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, it was told it will have to cut its dividend. Investors in Wells Fargo stock will be keenly interested to learn just how deep that cut will be when the company reports earnings.
And for banks, the novel coronavirus pandemic is all about earnings.
This is not a liquidity crisis like the financial crisis. But it is an earnings crisis, says Gerald Cassidy, an analyst for RBC Capital Markets. “We continue to believe this crisis will be an earnings issue for the banks, rather than a balance-sheet issue similar to 2008-09,” wrote Cassidy. The analyst forecast the company’s median earnings per share will drop 56% on a year-over-year basis.
What will an “earnings crisis” mean for Wells Fargo stock?
With Friends Like These…
Although it may not seem like it, Wells Fargo actually passed the Fed’s stress test. These tests put the bank’s balance sheets through a variety of hypothetical scenarios to ensure it has sufficient capital to hold up under varying degrees of economic strain. 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 has been known for providing one of the most generous dividends in the banking sector. However, the Fed is now requiring all banks to limit their dividend distributions.
This means none of the big banks will be increasing dividends this quarter. And some banks will have to reduce their dividend. 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 cut its dividend. However, investors are now wondering how deep that cut will be. According to JPMorgan Chase analyst Vivek Juneja, the bank will have to cut its dividend by more than 25% to meet Fed dividend limits. In fact, Juneja theorized the bank may have to cut the dividend by 50%.
Wells Fargo has a yield that is currently right around 8%, which comes out to approximately 51 cents per share. That’s more than double the yields of JPMorgan Chase (NYSE:JPM) and Bank of America (NYSE:BAC). This is one reason InvestorPlace’s David Moadel explains why a dividend cut, even a large one, may not be as bad as it seems.
“Let’s even assume that the dividend cut might be 50%. That would still leave income investors with a healthy 4% annual yield. Besides, smaller dividend payouts would mean that Wells Fargo gets to 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 more robust dividend yields in the sector. And to be fair, Wells Fargo is not cutting its dividend out of financial need. It’s being forced to. Plus, 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 Stock
The dividend cut comes as an addition to the asset cap that the Fed has placed on Wells Fargo. The $1.95 trillion cap was imposed as part of the bank’s penalty for creating fake accounts. At the end of 2019, the bank reported $1.93 in assets which put it right up against the cap. To that end, Wells Fargo petitioned the Federal Reserve in March to remove the cap so it could better assist customers affected by the novel coronavirus. The Fed said no.
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 for the last quarter.
Plus, the company recently announced it will cut tens of thousands of jobs starting this year. The company currently employs approximately 263,000 people.
A Tentative Buy If You’re Willing to Wait
To repeat a point I made earlier, this crisis is not the result of chicanery by the banks. And after absorbing this latest preventative medicine by the Fed, it’s possible that Wells Fargo may finally start to wipe off the stain that has been covering the stock.
The short-term outlook looks tough for growth investors. The bank has limited revenue streams in a low interest rate environment. And any help it might receive from additional Congressional funds flowing to the U.S. Small Business Administration (SBA) will be cosmetic.
However, if you’re a value investor, Wells Fargo will still have an attractive and safe dividend. Is that a good enough reason to own Wells Fargo stock? It’s tough to say, but there are worse reasons.
Chris Markoch is a freelance financial copywriter 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 hold a position in any of the aforementioned securities.
