Schwab stock: poised to benefit from high interest rates (NYSE: SCHW)

jetcityimage/iStock Editorial via Getty Images

Introduction

High inflation and high interest rates go together like peanut butter and jelly. My thesis is that Schwab (NYSE: SCHW) will benefit if inflation continues so that interest rates rise level and stay there for an extended period of time.

Net interest income

Bank call reports show that Schwab’s economics for net interest income are excellent. A substantial portion goes to the bottom line while other sources of income are less significant as they have higher expenses. In the April 2022 Spring Business UpdateChief Financial Officer Peter Crawford says the following:

Going forward, if the Fed raises rates to a range of 2.25% to 2.5% by the end of the year, as the market currently expects, we could see our net margin of interest climb to the mid-1.80 in the fourth quarter.

We have a visual of this increase in net interest margin (“NIM”):

NIM increase

NIM increase (April 2022 Spring Activity Update)

Interest-earning assets reached $632 billion in the last quarter of 1Q22 Release:

Interest-bearing assets

Interest-bearing assets (version 1Q22)

If NIM can reach 1.85% by 4Q22, that’s $11.7 billion in annualized net interest income without the $632 billion in interest-earning assets needing to grow. This compares to the $8.7 billion annualized we have from the NIM of 1.38% for 1Q22 [$2,183 million *4]. For comparison, the 2021 10-K shows that net interest income was just $8 billion.

What’s exciting is that NIM doesn’t have to stop at 1.85%; it can continue to rise well beyond this level. Historically, the NIM has been above 3% in higher interest rate environments. This was the case from 2006 to 2008 according to the graph below:

Historical NIM

Historical NIM (Author’s spreadsheet)

If interest rates continue to rise beyond 2022 and we hit a 3% NIM again, that means $19 billion in annual net interest income on $632 billion in interest-earning assets. of dollars !

Asset collection

Interest-earning assets increase as client assets increase, so it’s important to understand what drives client assets. I view Schwab as a bank that aggregates assets by offering discount money management services. In other words, they are the opposite of greed and even go so far as to offer free trade. Knowing that their fees are lower than others in the industry, Schwab is acutely aware that they also need to cut expenses. Schwab has always been disciplined with expense management so this is a competitive advantage; their Expenditure on Client Assets (“EOCA”) has historically been the lowest in the industry. According to January 2022 winter business Updatethey were able to increase their margins even as revenue on client assets (“ROCA”) declined:

Historical EOCA

Historical EOCA (January 2022 Winter Activities Update)

The EOCA for Schwab is only 14 basis points while it is 40 basis points for wiring houses and 55 basis points for brokers. The connection houses in the chart below are Morgan Stanley Wealth Management (MS), Bank of America Global Wealth & Investment Management (BAC), JPMorgan Asset & Wealth Management (JPM) and Wells Fargo Wealth and Investment Management (WFC). The brokers in the chart are LPL Financial, Raymond James and Stifel’s Global Wealth Management:

EOCA Advantage

EOCA Advantage (January 2022 Winter Activities Update)

Image Source: January 2022 Winter Activities Update

Schwab regularly gathers more assets due to its reputation for low prices. In the Fall 2018 Business Update, CEO Walt Bettinger noted that the Transfer of Assets (“TOA”) metric is important. Schwab continually earns more than $2 from competitors for every dollar competitors earn from Schwab. On average, clients regularly hold cash, so Schwab’s interest-bearing assets inevitably increase as overall client assets increase. Due to organic growth and acquisitions like Ameritrade, Schwab’s client assets grew from $1.24 trillion in 2006 to $7.86 trillion in 1Q22 and interest-bearing assets grew from $34.3 billion. dollars to $632 billion over the same period.

Now more than ever, the NIM is crucial because asset gathering has gone extremely well over the years, so the level of interest-bearing assets is prodigious. Again, there are now $632 billion in interest-bearing assets. According to the 2008 10-K, we have NIMs, actual interest bearing assets and actual net interest income for the 3 years below. I’ve added columns for 1Q22 interest-bearing assets and hypothetical net interest income based on historical NIMs multiplied by 1Q22 interest-bearing assets:

Year

NIM

ib real

assets

Real NIR

1Q22ib

assets

Hypothetical NIR

on 1Q22 assets

2006

4.18%

$34,275 million

$1,434 million

$632,376 million

$26,433 million

2007

4.61%

$35,733 million

$1,647 million

$632,376 million

$29,153 million

2008

3.80%

$43,771 million

$1,665 million

$632,376 million

$24,030 million

*ib bears interest

*NIR is net interest income

Evaluation

A risk for investors is that inflation and high interest rates don’t last as long as the headlines suggest, so Schwab’s NIM might not have the chance to climb as significantly as the management projects. The anticipation of a higher NIM is already priced in, so it’s not a negligible risk. Another risk is that competitors manage to offer higher savings rates in an attempt to convince Schwab customers to transfer money to them.

I like to look through a lens of having a 1.85% NIM in 4Q22 with $632 billion in interest bearing assets. This implies net interest income of $2.9 billion for the quarter, compared to $2.1 billion in 4Q21 Release. Also, I think almost all of that extra $0.8 billion ends up in the bottom line – maybe $0.7 billion. 4Q21 net income available to common shareholders was $1,449 million and I think it may be $700 million more in 4Q22 due to the above considerations, so it looks more like $2,149 million. Annualizing that, we come to $8.6 billion. It’s hard to say what kind of multiple is appropriate for these forward-looking earnings, but I think 15-20 times is reasonable, implying a valuation range of $129-172 billion.

There were 1,893,914,470 shares outstanding as of January 31 for 10-K, including 1,814,620,775 common shares plus 79,293,695 non-voting shares. Multiplying that by the May 3 stock price of $69.46 gives us a market cap of $131.6 billion. We also have $10 billion in preferred stock, but we can exclude that from the equation since we factor preferred stock dividends into our earnings multiple. In 2021, the $495 million in the “preferred stock dividends and other” line was the difference between net income of $5.9 billion and net income of $5.4 billion available to common shareholders. .

The market cap of $131.6 billion is near the lower end of my valuation range, so I think the stock is reasonably valued. If inflation and high interest rates continue to rise for a long period of time, I think the stock will do very well.

Comments are closed.