Early in the pandemic in 2020, Wells Fargo (WFC -0.56%) was one of the few banks that had to cut its quarterly dividend -- by about 80%, from $0.51 per common share to $0.10. The cut was not because Wells Fargo couldn't support the dividend, but more because the Federal Reserve put certain restrictions in place during the pandemic to ensure that banks were well capitalized.
Since then, these restrictions have been removed, and Wells Fargo has raised its quarterly dividend back to $0.30 per share for a roughly 2.2% annual dividend yield.
While I'm not sure that Wells Fargo will return to its former $0.51 per share quarterly dividend anytime soon -- which was likely higher than it should have been -- I do believe the bank can keep raising its dividend for years to come. Here's why.
Tons of excess capital
Wells Fargo has one of the most enviable capital positions of any of its large bank peers right now. Banks are required to hold a certain amount of regulatory capital as a percentage of their risk-weighted assets such as loans and bonds. This ratio is called the common equity tier 1 (CET1) capital ratio.
Each year, the Fed sets a specific minimum CET1 ratio for each of the large banks based on their size and riskiness. Banks can use excess capital above this ratio to distribute capital to shareholders through share repurchases and dividends.
Wells Fargo's minimum CET1 ratio is currently 9.2%, yet the bank's actual CET1 ratio is 10.3%. It may not sound like a lot, but when we're talking about billions of dollars, it's certainly meaningful. Currently, Wells Fargo is being prudent with capital due to an uncertain economic outlook. But credit quality is still quite clean at the bank, so it seems very well reserved for loan losses, which can eat into capital.
Furthermore, Wells Fargo has been hard at work on efficiency initiatives that have been cutting billions of dollars out of the bank's operating expenses, which will help improve its bottom line. Wells Fargo is also benefiting from the higher interest rate environment, which is increasing the yields on the bank's bond and loan holdings and driving higher revenue. Analysts expect Wells Fargo to drive meaningfully higher earnings next year, which also helps boost capital.
Plenty of room to grow the dividend
As you can see in the chart below, Wells Fargo currently has the lowest annual dividend yield of any of its large traditional bank competitors.
WFC Dividend Yield data by YCharts
Wells Fargo is more similar to Bank of America, and Citigroup only has such a large yield because it trades at such a depressed valuation. But I suspect Wells Fargo will want to remain competitive on its dividend yield with peers.
Additionally, the bank currently only has a dividend payout ratio (dividend/net income) of about 31%. CEO Charlie Scharf has also said that Wells Fargo's board of directors believes a 30% to 40% payout ratio is appropriate, leaving the bank ample room to grow the dividend and stay within the bank's desired range.
It won't happen all at once
Scharf has said in the past that "getting to a reasonable dividend level is certainly a priority for us." With a 30% payout ratio and a dividend yield not far from some of its peers', you could argue Wells Fargo is within a reasonable dividend level.
But remember: With earnings expected to improve, the bank would have to increase its dividend to maintain its payout ratio. The bank also has ample capital, and I'm sure management will want to stay competitive with its peers. I expect the bank to keep raising the dividend solidly on an annual basis.
