Charles Schwab Brokerage Takes A Beating

On Thursday, bank stocks got hammered, and so did shares of brokerage firm Charles Schwab, which dropped 13%. Schwab suffered 6% decline by midday.

Photo Insert: Schwab’s net interest revenue looks increasingly at risk as interest rates rise.

No doubt many investors are scratching their heads as to why Schwab would fall in line with bank stocks. The firm is synonymous with investing, not checking and savings.

Truth is, although the company may have cut its teeth as a discount brokerage, its business mix has since evolved to include financial advice, custody services for investment advisors and banking and lending.

With the advent of commission-free trading, Schwab’s other revenue sources have expanded, analyst Andrew Welsch reported for Barron’s Daily.

Last year, Schwab generated more than $10 billion of net interest revenue, which was about half its total annual revenue. That revenue is the difference between the interest Schwab earns on bonds and loans and the interest it pays out to its funding sources, which are primarily uninvested client cash balances.

Schwab’s net interest revenue looks increasingly at risk as interest rates rise.

With short-term rates above 5%, investors are less willing to let their cash sit idle in a sweep or bank account. In the fourth quarter, Schwab’s bank deposits were down 17% from a year earlier and 7% from the third quarter.

The firm said in a recent update that client cash as a percentage of client assets fell to 11.6% in January from 12.3% in December. The Westlake, Texas-based company still had $366.7 billion in deposits at the end of the fourth quarter.

Schwab’s net interest margin could come under pressure as short-term borrowing reaches a peak later this year, J.P. Morgan analysts write, referring to “cash shorting,” or the propensity of clients to move funds from low-yielding cash accounts to higher-yielding options.

“The key factor of how big cash sorting will be and how long it will last remains an unknown,” Kenneth B. Worthington, Michael Cho, and Madeline Daleiden wrote in a March 10 note.

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