Charles Schwab Posts Strong Q2 Results Despite Slowdown In Trading

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Charles Schwab

Charles Schwab (NYSE:SCHW) announced its second quarter earnings on July 16, with a 10% year-on-year (y-o-y) increase in net revenues to nearly $1.5 billion, driven by growth in net interest revenues (+19%) and asset management and administration fees (+10%). On the other hand, Schwab witnessed a 10% y-o-y decline in trading revenues to $212 million for the quarter due to low trading volumes during May and June. As a result of top line growth and a large proportion of fixed operating costs, Schwab’s net income surged by 30% over the prior year quarter to $302 million. [1]

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Asset Management Fees, Net Interest Yield Continue Growth

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Charles Schwab was successful in attracting new client accounts during the quarter at a rapid pace of over 80,000 new accounts every month, maintaining the trend seen in the last few years. Consequently, Schwab’s total client assets under management were over $2.4 trillion at the end of June, up from $2.2 trillion at the beginning of the year. The company charges a fee on these assets for its proprietary and third-party mutual fund offerings and advisory solutions such as equity and bond funds, money market funds and mutual funds. Asset management fees grew by 10% y-o-y to $632 million in the quarter, with growth driven by Schwab’s solutions such as separately managed accounts, customized personal advice for tailored portfolios and full-time portfolio management.

The yield on total client assets under management declined from 0.21% in 2008 to 0.10% in 2013. However, this trend has reversed so far this year, with the yield on these assets increasing to around 0.11% through June. We expect the yield to stay at present levels through the end of 2014 and subsequently increase in the coming years.

Schwab’s total interest earnings on deposits, loans and securities increased at a CAGR of 18% over the last three years. Although growth has continued in 2014, the rate of growth has slightly slowed down. Total interest earning assets including deposits, loans and securities have increased at an annual rate of 8% in the first half of 2014, compared to the same period in 2013. The average balance of interest earning assets during the first six months of 2014 was $137 billion. We have revised our forecast for total interest earning assets to increase at 10% over last year to $144 billion by the end of the year.

After a steady decline in net interest yield on deposits, securities and loans from 4.6% in 2007 to about 1.5% in 2013, the yield rate picked up in 2014. The decline in the last few years can be attributed to Fed policies such as the quantitative easing program. However, the yield on these assets started increasing from the previous quarter. Going forward, we expect the yield to increase in 2014 and 2015 due to the tapering initiatives by the Fed.

Profits Rise Despite Dip In Trading Volumes

Schwab’s trading commissions picked up in the first quarter after a slump in recent years. The company reported a nearly 14% y-o-y increase in daily average trades during the first quarter. However, trading volumes declined in Q2, particularly during the months of May (-14%) and June (-6%). Charles Schwab faced a decline in average trading volumes in the June quarter despite adding new brokerage accounts. Charles Schwab had 9.18 million brokerage accounts at the beginning of the quarter, which increased to 9.25 million active accounts by the end of June. As more clients open new accounts, the total trading volume on Schwab’s platform is likely to increase, even though the average number of trades executed by a typical client could remain subdued in the next quarter.

Despite a 10% decline in trading revenues in Q2, the company’s overall revenue grew by over 10%. Moreover, Schwab’s net income rose by more than 30% since expenses remained nearly flat. Given that many of the company’s expenses are fixed in nature, a consistent growth in client assets and subsequent interest revenue and asset management fee should continue to improve profitability for the company. According to our estimates, Charles Schwab’s trading division accounts for just over 8% of the company’s value, while net interest revenues and asset management fees contribute about 55% and 35% to the company’s value, respectively. Our price estimate for the stock is about in line with the current market price.

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Notes:
  1. Charles Schwab Q2 Earnings Press Release, Charles Schwab Investor Relations, July 2014 []