Charles Schwab, caught in a banking mess, may have a deal

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As fear gripped the banking industry, Charles Schwab (SCHW) was swept up in the dirt last week and continued to sink on Monday. The stock is now down about 30% for the past few days and about 35% for the year on concerns of mark-to-market losses on its held-to-maturity bond portfolio. Schwab has faced a steady flight of from accounts in search of higher returns in money markets and other instruments, which he calls cash sorting.

But any investor with a portfolio of high-quality bonds should know better. The value in a bond may go down materially, a paper loss, if interest rates rise, but if the bonds are held to maturity, the value will come back.

Besides the lost opportunity cost, a problem arises only when the bonds in the portfolio need to be liquidated. In part, the current banking crisis, including the collapse of Silicon Valley Bank (SIVB), stems from a decline in the value of bonds classified as held-to-maturity, with fears that they will be liquidated as depositors flee. . SVB had already sold bonds at a loss to meet deposits that were classified as available for sale.

But what about Schwab? It’s definitely no SIVB, is it?

Keefe, Bruyette and Woods are among those who view the stock selloff as an overreaction.

“Given the difference in business model and deposit base, there is no direct read-out from SIVB’s deposit position to SCHW, however we see a knee-jerk investor reaction to punishing stocks of other banks realizing higher deposit outflows.” understand.”

While KBW does not see capital issues, it does see a potential earnings impact, now that are likely to be at a substantial discount.” In the near term, a more severe deposit outflow scenario does not put the company at risk of becoming undercapitalized. And raising capital and not only puts the company at risk of being unprofitable for a quarter — but calls into question the true level of near-term earnings power.”

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Schwab will face intense scrutiny of its balance sheet, portfolio of held-to-maturity assets and the impact to earnings. The 30% drop in SCHW in two days represents fear of capital flight and Schwab’s unrealized losses could be realized if holdings need to be liquidated.

Two things help investors with mark-to-market bond losses, low interest rates and time. On the plus side, bank runs and panics are likely to have economic consequences that cause the Fed to slow down and potentially reverse rate hikes.

Morgan Stanley sees the pullback as a compelling buying opportunity. Morgan believes that SCHW has broad access to capital and can navigate a tail risk landscape with unprecedented deposit withdrawals in short time frames. Morgan thinks SCHW is positioned to generate approximately 20% earnings growth over the next five years while expanding net interest margin as the securities book is reinvested at much higher rates relative to the current 1.60%-1.70% average yield .

Analysts at Piper Sandler and Citi also expressed their confidence in SCHW, according to a report in cnbc on mondayBecause the stock was down about 11% earlier in the afternoon.

In addition, CEO Peter Crawford sought to assure investors of Schwab’s stability in a note on Monday, noting that more than 80% of its total bank deposits fall within FDIC insurance limits and that it has “significant liquidity.” including a on hand, portfolio-related cash flow of an estimated $100 billion.”

Some on Wall Street are motivated to panic and run on institutions, especially in light of the spate of withdrawals from SIVB – reportedly $42 billion a day, nearly a quarter of its deposit base. Undoubtedly, a treacherous moment has arrived, given the collective mark-to-market losses of more than $600 billion at financial institutions — Schwab accounts for more than $20 billion. It will take time to repair the damage. Bank runs are rare and impossible to predict, but as we’ve seen with SVB, they are always possible. Granted, the SVB served a concentrated community with approximately 95% of its deposits uninsured.

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Cooler heads will likely prevail and panic in the financial sector presents a rare opportunity to buy at a bargain at a formidable discount broker. Schwab is uniquely positioned to attract capital from money market funds and CDs. Although matching higher money market and CD rates with a lower fixed rate portfolio may be costly in the short term, Schwab will do well over the long term as its portfolio matures.

Caution from Wall Street may prevail in the near term due to losses from the sudden demise of SVB, Silvergate Capital (SI) and Signature Bank (SBNY). Nevertheless, savvy investors can take advantage of the concerns by buying the highest quality financial institutions such as Schwab on sale.

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