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In January, I believed that green shoots were clearly visible into 2024 in the case of The Charles Schwab Corporation (NYSE:SCHW). Most prominent were positive deposit inflows, as outflows in this area were the root of all concerns in the spring of 2023 and the quarters that followed.
Green shoots materialized further in the first quarter of 2024, most likely in terms of increased activity levels and assets held by Schwab’s clients, although deposit migration continued again.
A Round-Trip
In March of last year, shares of Charles Schwab traded around the $75 mark, as shares plunged towards $60 in the time frame of just two days following the implosion of the SVB Financial Group. Shares even fell toward the $50 mark in the weeks that followed.
The underlying concerns of this crisis were not really visible in the 2022 results, a year in which sales rose by 12% to $20.8 billion, with GAAP earnings reported at $7.2 billion, equal to $3.50 per share, as adjusted earnings were reported at nearly $4 per share.
Being a broker and bank under a single roof, shares were sold first, and questions were asked later, when the regional banking turmoil unfolded in March of last year. Of course, interest rate related outflows did not really impact the $7 trillion in client assets, which were held in separated and segregated accounts. This trend really hurt the balance sheet of Schwab itself, which totaled over half a trillion dollars, largely funded by deposits.
These assets were mostly financed by a $367 billion deposit base, yet with Schwab paying less than 50 basis points on these deposits in the fourth quarter of 2022, the door was left wide open for deposit migration, with risk-free rates peaking (in the form of short-term government bonds and money market funds). That is no issue as Schwab held cash and short-term assets, but if these assets were depleted, it could be forced to sell held-to-maturity or available-for-sale assets. This could lock in huge losses because of the duration of these assets.
This meant that Schwab was forced to attract other and more expensive forms of borrowing, as well as hiking deposit rates, to keep its balance sheet intact. However, this still resulted in huge deposit outflows, which fell $41 billion to $326 billion, on average, in the first quarter of 2023. Deposits fell another $21 billion in the second quarter to $304 billion, as the company hiked the rate paid on these to still a modest 1.11%.
Deposits fell another $20 billion in the third quarter to $284 billion, even as average deposit payments were hiked to 1.24%, as these higher costs of debt really hurt the top line as well as earnings. The green shoot was seen in the fourth quarter results, a quarter in which deposits rose by $5 billion to $290 billion (although still down $77 billion on an annual basis). The effective rate paid on these deposits rose to 1.37%, after the yield curve fell of course during the fourth quarter.
All in all, this had a huge impact on the business, with fourth-quarter sales down 19% to $4.5 billion and earnings cut nearly in half to $0.51 per share, as adjusted earnings for the year fell to $3.13 per share. The green shoot was that the business was a bit more stable, and its clients were doing well amidst record stock markets (as assets under administration rose to $8.5 trillion), yet the earnings power of Schwab fell to about $3 per share, or even less if we look at the fourth quarter results.
With net interest income being pressured mostly being a thing of the past early into the year, stock markets trading near their highs, inflows of customers continuing and synergies to be reaped from the deal with Ameritrade, there were some green shoots at $62 per share.
This made me have more appreciative of Schwab, as it managed the immediate tail risk quite well, as better duration management should allow for the avoidance of similar financial troubles (or at least similar concerns) going forward.
Re-Rating
Since early January, shares of Schwab have seen further gains, as shares have risen to the $73 mark here. This implies that shares trade at par compared to levels pre the regional banking crisis of last year.
By mid-April, Schwab reported first-quarter 2024 revenues of $4.74 billion. Revenues were down 7% from the first quarter of last year but marked a solid 6% increase on a sequential basis. This comes as continued net interest rate margin pressure was offset by growth of outside net interest income as client assets rose to $9.1 trillion! The NII number was aided by higher stock market levels as well as $96 billion in quarterly net inflows.
The banks saw deposits come down from $290 billion to just below $270 billion here, although the balance sheet shrank by similar numbers on a sequential basis to $469 billion. The bank paid a 1.35% rate on these deposits during the quarter, actually down slightly from the fourth quarter, which feels a bit like a missed opportunity as the company has over $50 billion in the forms of borrowing on which the business pays rates between roughly 3-5%.
Amidst still some pressure on the top line, pressure on the bottom line was much less pronounced. First-quarter adjusted earnings were down a fifth to $0.74 per share, providing confidence in the $3 per share run rate here.
And Now?
The reality is that The Charles Schwab Corporation seems to be doing fine if we neglect the net interest income comparisons, which are mostly visible on an annual basis, and these comparisons likely will improve meaningfully in the coming quarters.
This means that growth might actually return during coming quarters, as actual investment activity, as reflected in the number of accounts, activity levels, and clients under administration, are on the rise. These hard numbers outweigh the anecdotal evidence, that the migration of not all accounts has gone really smoothly.
Given all of this, the worst seems to be a thing of the past for The Charles Schwab Corporation shares, although the latest decline in deposits raises some question marks here. That said, the full recovery of these same shares means that the easy money has been made here already.
