The Federal Reserve isn't pleased with Wells Fargo's (WFC +0.11%) scandals, but it isn't opposed to the bank paying out billions of dollars to its shareholders.
Yesterday, the Fed said it had no objection to Wells Fargo's capital plan, which calls for increasing its quarterly dividends to $0.43 per share, up from $0.39, and buying back up to $24.5 billion of stock over the next four quarters.
Approval for big payouts also suggests to me that Wells Fargo is on the way out of regulatory troubles for its fake account scandals and historical sales practices, and it could soon be given the green light to grow once again.
Beefy buybacks
To be sure, a 10% increase in Wells Fargo's quarterly dividend is nothing to sneeze at, but the $24.5 billion boost to its buyback capacity is the real prize. It's the largest buyback plan of any of the big four U.S. banks.
Wells Fargo was valued at about $261 billion at market close yesterday, which suggests the company could repurchase more than 9% of its outstanding shares, assuming it bought back stock at recent market prices.
In some ways, past regulatory action laid the groundwork for Wells Fargo to get approval for a massive buyback program. In February, the San Francisco-based bank entered into a consent order agreement with the Federal Reserve, agreeing to hold its size to roughly $2.0 trillion in assets until the chief banking regulator is satisfied with its progress in improving its compliance and risk-management processes and oversight.
Banks need about $1 of equity capital for every $10 of deposits, so they must retain earnings to grow. Wells Fargo can't grow, so it's in a better position than perhaps any bank to send all of its earnings power right out the door in the form of dividends and buybacks.
Regulatory relief coming soon?
The Fed scrutinizes banks' capital plans based on quantitative and qualitative factors. For Wells Fargo, the qualitative portion was always the question mark. Given fake account scandals, billion-dollar fines, and intense regulatory scrutiny, the Fed had plenty of cover to fail the bank for qualitative reasons, assuming it wanted to.
Image source: Wells Fargo.
Initially, Wells Fargo believed it could get out from underneath its $2 trillion cap on assets as soon as October 2018. At its recent investor day, CEO Tim Sloan suggested that the cap may go on longer -- perhaps into the early months of 2019.
The fact that the Federal Reserve didn't oppose Wells Fargo's capital plans suggests to me that the worst of regulatory purgatory is in the rearview mirror. From my vantage point, whether the bank gets the green light to grow in 2018, 2019, or even in 2020, isn't necessarily all that important for the investment thesis.
It's my view that Wall Street had gone too far, valuing the bank as if it would never grow again. That possibility, though remote, seems far less likely today than it did even a few short days ago.
