Charles Schwab Earnings: Balance Sheet and Client Metrics Fine, but Funding Costs Rising

Charles Schwab Stock at a Glance

• Fair Value Estimate: $70.00
• Star Rating: 4 Stars
• Uncertainty Rating: High
• Economic Moat: Wide

Charles Schwab Earnings Update

There were no real signs of balance sheet stress or client attrition in Charles Schwab’s SCHW first-quarter earnings, but we expect the trajectory of earnings to look like a check mark with a near-term decline and longer-term uptrend.

Charles Schwab reported net income to common shareholders of $1.5 billion, or $0.83 per diluted share, on $5.1 billion of net revenue. Net revenue increased 9.5% from the previous year but sequentially declined 7%. Most of the net revenue decline was from higher funding costs that affected net interest income, as clients shift their transactional deposits into money market funds and fixed income securities and Schwab has to substitute for the deposits with higher-cost certificates of deposits and FHLBank borrowings.

While net revenue and earnings sequentially declined, the company still reported a strong annualized return on equity of 23% and operating margin of 41%. We plan to maintain our $70 fair value estimate for wide-moat-rated Charles Schwab and assess shares as undervalued.

Schwab Earnings Take Short-Term Hit

We expect earnings to look like a check mark with quarterly declines through 2023 or even mid-year 2024 and then a long uptrend. The earnings decline will initially come from higher funding costs and then from Federal Reserve rate cuts that decrease interest revenue on the company’s floating rate assets. Since the second quarter of 2022, deposits have decreased each quarter by $24 billion to $46 billion with a $41 billion decrease in the first quarter of 2023.

This is largely normal client behavior, as they move deposits into higher interest-yielding products. However, in most recent quarters, only $10 billion to $13 billion of the securities Schwab holds in its bank mature. This means Schwab has to fund the $10 billion to $30 billion quarterly difference with other sources, such as FHLBank loans that have an interest rate of about 5%. The 5% FHLBank loan expense is higher than Schwab’s revenue yield on interest earning assets of 3.19% in the quarter.