Charles Schwab, stuck in the banking mess, could be a bargain

As fear spreads through the banking sector, Charles Schwab (SCW) was swept up in the mess last week and continued to sink on Monday. The stock is now down around 30% in the past few days and around 35% for the year on fears of mark-to-market losses on its held-to-date bond portfolio. ‘due date. Schwab has faced a steady drain of cash from accounts in search of higher returns in money markets and other instruments, what it calls cash sorting.

But any investor with a high-quality bond portfolio should know more. Bond values ​​can drop significantly, creating losses on paper when interest rates rise, but if bonds are held to maturity, the value will return.

Besides the lost opportunity cost, a problem only arises if the bonds in the portfolio have to be liquidated. In part, the current banking crisis, including the fall of Silicon Valley Bank (SIVB), is driving down the value of bonds classified as held-to-maturity, with fears that they will be liquidated as depositors flee. . SVB had previously sold bonds classified as available for sale at a loss to meet the deposits.

But what about Schwab? It’s definitely not an SIVB, is it?

Keefe, Bruyette & Woods is among those who see the stock sell-off as an overreaction.

“We see no direct reading of SIVB’s deposit situation to that of SCHW given the difference in business model and deposit base, although we understand the knee-jerk reaction of investors to punish the actions of other banks that have achieved high deposit outflows.”

Although KBW does not see capital issues, it does see a potential impact on earnings, now likely becoming well-discounted in equities, “In the short term, a more severe deposit outflow scenario does not run the business the risk of being undercapitalized and having to raise capital, nor does it put the business at risk of being unprofitable, even for a quarter, but rather raises questions about the correct level of earning power at short term.”

Schwab will face intense scrutiny of its balance sheet, its portfolio of held-to-maturity assets and the impact on earnings. SCHW’s 30% drop in two days represents fears of capital flight and that Schwab’s unrealized losses could materialize if the holdings have to be liquidated.

Two things help investors with mark-to-market bond losses, lower interest rates and time. On the positive side, bank runs and panic will likely have economic consequences that will prompt the Fed to slow down and potentially reverse rate hikes.

Morgan Stanley views the pullback as providing a compelling buying opportunity. Morgan believes SCHW has broad access to capital and can navigate an extreme risk scenario with unprecedented deposit withdrawals in a short period of time. Morgan believes SCHW is positioned to generate earnings of around 20% over the next five years while increasing net interest margins as the securities portfolio is reinvested at much higher rates relative to the current average yield from 1.60% to 1.70%.

Analysts at Piper Sandler and Citi also expressed confidence in SCHW, according to a CNBC report on Monday, with the stock down nearly 11% by early afternoon.

Additionally, CEO Peter Crawford attempted in a note Monday to assure investors of Schwab’s stability, noting that more than 80% of its total bank deposits fall within FDIC insurance limits and that it has ” access to significant liquidity, including an estimated $100 billion in cash flow from cash, portfolio cash flow.”

Part of Wall Street is motivated to foment panic and rush at institutions, especially in light of the rapid withdrawals from SIVB – which are said to bring in $42 billion in one day, about a quarter of its deposit base. . Undoubtedly, a treacherous moment has arrived, given the more than $600 billion in market value losses collectively in financial institutions – with Schwab accounting for more than $20 billion. It will take time to repair the damage. Bank runs are rare and impossible to predict, but, as we have seen with SVB, they are always possible. Admittedly, SVB served a concentrated community with approximately 95% uninsured deposits.

Cooler heads will likely prevail and the panic in the financial sector presents a rare opportunity to buy shares of the formidable discount broker at a bargain price. Schwab is uniquely positioned to attract capital flight to money market funds and CDs. While it can be costly to match the high money market and CD rate with a low fixed rate portfolio in the short term, Schwab will do well in the long term as its portfolio matures.

Wall Street’s caution may persist in the near term, thanks to fallout from the abrupt demise of SVB, Silvergate Capital (SI), and Signature Bank (SBNY). Still, savvy investors can take advantage of worries by buying the highest quality financial institutions, like Schwab, on sale.

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