Charles Schwab's shares slide as it navigates higher-rate environment

As 2023"s last quarter drew to a close, Charles Schwab faced the headwinds of an evolving financial landscape, marked by the U.S. Federal Reserve's aggressive interest rate hikes. For Schwab, a company that leans heavily on client deposits and uninvested cash balances for bond purchases and loans, the rising interest environment necessitated an uptick in the interest paid on deposits. 

This macroeconomic maneuver proved a significant challenge for Schwab, with a 47% plummet in net income in Q4, underscoring the broader industry's struggle against the current fiscal tide.

Despite these headwinds, Schwab's earnings per share (EPS) of 68 cents still managed to outpace Wall Street forecasts by four cents. Yet, overall revenue fell short of expectations, dropping to $4.46 billion from the anticipated $4.49 billion.

Revenue per trade was $2.36, surpassing the estimate of $2.31. Trading revenue came in at $767 million, which is higher than the estimated $747.8 million. Schwab's net interest revenue was $2.13 billion, just below the estimate of $2.14 billion. 

Schwab's total net new assets were $66.3 billion, down 48% from the prior year and just below the estimate of $67.54 billion. Schwab's total client assets were reported at $8.52 trillion, higher than the estimated $8.43 trillion

The number of new brokerage accounts opened was 910,000, slightly higher than the estimated 904,533. The total active brokerage accounts reported were 34.84 million. 

Schwab reported bank deposits of $290.0 billion, down 21% YoY and exceeding the estimate of $279.6 billion. This highlights the theme of consumers pulling deposits in search of higher yielding assets. However, there does appear to be a slow down in momentum as SCHW discussed on its call. Deposit Account Fees were reported at $174 million, lower than the estimated $193.4 million. 

Interest paid on deposits reported an average rate of 1.37%, a notable increase from the 0.46% rate just a year prior. This strategic move to retain depositors in an increasingly competitive market, however, came at a cost. Specifically, interest paid on loans from the Federal Home Loan Bank, which Schwab tapped into as an additional funding source, surged to $423 million—quadrupling year over year.

The consequence of these strategic decisions was a marked erosion in net interest revenue, which tumbled 30% to $2.13 billion. Despite this downturn, Schwab has seen an 18% leap in asset management and administration fees, buoyed by climbing client assets—a silver lining in a challenging fiscal atmosphere.

Schwab"s leadership, while acknowledging the temporary nature of these challenges, cautioned stakeholders about the unpredictable factors ahead. They pointed to the dynamics of interest rates and client behaviors as key determinants of near-term financial performance. Executives at Schwab have projected a net interest margin of 2.25% to 2.65% by year-end, a downward revision from prior estimates of 2.70%.

Moreover, the earnings call highlighted a strategic pivot for 2024, focusing on reducing short-term borrowings—a response to last year's shifts in client preferences for higher-yielding options over low-paying bank sweep accounts. This cash sorting has pressured earnings, as Schwab typically earns more on sweep accounts than on alternative options.

Unexpectedly, Schwab reported a 25% year-over-year increase in long-term debt to $26.1 billion, hinting at a strategy to buffer against short-term liquidity challenges. Analysts, such as William Blair's Jeff Schmitt, speculate this rise in long-term debt may have contributed to the stock's early drop. Nonetheless, executives maintained that 2024 is set as a transition year with a firm goal to pare down short-term borrowings.

Investors responded to the earnings report with trepidation, as reflected in a more than 6% slide in Schwab"s shares in morning trading. This response was not just to the earnings but also to a one-time $172 million FDIC special assessment fee, further dampening the financial picture painted for Q4.

$SCHW(SCHW)