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Charles Schwab: Elevated Funding Risk Weighs On The Risk/Reward

AB Capital profile picture
AB Capital


  • Schwab may have missed consensus in 1Q20, but the underlying numbers were largely in line.
  • More worrying though is the expanding balance sheet amid a low-yield environment.
  • With Schwab's tier-1 leverage ratio set to move below its "operating objective," funding risk is a key concern.

On balance, Charles Schwab's (NYSE:SCHW) recent earnings miss was not particularly surprising given the challenging 1Q20 backdrop. There were some notable positives, though, as expense control improved, along with growth in accounts and net new assets, as well as continued balance sheet expansion. Net-net, I think SCHW's earnings power is challenged in a low-yield environment, and I would be particularly cautious about the near-term outlook as the funding risk appears to be elevated. In particular, the asset base is increasing amid a low yield environment, and thus SCHW's capital ratios could come under pressure, driving the need for a capital raise. At ~19x fwd earnings, I do not view the risk/reward as favorable.

Headline Miss But In Line on a Normalized Basis

At a 1Q20 GAAP EPS of $0.58, SCHW missed consensus estimates of $0.63, though core EPS power was likely closer to ~$0.62, excluding ~$37m of acquisition-related expenses and $27m of one-off expenses ($49m net of tax) related to the pandemic.


Income from continuing operations


(+) Extraordinary items, net of tax


= Recurring Net Income


(-) Preferred share dividends


= Recurring Net Income available to common shareholders


(/) Diluted shares outstanding


= Operating EPS


Source: Author's Est, Company Filings

Trading revenue came in at $188m (-13% YoY), with 1Q20 representing the first full quarter after the October pricing cuts. Total average daily trading volumes reached 1.5m, up from the 0.8m posted a year ago, as volatility and pricing cuts boosted volumes. I'd also note that Schwab recently included payment for order flow (PFOF) in trading revenue, suggesting an ~18% (implied $135m) of PFOF contribution in FY19.

Source: Company Filings

Net interest income (NII) came in at $1.6bn (-6% YoY), while asset management & trading revenues reached $827m (+10% YoY). While other revenue fell ~57% YoY, the headline number incorporated ~$25m of irregular items, including ~$10m

This article was written by

AB Capital profile picture
Semi-retired investor and former buy side professional. Keeping an eye on special situations and event-driven opportunities across the equity and credit universe. All views are my own.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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