Wells Fargo Dividend Is the Best Reason to Own the Stock. But Is It Enough?

The results are in. The Federal Reserve conducted its annual stress tests on the nation’s banks last week. As a reminder, the objective of the stress tests is to look at a bank’s liquidity under a worst case scenario. Wells Fargo (NYSE:WFC) was one of 33 banks with more than $100 billion in assets tested by the Federal Reserve.

Each bank went through a range of hypothetical scenarios designed to ensure its regulatory capital level held up under varying degrees of economic difficulty. Specifically, the Federal Reserve used multiple Covid-19 pandemic scenarios. The good news for investors is that closer scrutiny means when a bank passes the stress test, it’s more than a “Gentleman’s C.”

But regulation is a double-edged sword. In the case of Wells Fargo, a passing grade does not mean the bank gets off without consequences. In this case, the Federal Reserve is placing restrictions on dividend payments for the nation’s biggest banks. In addition to not being allowed to increase dividends, some banks will have to reduce their dividend. This will be based on a four-quarter average of each bank’s net income.

And this is the fate that befalls Wells Fargo. I wrote last week about bank stocks you could feel good about as the stress tests were wrapping up. I left Wells Fargo off my list because I suspected a dividend cut was likely. Sean Sechler had a similar outlook in advising investors to stay away from Wells Fargo.

Wells Fargo Has Bigger Problems Than a Dividend Cut

I don’t disagree with Sechler’s overall outlook. Wells Fargo is subject to a $1.95 trillion asset cap as part of its penalty for creating fake bank accounts in 2016. As recently as March, Wells Fargo petitioned the Federal Reserve to remove the cap so they could better assist customers affected by the novel coronavirus. The answer was no.

And with Wells Fargo reporting $1.93 trillion in assets at the end of 2019, the company is butting up against that cap. That means it will be nearly impossible for the company to increase its profits. And the bank has already been setting aside billions of dollars to cover expected loan losses due to the pandemic. This was a key reason the bank reported just a single penny in earnings per share (EPS) for the last quarter.

Now consider that the bank will likely report another miserable EPS when it reports its second quarter earnings on July 14. If the new stress tests set dividend payments based on a four-quarter average of profits, there’s only one direction for the company’s dividend to go.

Now About That Dividend

I’m not going to say it’s a good outcome for investors when a company cuts its dividend. And it’s no different for Wells Fargo. However, there are two important caveats. First, unlike during the financial crisis, this dividend cut is not being spurred by a liquidity crisis. The bank has no choice. Whether that’s a good or bad thing is for others to decide. The fact is, there’s nothing to say that Wells Fargo couldn’t maintain its dividend, it’s not being allowed to. There is a difference.

The second thing for investors to keep in mind is that this dividend cut is likely to be temporary. And Wells Fargo has a yield that is currently over 8% - that’s more than double the yields of JPMorgan Chase (NYSE:JPM) and Bank of America (NYSE:BAC).

The bank’s current dividend is 51 cents per share. It could cut that in half and still have one of the more robust dividend yields in the sector. And to be fair, there is nothing to indicate that Wells Fargo will not be able to pay some level of dividend.

Is Wells Fargo a Buy?

For growth investors, I don’t see how it could be. The bank has limited revenue streams and low-interest rates are not going to help the company’s outlook on that front. The company may get a boost if Congress approves hundreds of billions of additional spending to the U.S. Small Business Administration (SBA). But that’s just putting a bandage over a bullet hole given all the uncertainty in the economy.

However, if you’re a value investor, Wells Fargo may be an attractive option. The bank should still have an attractive dividend yield. And the dividend should be very safe. It’s not a great reason to own the stock. But it’s probably the best reason.