Following the collapse of SVB Financial's Silicon Valley Bank and Signature Bank last month, many investors were looking for other financial firms that could be vulnerable to deposit flight. One company under scrutiny was Charles Schwab (SCHW -0.05%), which has seen its deposit base shrink over the past year.
One reason for this deposit decline was client cash sorting, where customers moved funds from their bank accounts into higher-yielding investments like savings accounts or money market funds. While Schwab doesn't face the same concentration risk as Silicon Valley Bank or Signature Bank, investor fears resulted in a steep sell-off that has the stock trading down 32% since the beginning of March.
Fears over Schwab's deposit flight were put to rest (for now) following its recent quarterly earnings release. The company took steps to ensure it has plenty of liquidity to withstand further deposit shrinkage. Here's how it did that, and what investors will want to watch for next from the broker.
Clients have been looking elsewhere for yield
Charles Schwab offers wealth management, brokerage, banking, asset management, and other financial advisory services. The company has dealt with declining bank deposits for over a year now.
Last year, the Federal Reserve began raising its benchmark interest rate to bring down inflation. Over the past year, the Fed raised the rate from near zero to nearly 5%. The benchmark rate hasn't been that high since October 2007, and it's now allowing investors to take advantage of higher rates on lower-risk investments like money market funds or Treasury bills.
Customers can get higher interest rates on assets outside of their Schwab bank account and have been making the move over the past year. This is called client cash sorting, resulting in Schwab's deposits shrinking by $115 billion, or 17%, in 2022. This steady outflow of deposits is why Bank of America analyst Craig Siegenthaler double-downgraded the stock in February.
Schwab is different from those failed regional banks
The collapse of Silicon Valley and Signature had worried investors looking at Schwab.
It had previously dealt with client cash sorting from 2015 to 2019 when the Fed began tightening and gradually raising interest rates. At that time, it saw a 20% reduction in cash balances.
This time is slightly different because of the rapid pace of interest rate increases. But Schwab's situation differed from the two banks. For one, it has a more diverse deposit base. Second, it has plenty of cash flow it could tap into, so it wouldn't need to sell securities at a loss to cover falling deposits. This was apparent in its first-quarter earnings period.
Image source: Getty Images.
How Schwab made sure it had plenty of liquidity
In the first quarter, Schwab saw its deposit base shrink by another 11% as clients realigned their allocations. The company previously noted 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 12 months."
It finished the quarter with $49 billion in cash and cash equivalents, and it has also borrowed $45.6 billion from the Federal Home Loan Bank (FHLB) to ensure it has the liquidity to handle further outflows. The FHLB is a government-sponsored enterprise that offers low-cost funding for banks and other financial institutions. Schwab management said it secured $80 billion in borrowing capacity from the FHLB.
Otherwise, the company performed well in the quarter, growing revenue by 10% and diluted earnings per share by 24% from last year, with clients opening 1 million new brokerage accounts.
What's next for Schwab
In March, CEO Walt Bettinger told The Wall Street Journal that Schwab has "a sufficient amount of liquidity right there to cover if 100% of our bank's deposits ran off, without having to sell a single security."
However, it will continue to deal with client cash sorting in the coming quarters. Siegenthaler told investors that Schwab's money market flows declined in April, and another decline in May would be a positive sign that the sorting is decelerating.
Schwab managed the situation with its falling deposits well and looks to have quieted investor concerns for now. The company trades near its lowest valuation over the past decade and could be a solid buy for investors willing to hold the stock through this short-term volatility.
