Charles Schwab: counting the cost of riding out a deposit flight

Charles Schwab has shown that it can ride out a deposit flight. That is both good news and bad for the leading US brokerage and bank, whose share price has taken a drubbing following the collapse of three regional banks last month.

Client deposits stood at about $326bn at the end of the first quarter. That is down 11 per cent from the previous quarter and 30 per cent lower than the year ago period. Despite the outflow, Schwab increased revenue by 10 per cent to $5.1bn. Net income was 14 per cent higher at $1.6bn.

The good news is that the money is not leaving Schwab. Clients are mostly moving any uninvested cash from its low-yielding bank deposits into money-market funds offered by Schwab. True, the 0.27 per cent it nets in fees on these funds is paltry compared to what it would earn by putting clients’ idle cash to work itself. But the volume effect helps. The amount of cash parked in Schwab money market funds jumped 150 per cent to $358bn during the first quarter.

Unfortunately, Schwab buttressed its finances by borrowing heavily from the Federal Home Loan Bank system. It tapped the FHLB for $33.2bn during the first quarter, taking its total borrowing to $45.6bn. This has helped provide a financial buffer for Schwab and keep its tier one leverage ratio at a healthy 7.1 per cent, well above the regulatory minimum of 4 per cent.

But emergency liquidity is expensive. Schwab is paying about 5 per cent on these short-term loans. That compares to the 2 per cent average yield it expects to get from its securities holdings when they mature. Schwab said it expected to pay back the FHLB loans by the end of 2024.

Moreover, Schwab’s first-quarter results do not offer a full picture of the pressure it will face in the coming quarters. Net interest income benefited greatly from the sharp spike in interest rates last year. Assuming rates will eventually fall, these gains will be tougher in the quarters ahead.

A one-third drop in the company’s share price over the past month suggests fears that Schwab has a liquidity problem. That is wrong. Higher funding costs and uncertainty over its long-term earnings trajectory are the real worry.

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