What happened

Shares of the large brokerage firm Charles Schwab (SCHW 8.15%) fell nearly 32% in the first half of 2023, according to data compiled by S&P Global Market Intelligence. Like many others in the banking sector, the stock sold off significantly after the banking crisis erupted in March.

So what

After several banks in the U.S. failed, investors started to put all bank balance sheets under a microscope. Specifically, most banks had invested lots of excess liquidity into bonds prior to the Federal Reserve raising interest rates. Those bonds are now heavily underwater because bond values and yields have an inverse relationship.

These are just paper losses and will be recouped as long as banks can hold the bonds until maturity. But with deposit costs rising and deposits on the decline, investors are worried about banks that might have to sell the bonds at a loss to cover deposit outflows. This dynamic played a big role in bringing down banks earlier this year.

Schwab specifically has come under fire because its business model has always focused less on loans and more on putting excess liquidity into government-backed bonds. At the end of the first quarter, Schwab had billions of unrealized bond losses, enough to wipe out all of its tangible common equity.

Schwab has seen intense deposit pressure, as customers move excess deposits from their brokerage accounts into products that earn more yield. Deposits swept from brokerage accounts fell more than $63 billion in the first quarter of the year alone.

A little less than a month ago, Schwab provided an update, saying it expects second-quarter revenue to decline by 10% to 11% year over year, which is below consensus estimates. Schwab's CFO Peter Crawford said daily net outflows of sweep deposits continued to decline for a fourth consecutive month.

Now what

Schwab has built a tremendous business over the years, but the impact from deposit outflows could really hurt earnings if these continue. I do think the company can navigate these issues, and CEO Walt Bettinger said the company has enough access to liquidity to cover a full deposit run, not that it wouldn't be an absolute disaster if that actually happened.

But ultimately, I'd still like to get an eye on Q2 earnings and get another update to see how deposits are trending and if the outflows have continued to slow before I would go too heavily in on the stock. Until then, starting with a smaller, speculative position probably makes more sense.