Charles Schwab reported strong first quarter results overall, but faces ongoing headaches from so-called cash sorting. At $51, the stock price was slightly higher in morning trade.
According to the company’s earnings report released Monday, the company reported net income of $1.6 billion for the first quarter, up 14% from $1.4 billion for the same period last year. Schwab had adjusted earnings per share of 93 cents, beating the FactSet consensus of 90 cents. Shares are up 2.76% as of 11 a.m. EST Monday morning.
Schwab’s gains were “not as ugly as feared,” UBS analyst Brennan Hawken wrote in an April 17 research note. Hawken pointed to the strengths of Schwab’s core business in brokerage and custody. The brokerage firm raised $132 billion in core net new money, which was in line with expectations and “pretty solid given the environment,” Hawken wrote.
Bank deposits, which are the focus of investors, fell to $325.7 billion, down 11% from the fourth quarter. That’s a sign that customers continue to move money from underperforming bank accounts to higher-yielding options in a process known as cash sorting.
Deposits have been steadily declining for several quarters. The company had $465.8 billion in deposits at the end of the first quarter last year. When cash outflows exceed Schwab’s cash on hand or income from other assets, the company turns to other sources like loans from the Federal Home Loan Bank, but that’s an expensive solution. Schwab said it had raised $45.6 million in FHLB loans, up from $12.4 million in the fourth quarter.
Advertisement – Scroll to Continue.
Schwab executives said during a business update Monday morning that second-quarter sales are expected to decline by a mid- to high-single-digit percentage point year over year. The company said it was pausing its share buyback program, citing the recent turmoil in the banking sector and regulatory uncertainty.
Schwab executives said they are seeing signs that cash sorting is slowing down and reaching the end of its cycle, and they expect cash deposits to start growing at that point.
“While bank deposits shrank 11% year-on-year as clients rebalanced their allocations across our extensive range of transactional and investment cash solutions, we observed a decline in the average daily pace of bank sweep moves from January by March – even if this allows for a temporary surge in activity as the banking system turmoil begins,” CFO Peter Crawford said in a statement.
Advertisement – Scroll to Continue.
Responding to analysts’ questions during Business Update, Crawford said the company’s use of FHLB loans is temporary. “They will not be part of our long-term financial position and we will repay them as soon as possible,” he said.
The company said net sales rose 10% to $5.1 billion, driven by an increase in net interest income, which rose to $2.8 billion from $2.2 billion. However, Schwab’s interest expense increased to $1.2 billion in the quarter from $136 million in the same period last year.
More than half of Schwab’s net new money came from registered investment advisors held with Schwab. The company is the largest RIA custodian in the United States. Schwab is in the process of integrating TD Ameritrade, which it acquired in 2020. The Westlake, Texas-based company said it switched 500,000 TD customer accounts to Schwab’s platform earlier this year and is still on track to add millions more later in 2023.
Advertisement – Scroll to Continue.
Bank deposits. Much of the focus of Schwab’s business update was on Schwab’s bench. The company deposits uninvested cash from clients’ brokerage accounts into so-called sweep accounts at the bank, which yield just 0.45%. During the years of record-low interest rates, customers paid little attention to what they earned with cash. Now that has changed.
Schwab had $367 billion in customer deposits at the end of the fourth quarter, down 17% year over year and 7% down from the third quarter.
When asked by an analyst, Crawford said the company is unlikely to increase the interest rate it pays on customers’ uninvested cash, noting that customers tend to hold some cash on hand. “Whether we pay 45 basis points or 65 basis points or 100 basis points for this transaction [cash], it has little impact on customer behavior,” he said. “So I don’t see that aspect of our philosophy changing.”
Advertisement – Scroll to Continue.
Charles Schwab’s shares have become part of the regional bank stock market over the past few months.
Investors also appeared concerned about $14 billion in unrealized losses on Schwab’s securities portfolio (mostly mortgage-backed securities), although the company has said it does not have to realize those losses and has access to ample sources of liquidity.
“Cash sorting should weigh on results as customers continue to switch to higher-yielding cash products,” William Blair’s Schmitt wrote on Friday.
Advertisement – Scroll to Continue.
However, Schmitt has an Outperform rating on the stock.
“Cash sorting uncertainty could keep stocks range tight for the next few quarters,” he writes. “However, we believe the share price has fallen to a level where the risk-reward dynamics have shifted in the investor’s favour.”
Morningstar analyst Michael Wong recently cut his fair value estimate for Schwab to $70 from $87. He expects signs of accelerated cash sorting, but nothing “alarming”. He also notes that Schwab’s weekly money market fund data for March was fairly consistent in the $4 billion to $7 billion range.
“We estimate the shares are undervalued compared to our fair value estimate of $70 and believe the discount is related more to market uncertainty about the company’s earnings power and less to concerns about its access to financing and capital.” ,” Wong wrote on April 13.
Write to Andrew Welsch at [email protected]