Wednesday, June 20, 2007
In late June of 2006, Wells Fargo (WFC) raised their dividend by 7.7%. This increase was below their trailing 20 year, 10 year, and 5 year average hikes of near 15% per annum. When I first saw the 7.7% print, I thought it made some sense. The Fed had been raising interest rates for two years, WFC's net interest margins were being squeezed, and business was beginning to slow. All these factors would appear to justify a slower dividend growth rate. However, the more I thought about it the more I realized that the weak dividend hike was signalling something more significant. WFC's earnings through the 12 months ending in June of 2006 had grown at nearly 12%, and its earnings and dividend growth had been very comparable for many years. So the 7.7% rate hike required an explanation. When I called the company, I got the distinct feeling that they were trying to explain away the dividend action as though it was no big deal. That was a very different attitude for them to take, because they had been touting their dividend growth for a number of years. As I hung up the phone, I was sure that WFC was signalling a weaker year ahead. Then it hit me. It was real estate. WFC was one of the largest mortgage underwriters in the country. It was a big part of their business. If they were being cautious, it had to be because of they had real estate worries. I discussed my concerns with our investment committee and we agreed the right thing to do was to lighten up on US banks and particularly regional mortgage banks. We also scaled back our holdings of WFC. WFC's June 2006 weak dividend hike, in my judgment, signaled housing was going to be a bigger problem than was generally believed at the time. Twelve months later it is clear that they were right. Next week at their regular board meeting, WFC is set to announce their dividend for the coming year . Here's my impression of what their dividend hike will signal. If the hike is between 5% and 7%, we can expect real estate woes to continue for another year. A 7% to 9% hike would suggest a bottom in real estate is in sight. A hike of more than 9% would mean that they not only see the mortgage business bottoming very soon, but also that they are gaining market share. A dividend hike of under 5% would be a very unwelcomed occurrence. That would mean that WFC is bracing for even more bad news in the housing market. We'll let you know their decision next week.