Speaking recently at a conference, Wells Fargo (NYSE:WFC) CEO Charlie Scharf touched on the bank's beaten-down quarterly dividend, which got reduced to just $0.10 per common share last year during the pandemic. The reduction was due in part to the bank's earnings struggles last year, as well as capital distribution restrictions put in place by the Federal Reserve. With those restrictions expected to soon expire, Wells Fargo will be able to raise its dividend back to a healthier level and repurchase shares at a higher level so long as it can pass annual stress testing.

Wells Fargo previously had a much higher dividend yield than its peers, so many investors are interested to see where the dividend could go once restrictions are lifted. Here are three things that Scharf said at the conference that give us hints about the direction of the bank's dividend.

Two bank executives confer.

Image source: Getty Images.

1. The dividend is a priority

Wells Fargo has significant excess capital, but there is always the question of how a bank will use that capital -- and more specifically, how it will return that capital to shareholders. The two main ways to do this are by increasing the dividend or repurchasing shares. With the Fed's restrictions being removed, some might have wondered whether Wells Fargo would focus more on share repurchases, but that does not appear to be the case.

"So, as we get back to a more normalized ability to return capital to shareholders, we would like to get to a more normalized dividend level," Scharf said at the conference. "And then as we look at excess capital, then buybacks come into play. But getting to a reasonable dividend level is certainly a priority for us."

I think this comment is important because given Wells Fargo's significant excess capital, the bank could raise its dividend more quickly if it wants to. And with Scharf saying the dividend is a priority, perhaps it will.

2. Targeting a payout ratio

Paying out just a $0.10 quarterly dividend for the last three quarters has given Wells Fargo a very low dividend payout ratio, even when looking at its dulled earnings. For instance, when the bank generated just $0.42 earnings per share (EPS) in the third quarter of 2020, that $0.10 dividend represented a 24% payout ratio -- below most banks' typical 25% to 40% range. With the bank reporting $1.09 EPS in the first quarter of the year, the bank's payout ratio was a mere 9%.

Scharf said that in discussions he's had with the bank's board of directors, they've talked about a 30% to 40% payout ratio being a "reasonable range to think about as an industry." Analysts on average currently expect Wells Fargo to generate $3.79 EPS in 2021, with the high estimate at $4.88. Let's say Wells Fargo generates EPS of $4 -- a 30% payout ratio would equate to an annual dividend of $1.20 per common share and a quarterly dividend of $0.30 per common share. This payout range also suggests that the bank's prior quarterly dividend before the pandemic of $0.51 per share was likely too high. In 2018 and 2019, somewhat more normal years for the bank, Wells Fargo generated EPS of $4.08 and $4.31, respectively. Even at $4.31 EPS, a $0.51 quarterly dividend or $2.04 annual dividend equates to a 47% payout ratio.

3. Returning to normal quicker

The big question is how fast can Wells Fargo get to that 30% to 40% payout ratio level. Obviously, part of it depends on what a sustainable stream of earnings looks like, so Scharf will be cognizant of that, but I think there is some evidence that we could see the quarterly dividend get back to the $0.20 to $0.25 range sooner rather than later.

Another key comment Scharf made was about the bank's common equity tier 1 (CET1) ratio, a key metric bank investors watch that measures a bank's capital as a percentage of its risk-weighted assets such as loans. And remember, the numerator in the CET1 ratio, capital, is where the dividend comes from. Wells Fargo's current CET1 ratio sat at 11.8% at the end of the first quarter, and Scharf said the bank's target level is about 10.25% to 10.30%. Scharf said the bank could get down to its target CET1 ratio in about a year, give or take, from the time it can start returning capital to shareholders, which is likely next quarter. That's a good amount of capital to burn through, which makes me think a quicker return to a more normalized dividend is certainly possible.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.