SCHW - Charles Schwab Stock: Undeserved Panic Selloff

2023-03-13 15:55:36 ET

Summary

• Charles Schwab was ensnared by the recent Silicon Valley Bank and Signature Bank debacle.
• With more than 60% of its asset base tied up in investment securities, investors are growing increasingly concerned.
• Investors need not worry too much as over 80% of deposits at its banks are insured.
• While fearful investors are bailing out, those with courage have a chance to grab the steepest pullback in recent times.

The collapse of Silicon Valley Bank ( SIVB ) has battered even the leading financial services company, The Charles Schwab Corporation ( SCHW ).

SCHW fell to a low of $45 to start today's trading (March 13) before buyers returned to stem the tide, in line with the broad market recovery. However, SCHW still pulled back more than 36% from its early March highs at writing, as investors grew increasingly concerned over its massive investment securities portfolio.

Interestingly, the market seemed pretty calm about it when Charles Schwab released its 10-K in February. However, SVB's fallout over its substantial debt securities portfolio has spooked investors.

Charles Schwab's $333.24B worth of available-for-sale or AFS and held-to-maturity or HTM portfolio represented more than 60% of its total asset base.

As the company mainly invested in longer-dated securities for its portfolio, it resulted in a fair value that was $26.4B lower than its amortized cost.

However, as we highlighted, it didn't matter much to investors before the SIVB debacle. But, the market has grown leery of such numbers recently as market operators parse whether Charles Schwab could be forced to take realized losses if it loses its deposit base rapidly.

Management attempted to calm investors' nerves, as CFO Peter Crawford reserved a special commentary in the company's monthly activity update for February.

Crawford articulated that the company's " approach to managing [its] assets are quite different than traditional banks." Accordingly, we believe Crawford intends to impress upon investors that the company's approach is more conservative.

He highlighted that the loan-to-deposit for its banks is "approximately 10%." In addition, "nearly all the loans [are] over-collateralized by first-lien mortgages or securities."

However, investors chose to focus on the glaring similarities with SVB and Silvergate (SI). Bloomberg reported that:

There are only two other banks that have more than 50% of their assets invested in bonds. These two banks are Silicon Valley Bank and Silvergate, both of which have collapsed this month. - Bloomberg

Hence, Crawford needs to remind investors that the company's prudent lending and leverage practices do not conflict with its ability to hold its AFS assets for the long term or its HTM portfolio to maturity. Crawford added:

Focusing attention on unrealized losses within HTM has two logical flaws. First, those securities will mature at par, and given our significant access to other sources of liquidity there is very little chance that we’d need to sell them prior to maturity (as the name implies). - Charles Schwab February 2023 Activity Update

It makes sense right? Charles Schwab is telling investors they don't need to sell their AFS or HTM portfolio and don't intend to.

The company has a much "lower-risk" deposit base than SVB. It has "less than 20% uninsured deposits, making them stickier." Hence, deposit migration risks are very different from SVB, which had 93% uninsured deposits, while Signature Bank ( SBNY ) had 90% uninsured deposits.

Wells Fargo ( WFC ) stressed depositors would bail "if there are doubts about the bank's solvency." Hence, we believe it doesn't make sense that investors should categorize SCHW in the same category as the other two banks that are now under the FDIC's control.

Furthermore, management reminded investors they have significant liquidity to sustain any potential outflow. Crawford updated that the company has over "$100 billion of cash flow." In addition, it is bolstered by "$300 billion of incremental capacity with the Federal Home Loan Bank or FHLB."

Charles Schwab is also confident it could raise another "$8B in potential retail CD issuances per month." Also, it has access to the $25B in the Fed's recently announced Bank Term Funding Program or BTFP to backstop depositors.

With that in mind, the company highlighted that it's on track to report revenue growth of 10% in FQ1'23. While it could have disappointed investors, as the consensus estimates projected a 14% uptick, we believe management was likely conservative.

Given the heightened macro risks and financial instability risks, investors should expect management to be less aggressive and not more.

In any case, with the significant drop in its stock price and valuation over the past month, shouldn't it already be priced in?

We view a potential bear trap or false downside breakdown on SCHW's price action pending validation. Bear traps are usually scary, as they are intended to ensnare investors to sell at the "lows."

Hence, we expect the company to emerge from the crisis and not bite the dust, and also not follow in the footsteps of SIVB or SBNY.

The company has a well-diversified business model, and a high insured deposits ratio, undergirded by prudent lending practices. It is also supported by ample liquidity, which doesn't suggest significant stress that investors should be unduly concerned about.

More conservative investors could wait for the signal to be validated. However, we believe the extent of the selloff has created an attractive opportunity for investors with high conviction over its survival.

With a NTM normalized P/E of 12.2x, it's well below the two standard deviation zone under its 10Y average of 22x. You may not want to miss this opportunity if you have been waiting for a steep pullback.

Rating: Buy

Note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice.

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