The huge investment brokerage and bank Charles Schwab (SCHW -0.05%), which had more than $7 trillion of client assets at the end of 2022, has come under selling pressure after three banks, including SVB Financial, recently collapsed in less than a week's time.
One big reason for the meltdown has to do with the fact that banks had invested a lot of deposits into government-backed bonds that lost value as interest rates have soared, because bond yields and bond prices have an inverse relationship. At the same time, the Federal Reserve had rapidly raised interest rates and begun the process of quantitative tightening, which put pressure on bank deposits and led to outflows. Bond losses are often only temporary if a holder can hold the bonds until maturity, but if a bank has to sell them to cover significant deposit outflows, those losses can become very real and present big problems.
At the end of 2022, Schwab had average tangible common equity of $17.4 billion. Meanwhile, the bank had $12.3 billion of unrealized losses in its available-for-sale (AFS) bond portfolio, which the bank intends to sell before they mature. However, these losses are marked-to-market and have already been subtracted from equity. The real concern is in Schwab's held-to-maturity (HTM) bond portfolio, where Schwab has unrealized losses of $15.6 billion. These have not been accounted for, and if Schwab ever had to dip into this portfolio to cover deposit outflows, the company would be in deep trouble.
Despite these massive unrealized bond losses, there are two main reasons I'm not as concerned about Schwab facing liquidity issues that would bring the company down.
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1. A much more diverse deposit base
Unrealized bond losses are only one part of the story that led to the collapse of SVB. The other issue was a run on deposits that played out incredibly quickly. SVB's deposit base was concentrated among early-stage companies and venture capital and private equity firms. Clients pulled roughly $42 billion of deposits on March 9.
Schwab runs a much different business composed of 33.8 million brokerage clients, 2.4 million corporate retirement plans, and 1.7 million banking accounts. More than 80% of its deposits are insured by the Federal Deposit Insurance Corporation, whereas hardly any of SVB Financial's deposits were FDIC insured.
A big way that Schwab gets deposits, according to the firm's regulatory filing, is that "cash awaiting investment in a portion of our client brokerage accounts is swept to our banking subsidiaries and those bank deposits are then used to extend loans to clients and purchase investment securities."
So, for Schwab to really experience a bank run like SVB, it would have to be a really big event that prompted millions and millions of people with smaller accounts to leave the company. Schwab has actually seen huge fluctuations in its bank deposit balances already. In 2022, they fell to $367 billion from nearly $444 billion in 2021, but that was while rates were rising very rapidly, and the market was getting crushed.
Schwab has also paid hardly anything for these deposits compared to other banks. For the three months ending 2022, the average rate it paid on bank deposits was just 0.46%, whereas the federal funds rate exceeded 4% at the end of 2022. The company could increase what it pays on deposits, which will weigh on earnings, but likely do a better job of helping the brokerage retain deposits in the near term.
The other thing to keep in mind is that Schwab has a very strong brand that people rely on. It's also one of the largest brokerages to trade stocks and other assets, and market volatility can actually lead more people to want to trade.
2. Better liquidity position
Schwab also seems to have a lot of liquidity at its disposal should it ever need to draw on any, and it looks like it could handle significant deposit outflows even now. In a recent update, the bank said that it has an "estimated $100 billion of cash flow from cash on hand, portfolio-related cash flows, and net new assets we anticipate realizing over the next twelve months."
Looking more closely at the bank's annual regulatory filing, Charles Schwab had more than $40 billion of cash and cash equivalents at the end of 2022. It also said that it has an available borrowing capacity from the Federal Home Loan Bank (FHLB) of $68.5 billion. Furthermore, more than $25 billion of Schwab's AFS securities are set to mature within one year.
We also know the bank could now potentially tap the Federal Reserve's new Bank Term Funding Program (BTFP), which the Fed created after the collapse of SVB and Signature Bank and allows qualifying banks to post certain assets such as collateral in return for a one-year loan. Ultimately, Schwab believes it has over $300 billion of incremental borrowing capacity from various short-term credit facilities.
JPMorgan Chase analyst Kenneth Worthington issued a research note yesterday saying that with the BTFP now in place, liquidity concerns in the near term have been "significantly de-risked if not outright eliminated for the next year."
