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Good morning people FYI Charles Schwab’s growing paper losses raise questions for investors

By Bloomberg Wire
6:00 AM on Mar 28, 2023 CDT

The Westlake-based investment firm’s $7 trillion empire built on low rates is showing cracks.

https://www.dallasnews.com/business/personal-finance/2023/03/28/charles-schwabs-growing-paper-losses-raise-questions-for-investors/

On the surface, Charles Schwab Corp. being swept up in the worst U.S. banking crisis since 2008 makes little sense.

The firm, a half-century mainstay in the brokerage industry, isn’t overexposed to crypto like Silvergate Capital and Signature Bank, nor to startups and venture capital, which felled Silicon Valley Bank.

Fewer than 20% of Schwab’s depositors exceed the FDIC’s $250,000 insurance cap, compared with about 90% at SVB. And with 34 million accounts, a phalanx of financial advisers and more than $7 trillion of assets across all of its businesses, it towers over regional institutions.

Yet the questions around Westlake-based Schwab won’t go away.

Related:Charles Schwab CEO Walter Bettinger on the ‘meme stock craze’ and 1,800 open jobs in North Texas
Rather, as the crisis drags on, investors are starting to unearth risks that have been hiding in plain sight. Unrealized losses on the firm’s balance sheet, loaded with long-dated bonds, ballooned to more than $29 billion last year.

At the same time, higher interest rates are encouraging customers to move their cash out of certain accounts that underpin Schwab’s business and bolster its bottom line.

It’s another indication that the Federal Reserve’s rapid policy tightening caught the financial world flat-footed after decades of declining rates. Schwab shares have lost more than a quarter of their value since March 8, with some Wall Street analysts expecting earnings to suffer.

“In hindsight, they arguably could have had more prudent investment choices,” said Morningstar analyst Michael Wong.

CEO Walt Bettinger and the brokerage’s founder and namesake, billionaire Charles Schwab, have said the firm is healthy and prepared to withstand the broader turmoil.

The business is “misunderstood,” and it’s “misleading” to focus on paper losses, which the company may never have to incur, they said in a statement.

“There would be a sufficient amount of liquidity right there to cover if 100% of our bank’s deposits ran off,” Bettinger told the Wall Street Journal in an interview, adding that the firm could borrow from the Federal Home Loan Bank and issue certificates of deposit to address any funding shortfall.

Through a representative, Bettinger declined to comment for this story. A Schwab spokesperson declined to comment beyond the prepared statement.

The broader crisis showed signs of easing on Monday, after First Citizens BancShares Inc. agreed to buy SVB, buoying shares of financial firms including Schwab. The stock is still down 42% from its peak in February 2022, a month before the Fed started raising interest rates.

Related:Westlake’s Charles Schwab agrees to pay $186.5 million for misleading customers about fees
Unusual operation

Schwab is unusual among peers. It operates one of the largest U.S. banks, grafted onto the biggest publicly traded brokerage. Both divisions are sensitive to interest-rate fluctuations.

Like SVB, Schwab gobbled up longer-dated bonds at low yields in 2020 and 2021. That meant paper losses mounted in a short period as the Fed began boosting rates to stamp out inflation.

Three years ago, Schwab’s main bank had no unrealized losses on long-term debt that it planned to hold until maturity. By last March, the firm had more than $5 billion of such paper losses — a figure that climbed to more than $13 billion at year-end.

It shifted $189 billion of agency mortgage-backed securities from “available-for-sale” to “held-to-maturity” on its balance sheet last year, a move that effectively shields those unrealized losses from impacting stockholder equity.

“They basically saw higher interest rates coming,” said Stephen Ryan, an accounting professor at New York University’s Stern School of Business. “They didn’t know how long they would last or how big they would be, but they protected the equity by making the transfer.”


The rules governing such balance sheet moves are stringent. It means Schwab plans to hold more than $150 billion worth of debt to maturity with a weighted-average yield of 1.74%. The lion’s share of the securities — $114 billion at the end of 2022 — won’t mature for more than a decade.

The benchmark 10-year Treasury yield now is 3.5%.

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