Charles Schwab Corporation (NYSE:SCHW) announced its quarterly results on April 15, and reported a y-o-y increase of 8.5% in its revenues. The increase was driven primarily by asset management and administration fees (up 14% y-o-y) and net interest revenue (up 8% y-o-y) since both of these divisions benefited from an impressive growth in client assets. However, as mentioned in our pre-earnings article, trading revenues remained a strain for the firm, declining by 8% y-o-y.
Going forward, we expect the company to continue attracting assets on a net basis but remain cautious because a lot of the growth in client assets in this quarter is due to market action and remains subject to market movements. We also remain concerned about the state of Schwab’s transaction based business and expect the revenue generated by the firm per trade to continue declining over the course of this year as the profitability of this business declines.
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Our revised price estimate for the firm’s stock is around $16 per share.
Asset Management Division Driving Results
The asset management division accounts for nearly 42% of the value in the company and generates a similar proportion of its overall revenues. The revenues within this segment are generated in the form of asset management and administration fees when clients invest in Schwab money market funds, mutual funds and other advice solutions, such as separately managed accounts.
Fortunately for Schwab, this division continues to benefit from an increase in average client balances in all these products. The average balances in Schwab’s money market funds, mutual funds and advice solutions increased y-o-y by 4%, 9% and 17% in the first quarter, respectively. Overall, the company reported a total of $43.4 billion in net new assets in Q1, which is up 12% from the same period last year. The asset levels also benefited from a rally in the stock market, which contributed another $90 billion to the company’s asset base. Schwab’s total client assets stand at around $2.1 trillion, as of 1Q13.
Another positive for this division was the y-o-y decline in fee waivers that were given to Schwab’s money market clients for the last few years, so that they do not earn negative yields on these products in a low interest rate environment. The fee waivers as a percentage of money market revenues before any discounts decreased from 73% in Q1 2012 to 67% in Q1 2013.
Going forward, we expect the company to continue attracting assets at an impressive pace as seen in this quarter. However, one risk to this trend is the dependence of these assets on the performance of the stock markets. While the company is currently benefiting from a rally in the markets, we could see a large decline in its client asset base, if the stock market plunges or becomes uncertain in the coming months and causes investors to withdraw money.
We expect the fee waivers on money market funds to continue declining as the macroeconomic environment improves.
Increase In Asset Base Also Driving Net Interest Revenues Upwards
Revenues from interest earning assets make up for 46% of the value in Schwab and have also benefited from an increase in assets held by the company. The net interest income earned by the company increased by 8% in Q1 2013 y-o-y, and reached $469 million as the average balance in interest earning assets increased by 21% y-o-y over the same period, to reach $126 billion. A decline of 16 basis points in the average yield earned on these assets acted as the primary headwind for this business.
We expect the interest earning assets to continue increasing in double digit percentages over the next few quarters. However, yields may decline further and offset some of the revenue growth.
Trading Revenues Remain Hurt
Schwab’s trading revenues remained depressed even though trading activity showed some improvement in 2013. For Schwab, the daily average client trades in January, February and March were up y-o-y by 8%, 1% and 7% respectively. However, the company reported trading revenues of $223 million for Q1, which is down 8% from the same quarter last year. We believe that the decline in trading revenues when trading volumes were up may be due to heavy discounts offered by the company. If this trend persists, we expect the revenue earned by the company per trade to decline significantly over the course of this year.
This is a sign of concern for us, especially because trading volumes are not meaningfully up and seemed to be fizzling out as of March end. The daily average client trades reported by the company fizzled to 486,000 trades in March, after touching a figure of 506,000 in February and it seems to early to judge whether trading volumes are indeed witnessing a recovery.
Net New Accounts Remain An Unknown
As mentioned in our pre-earnings article, our analysis suggests that Schwab’s net new brokerage account figures were significantly lower than competitors like E*Trade (NASDAQ: ETFC) in 2012, and could signal that the company’s customer attrition rates are high. Due to this reason, we were keenly awaiting the release of this figure in this quarterly earnings release.
However, the company did not disclose this figure in the latest quarterly earnings report and instead focused on another metric called net new “retail” accounts – a number which is up significantly from the same time last year. As a result, we remain cautious about the company’s performance on this front.