- Wednesday, October 16, 2024
Charles Schwab, one of the largest brokerage firms in the nation, is expected to report its earnings on Monday. Shareholders are eagerly waiting for signs that the company's cash sorting issues are finally behind it.
Cash Sorting Woes
This year has been challenging for Schwab as customers continue to move their assets to higher yielding options in today's high-interest rate environment. This trend, known as cash sorting, has led to a sharp decrease in the company's bank deposits and a rise in financing costs. Moreover, Schwab also experienced some attrition of TD Ameritrade customers in July and August.
Financial Impact
As a result of these challenges, Schwab's stock has taken a hit and is currently down 38% for the year. Analysts anticipate third-quarter earnings of 75 cents per share, compared to $1.10 during the same period last year.
The Importance of Schwab's Bank
While Schwab is renowned for its discount brokerage business, investors have been closely monitoring its bank due to the cash sorting issue. Schwab transfers customers' uninvested cash into low-paying bank accounts, but this strategy has become less profitable as interest rates have risen rapidly. Customers have consequently been moving their uninvested cash to higher-paying options like money-market funds. This shift has put pressure on Schwab's earnings, especially when deposit outflows surpass the company's available cash, forcing them to resort to costly funding sources.
Deposit Decrease
According to S&P Global Market Intelligence, Charles Schwab experienced the largest year-over-year decrease in deposits among the top 15 bank deposit holders. Deposits dropped by 31.1% to $304.79 billion.
Signs of Improvement
Despite these challenges, Schwab executives believe that the cash sorting issue is gradually subsiding. The data indicates that it slowed down in April, May, and June, before picking up again in August. J.P. Morgan analyst Kenneth B. Worthington supports this view and suggests that sorting will be the determining factor in Schwab's near-term earning power. It will also determine the optimal mix of customer bank cash and customer money-market fund cash.
In conclusion, Charles Schwab faces significant challenges due to cash sorting issues and decreasing deposits. However, there are signs of improvement and a potential recovery for the company.
Worthington's Projections
Worthington, an expert in the field, anticipates a slowdown in cash sorting this year. As a result, he revised his earnings estimates due to the increased borrowing associated with this surge. Specifically, he lowered his projections for 2024 and 2025 from $4.82 and $6.00 to $4.25 and $5.44, respectively.
Overweight on Schwab Stock
Notably, Worthington holds an overweight position on Schwab stock. Moreover, he has set a price target of $92 for December 2024.
TD Ameritrade Integration Progress
In addition to cash sorting, it is crucial for investors to stay informed about the progress of the TD Ameritrade integration. Schwab acquired its competitor three years ago and has spent the current year transitioning customers and advisors from TD's platform to its own. Although Schwab experienced some attrition of Ameritrade customers in July and August, with net new assets declining during these months, September is expected to yield better results. Most advisors who intended to leave likely did so before Labor Day weekend when Schwab migrated $1.3 trillion worth of assets from TD Ameritrade to its own platform.
"We anticipate a resumption of net new assets at approximately $30 billion per month in October, with a significant improvement in September as well," predicts Worthington.
Furthermore, Schwab plans to continue migrating retail investors from TD Ameritrade's platform to its own throughout the remainder of this year and the following year.
Cost-Cutting Measures and Market Impact
Schwab may provide an update on cost-cutting measures during Monday morning's announcement. In August, the company disclosed its intention to lay off employees and close certain offices, with the aim of achieving at least $500 million in annual cost savings.
In addition, the company's client assets may have experienced a decline due to equity market fluctuations. As of the end of the second quarter, Schwab reported holdings of $8.02 trillion in client assets.
Potential Unrealized Losses
Lastly, Schwab may also disclose a notable increase in unrealized losses related to fixed-income securities due to interest-rate risk in its bank portfolio. However, these losses will only become realized if the company holds the securities until maturity, as clarified by Michael Wong, an analyst at Morningstar, in his October 6 note.
Wong's fair value estimate for Schwab is $80, and he believes that the current share price significantly undervalues the company.
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