The year 2020 has been difficult for the financial stocks. The banks and real estate investment trusts (REITs) have been working through credit issues as their customers have been negatively affected by the COVID-19 pandemic-related shutdowns.
Aside from these issues, Wells Fargo ( WFC -2.37% ) also has regulatory issues that go back years. And CME Group ( CME -0.57% ) is struggling with the current very low interest rate environment. As an exchange, it doesn't take much credit risk, but that hasn't made it immune.
Given the current economic environment, which of these two companies would be the better dividend stock? Let's take a closer look and see if we can find an answer.
COVID-19 forces Wells Fargo to cut its dividend
The past year has been difficult for Wells Fargo. The company cut its dividend by 80% as it began to set aside additional reserves for potential losses early in the COVID-19 pandemic. The company is still operating with an asset cap that has been in place since February 2018 as a result of government sanctions related to a phony accounts scandal in 2016. The consent order prevents Wells from increasing its assets over $2 trillion. The cap will remain in place until the company has "finalized, adopted and implemented the enhanced plans for governance and risk management to the satisfaction of the Federal Reserve" and a third-party review has been completed. While the timeframe for completion is open-ended, analysts have been speculating that Wells might be able to exit the cap sometime in 2021.
Wells Fargo was more or less forced to cut its dividend, given that the Fed limits all bank dividends to the average net income of the previous four quarters. The losses in the second quarter made the cut prudent. Wells also launched an expense-cutting program, which will give the company breathing room to increase the dividend in the future. Getting out of the asset cap will go a long way toward Wells Fargo becoming a better dividend stock. According to at least one estimate, the asset cap has cost Wells something like $4 billion in foregone profits. At current levels, Wells Fargo's dividend yields 1.4%.
Wells recently released the results of its Fed stress test and management commented on the dividend. Wells CEO Charlie Scharf said: "Returning capital to shareholders remains a priority for Wells Fargo. While we expect to have modest capital distribution capacity in the first quarter, we continue to have significant excess capital above regulatory requirements." Wells clearly wants to increase the dividend when regulators permit; however, that might have to wait until after COVID-19 has been brought under control. Once Wells is able to get out from under its asset cap, it will be able to increase the dividend as well.
The Fed's economic support has hurt CME Group
CME Group is going through a Fed-induced chill as well, although this one is no fault of its own. CME Group is one of the world's biggest derivatives exchanges, and its lifeblood is interest rate products. These include things like Treasury futures, Eurodollar futures, and LIBOR. The problem for CME Group is that the Fed has pushed interest rates down to the floor, which has depressed volatility. Investors who hedge interest rate risk are trimming back their requirements since rates are sitting at close to zero. If your company is hurt by falling rates, are you really going to spend money hedging that risk when rates are already as low as they can go?
CME Group has noted that the Fed's buying of Treasuries has collapsed volatility in the bond market, and that has translated into lower trading. As a general rule, the exchanges benefit from volatility in their markets. The company is optimistic that this is a temporary phenomenon, and that the sheer addition of Treasuries that have been issued to fund the government during COVID-19 will eventually need to be hedged. That supply will drive volume going forward.
For the immediate future, depressed bond market volatility will affect CME's earnings, which makes it tough for CME to bump its dividend. Note that CME pays two different dividends. The company pays an $0.85 per share quarterly dividend and also pays an annual variable dividend. This year, the variable dividend will be $2.50 a share. CME investors will then get four quarterly per-share dividends of $0.85 each and a $2.50 variable dividend, which works out to be $5.90 in cash dividends or a dividend yield of 3.2%.
Which will be the better dividend stock in 2021?
While both CME Group and Wells are in difficult markets, CME Group doesn't have regulatory issues, while Wells Fargo does. Wells will be a great stock once the Fed releases it from the doghouse, but until then it is hard to recommend. CME Group has its own problems with bond market volatility, but this will eventually pass. In the meantime, between the quarterly dividend and the variable dividend, it has a much better yield than Wells. CME is the better dividend stock in 2021.