1. How to use GuruFocus - Tutorials
  2. What Is in the GuruFocus Premium Membership?
  3. A DIY Guide on How to Invest Using Guru Strategies
Robert Abbott
Robert Abbott
Articles (800)  | Author's Website |

Wells Fargo Faces a Forced Dividend Cut

The bank comes up wanting in the June stress test and must cut its dividend

June 30, 2020 | About:

Well that didn’t last long! On June 18, I wrote about Wells Fargo & Co. (NYSE:WFC) being  “A Sudden Dividend Hotshot."

On June 29 came word that the company would have to cut its dividend after coming up short in the Federal Reserve Board’s most recent stress test. As you may recall, stress tests came out of the carnage in the financial sector during the 2008 financial crisis. The tests are designed to find out how well banks can withstand heightened loan losses.

In a news release dated June 25, the Board wrote, in part:

“In addition to its normal stress test, the Board conducted a sensitivity analysis to assess the resiliency of large banks under three hypothetical recessions, or downside scenarios, which could result from the coronavirus event. The scenarios included a V-shaped recession and recovery; a slower, U-shaped recession and recovery; and a W-shaped, double-dip recession.”

Under those scenarios, the Fed expected aggregate loan losses among the 34 banks involved to range from $560 billion to $700 billion. Additionally, aggregate capital ratios were expected to decline from 12% in the final quarter of 2019 to a range of 7.7% to 9.5% this year.

The Board added, “Under the U- and W-shaped scenarios, most firms remain well capitalized but several would approach minimum capital levels.”

Large banks, as a result, face several new requirements for the immediate future:

  • For the third quarter (which begins July 1), they must suspend their share repurchases to preserve capital.
  • They must cap their dividend payments.
  • Pay dividends based on a formula that includes their recent income.
  • The large banks must re-evaluate and submit their longer-term capital plans.

Wells Fargo responded to the new regulations in a news release issued on Monday, June 29. It noted, “Based on these instructions, the company expects its common stock dividend in third quarter 2020 will be reduced from the current level of $0.51 per share. The company expects that the level of the third quarter dividend will be announced when it releases second quarter financial results on July 14, 2020.”

How much will the dividend be reduced? That’s the unanswered question, and one which the board will have to tackle before it makes an announcement on July 14.

A preliminary estimate comes from the Dividend Forecast team at Bloomberg, which thinks the dividend will fall to 20 cents. That would be down 31 cents from the most recent payment.

And, to make the cut sting even more, Wells Fargo is the only one among its peers to have to take this action. As the headline on the Bloomberg article put it, “Wells Fargo to Cut Dividend as Top Rivals Maintain Payouts." Those rivals are JPMorgan Chase (NYSE:JPM), Citigroup (NYSE:C), Bank of America (NYSE:BAC) and Goldman Sachs (NYSE:GS).

According to the article, the bank finds itself in these circumstances, in part, because of the heavy legal expenses incurred in dealing with a series of scandals that have rocked it since 2016.

Turning to specifics, we can expect a cut to affect all metrics related to the Wells Fargo dividend. It has again driven down the price of the stock, as shown in this three-month chart:

GuruFocus Wells Fargo stock price chart

On June 25, the stock closed at $27.37; at mid-day on June 30, it had fallen to $25.51. That’s a drop of $1.86, an almost 7% decline.

Dividend yield

Ironically, the falling price has increased the dividend yield yet again.

This most recent fall in the share price pushed up the yield, from 7.42% on June 18 to 7.99% at the close on June 30.

Once the dividend has been cut, the yield will descend back into the real world. Still, if the market is not fully pricing in the expected dividend cuts, then the price will fall further on July 14 and 15, and that will push up the yield, too.

Any forecast about dividend yield or share price at this time are essentially meaningless.

Dividend payout ratio

Similarly, we won’t have a reliable payout ratio until the dividend is announced and settled. Even then, though, there is still the ongoing Covid-19 situation, which is unlikely to be resolved this year.

On June 18, the payout ratio stood at 69%, and any cut in the dividend will reduce that ratio.

Dividend growth rate

Wells Fargo has ambitiously been growing its dividend over the past decade, and for the decade as a whole, the growth rate averaged 20.80%.

Don’t expect more of the same in the decade ahead.

Forward dividend yield

After July 14, expect the forward yield to drop significantly. Following the forthcoming announcement, the forward yield will be based on that rate alone, not on it plus the three preceding payments.

What can we expect? Well, if we use the estimate of a 20-cent dividend, as compared to the previous dividends of 51 cents, we can make an educated guess.

This is the formula for the forward yield, and what the new yield might be:

“Forward Annual Dividend Yield = Forward Full Year Dividend / Current Share Price”

($0.20 * 4) / $25.57 = 3.13% or

$0.80 / $25.57 = 3.13%

Keep in mind that the 20-cent per quarter dividend payment is just one educated guess. The actual dividend may be higher or lower.

Five-year yield on cost

This was part of the promising case for Wells Fargo a couple of weeks ago, but it, too, will shrink once the dividend is cut.

At that time, the yield on cost was expected to be slightly better than 10% per year, assuming an investor bought and held the stock for five years, while the company continued to increase the rate at the same pace as it had for the previous five years.

Obviously, there is little likelihood the bank can repeat the increases of the previous five years.

Stock buybacks

As we saw, there will be no stock buybacks among the banks in the third quarter, as stipulated by the Federal Reserve Board.

I wouldn’t expect any from Wells Fargo in the subsequent quarters either, considering its need to rebuild its capital and its financial credibility.

Conclusion

As I introduced the Wells Fargo dividend case on June 18, I noted that it had become a dividend hotshot, “at least temporarily.” As it turns out, “temporarily” was the defining word.

The bank is no longer a dividend hotshot, and we wouldn’t expect it be much more than a limping dividend stock for the next couple of years.

Still, the company is more than just its dividends and buybacks, and investors may find other reasons to invest at the current price.

Disclosure: I do not own shares in any companies named in this article and do not expect to buy any in the next 72 hours.

Read more here:

Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.

About the author:

Robert Abbott
Robert F. Abbott has been investing his family’s accounts since 1995 and in 2010 added options -- mainly covered calls and collars with long stocks.

He is a freelance writer, and his projects include a website that provides information for new and intermediate-level mutual fund investors (whatisamutualfund.com).

As a writer and publisher, Abbott also explores how the middle class has come to own big business through pension funds and mutual funds, what management guru Peter Drucker called the "unseen revolution."

Visit Robert Abbott's Website


Rating: 4.0/5 (1 vote)

Voters:

Comments

Please leave your comment:



Performances of the stocks mentioned by Robert Abbott


User Generated Screeners


pjmason14Momentum
pascal.van.garsseHigh FCF-M2
kosalmmuse6
kosalmmuseBest one1
DBrizanall 2019Feb26
kosalmmuseBest one
DBrizanall 2019Feb25
kosalmmuseNice
kosalmmusehan
MsDale*52-Week Low
Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)