Charles Schwab: Stellar Future With Higher Interest Rates

Aug. 10, 2022 12:20 AM ETThe Charles Schwab Corporation (SCHW)10 Comments
Eric Sprague profile picture
Eric Sprague
3.65K Followers

Summary

  • The average yield on Schwab's interest-earning assets went up 26 basis points from 1.47% in 1Q22 to 1.73% in 2Q22.
  • Net interest went up $361 million from $2,183 million in 1Q22 to $2,544 million in 2Q22.
  • The 2Q22 period was in an environment where interest rates were lower than they are today and lower than they are expected to be in the future.

Charles Schwab Consumer Location. The Charles Schwab Corporation Provides Brokerage, Banking and Financial Services I

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Introduction

My thesis is that Schwab (NYSE:SCHW) has a stellar future as we move to a world with higher interest rates. Net interest revenue went up $361 million from $2,183 million in 1Q22 to $2,544 million in 2Q22. Bank call reports show that more of this type of revenue makes its way to the bottom line than other types of revenue. As such, GAAP net income and adjusted net income went up from $1,402 million and $1,591 million, respectively, in 1Q22 to $1,793 million and $1,981 million, respectively in 2Q22 per the 2Q22 release.

The Numbers

Interest revenue went up from 1Q22 to 2Q22 because the average yield burgeoned from 1.47% to 1.73% as rates increased. We see from the 1Q22 release that the net interest revenue was $2,183 million after $136 million in expenses on the $2,319 million interest revenue:

1Q22 net interest revenue

1Q22 net interest revenue (1Q22 release)

The 2Q22 release shows that net interest revenue was $2,544 million after $166 million in expenses on the $2,710 million interest revenue:

2Q22 net interest revenue

2Q22 net interest revenue (2Q22 release)

It is crucial that the average yield went up 26 basis points from 1.47% to 1.73%. This allowed Schwab to generate more interest revenue even though the level of interest-earning assets went down from $632.4 billion to $623.6 billion.

One of the intriguing things about these numbers is that the 2Q22 period was in an environment where interest rates were lower than they are today and lower than they are expected to be in the future. The FRED Federal Funds Effective Rate went up from almost 1.75% to nearly 2.5% in late July but this was after the 2Q22 period ended:

Historical Federal Funds Effective Rate

Historical Federal Funds Effective Rate (FRED)

In the July 2022 Summer Update, it is shown that this effective rate is expected to continue climbing up to 3.5% in the near future:

Federal Funds Effective Date Since January

Federal Funds Effective Date Since January (July 2022 Summer Update)

The Secured Overnight Financing Rate (“SOFR”) is replacing the London Interbank Offered Rate (“LIBOR”) but rates are going up no matter how we look at things. The Federal Reserve Bank of New York shows that the SOFR was under 1.5% for most of 2Q22 and it went above 2.25% starting on July 28th:

SOFR

SOFR (Federal Reserve Bank of New York)

Valuation

The 2Q22 adjusted net income is $1,981 million such that the adjusted annualized net income is $7,924 million. I think Schwab is worth 20 to 22x this amount or $158 to $174 billion.

The 2Q22 10-Q shows 1,897,087,826 total shares as of July 29th based on 1,817,794,131 common shares plus 79,293,695 nonvoting shares. Multiplying this by the August 9th share price of $69.04 gives us a market cap of nearly $131 billion. There is also $10.7 billion in preferred shares that should be included because the adjusted net income figure does not include the $141 million in preferred stock dividends. As such, the sum of the common market cap and preferred shares comes to $141.7 billion.

I think the common stock is undervalued as the sum of the common market cap and preferred shares is less than my valuation range.

This article was written by

Eric Sprague profile picture
3.65K Followers
I'm an individual investor heavily influenced by Warren Buffett and Charlie Munger. Munger's 1994 USC Business School Speech is something I think about a lot: ### Over the long term, it's hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return—even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result. ... Another very simple effect I very seldom see discussed either by investment managers or anybody else is the effect of taxes. If you're going to buy something which compounds for 30 years at 15% per annum and you pay one 35% tax at the very end, the way that works out is that after taxes, you keep 13.3% per annum. In contrast, if you bought the same investment, but had to pay taxes every year of 35% out of the 15% that you earned, then your return would be 15% minus 35% of 15%—or only 9.75% per year compounded. So the difference there is over 3.5%. And what 3.5% does to the numbers over long holding periods like 30 years is truly eye-opening. If you sit back for long, long stretches in great companies, you can get a huge edge from nothing but the way that income taxes work. ### Feel free to follow me on twitter: https://twitter.com/ftreric

Disclosure: I/we have a beneficial long position in the shares of SCHW, VOO either through stock ownership, options, or other derivatives. 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.

Additional disclosure: Disclaimer: Any material in this article should not be relied on as a formal investment recommendation. Never buy a stock without doing your own thorough research.

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