In July, I believed that Charles Schwab (NYSE:SCHW) delivered on a solid second quarter earnings report. The company posted resilient results in tough market conditions, and even as sales and earnings were down, the shortfall was manageable with deposit outflows stabilizing somewhat.
With some of the headwinds dissipating, stability was seen, which is not the same as concluding that appeal was seen after shares had recovered quite a bit, while earnings power remained impaired. Over the summer, investors have been dealing with further increases in interest rates and some pressure in broad market indices, something which will weigh on Schwab in the third quarter results.
Subsequently, shares lost another ten dollar which has improved appeal, but I am awaiting third quarter results this month before considering initiating a position here.
A Recap
Schwab was a $75 stock early in March, as the regional banking crisis and implosion of SVB Financial Group made that shares traded at just $60 per share two days later, with shares falling to the $50 mark in the weeks which followed.
Ahead of the regional banking crisis, Schwab posted strong 2022 results, with revenues up 12% to $20.8 billion as GAAP earnings came in at $7.2 billion, equal to $3.50 per share, while adjusted earnings came in at nearly $4 per share.
The combination of a broker and bank under a roof made that investors in Schwab voted with their feet when the turmoil unfolded, as the company has taken on quite some assets on the balance sheet. Holding of $7 trillion in client assets in both separated and segregated accounts, the balance sheet of Schwab itself totaled $552 billion.
On the own balance sheet, Schwab paid a mere 46 basis points on a $367 billion deposit base in the fourth quarter, leaving the window wide open for deposit migration. This happened as 2022 pre-tax profits of $9.4 billion left sufficient room to hike deposits without forfeiting earnings entirely, in order to avoid deposit migration. Avoiding deposits leaving the firm was key as Schwab otherwise had to sell other assets after liquid assets were depleted, and available-for-sale and held-to-maturity assets were trading underwater amidst the duration risks of these assets.
First quarter results for this year still showed a 10% increase in sales to $5.1 billion with GAAP earnings up 14% to $1.6 billion as GAAP earnings came in at $0.83 per share. This of course came as the banking crisis unfolded only towards the very end of the quarter.
The company reported $132 billion in asset inflows to $7.5 trillion, yet the impact of deposit migration was already seen. Net interest income fell from $3.0 billion in the fourth quarter of 2022 to $2.8 billion, as the balance sheet shrank by $16 billion to $535 billion, with deposits down $41 billion to $326 billion (based on average, and not ending assets).
With the banking crisis rapidly moving to the background, Schwab posted resilient second quarter results. Second quarter sales of $4.66 billion were down 9%, less bad than I previously believed. GAAP earnings came in at $1.29 billion, down 28% year-over-year, with earnings reported at $0.64 per share.
These declines came as net interest income fell to $2.3 billion, as funding costs rose to 1.49%, in part because Schwab paid an average of 1.11% on bank deposits, while resorting to other expensive borrowing forms as well. The balance sheet kept shrinking, down another $24 billion to $511 billion, with bank deposits down another $21 billion to $304 billion. On the other hand, assets under administration surpassed the $8 trillion mark amidst inflows and a recovery in asset values.
Even as I believed that earnings power around $4 per share in 2022 might fall to $3 per share, the situation looked quite decent given the circumstances, although that 2022 earnings power was never really fair as the company borrowed too cheaply from depositors, the core clients of the business. With earnings power trending around $3 per share, I was cautious as shares recovered to the sixties over the summer.
Back To Square One
Since the summer, shares of Schwab have gradually fallen to the $55 mark here, losing another $10 per share over the summer. This came as the summer has been rather uneventful.
In August, Schwab posted its results for the month of July, posting core new asset inflows of $13.7 billion with client assets rising to $8.24 trillion. A month later, Schwab posted its results for the month of August. Net inflows were reported at $28.1 billion, although that client assets fell to $8.09 trillion amidst rocky markets while core net inflows fell to $4.9 billion.
Average interest earnings assets and deposits continued to fall on a sequential basis, although the pace of the slowdown has become much more modest, with part of the declines attribute to attrition caused by the Ameritrade acquisition integration.
The issue is that of lower earnings power, a trend seen in the second quarter, even as the regional banking crisis retracted. While the third quarter results benefit from some asset inflows, the issue is that the S&P 500 trades about a hundred points lower than the second of the second quarter. Moreover, interest rates have risen which raises the issue of cost of deposit and migration, which has not come to a standstill in the second quarter.
What Now?
The reality is that Schwab appears on track to post soft third quarter results, as the signs are not too great. As I failed to see appeal at $65 in July, appeal has increased as shares fell another ten dollars to $55 at this point in time. This makes that appeal is on the increase, but the third quarter is going to become another tough quarter. In fact, higher interest rates made that deposit migration remains a key cause of concern and profit pressure in the coming quarters is seen in all likelihood.
Hence, I see appeal increasing a great deal, but I am waiting for further insight into the business in the third quarter before considering a potential allocation.
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