Thursday, April 06, 2023 7:08:38 AM
Apr. 06, 2023 3:44 AM ETThe https://seekingalpha.com/article/4592577-charles-schwab-stock-off-the-charts-liquidity-hold
Recently investors sold off Charles Schwab yet again as bank contagion fears resurfaced.
Oil spiked after OPEC cut output, leading to fears that the Fed would have to start raising rates again.
That would cause even more losses on Schwab's securities.
It's true that Schwab's unrealized losses whittle its book value down to a smaller than reported figure, but the bank can cover potential withdrawals.
Schwab's liquid, uncommitted assets as a percentage of deposits are actually higher than for many other banks.
Charles Schwab (NYSE:SCHW) stock took a dip on Tuesday as economic jitters re-kindled investors' fears about bank stocks. The stock fell 3% in just one day of trading. Although no material news about Schwab was released on Tuesday, it may have gotten caught up in renewed interest rate worries. Recently, OPEC decided to cut output, which caused oil futures to spike 5% in a single day. This naturally got investors worried about more rate hikes, which in Schwab's case would be troubling, as it is sitting on a massive amount of unrealized securities losses. It reports $12.3 billion in losses in its financial statements, an amount that gets counted as equity. It also discloses $15 billion in losses on held to maturity securities; those aren't considered part of equity, but do affect liquidity. Further, Schwab has been reclassifying securities from available for sale ("AFS") to held to maturity ("HFS") in recent quarters, a behavior typical of the banks that failed in March. Basically, Schwab actually has $27.3 billion in losses rather than the claimed $12.3 billion. The AFS securities are already reported at fair value, but the HTM losses aren't. If those securities were reported at fair value they'd reduce Schwab's $36 billion in shareholder's equity to $21 billion.
These figures all look pretty alarming. However, the way the "unrealized losses" discourse played out in the media after Silicon Valley Bank collapsed was a little misleading. Media outlets like Bloomberg endlessly highlighted the banks' $620 billion in unrealized losses after SVB failed, because that bank's unrealized losses contributed to its collapse. Basically, when a bank run happens, you have to start selling securities, because your cash position gets whittled down to $0. Once you start selling, unrealized losses transform into realized losses. If your unrealized loss is big enough, it can result in you failing to pay off your depositors.
That's all well and good, but unrealized losses as a single factor, considered in themselves, do not cause banks to fail. A large enough unrealized loss can certainly cause book value to decrease, but it won't necessarily cause a failure. What matters is the amount of market value left AFTER the unrealized losses are subtracted. As it turns out, Schwab's liquidity after unrealized losses is about 67% of the value of its liabilities. So, it would take a truly colossal bank run for Schwab to go broke. That fact in itself does not make Schwab a buy, but this stock certainly doesn't look like an obvious sell either.
Charles Schwab - Liquidity Covers 67% of the Liabilities
Earlier I mentioned that Charles Schwab's liquid assets are 67% of liabilities, so I will now explain how I arrived at that figure.
On Charles Schwab's balance sheet it reports $147.8 billion worth of AFS securities and $173 billion in HTM securities, which is enough to cover almost all of the deposits. However, if you scroll a little further down the company's 10-K, you notice that there are significant amounts of unrealized losses in both categories of securities. The AFS securities are already reported at fair value, so what we see on the balance sheet there reflects economic reality. That's not the case with the HTM securities. Those are actually worth $158 billion, or $12.3 billion less than what's reported on the balance sheet.
It is true that Charles Schwab is sitting on large amounts of unrealized securities losses. However, If you look at the amount of liquid securities it has, and compare them to deposits, you quickly notice that the company's liquidity is robust.
So, Schwab has $346.1 billion in very liquid assets if everything is adjusted down to fair value. Against this, we have $515.1 billion in liabilities. So, Schwab's liquidity covers 67% of all liabilities. It also covers a whopping 94.6% of deposits, which is an unheard of figure for more conventional banks. As I wrote in a recent article on Bank of America (BAC), 50% coverage is pretty good for such banks.
The reason why I refer to liquidity as a percentage of total liabilities in Schwab's case is because it is primarily a brokerage. It has large sums of payables to brokerage clients that could cause runs on its liquidity-most of the big banks have these as well, but they're smaller in proportion to total liabilities. I think it's best to look at Schwab in terms of total liabilities instead of deposits for this reason. Certainly, it's the most prudent approach: if you simply compared Schwab's liquidity to its deposits you'd conclude it's swimming in liquidity and nearly "unsinkable," an overly euphoric conclusion that ignores earnings related risks and the ever-shrinking book value.
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