2023-04-17 17:54:39 ET
Summary
- The Charles Schwab Corporation posted solid first quarter headline results.
- With the banking crisis arriving late in the quarter and disclosure being limited, it is too early to read into the numbers.
- The anticipated second quarter revenue declines look manageable, thereby perhaps a bit upbeat.
At the start of April, I concluded that appeal for the shares of The Charles Schwab Corporation ( SCHW ) appeared to be improving. I arrived at that conclusion after Charles Schwab had seen continued pressure on its share price, despite asset inflows, an implicit government backstop, insider buys and stabilized financial markets.
All these arguments made me more upbeat on Schwab, even as the idiosyncratic risks prevented me from getting too upbeat.
Some Perspective
In the first days after the SVB Financial Group (SIVBQ) implosion in March, shares of Schwab fell from $76 to $62 in the time span of just two days, as the company lost $25 billion in shareholder value in the process. In the weeks thereafter, shares fell further to the $50 mark, with investors pricing in a lot of uncertainty.
This marked a violent trend brake for a multi-year growth trend, as the asset manager and bank has seen total assets on the balance sheet rise from $140 billion to $550 billion over the past decade, creating a great deal of shareholder value in the meantime.
For the year 2022, the company grew sales by 12% to $20.8 billion as the company posted steep GAAP earnings at $7.2 billion, equal to $3.50 per share, with adjusted earnings coming in forty cents higher. Most of the assets managed by Schwab do not appear on the balance sheet, as the company held over $7 trillion in client assets in 2022, and despite more than $400 billion inflows for the year, client assets were down on the year amidst lower valuations. It is important to understand that these client assets are not apparent on the balance sheet (as these assets are held in separate accounts).
Nonetheless, not all was good as the $552 billion asset base of Schwab fell in 2022 as the company paid a mere 0.46% on bank deposits of $367 billion in the fourth quarter. Pre-tax profits of $9.4 billion (for the year) left a lot of room to hike deposit rates, although not to levels equivalent to risk-free rates. While deposits were flowing out, that is not an issue as long as the company has sufficient liquid assets to meet the redemption requests.
Longer dated assets made that Schwab might face an issue if it would be forced to sell some of these assets, as the company held $148 billion in available-for-sales securities and another $173 billion in assets held-to-maturity, as the 2022 10-K filing revealed an unrealized loss of around $14 billion on these.
Since the start of the banking crisis, the company has seen some mixed news. The company has actually see huge net asset inflows by clients, seen at $42 billion in February, but that is only part of the story. The company saw $5 billion in sweep outflows in the same month, as clients place more money in (money market) securities, moving it out of cash.
This seems to be a realization of the risks taken by these customers holding money over the deposit insurance limit, while many customers have awoken to higher rates of return offered elsewhere as well, moving money into money market accounts and other securities which provide a higher yield.
Even comments by CEO Bettinger, which claimed that the company could still operate if it would lose all of its deposits, and large insider buys, this did not really create a bounce. With shares down a lot and a lot of government and Federal Reserve guarantees and measures taken, the risk-reward looked a lot more compelling, making me cautiously warming up to Schwab.
And Now - The Earnings
Since the start of April, shares of Schwab have seen relatively low volatility and traded around the $50 mark, displaying very little volatility on the back of the release of the much anticipated first quarter earnings report .
Looking at the headline numbers, the first quarter looked solid. First quarter revenues rose 10% to $5.1 billion as GAAP earnings rose 14% to $1.6 billion, for earnings of $0.83 per share. Earnings per share rose as much as 24% on the back of share buyback activity with adjusted earnings coming in ten cents higher. While that might make sense, I am somewhat puzzled to read that the dividend has been hiked by 14% to $0.25 per share. On the commercial side, the company furthermore opened one million new accounts during the quarter and saw $132 billion in core asset inflows to more than $7.5 trillion.
So far, that is the good news, as the company recognizes that it faces some pressure on the business, announcing a pause in the share buyback program here. The company was forced to hike interest on deposits and other borrowings to $1.2 billion for the quarter, pressuring margins. This meant that net interest income of nearly $2.8 billion was down from more than $3.0 billion in the fourth quarter of 2022, although still up year-over-year.
The company continued to shrink from a balance sheet perspective, down $16 billion on a sequential basis to $535 billion and change. The bank lost about $41 billion in deposits during the quarter to a level around $326 billion, largely resorting to the Federal Loan Bank from which it borrowed large sums. This did not come cheap, with an effective rate paid of more than 5%, being dilutive with average assets now yielding just over 3% returns. Cash holdings fell, with investments quite stable, perhaps as they are underwater as a result of the duration risk, but quarterly filings should provide more insight on this.
The issue is that the numbers do not all the story, as the company focuses on average assets for the quarter, and not ending assets. The same essentially applies to interest expense as well, as the real marginal rate by the end of March is probably diluted by the fact that the crisis only unfolded late in the quarter.
This is confirmed by comments made by CFO Peter Crawford which indicated that total revenues are expected to be down by high single digits year-over-year, which amidst flattish operating costs would cut earnings by a third. That actually looks pretty attractive as the worst margin pressure (at least in the near term) is likely seen in the second quarter.
Final Remark
That being said, I fear continued The Charles Schwab Corporation deposit outflows and continued higher expenses on debt, which quite frankly means a high single-digit decline in revenues look quite upbeat to me. Then again, we do not know the ending balances of the balance sheet just yet, as that will be telling a lot, in combination with more color on deposit trends and general expense trends.
Hence, The Charles Schwab Corporation numbers look quite all right, but they are not telling the full story yet. Nonetheless, the second quarter revenue outlook looks relatively solid, but optimistic as well, making me cautiously upbeat, as I look forward to The Charles Schwab Corporation 10-Q filing or more clues in the days to come.
For further details see:
Charles Schwab Earnings: First Glance Looks Solid, Waiting For The Answers