Wells Fargo: Add Duration to My Portfolio with 6.3% Preferred Stock Yield (NYSE:WFC)

introduction

As I’ve mentioned in some of my previous articles, I’m looking to add duration to my bond portfolio. Preferred stocks are an important part of any income-focused portfolio, but I continue to watch them closely. Check your issuer’s financial performance on a quarterly basis and take action if you need to fine-tune your positions. My goal is to review these investments quarterly, which is even more important for non-cumulative preferred stocks (where preferred dividends can be skipped). Although it’s not my primary concern, the reputational damage from skipping the dividend in the first place would be much worse than the hundreds of millions of dollars it would save the company.

I like so-called ‘bankrupt’ preferred stocks, Wells Fargo & Company (New York Stock Exchange: WFC) Series L preferred stock (New York Stock Exchange:WFC.PR.L) is one of the “broken” preferred stocks for which it is not realistic to expect the preferred stock to be called in the short or medium term future.

Despite loan loss provisions of about $1 billion, preferred dividends are still well-covered.

Two factors that are important to me are the dividend coverage ratio and the asset coverage ratio, first of all.

Wells Fargo has apparently already released its first quarter 2024 results, which is a good starting point for judging how well the bank is performing and what this means for its preferred dividend coverage ratio.

In the first quarter of this year, Wells Fargo reported total interest income of $22.8 billion, an increase of more than 15% compared to the first quarter of last year. Unfortunately, interest expenses also increased by 75% to $10.6 billion, with interest expenses also increasing by $4.6 billion (in absolute terms). Accordingly, net interest income decreased by 8.3% to $12.2 billion compared to $13.3 billion in the first quarter of last year.

The bank saw a significant increase in non-interest income thanks to a 50% increase in trading and securities profits, which led to a $1.25 billion increase in non-interest income while non-interest expenses increased by ‘only’ $0.70. middle. This means pre-provision and pre-tax earnings for the first quarter of this year were approximately $6.5 billion, compared to $7.05 billion in the first quarter of last year. This is actually a $550 million decrease despite a $270 million decrease in loan loss provisions. Also keep in mind that the FDIC’s new special assessment had a negative impact of nearly $300 million on the bottom line.

This means that reported net income was $4.62 billion, which is not that bad compared to $4.88 billion in the first quarter of last year, and after deducting preferred dividends of $306 million, net income attributable to Wells Fargo’s common shareholders was $4.3 billion. It became a dollar. This amounts to $1.21 per share.

The income statement clearly shows that preferred dividends are very well covered, despite some non-recurring items such as FDIC special assessment charges. The bank needed only $306 million of its $4.62 billion net income to cover these preferred dividends, meaning its payout ratio was just 6.6% of net income.

Meanwhile, the income statement has plenty of margin for error to set aside higher provisions in case Wells Fargo sees additional signs of weakness in its loan portfolio. Even if quarterly loan loss provisions quadrupled to $3.8 billion per quarter ($15 billion per year), preferred dividends would still be fully covered by the bank’s profits.

“Destroyed” preferred stocks are still my preferred choice.

As I explained in a previous article, there is one particular issue with preferred stocks that I like the most. That is, it is a non-cumulative perpetual convertible traded using (WFC.PR.L) as its ticker symbol.

The preferred stock was initially issued by Wachovia and cannot be called by Wells Fargo (the company that acquired Wachovia). There is a conversion feature with a conversion price of $156.7, but this will only work if Wells’ common stock is trading significantly above $200 under the terms of the preferred stock. To be precise, Series L preferred stock can be converted into 6.3814 shares of Wells Fargo, and WFC can force conversion only if the common stock price exceeds $203.72 for 20 trading days out of a 30 consecutive trading day period. When that happens, you will receive at least $1300 of common stock (6.3814 * lowest price $203.72 – market price may be higher), which will also allow you to realize capital gains on preferred stock.

Investors in Wells Fargo’s Series L should not expect a forced conversion in the near future and should view the Series L as a perpetual security.

At the current stock price of $1,185 per share, an annual dividend of $75 represents a preferred dividend yield of just over 6.3% currently. It’s not the highest on the street, but it’s an acceptable return if you’re looking for longevity.

investment thesis

I have a slight long position in Wells Fargo’s preferred Series L because I like the low probability of the security being forced to convert. Since I wanted to add duration to my portfolio, I think I should add my position in Series L as the weakness in the stock price is an opportunity to capture the 6.3% yield.