Charles Schwab had a tough second quarter – bank deposits and net income fell – but the company’s earnings were still better than Wall Street expected.
Charles Schwab
(ticker: SCHW) shares edged higher on Tuesday in premarket trading, though they are still down about 30% for the year.
“Although recent results have been negatively impacted by a number of temporary factors, we remain extremely well positioned for the years to come,” Chief Financial Officer Peter Crawford said.
Schwab’s second-quarter net income fell to $1.3 billion from $1.8 billion in the same period a year ago, a decline of 28%. Net revenue fell 9% year over year to $4.66 billion. The company reported adjusted earnings per share of 75 cents. Analysts polled by FactSet had forecast non-GAAP earnings per share of 71 cents and revenue of $4.61 billion.
Bank deposits fell again, falling to $304 billion, from $326 billion in the first quarter and $442 billion in the year-ago period. Schwab customers moved money from sweep accounts to higher-paying options in a process known as money sorting. This put pressure on Schwab’s earnings because when deposit outflows exceed cash, the company must rely on other more expensive sources of financingsuch as CDs and Federal Home Loan Bank loans.
Crawford said the company’s decline in revenue was primarily due to Charles Schwab’s increased reliance on additional funding to compensate for sorting cash.
“While the anticipated realignment of client cash, along with net purchases of equities in June, have depressed cash levels, we have observed a continued and substantial deceleration in the daily pace of cash outflows compared to months. precedents,” he said. “The continuation of this trend through the end of the quarter further strengthens our belief that this realignment activity will wind down before the end of 2023, unlocking growth in customer cash held on the balance sheet.”
Charles Schwab’s interest income climbed to $4.1 billion for the quarter, from $2.7 billion for the same period a year ago. But interest expense also soared from $166 million to $1.8 billion, leading to a decline in net interest income for the quarter of $2.29 billion from $2.54 billion.
Total expenses excluding interest increased slightly from $2.8 billion to $2.96 billion.
The company is onboarding TD Ameritrade customers and advisors, a Herculean task. Schwab, which is the nation’s largest custodian of registered investment advisers, provided an update on its progress: “With approximately 30% of client accounts converted so far, we are on track to transition nearly all clients Ameritrade balances before year-end – with the final transition group expected in the first half of 2024,” said CEO Walt Bettinger.
This is breaking news. Read a snapshot of Schwab’s earnings below and check back soon for more analysis.
Analysts expect Schwab to report second-quarter EPS of 71 cents, up from 97 cents a year ago.
The time of dreams
It was a tough year for Charles Schwab stocks. Investors will look to the company’s second-quarter earnings report for signs that relief is on the horizon.
Over the past year, Schwab customers have shifted money from sweep accounts to higher-yielding offerings that are less profitable for the company. This process, known as species sortingwas a headache for Charles Schwab and will be a key theme in Tuesday’s results.
“While we expect sorting to decelerate, we expect sorting to remain at a high level, preventing net deposit growth through 2024, given our estimate of $20 billion in organic liquidity generation per quarter” , Bank of America analysts wrote in a July 11 research note. .
Analysts polled by FactSet expect non-GAAP earnings per share of 71 cents and revenue of $4.61 billion. In the same quarter last year, Schwab reported EPS of 97 cents and revenue of $5.1 billion.
Charles Schwab stock, which is down about 30% this year, was trading around $59 per share Monday morning. That’s well below the stock’s 52-week high of $86.63. Bank of America analysts have a price target for Schwab stock of $52.
Financing costs. Although Charles Schwab is best known for its online brokerage platform, the company also operates a major bank that generates considerable revenue. Charles Schwab sweeps up uninvested client cash in bank accounts that only earn 0.48%.
Last year, Schwab generated more than $10 billion in net interest income, the difference between the interest Schwab earns on bonds and loans and the interest it pays to its funding sources. Net interest income accounted for about half of the company’s total annual revenue last year.
But as interest rates soared, customers shifted their uninvested money to higher-paying options, like CDs and money market funds. According to Charles Schwab, first-quarter client assets in proprietary and third-party purchased money market funds totaled $343.5 billion, up 179% year-over-year.
Bank deposits, however, are down. The company had $325.7 billion in deposits at the end of the first quarter, up from $465.8 billion in the same period a year ago.
When deposit outflows exceed Schwab’s cash, the company must rely on other more expensive sources of financing, such as CDs and Federal Home Loan Bank loans. Charles Schwab said he issued $41 billion worth of CDs in May, up from $6 billion at the start of the year. “Given these funding costs are around 5% or more, this puts pressure on net interest margin (NIM) and ultimately earnings,” wrote analyst Jeff Schmitt. William Blair, in a June 14 update.
Bank of America analysts suggest Schwab may be able to sell some securities from its available-for-sale portfolio in the coming quarters, allowing it to repay some of its growing external funding pool. “This action would free up capital, remove some pressure on its NIM, and accelerate the bullish reinvestment thesis, although we don’t believe this catalyst will occur until volatility in regional bank stocks reaches a level. low/stable,” they wrote. .
There are signs that species sorting has decreased. UBS analysts point to lower inflows into Schwab money market funds. “Month-to-date, the average daily pace of inflows is $543 million, 41% lower than the historical average of $927 million,” they wrote in a July 14 research note. . “Furthermore, it is 46% lower than the daily average excluding April (low due to tax payments). Although the flows of money market funds do not provide a perfect indicator of sorting, they do suggest a deceleration in the sorting process.
Investors will also be looking for updates on Charles Schwab’s efforts to onboard TD Ameritrade clients and advisors. The company bought TD in 2019, but transitioning accounts is a big, time-consuming undertaking. So far, the company has transferred approximately 5.5 million retail customer accounts from TD to Schwab. He said he remains on track to transfer nearly all remaining TD customer accounts through 2023 and early 2024.
Charles Schwab is the nation’s largest custodian of registered investment advisers, providing RIAs with technology, asset management and other services. The RIA segment is among the fastest growing segments of the wealth management industry.
Charles Schwab, who also operates a major online brokerage firm, has accumulated new assets this year. In May, net new base assets contributed to the company by new and existing customers totaled $20.7 billion, according to Charles Schwab. Total client assets stood at $7.65 trillion at the end of May, up 5% from May 2022, according to Schwab’s monthly update.
If the cash sorting numbers aren’t worse than expected, investors should see some positive news from other parts of society reported on Tuesday.
Write to Andrew Welsch at andrew.welsch@barrons.com
