2023-07-19 08:30:00 ET
Summary
- Charles Schwab's shares spiked by 12.6% after Q2 2023 financial results exceeded expectations, despite a decline in net revenue from $5.09 billion to $4.66 billion year-on-year.
- The company's total client assets increased for the fourth consecutive month to $8.02 trillion in June, driven by strong market returns and $33.8 billion in net new assets from clients.
- Despite the positive results, average interest-earning assets and bank account deposits have continued to decline.
- When coupled with recent share price appreciation, the company warrants a modest downgrade.
July 18th ended up being a really fantastic day for shareholders of brokerage and banking giant Charles Schwab ( SCHW ). After reporting financial results covering the second quarter of the company's 2023 fiscal year, shares spiked higher, closing up 12.6% for the day. This is not the only upside that the company has experienced in recent months. In March of this year when the bottom fell out in the financial sector, I ended up opening a position in the company. Since then, I am up 23.9%. But obviously from the math, you can tell that the largest chunk of this gain just occurred. In many cases, you will find some bad news mixed in with the good whenever a company reports positive financial results. But the amount of bad reported in this quarterly release truly was small. Almost across the board, the company boasted results that exceeded expectations or numbers that imply that the future for the enterprise looks bright. Having said that, it does look as though some of the easy money has already been made. So while I do believe that the future for the company is positive, I have decided to downgrade it slightly from a ’strong buy’ to a ‘buy’.
Multiple reasons to be bullish
To start with, we should touch on how Charles Schwab performed when it came to the headline news items that it announced . For the second quarter of 2023, net revenue for the company came in at $4.66 billion. Even though that's a decline compared to the $5.09 billion the company reported one year earlier, it is $45 million greater than what analysts anticipated . As I revealed in an earnings preview for the business shortly before earnings were released, a decline in revenue was practically guaranteed. The biggest chunk of the drop came from the net interest income the company generates. That totaled $2.29 billion for the quarter. That was down from the $2.54 billion management reported one year earlier.
What's really interesting is that this occurred even as the net interest margin reported by management grew from 1.62% to 1.87%. The problem, then, involved a decline in the total interest earning assets on the company's books from an average for the quarter of $623.6 billion last year to $485.4 billion this year. This, in turn, was driven largely by available for sale securities declining from an average balance of $287.3 billion to $145 billion. This resulted in a reduction when it comes to interest revenue of $297 million even after the yield on these assets grew from 1.51% to 2.18%. The company also was hit by an extra $835 million coming from bank deposit expenses because of a surge in the amount that the business had to pay out on assets, some of which was offset by a reduction in overall funds that the company had to pay interest on. Another big driver for the business when it came to a reduction in its net interest income was the $46.8 billion that the company had borrowed on average throughout the month from the Federal Home Loan Bank program. With a hefty cost per annum of 5.13%, the firm ended up paying $606 million for those amounts.
There were other areas where the company experienced some weakness. Even though the firm benefited from a rise in asset management and administration fees from $1.05 billion to $1.17 billion, it reported a decline in trading revenue from $885 million last year to $803 million this year. That, management said, came about even as the average revenue per trade for the business inched up from $2.29 to $2.46 and was the result of the daily average trades for the company declining from 6.23 million to 5.27 million. Bank deposit account fees also hurt the company, dropping from $352 million to $175 million. This was driven largely by a drop in the amount of assets that were held in bank accounts on behalf of clients. But I would get into that a bit more later.
Even though the company reported a drop in net revenue, it's important to note that the reason for the market’s optimism centered around the fact that the business exceeded expectations. The same type of phenomenon occurred when it came to the firm's bottom line. Earnings per share dropped year over year from $0.87 to $0.64, while adjusted earnings per share fell from $0.97 to $0.75. Although this looks bad at first glance, the earnings per share reported by the company exceeded expectations by $0.02, while adjusted earnings per share exceeded expectations by $0.04.
Outside of the headline news, there were some other really important data points that investors should focus on. The one that caught the most attention from investors involved total client assets for the company. These came in at $8.02 trillion for June. This is the 4th month in a row that we have seen an increase. And this increase is rather large when you consider that, in the month of May, the company had $7.65 trillion in client assets. And at the end of the first quarter this year, client assets totaled $7.58 trillion.
Much of this growth was driven by strong market returns. In the month of June alone, the company benefited to the tune of $331.8 billion from market fluctuations. However, the company also enjoyed really strong net new assets coming in from clients. These were $33.8 billion. This was the highest since the $72.9 billion the company reported back in March. And it also is refreshing when you consider that inflows in recent months were as weak as $13.6 billion. That occurred in the month of April.
Obviously, growth in net new assets was driven in part by existing customers. But it's also relevant to mention that the company added another 315,000 brokerage accounts during the month of June alone. That's up from 314,000 in May and is well within the range of what the company has historically achieved on a monthly basis. Meanwhile, the number of active brokerage accounts for the business grew a more modest 71,000, climbing from 34.31 million in May to 34.38 million in June. At the end of the first quarter, the company had 34.12 million active brokerage accounts.
As much as I would love to sit here and tell you that everything was fantastic. There were some negative developments. I already mentioned, for instance, the fact that, even though financial performance exceeded expectations, it was still lower year over year. A big part of the company's problems centers from the fact that average interest earning assets continue to decline. By June, they had fallen to $479.75 billion. That's down from $483.44 billion one month earlier and down from $497.63 billion at the end of the first quarter. In June of last year, the company had $614.10 billion in average interest earning assets. Even though this may look distressing, the fact of the matter is that the company is experiencing this because higher interest rates are causing customers to take capital and allocate it in other ways that are more profitable for them.
Along this vein, the company's bank account deposits have declined over the past year, falling from $155.6 billion at the end of the second quarter of 2022 to $102.7 billion at the end of the most recent quarter this year. It is important to note, however, that the decline in bank account deposits has really slowed down over the past couple of months. In June, the company saw a reduction of only $300 million. And in May, the reduction was $200 million. The good news is that, even as this has occurred, the amount of money in money market funds has shot up. This number is now at $395.6 billion. That's significantly higher than the $168.5 billion the company had one year earlier.
Takeaway
When you look at the picture for Charles Schwab in its strategy, things are definitely looking up. The worst for the company has definitely passed by. Those who believed this would occur have most certainly benefited handsomely. Moving forward, I expect fundamental improvements to continue for the most part. However, I do think some of the easy money has been made by this point. I have not yet sold any of my shares of the company. However, I likely will start to reduce my holdings in fairly short order so that I can focus on opportunities elsewhere. I only like to focus on a small number of very lucrative prospects. And at the moment, I have my eyes set on something else. But for those who have a long-term outlook, I can definitely understand remaining bullish on the firm. That is why I, myself, I'm still going to be optimistic enough to rate the business a ‘buy’ moving forward.
For further details see:
Charles Schwab Stock: The Surge After Q2 Earnings Justified