Why We Reduced Our Price Estimate For Schwab’s Stock To $41

After cutting trading commissions to zero at the beginning of the month, Charles Schwab (NYSE: SCHW) published better-than-expected third quarter results last week. As we pointed out earlier, trading commissions have historically formed a small part of Schwab’s revenues with the top line being driven primarily by its net interest income figure. Trefis takes a closer look at the trends in net interest margin and the federal funds rate over recent quarters in the interactive dashboard Schwab’s Earnings: Performance and 2019 outlook.

A Quick Look at Schwab’s Revenues

Charles Schwab reported $10.1 billion in Total Revenues for full-year 2018. This included four revenue streams:

• Net Interest Revenue: $5.8 billion in FY2018 (57% of Total Revenues). It is the interest earned on loans and margin receivables net of interest expense on funding sources.
• Asset Management and Administration Fees: $3.2 billion in FY2018 (32% of Total Revenues). The company earns fees from managing proprietary money market mutual funds, ETFs, and advisory services, in addition to some third-party funds.
• Trading Revenue: $763 million in FY2018 (8% of Total Revenues). A trading commission is charged for executing trades in stocks, bonds, options, futures, etc.
• Other Revenues: $317 million in FY2018 (3% of Total Revenues). It includes order flow income, service fees, software fees, and exchange processing fees.

Rate Cuts To Hamper Schwab’s Earnings In 2020

• Considering the low short-term interest rate environment and fierce competition for market share, we have revised our price estimate for Schwab downwards by 12% to $41 per share.
• In 2018, the company benefited from the sequential rate hikes by the Fed and subsequently reported a 36% surge in net interest revenues.
• Details about how changes in Schwab’s net interest margin compare with movements in the Federal Funds rate is available in our interactive dashboard
• Consistent with the company’s NIM guidance figure for 2019 and a downward trend in interest rates, we expect Schwab net-interest margin to match the level seen in early 2018 over 2020.
• Schwab’s interest-earning assets have been bolstered by the expanding client receivables in the last six quarters, as a result of increased market volatility.
• We expect the interest-earning assets to continue growing at a strong pace until the presidential elections next year and stabilize as the new government assumes office.
• Despite expectations of further rate cuts, the interest income is likely to grow in 2020 supported by Schwab’s large asset base.
• The company’s management awaits Fed’s economic projections for revenue guidance, but we expect Schwab to post single-digit revenue declines and earnings erosion in 2020, as flatter interest income and lower asset management fees compound the impact of eliminated trading commissions on the top line.

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