Charles Schwab: Great Performance in Fed Bank Stress Test, but Don’t Expect Share Repurchases

Charles Schwab Stock at a Glance

• Fair Value Estimate: $70
• Morningstar Rating: 4 stars
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: High

Charles Schwab Update

The Federal Reserve has released the results of its annual stress tests for the banks. Similar to the 2022 stress test, Charles Schwab did exceptionally well. Schwab SCHW was one of the four banks whose minimum common equity Tier 1 capital ratio during the stress period increased amid an increase to 22.8% from 21.9% for the firm from its fourth-quarter ratio of 2022.

Schwab often references an internal target for its Tier 1 leverage ratio of 6.5%-6.75%, and its projected minimum in the stress test is 7.4%. We are maintaining our $70 per share fair value estimate for wide moat-rated Charles Schwab.

Schwab’s banking assets are mainly composed of U.S. Treasuries and agency-mortgage-backed securities, so it has a relatively small number of loans that are subject to credit losses. In the severely adverse scenario, Schwab is modeled to incur $1.4 billion of loan losses, which is small when compared with the $27 billion of common shareholders’ equity the company had at the end of the first quarter of 2023.

While Schwab is well capitalized according to the Fed’s stress test, we don’t expect the company to materially increase its dividend or share repurchase activity. The company will likely retain capital until market scrutiny of unrealized losses on securities portfolios has gone away. Regulation may also change to include unrealized losses on securities in capital ratios for more banks, so Schwab may also retain earnings in anticipation of this change.