Rising interest rates have challenged Charles Schwab (NYSE: SCHW)’s business model, and the financial services company has seen significant declines in bank account deposits in recent years.
Schwab’s bank deposit outflows have slowed recently and the company is taking steps to make its business more resilient. Here’s what you need to know if you’re considering buying Charles Schwab stock today.
Charles Schwab changes business
Rising interest rates weighed heavily on companies like Charles Schwab that relied on low-cost deposits. Before the Fed’s aggressive rate hike cycle began in 2022, Charles Schwab had more than $157 billion in bank accounts. Schwab’s deposits have fallen 48% over the past few years, to $82 billion at the end of the third quarter.
The downward trend accelerated into early 2023, and many feared that Schwab would become another struggling financial institution. Financial services companies have had to rely on additional funding from the Federal Home Loan Bank (FHLB) to ensure sufficient liquidity in the face of declining deposit balances. These loans increased Schwab’s financing costs and compressed its net interest margin.
In its second-quarter earnings release, the company made major changes that are likely to have an impact for years to come. The company plans to begin transferring surplus deposits to third-party banks to share the economics of holding bank account deposits. Chief Executive Officer Walt Bettinger said the move will improve the company’s liquidity and make it “less capital intensive.”
Bank deposits have long been an important low-cost source of funding for Schwab. However, as interest rates rise, this has hit again. A move to reduce the size of banking operations seems necessary, especially if banks have to deal with higher interest rates than those seen in the 2010s.
Assets and asset management are becoming increasingly important
During the company’s third-quarter earnings call, investors looked to see what’s in store for Schwab next. The company is working to repay its costly FHLB loan. Schwab’s FHLB loans during the quarter were $22.6 billion, down $2.8 billion from the second quarter and down $9.2 billion year over year. The repayment of these loans expanded Schwab’s net interest margin to 2.08% in the third quarter from 1.94% last year.
Schwab’s net revenue for the quarter increased 5% to $4.8 billion. This growth was primarily driven by asset management fees, which increased more than 20% to $1.5 billion.
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SCHW Revenue (Quarterly) Chart
SCHW Revenue (Quarterly) Data by YCharts
Assets and asset management are becoming increasingly important to Schwab’s business. “We’ve gone the extra mile to support our advisors in wealth, asset management and lending,” Bettinger said on the earnings call.
More and more institutions are pursuing asset management and asset management because of the stable fee income it provides. Over the past year, Schwab added $346 billion in net new assets. Customer assets rose from $7.8 trillion to $9.9 trillion in the past year, buoyed by a bull market in stocks.
Should you buy, sell or hold Schwab?
Schwab’s move to reduce its banking operations is painful but necessary because of the long-term risk that inflation and interest rates will remain high. This is because major structural changes have occurred in recent years.
Countries are moving toward more protectionist policies. This, combined with rising fiscal debt, government deficits and rising geopolitical tensions, could continue to put upward pressure on inflation. If that happens, inflation and interest rates could remain much higher than they were throughout the 2010s.
Currently, the company’s stock price is 2.8 times book value, which is cheaper than the average of 3.5 times book value over the past 10 years. Current investors can continue to hold, but with a multi-year transformation underway, we think there are better stocks for investors to buy today.
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Charles Schwab is an advertising partner of The Ascent, a Motley Fool. Courtney Carlsen has no position in any stocks mentioned. The Motley Fool recommends Charles Schwab. The Motley Fool has a disclosure policy.
Charles Schwab: Buy, Sell or Hold? Originally published by The Motley Fool
