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Even Under Stress, Wells Fargo Will Come Out on Top

Banking giant Wells Fargo (NYSE:WFC) has endured much of the same economic pressure that the broader financial sector has suffered during the novel coronavirus pandemic. That pressure, in turn, has weighed on the Wells Fargo stock price this year.

As if the big banks didn’t know it already, the Federal Reserve declared in its recently released annual banking-sector stress test that a second Covid-19 wave would have “significant negative effects on many banks’ capital levels.”

Along with playing the role of Captain Obvious, the Fed decided to place some restrictions on Wells Fargo and its mega-banking brethren. As a result, there’s chatter of an impending dividend cut.

Besides being a source of consternation for investors, this development could have an impact on the Wells Fargo stock price. Should current share owners dump their holdings, then? Not so fast, as there’s always more to the story than the headlines would lead you to believe.

A Closer Look at Wells Fargo Stock

Is the glass half-empty or half-full for holders of Wells Fargo stock? As always, it depends on one’s perspective. Value seekers, for example, should be glad to discover that the stock is sporting a very low trailing 12-month price-to-earnings ratio of about 8.77.

Meanwhile, income-oriented investors should appreciate the forward annual dividend yield of around 8%. On the other hand, the price action of Wells Fargo stock has indicated weakness and a lack of direction lately.

Compared to some other market sectors (technology, pharmaceuticals, precious metals, etc.), banking stocks and particularly Wells Fargo shares have generally underperformed during the pandemic. The bulls aren’t even close to getting the stock price back to the 52-week high of $54.75.

So, is Wells Fargo stock a bargain or just dead money? Let’s dig a little deeper, starting with the Fed’s recent round of restrictions.

Banking’s Burden

After the Federal Reserve conducted “sensitivity analyses” of 34 U.S. mega-banks, the agency ominously declared that “several would approach minimum capital levels” under certain envisioned scenarios.

In other words, some big banks would be in rough shape if economic conditions worsen. Consequently, the Fed is now saddling the banks with rules and restrictions that could make life more difficult for Wells Fargo and its stakeholders.

First, the Fed ordered the banks suspend their share buybacks in order to conserve funds. This restriction isn’t expected to have a material impact on Wells Fargo.

Next, the banks will be required later this year to resubmit their capital plans. Again, it’s a pain in the you-know-what but ultimately it shouldn’t be a major source of concern for Wells Fargo stockholders. Heck, maybe a positive result could convince the Fed to lighten up a bit.

Dividend Danger

That last idea is likely just wishful thinking as the Fed did indeed threaten to possibly “take additional policy actions to support the U.S. economy and banking system.”

Still, so far we haven’t touched upon any insurmountable issues between the Fed and Wells Fargo. The potential problem comes with the next point of contention, which is Wells Fargo’s generous dividend payouts.

Specifically, the Fed is now requiring these banks to limit their dividend distributions, keeping them no greater than the levels distributed during the second quarter. The Fed also threatened to limit distributions even further for individual banks on a case-by-case basis.

In response to this, Wells Fargo announced that it expects to reduce its dividend. The bank declined to specify the amount of the reduction.

For argument’s sake, let’s imagine a worst-case scenario. J.P. Morgan analyst Vivek Juneja proposes that “Wells Fargo needs to cut its dividend by much more than 25% to be comfortable that it will not trip over the Fed’s dividend limits in future quarters.”

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.

The Bottom Line on Wells Fargo Stock

The Federal Reserve might be overreaching in imposing the aforementioned restrictions on Wells Fargo.

Still, even the imagined worst-case scenario isn’t so bad. Wells Fargo stockholders need not fear the Fed, then, even if they don’t particularly like it.

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