will be keen to know how deep that cut will go when the company reports earnings.
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And for banks, the new coronavirus pandemic is about profit.
This is not a liquidity crisis like the financial crisis. But it is a profit crisis, says Gerald Cassidy, an analyst at RBC Capital Markets. “We continue to believe that this crisis will be a profit problem for banks, rather than a balance sheet problem similar to 2008-09,” wrote Cassidy. The analyst forecast that the company’s average earnings per share will fall 56% year-over-year.
What will a “profit crisis” mean for Wells Fargo’s shares?
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Although it may not seem like it, Wells Fargo passed the Fed stress test. These tests put the bank’s balance sheets through a variety of hypothetical scenarios to ensure it has enough capital to sustain itself under varying degrees of economic stress. In its most recent tests, the Fed used several scenarios focused on the Covid-19 pandemic.
But in this case, a passing grade was not without consequences. Wells Fargo is known for providing one of the most generous dividends in the banking sector. However, the Fed now requires that all banks limit their dividend distributions.
This means that none of the big banks will increase dividends this quarter. And some banks will have to cut their dividends. This will be based on a four-quarter average of each bank’s net income.
How Far Will Wells Fargo Cut Its Dividend?
Wells Fargo was proactive in announcing that it would reduce its dividends. However, investors are now wondering how deep that cut will go. According to JPMorgan Chase analyst Vivek Juneja, the bank will have to cut its dividend by more than 25% to meet the Fed’s dividend limits. In fact, Juneja theorized that the bank may have to cut the dividend by 50 %.
Wells Fargo has a return that is currently around 8%, which is equivalent to about 51 cents a share. That’s more than double the returns of JPMorgan Chase (NYSE:JPM) and Bank of America (NYSE:BAC) This is a reason InvestorPlace’s David Moadel explains why a dividend cut, even a large one, may not be as bad as it sounds.
“Let’s even assume that the dividend cut could be 50%. That would still leave income investors with a healthy 4% annual return. Also, smaller dividend payments would mean Wells Fargo can retain more of its capital. Perhaps, then, the Fed would only be doing Wells Fargo a favor, albeit unintentionally. ”
AND InvestorPlace’s Ian Bezek reminds investors that Wells Fargo has survived a dividend cut in the past.
Simply put, even cut in half, Wells Fargo could have one of the strongest dividend yields in the industry. And to be fair, Wells Fargo is not cutting its dividend out of financial need. He is being forced to do it. Also, there is nothing to indicate that Wells Fargo will not be able to pay some level of dividend, nor that the cut will be anything but temporary.
There are other problems for Wells Fargo’s actions
The dividend cut comes as an addition to the asset limit that the Federal Reserve has placed in Wells Fargo. The $ 1.95 billion limit was imposed as part of the bank’s fine for creating fake accounts. At the end of 2019, the bank reported $ 1.93 in assets that placed it right in front of the limit. To that end, Wells Fargo asked the Federal Reserve in March to remove the limit in order to better help customers affected by the new coronavirus. The Fed said no.
That means that it will be almost impossible for the company to increase its profits. And the bank has already been setting aside billions of dollars to cover expected credit losses due to the pandemic. This was a key reason why the bank reported a single penny in earnings per share in the last quarter.
In addition, the company recently announced that it will cut tens of thousands of jobs starting this year. The company currently employs approximately 263,000 people.
A provisional purchase if you are willing to wait
To repeat a point I mentioned earlier, this crisis is not the result of the deception of the banks. And after absorbing this latest preventative drug from the Fed, Wells Fargo may finally start cleaning up the stain that’s been covering the stock.
The short-term prospects seem difficult for growing investors. The bank has limited income streams in an environment of low interest rates. And any help you may receive from additional Congressional funds flowing to the United States Small Business Administration (SBA) will be cosmetic.
However, if you are a value investor, Wells Fargo will still have an attractive and safe dividend. Is this reason enough to have Wells Fargo shares? It is difficult to say, but there are worse reasons.
Chris Markoch is a freelance financial writer who has been covering the market for over five years. He has been writing for InvestorPlace since 2019. As of this writing, Chris Markoch did not have a position in any of the aforementioned values..
