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Why Wells Fargo Will Increase Its Dividend

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This Thursday is arguably the biggest day of the year for bank investors. It's the day they learn which banks received regulatory approval to increase quarterly dividend payouts.

While this may seem like a no-brainer considering the bumper year most banks had in 2012, over the past two years, we've seen that nothing could be further from the truth. In 2011, the Federal Reserve sent Bank of America (NYSE: BAC  ) scurrying off with its tail between its legs after having its request denied. And Citigroup's (NYSE: C  ) analogous experience in 2012 contributed to the ousting of its now-former CEO Vikram Pandit.

There are nevertheless a handful of lenders that stand a better chance than others of gaining the requisite approval. And Wells Fargo (NYSE: WFC  ) falls squarely into this category.

Will the Fed approve Wells Fargo's dividend request?
If you haven't been following Wells Fargo as closely as, say, a bank analyst has been over the past few months, this may seem like a presumptuous question, because it presupposes that Wells Fargo has asked for approval in the first place. Rest assured, however: There's little question that it's done so.

Speaking at a conference in December, Wells Fargo's CEO John Stumpf said specifically that the nation's largest home lender will ask regulators for permission to return more capital to shareholders.

While this could theoretically be limited to share buybacks, that interpretation seems unlikely. Prior to the financial crisis, Wells Fargo paid out anywhere between 35% and 50% of its earnings to shareholders via dividends. Since then, its payout ratio dropped dramatically and has only recently made its way back to the mid to high 20% range. Coupled with Stumpf's statement, in turn, it seems safe to assume that Wells Fargo is looking to move its payout ratio back to its historical norm.

This leaves the question of whether the Fed will approve the bank's presupposed request. And I believe the answer to this is also "yes."

According to the central bank, petitioners seeking to return capital to shareholders must demonstrate the "ability to maintain capital above each minimum regulatory capital ratio and above a tier 1 common ratio of 5 percent on a pro forma basis under expected and stressful conditions throughout the planning horizon."

The ability of the nation's largest banks to do so was just tested as a part of the 2013 Dodd-Frank stress tests, the results of which were released last Thursday -- click here to learn everything you need to know about how each of the nation's largest banks performed. And if you're a shareholder in Wells Fargo, then you'll be happy to hear that it made its way through the Fed's hypothetical economic gauntlet with ease.

Source: Dodd-Frank Act Stress Test 2013: Supervisory Stress Test Methodology and Results.

As you can see in the chart above, while Wells Fargo's tier 1 common capital ratio fell by 290 basis points under the Fed's "severely adverse" economic scenario, it nevertheless settled at 200 basis points above the 5% regulatory minimum. Translated into dollars and cents, even after being subjected to the central bank's arguably extreme economic assumptions, it still had $21.34 billion in excess capital above and beyond what's required.

Indeed, I'd even go so far as to say that it'd be hard to imagine a scenario under which the Fed wouldn't approve a request by Wells Fargo. Between the third quarter of 2011 and the third quarter of last year, its tier 1 common capital increased by $13.9 billion, or 15%, while its risk-weighted assets grew by only 8.5%. As a result, its excess tier 1 common capital -- beyond 5% of risk-weighted assets, that is -- shot up by nearly $10 billion. At this rate, in other words, Wells Fargo could comfortably double its dividend payout and still continue to grow its equity base.

At the end of the day, of course, nothing is guaranteed. But, if you ask me, the likelihood that Wells Fargo will be able to raise its dividend this year is just about as close as you can get to certainty.

Want to learn more about Wells Fargo?
Wells Fargo's dedication to solid, conservative banking helped it vastly outperform its peers during the financial meltdown. Today, Wells is the same great bank as ever, but with its stock trading at a premium to the rest of the industry, is there still room to buy, or is it time to cash in your gains? To help figure out whether Wells Fargo is a buy today, I invite you to download our premium research report from one of The Motley Fool's top banking analysts. Click here now for instant access to this in-depth take on Wells Fargo.

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