Charles Schwab’s Q3 Results Driven By Interest Revenues, Asset Management Fees

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Charles Schwab (NYSE:SCHW) announced its third quarter earnings on October 15, reporting a 13% year-on-year increase in net revenues to over $1.5 billion for the quarter. Schwab’s trading revenues declined by 7% y-o-y to $209 million in Q3, owing to low trading volumes during the quarter. Robust growth in interest-based revenues and asset management revenues more than offset the decline in trading revenues. Net interest revenues rose by 13% to $573 million while asset management and administration fees grew by 11% y-o-y to $649 million. Additionally, Schwab’s Other Revenues more than doubled to $120 million in the quarter, which the company attributed to a net insurance recovery of about $45 million during the quarter. In this note we take a look at how the company’s various divisions performed in Q3. [1]

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Asset Management Fees, Interest Revenues Continue To Rise

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Schwab’s asset management revenues include the fees that the brokerage charges for its proprietary and third-party mutual fund offerings and advisory solutions such as equity and bond funds, money market funds and mutual funds. Schwab’s total client assets totaled $2.4 trillion at the end of September 2014, 12% higher than the year ago level. The implied yield on total client assets stayed at prior year levels of under 0.11%. With total client assets growing over 10% y-o-y by the end of the year and a nearly flat yield, we forecast Schwab’s asset management and administration revenues to be around 13% higher in 2014 over the previous year.

Schwab’s interest-earning assets grew by almost 5% y-o-y to $138 billion in Q3 as the brokerage successfully added new trading accounts accounts during the quarter. Schwab ended the quarter with over 9.31 million brokerage accounts, up from 9.25 million at the end of the June quarter. We forecast the total-interest earning assets to increase by 7-8% to $140 billion by the end of the year. The implied net interest yield on these assets was almost 15 basis points higher than the prior year quarter at 1.65% on a full year basis. We expect the net interest yield to be close to 1.70% by the end of 2014, while the yield could rise more steeply in the long run.

Subdued Trading Activity

Revenues generated by trading commissions business were lower in Q3 compared to the prior year quarter. Trading volumes declined in both July (-8%) and August (-2%) on a year-on-year basis but picked up slightly in September. As a result, Schwab’s daily average client trades were 2% lower than the year ago quarter at 469,000 trades per day. Despite the decline in average volumes in Q3, the company has consistently added new brokerage accounts. The company ended the June quarter at around 9.2 million brokerage accounts, which increased to over 9.3 million active accounts at the end of September. [2]

Margins Improve As Expenses Rise Marginally

Schwab’s year-to-date operating expenses have stayed at prior year levels. Although compensation and professional services expenses both rose by about 8% y-o-y, the company’s total operating expenses increased by only 6% to $2.8 billion in 2014 year-to-date Comparatively, net revenues generated by the brokerage have grown by 13% to $4.5 billion from January through September. As a result, Schwab’s net income has increased by nearly 30% to $971 million.

According to our estimates, Schwab’s adjusted EBITDA margin rose from 32.2% in 2010 to 35.1% in 2013. This has further improved in 2014 thus far. With the growing client asset base under management and rising interest rates, the brokerage’s EBITDA margins could continue to improve in the long run. We have a revised $25 price estimate for the company’s stock, which is roughly in line with the current market price.

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Notes:
  1. Charles Schwab Q3 2014 Earnings Press Release, Charles Schwab Press Release, October 2014 []
  2. Charles Schwab Monthly Metrics For August, Charles Schwab Investor Relations, September 2014 []