The knee-jerk reaction makes enough superficial sense -- SVB Financial's Silicon Valley Bank became insolvent, raising questions about the entire banking industry's health. Brokerage firm Charles Schwab (SCHW 0.67%) is also in the banking business. Investors sold their Schwab shares first, deciding they'd ask questions later.
Eventually, however, you'd expect these investors to start finding or figuring out answers to their questions. So far, they're not. If they were, Charles Schwab stock wouldn't continue falling. Shares reached a new 52-week low on Friday and now sit 31% below their price just before the SVB debacle took shape.
As the adage goes, though, never look a gift horse in the mouth. Here are the three top reasons to use this dip as an entry point into a new position in Schwab.
The assets in question are poised to recover (some) value
As a quick, over-simplified reminder of what caused Silicon Valley Bank to implode, the bonds bought with its customers' deposits lost so much value when interest rates began to rise that the bank began struggling to cover withdrawals.
The practice isn't unusual. In fact, that's how the banking business works. Most of the money deposited into checking and savings accounts is deployed through loans to other customers or used to buy interest-bearing instruments. Bank of America, Citigroup, Wells Fargo, and all other banks do the same.
Although it's more brokerage firm than bank, Schwab does it, too. And like Silicon Valley Bank's assets ultimately covering its customer deposits, Schwab's similar investments lost value once rates started to rise. Per the company's fourth-quarter report, these underlying securities that cost Schwab $333 billion are now worth only around $307 billion.
In the banking business, that's kind of a big deal.
However, here are two noteworthy nuances about these unrealized losses sitting on Charles Schwab's balance sheet.
First, Schwab isn't just a bank. It has plenty of other sources of liquidity if it needs them...but so far, it hasn't.
Second, these unrealized losses may have shrunk during the first quarter anyway, thanks to a modest rebound in bond values. Although we don't know the exact makeup of this fixed-income portfolio, it's a reasonably safe bet that these bonds' underlying values have improved similarly to the near 3% growth of the S&P 500 Bond Index since the end of the fourth quarter. It's still well below last year's peak. Though, with rate hikes set to slow and maybe even reverse course, all bond values could continue to inch higher in the foreseeable future.
Higher interest rates are proving very, very profitable
Putting the question of asset base values aside, Schwab is doing well in the shadow of higher interest rates regardless. In fact, it's doing much better than it was just a year earlier, specifically because of higher interest rates.
It's an often-overlooked detail about brokerage firms, but trading commissions are no longer their top sources of revenue. These financial institutions make a huge chunk of their money on interest-bearing assets like cash deposits and money markets. And just like banks, the higher interest rates are, the more profitable cash and near-cash instruments become.
To this end, Schwab's 2022 net interest revenue was more than 25% better than 2021's, with quarter four's net interest income up 40% from the prior year's fourth quarter. The graphic below puts things into perspective.
Data source: Charles Schwab Corp. Chart by author. All figures are in millions of dollars.
While interest rates may be peaking or even set to pull back just a bit, the bulk of the interest-based profit surge is set to stick around for at least several more years. Indeed, it may grow even more. The company's scored a lot of new cash and accounts since Silicon Valley's demise, with investors seeking seemingly safer places to park their money. The brokerage house scored over $16 billion in net new assets during the week ending March 16 alone.
Charles Schwab's businesses are more resilient than you realize
Last but not least -- and possibly, most important -- Schwab's revenue is more resilient than the market's currently giving it credit for.
Sure, economic malaise is a general drag on brokerage firms. Investors need inspiration to put new money into (and keep money in) the stock market, after all. By and large, though, most people keep their money invested even in turbulent times.
It matters for one simple reason: Schwab collects management fees from the mutual funds and exchange-traded funds (ETFs) its customers own. These fees are collected regardless of how that fund or ETF performs. While the fee-based income the brokerage firm pockets is tethered to the broad market's ebb and flow, barring an outright meltdown of the stock market, Charles Schwab can count on quarterly fee and management income of roughly a billion dollars.
Data source: Charles Schwab Corp. Chart by author. All figures are in millions of dollars.
That said, it's not like trading revenue is exactly erratic, either. Good times or bad, now-Schwab-owned TD Ameritrade's investors of all ilks are usually doing something that generates trading revenue.
Buy Schwab stock sooner than later
Have Schwab shares already made their low linked to the fallout of SVB's crisis? Maybe, maybe not. It's hard to say.
It's not a stretch to suggest, however, that this stock's closer to a major low than not. It was thrown out with the proverbial bathwater, and investors as a whole still haven't caught their mistake. The details explained above won't be obscured forever, though. The first-quarter report due in the middle of this month may well be the catalyst that changes the market's view of this well-grounded brokerage outfit.
