Is Schwab Really Different than Silicon Valley Bank?

There are several differences between the two banks at first glance:

Charles Schwab Corporation mass majority of clients (80%) deposits are not over the $250,000 FDIC cap. Schwab does not seem to be over its skis with VC’s or start-up companies. Schwab as 7 trillion dollars in assets and 34 million accounts.

So, why won’t the questions about Schwab go away?

It might be because of $29 billion in unrealized losses last year or because with new higher interest rates some of their customers moved their money to other opportunities outside of Schwab’s system.
Schwab shares are down more than 25% of their value in less than a month (from March 8, 2023). Just another example of how the Fed’s policy change, after years of lowering rates, abruptly affected the economy.

Regardless of those facts, last week in a statement, the CEO, Walt Bettinger, and founder, Charles Schwab, both have said publicly the brokerage is “healthy” and “misleading” to focus on paper losses that may never happen.

The Wall Street journal published an interview on March 23, 2023 with Bettinger quoted saying, “There would be a sufficient amount of liquidity right there to cover if 100% of our bank’s deposits ran off.” Then added the firm could borrow from the Federal Home Loan Bank and issue certificates of deposit to address any funding shortfall.

Because Schwab has two divisions – a publicly traded brokerage and operating as one as one the largest US banks -both sensitive to interest-rate movements.

Schwab similar to SVB, took longer-dated bonds in 2020 and 2021 with low yields. Meaning losses grew on paper as the Federal Reserve fought inflation by raising rates.

The primary bank of Schwab had no unrealized losses on long-term debt that it intended to retain till maturity three years prior. The company had such paper losses totaling more than $5 billion by last March; by year’s end, the amount had increased to more than $13 billion.

Last year, it changed the status of $189 billion in agency mortgage-backed securities on its balance sheet from “available-for-sale” to “held-to-maturity,” thereby protecting those unrealized losses from having an effect on stockholder equity.

Such balance sheet adjustments are subject to strict regulations. This indicates Schwab intends to keep debt with a weighted average yield of 1.74% (with a total value of more than $150 billion until it matures). The majority of the securities won’t mature for more than ten years. Rock meets hard place.

The next challenge is rising interest rates for cash – client money that is not moving.

Cash deposits from Schwab’s brokerage accounts “sweep” to its bank. Then the deposits can be reinvested in higher-yielding products.

One of the most crucial measures for a bank is net interest income, which is the difference between what Schwab makes and what it pays out in interest to customers.

Last year, 51% of Schwab’s entire net revenue came from net interest income.

Following a year of rates that have been climbing quickly, there is more motivation to avoid being cash-stagnant. Schwab’s sweep accounts only pay 0.45% in interest, whereas several money-market funds yield more than 4%.

Schwab’s management recognized that this activity increased last year, however it is unclear how much money clients might remove from its sweep vehicles.

According to Schwab’s annual report, “as a result of rapidly rising short-term interest rates in 2022, the company noticed a rise in the pace at which clients shifted certain cash holdings” into higher-yielding options. When the outflows persisted, they surpassed the cash generated through maturities and pay-downs on our investment portfolios as well as excess cash on hand.

According to an annual report submitted to regulators, the brokerage’s banking divisions had the ability to borrow $68.6 billion in addition to borrowing $12.4 billion from the FHLB system through the end of 2022.

According to the filing, Schwab has already borrowed an extra $13 billion from the FHLB this year.
Barclays Plc and Morningstar recently lowered their price expectations for Schwab shares as a result of analyst consideration of these risks.

Analysts have been weighing these factors, with Barclays Plc and Morningstar lowering their price targets for Schwab shares in recent weeks.

Bettinger and Schwab are confident their 50 plus years of client-centric approach continues to provide stability. Believing Schwab is different than other banks.

Only time will tell.

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