As fear ripples through the banking industry, Charles Schwab (SCHW) was swept into the mess last week and continued to sink Monday. The stock is now down around 30% for the past few days and around 35% for the year, over concerns of mark-to-market losses on its held-to-maturity bond portfolio. Schwab has faced a steady flight of cash from accounts in search of higher returns in money markets and other instruments, which it calls cash sorting.
But any investor with a portfolio of high-quality bonds should know better. The value in bonds can go down materially, creating paper losses when interest rates increase, but if the bonds are held to maturity, the value will return.
Aside from the cost of lost opportunity, a problem only arises if bonds in the portfolio need to be liquidated. In part, the current banking crisis, including the fall of Silicon Valley Bank (SIVB) , generates from the decline in the value of bonds classified as held-to-maturity, with the fear they will be liquidated when depositors flee. SVB had already sold bonds that were classified as available-for-sale at a loss to meet deposits.
But what about Schwab? It’s certainly no SIVB, right?
Keefe, Bruyette & Woods is among those who see the stock selloff as an overreaction.
“We see no direct read across from SIVB’s deposit situation to SCHW’s given the difference in business model and deposit base, although we understand the knee-jerk investor reaction to punish other banks stocks that have been realizing high deposit outflows.”
Although KBW doesn’t see capital issues, it does see a potential earnings impact, now likely becoming well discounted in the shares, “Near term, a more severe deposit outflow scenario doesn’t put the company at risk of the possibility of being undercapitalized and having to raise capital and also does not put the company at risk of being unprofitable, even for a quarter — but rather raises questions of the correct level of near-term earnings power.”
Schwab will face tough scrutiny of its balance sheet, portfolio of held-to-maturity assets, and earnings impact. The 30% decline in SCHW in two days represents the fear of capital flight and that Schwab’s unrealized losses may become realized if holdings need to be liquidated.
Two things help investors with mark-to-market bond losses, lower interest rates and time. On the plus side, bank runs and panic will likely have economic consequences that cause the Fed to slow and potentially reverse rate hikes.
Morgan Stanley sees the pullback as offering a compelling buying opportunity. Morgan believes SCHW has vast access to capital and can navigate a tail risk scenario with unprecedented deposit withdrawals in a short time frame. Morgan thinks SCHW is positioned to compound earnings around 20% over the next five years while expanding net interest margins as the securities book is reinvested at much higher rates relative to the current 1.60%-1.70% average yield.
Analysts from Piper Sandler and Citi also expressed their confidence in SCHW, according to a report in CNBC on Monday, as the stock was down nearly 11% by the earlier afternoon.
In addition, CEO Peter Crawford in a note on Monday tried to assure investors of the stability of Schwab, noting that more than 80% of its total bank deposits fall within the FDIC insurance limits and that it has “access to significant liquidity, including an estimated $100 billion of cash flow from cash on hand, portfolio-related cash flows.”
Some of Wall Street is motivated to foment panic and runs on institutions, especially in light of the rapidity of withdrawals from SIVB — reportedly $42 billion in one day, about a quarter of its deposit base. Undoubtedly, a treacherous moment has arrived, given the over $600 billion of mark-to-market losses collectively at financial institutions — with Schwab accounting for over $20 billion. It will take time to repair the damage. Bank runs are rare and impossible to predict, but, as we’ve seen with SVB, they are always possible. Granted, SVB served a concentrated community with around 95% of uninsured deposits.
Cooler heads will likely prevail and the panic in the financial sector presents a rare opportunity to buy shares in the formidable discount broker at a bargain. Schwab is uniquely positioned to attract capital fleeing to money market funds and CDs. Although it may be costly to match up the high money market and CD rate with a low fixed rate portfolio in the short term, Schwab will do well over the long run as its portfolio matures.
Caution from Wall Street can persist in the near term, thanks to the fallout from the abrupt demise of SVB, Silvergate Capital (SI) , and Signature Bank (SBNY) . Still, savvy investors can take advantage of the concerns by buying the highest quality financial institutions, like Schwab, on sale.
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