To The Moon

Summary

• A window of opportunity has been created in Charles Schwab with the sell-off caused by the collapse of two banks in the US.
• Charles Schwab is no Silicon Valley Bank because it follows sound liquidity management practices, has a stable deposit base largely within FDIC $250k thresholds, and a management supporting its stock.
• The stock price should recover as confidence returns to the mid-size US banking space.

Justin Sullivan/Getty Images News

The Charles Schwab Corporation (NYSE:SCHW$Charles Schwab(SCHW)$ ) came under selling pressure last week triggered by the run on smaller and mid-sized US banks, making it the favorite stock of many self-styled contrarian investors. Now that regulators have stepped into offer aliquidity lifelineto these banks, let's see if there remains any opportunity to take advantage of the potential price dislocation.

Similarities with SVB

The sell-off in Charles Schwab came as a fallout of the collapse of Silicon Valley Bank (SIVB) and Signature Bank (SBNY). Stock trading being a game of anticipation, people were quick to sell stocks of other banks with some of the similar traits as the two failed banks. One of the screening lists doing rounds on social media compares the level of unrealized losses on available-for-sale and held-to-maturity bonds relative to shareholders' equityof US banks to make a point that Charles Schwab may have a gaping hole in its capital just like the failed Silicon Valley Bank ("SVB").

Although there is some truth to it in the sense that Charles Schwab has unrealized losses on its bond portfolio of approx. $26.4 billion which have not been run through its regulatory capital (a modified version of shareholders equity used to gauge the capital adequacy of a bank), this is not based on a management choice rather banking regulation currently applicable in the US has been designed this way. Therefore, this arguably lazy analysis fails to zoom into the real causes of the SVB collapse, namely concentration of the funding base, prevalence of large uninsured deposits, and poor liquidity management.

Differences vs. SVB

In my opinion, there are several differences in the Charles Schwab story vis-a-vis SVB, and it stands to reason that Charles Schwab is no SVB. Let's go deeper into these differences to show that investors have overreacted as far as Charles Schwab is concerned.

Better liquidity management

The most glaring difference between SVB and Charles Schwab is in the liquidity management area, which is at the heart of the banking industry. According to its 2022 10-K report, SVB was a Category IV bank underUS regulation, which means that effectively it was not subject to liquidity reporting requirements like Liquidity Coverage Ratio ("LCR") and Net Stable Funding Ratio ("NSFR"). For anyone unfamiliar, LCR basically ensures that a bank has sufficient liquid assets in hand like cash or high-quality securities to meet cash outflows like deposits maturing in the next 30 days. It is open to speculation how SVB management used this considerable leeway to their advantage by not following good liquidity management practices.

Charles Schwab on the other hand is a Category III bank which is subject to full LCR rule (as disclosed in its 2022 10-K report). As of December 2022, Charles Schwab reported an LCR ratio of 123%. So there is hardly any blemish on its ability to maintain liquidity. Moreover, the US Federal Reserve has thrown a lifeline to banks facing temporary liquidity pressures under its Bank Funding Term Program ("BFTP") where the banks can pledge their securities portfolio at par (i.e., without any haircut) to get funding for up to a year at a pricing of one-year overnight index swap ("OIS") rate +10 basis points. This facility will act as a backstop if depositors choose to withdraw their money in a hurry.

Lower level of uninsured deposits

The other difference between SVB and Charles Schwab is the profile of their deposits. SVB counted the California venture capital and start-up industry as its main customers and over 87% of its deposits were uninsured (my calculation based on 2022 10-K Page 80) which implies that they were larger than the $250,000 threshold up to which FDIC insures deposits in the US. This concentration of larger and uninsured deposits proved to be the death knell of SVB as it bled deposits at unprecedented speed fueled bysocial media.

Charles Schwab on the other hand has a far smaller level of uninsured deposits at around 16% of its total deposit base (my calculation based on 2022 10-K report note 5). This is because the core business of Charles Schwab is stock brokerage and its bank deposits are basically obtained by offering a sweep program to the brokerage clients who have idle funds in their stock trading accounts. Charles Schwab pays some interest on most of these sweep deposits (unlike SVB, who had a large chunk of deposits on which it paid no interest). These deposits being insured for the most part ensures that customers don't feel nervous when they read bank failure headlines in their social media feeds. As a mark of calming nerves, Charles Schwabreportedon March 17th $16.5 billion inflows from clients moving funds, contrary to fears of deposit flight.

Insiders buying to support the stock

Another thing to highlight is the difference between the insider activity of SVB and Charles Schwab. In the run-up to its collapse, SVBinsiderswere selling their shares, notably the CEO. Charles Schwab's CEO madeheadlineslast week with his purchase of 50,000 shares (worth approx. $3 million). This is a vote of confidence by the management that they are putting their money where their mouth is, and investors should take note.

Final thoughts

In final counting, banks rely on confidence given their highly leveraged balance sheet structure with a mismatch between the maturity of their assets and liabilities. Confidence has been shaken for the time being due to the failure of a couple of poorly managed banks. I believe confidence will be gradually restored as regulators step in with liquidity lifelines and support for struggling banks. It's a good time to position oneself into sound banks whose prices have taken a beating. Charles Schwab is one such bank with good liquidity management practices, a strong deposit franchise, and a management standing firmly behind their stock price. In my view, the window of opportunity of investing in Charles Schwab is unlikely to last for long.

Take everything you read with substantial skepticism and a healthy grain of salt. Invest based on your own financial profile and your appetite for volatility. Information discussed here should not be considered as an "investment advice" or as a "recommendation."

Source: seeking alpha