Charles Schwab Earnings Preview: Asset-Based Revenues To Drive Q4 Results

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Charles Schwab

Charles Schwab (NYSE:SCHW) is scheduled to announce its fourth quarter earnings on Monday, January 18th. The slump in trading activity experienced throughout the year may remain a drag on the company’s performance. The brokerage’s trade metrics indicate a deterioration in trading activity, with a slowdown in daily average revenue trade (DART) levels in October and November. However, we expect asset based revenues to hold strong and drive the company’s performance. Schwab’s top line grew by 3% year on year (y-o-y) to $1.6 billion in the third quarter. Asset management fees and net interest revenues accounted for 82% of the company’s total year-to-date net revenue – increasing by 4% and 9% y-o-y, respectively, through the first nine months of 2015.

In terms of the bottom line, the company has practiced strict financial discipline as it faced a highly volatile market and low interest rate environment. It has worked to curtail operating expenses – which include compensation, professional services, occupancy, advertising, depreciation and communications -but is still seeing growth in expenses, despite a Q3 decline. The brokerage likely stuck to its annual target of expense growth during the fourth quarter (4% y-o-y).

We have a $28 price estimate for the Schwab, which is slightly lower than the current market price.

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Net Interest Revenues To Grow

For the past five years, Schwab has successfully added net interest earning assets to its portfolio at a CAGR of 10%. In the third quarter, the average balance of interest earning assets grew by 15% y-o-y, resulting in $154 billion interest earning assets at the end of September. [1] The growth from the previous quarter was sustained in October and November, as the balances grew by 17% and 18% y-o-y, respectively. Consequently, we forecast Schwab’s total interest earning assets to continue the growth momentum in Q4.

Schwab’s net interest yield on total deposits, loans and securities have been at historically low levels following the financial crisis of 2008. On the back of expectations of a Fed interest rate hike, the net yield increased to 1.64% in 2014, but then remained stagnant at around 1.60% through September this year. We expect the net yields to rise slightly in 2015 owing to the Fed’s decision to hike interest rates in December and more steeply over the next few years, giving a boost to Schwab’s net interest revenues. ((At Last, Money-Fund Yields Should Rise Within Days, Wall Street Journal, December 2015))

Assets Under Management To Witness Growth

After adding 254,000 new brokerage accounts in Q3, Schwab saw a decline in the number of new accounts added during October and November. Meanwhile, the company’s total assets under management fell to $2.42 trillion at the end of September from $2.56 trillion at the end of July. Subsequently, total client assets increased by approximately 3% annually to $2.56 trillion at the end of November. [2] Despite uninspiring growth in balances, revenues from assets under management rose by 2% y-o-y to $663 million in Q3. We expect this segment to see steady, if unspectacular, growth in Q4.

The yield on assets under management have remained stagnant at 0.10% over the past few years. But with the Fed’s decision regarding interest rates, we expect a gradual escalation in yields at the beginning of 2016.

Trading Metrics Remained Stagnant

Schwab began the year with dismal trading activity, as daily average revenue trades (DARTs) fell by 7% y-o-y to 313,000 in the first quarter. In the second quarter, the downtrend was sustained, causing DARTs to fall again by 3% y-o-y to 267,000. However, factors including the uncertainty in China led to a pickup in trading activity in the third quarter. The upswing didn’t continue in the first month of Q4, as DARTs in October declined by 18% y-o-y. With November witnessing stagnant volumes, it is unlikely that revenue trade volumes will grow significantly in Q4.

On a related note, the brokerage has been consistently slashing trading commissions due to competitive pressure from low- and no-commission brokerages. In Q3, the average revenue per trade declined by 5% to $11.67, whereas for the nine month period, the figure was down by 2% to $11.87. This drop in commissions per revenue trade could prevent Schwab from growing its trade revenues meaningfully for the year.

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Notes:
  1. Quarterly Report: Schwab Q3 Performance, The Sec, October 2015 []
  2. Schwab Monthly Metrics for November, Charles Schwab Investor Relations, December 2015 []