Charles Schwab: US’s favourite broker is far from broken

The abrupt collapse of Silicon Valley Bank has not only hammered the share prices of small and regional lenders. America’s largest brokerage, Charles Schwab, is feeling the squeeze too.

Shares in Schwab have shed nearly a quarter of their value, or $36bn, over the past week, making it the sixth worst performing financial stock on the S&P 500.

The discount broker makes for an unlikely target for investors looking for the next SVB. But over the years it has mushroomed into one of America’s largest banks by deposits. These deposits, which stood at almost $367bn at the end of last year, are now in the spotlight.

Like SVB, Schwab put clients’ cash to work in higher-yielding debt securities like Treasuries and mortgage-backed securities in the years when interest rates were low. These are now underwater amid the run up in interest rates. Unrealised losses on its $333.3bn securities portfolio stood at nearly $28bn as of December 31.

Schwab also suffers from deposit outflows — albeit in the form of “cash sorting”. This is when clients chase higher returns elsewhere. That is reflected in a 17 per cent drop in deposits in 2022.

The bear scenario is as follows. A spike in cash sorting could force Schwab to liquidate securities and crystallise paper losses. That could drag down its Tier 1 leverage ratio below the regulatory minimum of 4 per cent and force a capital raise.

The scenario is unlikely. Eighty per cent of Schwab’s deposits are insured. Cash sorting settles down as rate hikes ease.

Schwab ended 2022 with a 7.2 per cent leverage ratio. That equates to a $17bn buffer. The business generates about $28bn of cash each quarter through principal maturity, interest and net new asset growth. Schwab has access to over $300bn of liquidity through the Federal Home Loan Bank (FHLB) and other facilities. That is ample capacity to handle even dire short-term illiquidity.

That said, anxiety is contagious. But this creates opportunities for bargain hunters who take the long view.