The stress test results and capital return approvals offered some unique insights into the largest banks. While some banks provided big increases to capital returns, others provided limited to no increases. The banks in the different camps might surprise investors.
Wells Fargo (NYSE:WFC) offers one of the largest dividend yields in the banking sector and is the slight leader in the big banks over JPMorgan Chase (NYSE:JPM). The question though is whether Wells Fargo offers any upside in the sector.
Stress Test Results
For a top notch financial like Wells Fargo, passing the annual stress test wasn't an issue. The real question was the capital ratios and the capital return amounts.
The market though got a surprising twist as Wells Fargo came in with relatively low capital levels after the severely adverse scenario compared to the other big banks like Bank of America (NYSE:BAC) and Citigroup (NYSE:C).
The comparative ratios were as follows:
CET1 ratio - stress test
- Wells Fargo - 7.2%
- BoA - 8.1
- Citigroup - 9.2
- JPMorgan - 8.3
CET1 ratio - planned captial actions
- Wells Fargo - 6.1%
- BoA - 7.1
- Citigroup - 7.7
- JPMorgan - 6.8
Not only is Wells Fargo the lowest capitalized of the group, but the bank is a whole full percentage point below the lowest capital ratio of the group after the planned capital actions.
No Capital Return Upside
The biggest misconception in the market is that other banks like Bank of America and Citigroup aren't profitable or are higher risk banks. In that regards, investors that focus solely on dividends miss the big picture.
Wells Fargo was a beacon of stability in the financial crisis. The bank though isn't shinning as bright anymore based on the above results. On top of that, the bank was already fully returning capital to shareholders based on the 2016 numbers.
For the next year, Wells Fargo only offered that the bank plans to start with a $0.38 quarterly dividend and return 55% to 75% of profits. As an example, Wells Fargo made the following quarterly payouts last year that the bank should approximate this year.
The problem is that Wells Fargo is already priced as the superior bank though the capital ratios and capital returns aren't top notch anymore. Even prior to the recent capital raises for BoA and Citigroup, those supposedly inferior banks were already offering comparative net payout yields (net stock buyback yield plus dividend yield).
With Citigroup more than tripling the dividend yield to 1.6%, or an increase of 110 basis points, the bank immediately increases the net payout yield to 6.8% going forward. In addition, the bank approved a larger stock buyback that will shoot the yield higher as the buybacks take place.
Wells Fargo remains a sold bank, but the bank has the lowest capital ratios of the biggest banks and the capital returns are being surpassed by the supposed weaker banks like Citigroup.
As a relative value, remember that Wells Fargo is worth roughly $100 billion more than Citigroup though the later approved a stock buyback of up to $2 billion more than Wells Fargo spent over the last year.
Investors probably can't go wrong with this bank offering a 3.2% dividend yield and a solid value with interest rates plunging. From a relative value perspective though, other large banks offer more value and surprisingly better capital ratios suggestive of less risk and more increases in capital returns next year.
Disclosure: I am/we are long C.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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