Cash sorting issues could linger longer than in previous cycles, according to a Citi analyst who lowered its earnings per share estimates to reflect the potential for lower sweep account deposits and higher near-term funding costs.
Shares of Charles Schwab (ticker: SCHW) are down about 35% so far this year as investors reassess the impact of rising interest rates and scrutinize the company’s balance sheet. Schwab has large unrealized losses on mortgage-backed securities, which it renamed held to maturity on its balance sheet last year, meaning the company has no intention of selling them before maturity.
Citi analyst Christopher Allen still rates the stock as a Buy as he sees Schwab’s size and ability to attract net new money for its brokerage business as attractive over the long term. Allen and other analysts also don’t think Schwab has a liquidity problem. But the company faces short-term headwinds. Allen lowered his price target to $65 from $75. Schwab is currently trading at around $54 per share.
Charles Schwab transfers customers’ uninvested money to sweep accounts, which pay customers low interest rates but earn Schwab high profits. With short-term interest rates in excess of 4%, customers have been moving cash from low-paying accounts to higher-yielding options such as CDs and money market funds.
When customer deposit outflows exceed Schwab’s cash balance and amounts generated by maturing securities, the company turns to other short-term sources of funding, such as B. Federal Home Loan Bank loan, but it is an expensive solution. Allen expects that Schwab will have to tap into such sources more often, leading to higher costs.
He also expects deposits into highly profitable sweep accounts to decline. 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.
A company spokeswoman did not respond to a request for comment on Allen’s report. Schwab executives have previously said they believe cash sorting will largely slow down through 2023. Sweep account outflows in February were about $5 billion lower than in January, and average daily outflows since March are in line with February, according to the company.
Allen writes that total net inflows for the month are $25.6 billion and could be $81 billion for the quarter. “Given increased inflows, we estimate that money market funds will account for approximately 41% of cash balances in Q1, versus 32% in Q4 and 16% in Q1 22,” he writes.
Allens expects “Schwab deposits to decline in the coming quarters given cash sorting momentum, with sweep deposits expected to hit a cumulative decline of 37% through Q3’23 (from Q1’22).” However, he expects the pace of the decline to slow later this year.
“Over the long term, we like the stock given the platform’s economies of scale and ability to attract net new investments and drive long-term growth,” Allen writes. “We recognize that the stock could remain range-bound until we see more clarity on client cash dynamics, but still believe current levels will prove an attractive entry point for those with longer-term time horizons.”
Write to Andrew Welsch at andrew.welsch@barrons.com
Schwab’s cash-sorting problems could persist, says Citi analyst
text size
Charles Schwab Corp.
Callaghan O’Hare/Bloomberg
Karl Schwab
‘S
Cash sorting issues could linger longer than in previous cycles, according to a Citi analyst who lowered its earnings per share estimates to reflect the potential for lower sweep account deposits and higher near-term funding costs.
Shares of Charles Schwab (ticker: SCHW) are down about 35% so far this year as investors reassess the impact of rising interest rates and scrutinize the company’s balance sheet. Schwab has large unrealized losses on mortgage-backed securities, which it renamed held to maturity on its balance sheet last year, meaning the company has no intention of selling them before maturity.
Citi analyst Christopher Allen still rates the stock as a Buy as he sees Schwab’s size and ability to attract net new money for its brokerage business as attractive over the long term. Allen and other analysts also don’t think Schwab has a liquidity problem. But the company faces short-term headwinds. Allen lowered his price target to $65 from $75. Schwab is currently trading at around $54 per share.
Charles Schwab transfers customers’ uninvested money to sweep accounts, which pay customers low interest rates but earn Schwab high profits. With short-term interest rates in excess of 4%, customers have been moving cash from low-paying accounts to higher-yielding options such as CDs and money market funds.
When customer deposit outflows exceed Schwab’s cash balance and amounts generated by maturing securities, the company turns to other short-term sources of funding, such as B. Federal Home Loan Bank loan, but it is an expensive solution. Allen expects that Schwab will have to tap into such sources more often, leading to higher costs.
He also expects deposits into highly profitable sweep accounts to decline. 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.
A company spokeswoman did not respond to a request for comment on Allen’s report. Schwab executives have previously said they believe cash sorting will largely slow down through 2023. Sweep account outflows in February were about $5 billion lower than in January, and average daily outflows since March are in line with February, according to the company.
Allen writes that total net inflows for the month are $25.6 billion and could be $81 billion for the quarter. “Given increased inflows, we estimate that money market funds will account for approximately 41% of cash balances in Q1, versus 32% in Q4 and 16% in Q1 22,” he writes.
Allens expects “Schwab deposits to decline in the coming quarters given cash sorting momentum, with sweep deposits expected to hit a cumulative decline of 37% through Q3’23 (from Q1’22).” However, he expects the pace of the decline to slow later this year.
“Over the long term, we like the stock given the platform’s economies of scale and ability to attract net new investments and drive long-term growth,” Allen writes. “We recognize that the stock could remain range-bound until we see more clarity on client cash dynamics, but still believe current levels will prove an attractive entry point for those with longer-term time horizons.”
Write to Andrew Welsch at andrew.welsch@barrons.com
Source : www.barrons.com