Charles Schwab's $7 trillion empire showing some cracks
As the economic crisis drags on, investors are uncovering firm's risks
On the surface, Charles Schwab Corp. being swept up in the worst U.S. banking crisis since 2008 makes little sense.
The firm, a half-century mainstay in the brokerage industry, isn't overexposed to crypto like Silvergate Capital and Signature Bank, nor to startups and venture capital, which felled Silicon Valley Bank. Fewer than 20% of Schwab's depositors exceed the FDIC's $250,000 insurance cap, compared with about 90% at SVB. And with 34 million accounts, a phalanx of financial advisers and more than $7 trillion of assets across all of its businesses, it towers over regional institutions.
Yet the questions around Schwab won't go away.
Rather, as the crisis drags on, investors are starting to unearth risks that have been hiding in plain sight. Unrealized losses on the Westlake, Texas-based firm's balance sheet, loaded with long-dated bonds, ballooned to more than $29 billion last year. At the same time, higher interest rates are encouraging customers to move their cash out of certain accounts that underpin Schwab's business and bolster its bottom line.
It's another indication that the Federal Reserve's rapid policy tightening caught the financial world flatfooted after decades of declining rates. Schwab shares have lost more than a quarter of their value since March 8, with some Wall Street analysts expecting earnings to suffer.
“In hindsight, they arguably could have had more prudent investment choices,” said Morningstar analyst Michael Wong.
Chief Executive Officer Walt Bettinger and the brokerage's founder and namesake, billionaire Charles Schwab, have said the firm is healthy and prepared to withstand the broader turmoil.
The business is “misunderstood,” and it's “misleading” to focus on paper losses, which the company may never have to incur, they said last week in a statement.
“There would be a sufficient amount of liquidity right there to cover if 100% of our bank's deposits ran off,” Bettinger told the Wall Street Journal in an interview published Thursday, adding that the firm could borrow from the Federal Home Loan Bank and issue certificates of deposit to address any funding shortfall.
Through a representative, Bettinger declined to comment for this story. A Schwab spokesperson declined to comment beyond the Thursday statement.
The broader crisis showed signs of easing on Monday, after First Citizens BancShares Inc. agreed to buy SVB, buoying shares of financial firms including Schwab, which was up 3.1% at 2:29 p.m. in New York. The stock is still down 42% from its peak in February 2022, a month before the Fed started raising interest rates.
Schwab is unusual among peers. It operates one of the largest U.S. banks, grafted on to the biggest publicly traded brokerage. Both divisions are sensitive to interest-rate fluctuations.
Like SVB, Schwab gobbled up longer-dated bonds at low yields in 2020 and 2021. That meant paper losses mounted in a short period as the Fed began boosting rates to stamp out inflation.
Three years ago, Schwab's main bank had no unrealized losses on long-term debt that it planned to hold until maturity. By last March, the firm had more than $5 billion of such paper losses — a figure that climbed to more than $13 billion at year-end.
It shifted $189 billion of agency mortgage-backed securities from “available-for-sale” to “held-to-maturity” on its balance sheet last year, a move that effectively shields those unrealized losses from impacting stockholder equity.
“They basically saw higher interest rates coming,” Stephen Ryan, an accounting professor at New York University's Stern School of Business, said in a phone interview. “They didn't know how long they would last or how big they would be, but they protected the equity by making the transfer.”
Schwab's other headache from higher interest rates stems from cash.
At the root of Schwab's income is idle client money.
The firm “sweeps” cash deposits from brokerage accounts to its bank, where it can reinvest in higher-yielding products. The difference between what Schwab earns and what it pays out in interest to customers is its net interest income, among the most important metrics for a bank.
Net interest income accounted for 51% of Schwab's total net revenue last year.