I shared this information on the blog on June 30th - "Simon Property Group (SPG) and Wells Fargo (WFC) to cut dividends"
While we didn't know at the time how big the dividend cut would be, we only knew that there would be a dividend cut.
Back at the end of June, the Federal Reserve initiated a new round of stress tests, which capped dividend payments at major financial institutions. I discussed this with you right when I posted an article: Expect Dividend Cuts and Dividend Freezes in the Banking Sector
"For the third quarter of this year, the Board is requiring large banks to preserve capital by suspending share repurchases, capping dividend payments, and allowing dividends according to a formula based on recent income. The Board is also requiring banks to re-evaluate their longer-term capital plans.
All large banks will be required to resubmit and update their capital plans later this year to reflect current stresses, which will help firms re-assess their capital needs and maintain strong capital planning practices during this period of uncertainty. The Board will conduct additional analysis each quarter to determine if adjustments to this response are appropriate.
During the third quarter, no share repurchases will be permitted. In recent years, share repurchases have represented approximately 70 percent of shareholder payouts from large banks. The Board is also capping dividend payments to the amount paid in the second quarter and is further limiting them to an amount based on recent earnings. As a result, a bank cannot increase its dividend and can pay dividends if it has earned sufficient income."
There were several banks that went through these stress tests, but almost all of them managed to keep their dividends unchanged.
The only bank to cut dividends was Wells Fargo (WFC). Again, the bank announced that on June 29th that they would be announcing a dividend cut when they reported their results on July 14th.
Our friends at Dripinvesting shared this chart comparing the average bank earnings to the dividend payouts. Wells Fargo looks like the only bank where the dividends exceeded its estimated average net income.
Source: Drip Investing/FactSet
Today, they reported their results, and cut dividends from 51 cents/share to 10 cents/share. The stock sold off, perhaps due to the poor quarterly results. In reality, the announcement of a dividend cut in advance, when everyone else is keeping their dividends should have been enough of a warning sign to prompt investors to re-evaluate their positions.
Chief Executive Officer Charlie Scharf said, “We are extremely disappointed in both our second quarter results and our intent to reduce our dividend. Our view of the length and severity of the economic downturn has deteriorated considerably from the assumptions used last quarter, which drove the $8.4 billion addition to our credit loss reserve in the second quarter. While the negative impact of the pandemic is unprecedented and many of our business drivers were negatively impacted, our franchise should perform better, and we will make changes to improve our
performance regardless of the operating environment.
“Though our income performance was weak, our capital and liquidity continues to be extremely strong with both our CET1 ratio and LCR increasing from the end of the prior quarter. However, it is critical in these uncertain times that our common stock dividend reflects current earnings capacity assuming a continued difficult operating environment, evolving regulatory guidance, and protects our capital position if economic conditions were to further deteriorate. Given this, we believe it is prudent to be extremely cautious until we see a clear path to broad economic improvement. We are confident that this eventual economic improvement combined with our actions to increase our margins will support a higher dividend in the future,” Scharf added. Source: Wells Fargo
Probably the reason for Wells Fargo's dividend cut can be traced to the current recession that we are in, caused by Covid-19 and related depressed economic activity. The other reason is the several scandals that ruined Wells Fargo's reputation, and limited the scope of its operations. As a result, the bank didn't prosper as much in the past couple of years, and is taking things worse than competitors.
One of Wells Fargo's largest shareholders is no other than Warren Buffett's Berkshire Hathaway. Berkshire's annual dividend income from Wells Fargo will decrease from $705 million to $138 million. Buffett has gone from praising Wells Fargo and its culture, to being largely silent about the problems that the bank is facing. Of course, when you are a famous investor, you need to be very careful what you say in public.
Back when I analyzed the bank in 2013, it didn't look like a very good idea, since revenues were not growing. Earnings per share were growing due to the reduction in reserves for bad loans. I still bought some, because Buffett was buying it. It remained a very small position. I managed to sell a large portion of my position a few years ago when I did some reshuffling of assets in tax-deferred accounts. This was luck, not skill.
It looks like the US banking sector is not a good place for long-term dividend growth investing. Wells Fargo had a 34 year track record of annual dividend increases, but it lost it in 2009 when it cut dividends. It is now losing its 10 year track record of annual dividend increases. If it's earnings per share are not sufficient, Wells Fargo may be required to cut dividends or even suspend them. The same is true for all the other major banks of course.
It would be interesting to watch how the current economic recession plays out. If the recession deepens, because the Covid-19 does not seem to be under control in the US, then Wells Fargo would seem like the first shoe to drop. Translation - we may get more dividend cuts from other banks. If you believe this scenario, selling Wells Fargo may be a good choice.
On the other hand, if we manage to contain the virus through a combination of factors such as better usage of masks, vaccines/better treatments, people taking this virus more seriously, and others, we may be able to overcome a lot, and even get a decent recovery soonish. That scenario would entail a lower likelihood of dividend cuts from other major US Banks. If you believe this scenario, buying Wells Fargo today may be a decent choice.
Relevant Articles:
- Expect Dividend Cuts and Dividend Freezes in the Banking Sector
- Simon Property Group (SPG) and Wells Fargo (WFC) to cut dividends
- Should you invest in Wells Fargo (WFC)?
- Why Warren Buffett Likes Investing in Bank Stocks
