A Morgan Stanley analyst lowered earnings estimates for
Karl Schwab
due to the impact of clients shifting cash into higher yielding options and uncertainty as to when this behavior may stop.
With “limited visibility” of these and other variables, including the regulatory landscape, “we are moving to the sidelines,” analyst Michael J. Cyprys wrote in a March 30 research note. He downgraded the brokerage firm to even weight from overweight and lowered his price target on Charles Schwab (ticker: SCHW) to $68 from $99. Shares are currently trading around $52, down from their 52-week high of $89.
Cyprys wrote that customers are moving cash from sweep accounts into money market funds at a monthly rate of $20 billion, twice what he envisioned. “This means that Schwab will make less money monetizing cash, which will hurt revenue in addition to higher funding costs,” Cyprys wrote.
He adds that cash redistribution, known as cash sorting, “is not improving at the pace we expected and the regulatory landscape will tighten, all of which weigh on earnings prospects, reduce returns on capital and limit strategic flexibility.”
Cyprys joins several Wall Street analysts who recently revised their outlook on Schwab stock, which is down 37% so far this year. Investors have reassessed the impact of interest rates on Schwab’s earnings potential and scrutinized billions of dollars of unrealized losses on its balance sheet.
Schwab funnels uninvested client money into bank accounts that pay clients low interest but are profitable for the brokerage firm. With short-term interest rates in excess of 4%, customers have been switching cash from Schwab’s low-paying Sweep accounts to higher-paying options.
Schwab had $367 billion in deposits at the end of the fourth quarter, down 17% year over year and 7% down from the third quarter.
Not all money leaves Schwab. For example, some customers invest cash in money market funds. But Schwab doesn’t make as much profit with other investment products. In addition, when customer deposit outflows exceed Schwab’s cash on hand and amounts generated by maturing securities, the company seeks other sources of short-term funding such as B. Loans from the Federal Home Loan Bank. These other sources of funding can be costly solutions.
“While customers are not leaving and Schwab has other sources of liquidity, earnings are under more pressure than we anticipated,” Cyprys wrote.
The problem for Schwab and its shareholders is the uncertainty of when cash sorting will end. Schwab executives have previously said they expect it to slow down this year and have said the company has access to ample funding and liquidity to handle the outflow of deposits. A spokeswoman for Charles Schwab did not respond to a request for comment.
Cyprys expects cash sorting to ease at some point and maintains a favorable long-term outlook for Schwab, citing its size and strength. The company has 34 million account holders and $7.4 trillion in client assets.
“But we recognize that a significant slowdown in cash sorting, followed by a reassessment of earnings expectations, are necessary prerequisites for the market to buy into a recovery story,” he wrote.
Write to Andrew Welsch at andrew.welsch@barrons.com
Morgan Stanley analyst downgrades Schwab over concerns over client liquidity
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Karl Schwab
Victor J. Blau/Bloomberg
A Morgan Stanley analyst lowered earnings estimates for
Karl Schwab
due to the impact of clients shifting cash into higher yielding options and uncertainty as to when this behavior may stop.
With “limited visibility” of these and other variables, including the regulatory landscape, “we are moving to the sidelines,” analyst Michael J. Cyprys wrote in a March 30 research note. He downgraded the brokerage firm to even weight from overweight and lowered his price target on Charles Schwab (ticker: SCHW) to $68 from $99. Shares are currently trading around $52, down from their 52-week high of $89.
Cyprys wrote that customers are moving cash from sweep accounts into money market funds at a monthly rate of $20 billion, twice what he envisioned. “This means that Schwab will make less money monetizing cash, which will hurt revenue in addition to higher funding costs,” Cyprys wrote.
He adds that cash redistribution, known as cash sorting, “is not improving at the pace we expected and the regulatory landscape will tighten, all of which weigh on earnings prospects, reduce returns on capital and limit strategic flexibility.”
Cyprys joins several Wall Street analysts who recently revised their outlook on Schwab stock, which is down 37% so far this year. Investors have reassessed the impact of interest rates on Schwab’s earnings potential and scrutinized billions of dollars of unrealized losses on its balance sheet.
Schwab funnels uninvested client money into bank accounts that pay clients low interest but are profitable for the brokerage firm. With short-term interest rates in excess of 4%, customers have been switching cash from Schwab’s low-paying Sweep accounts to higher-paying options.
Schwab had $367 billion in deposits at the end of the fourth quarter, down 17% year over year and 7% down from the third quarter.
Not all money leaves Schwab. For example, some customers invest cash in money market funds. But Schwab doesn’t make as much profit with other investment products. In addition, when customer deposit outflows exceed Schwab’s cash on hand and amounts generated by maturing securities, the company seeks other sources of short-term funding such as B. Loans from the Federal Home Loan Bank. These other sources of funding can be costly solutions.
“While customers are not leaving and Schwab has other sources of liquidity, earnings are under more pressure than we anticipated,” Cyprys wrote.
The problem for Schwab and its shareholders is the uncertainty of when cash sorting will end. Schwab executives have previously said they expect it to slow down this year and have said the company has access to ample funding and liquidity to handle the outflow of deposits. A spokeswoman for Charles Schwab did not respond to a request for comment.
Cyprys expects cash sorting to ease at some point and maintains a favorable long-term outlook for Schwab, citing its size and strength. The company has 34 million account holders and $7.4 trillion in client assets.
“But we recognize that a significant slowdown in cash sorting, followed by a reassessment of earnings expectations, are necessary prerequisites for the market to buy into a recovery story,” he wrote.
Write to Andrew Welsch at andrew.welsch@barrons.com
Source : www.barrons.com