Charles Schwab (SCHW 0.19%) has faced challenges in recent years due to high-interest rates affecting its business model. The company’s heavy reliance on low-cost deposits has led to a decline in bank deposits, prompting a need to reconsider its approach. During the second-quarter earnings call, CEO Walt Bettinger announced plans to downsize the bank over the coming years, aiming to address these issues.
Charles Schwab’s strategy has revolved around low-cost funding, with excess deposits being transferred to third-party banks to reduce its bank’s capital intensity. This adjustment is expected to enhance liquidity and mitigate the impact of deposit outflows caused by interest rate hikes. While the low-cost deposit model was lucrative when interest rates were low post-recession, it struggled as rates began to rise, leading to a phenomenon referred to as “client cash sorting.”
Customers opted for higher-yield savings options over low-yielding bank accounts, resulting in significant deposit outflows for Schwab. This shift accelerated notably as the Federal Reserve raised interest rates, making alternative interest-bearing products more appealing to investors. Schwab witnessed a substantial decline in bank account deposits, prompting a reliance on more expensive funding sources and affecting net interest margins negatively.
As Schwab proceeds with its bank downsizing initiative, analysts have adjusted their earnings and net interest income projections for the company. While this strategic shift may constrain growth and financial performance in the short term, it aligns with the evolving economic landscape characterized by potential inflation and higher interest rates.
Considering this transformation, investors are advised to exercise caution with Charles Schwab. The stock is trading around its historical averages in terms of price-to-earnings and price-to-book value. While holding onto existing investments could be prudent, there might not be an immediate need to acquire additional shares given the anticipated volatility and subdued returns during the business restructuring phase.
Charles Schwab’s proactive approach in adapting to market dynamics reflects a recognition that past strategies might not be sustainable in a changing environment. The company’s willingness to make necessary adjustments signals a proactive stance towards risk management and future growth prospects, warranting close observation by investors in the upcoming quarters.
Charles Schwab is an advertising partner of The Ascent, a Motley Fool company. Courtney Carlsen has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Charles Schwab. The Motley Fool recommends the options market. The Motley Fool has a disclosure policy.
