15 Mar Bank Failure – Buy Charles Schwab (SCHW)
- Silicon Valley Bank triggered runs on the entire financial sector
- Regional Banks hit especially hard – but likely regulation coming
- Contagion fear creates opportunity in other companies with little to no exposure to the same issues that cut down SVB
- Schwab down 25% in the last week
- Schwab is an entirely different business to regional banks with $7.4trillion of client assets.
- Markets should quickly re-rate the stock back to prior levels
The problem with financial institutions failing is the contagion effect into other institutions.
What we are seeing in the market now is fear of that contagion. Some regional banks like First Republic Bank (FRC) fell 60%. Even the large banks have been affected with Citigroup (C) falling 8%.
The Feds plan to offer banks a line of credit for cash requirements should stop any further failures. At least for the time being, and likely for good.
Silicon Valley Bank is a major player in the tech Venture Capital ecosystem but its failure doesn’t really directly impact other financial institutions.
Which leads to the question of whether these deeply oversold regional banks are now a good buying opportunity.
If there is little risk of contagion then it should be business as normal for regional banks and their share prices offer deep value.
However, buying these banks comes with two unknown risks:
- Regulation – the second largest bank failure in history will no doubt lead to enhanced regulation on the rest.
- Client sentiment towards small banks has been damaged and that could take a long time to repair
There is still some uncertainty around what the impacts will be on this sector going forward. My feelings are that these moves are massive overreactions and the stocks of many regional banks are buys here.
But there is probably a better way to play this move.
One company that has been unfairly tarnished by SVBs failure is Charles Schwab (SCHW)
SCHW fell 32% as the news broke, but has recovered 10% yesterday when the Federal Bank Term Funding program was announced. It is still down 26% in the last week and is down 32% from where it started the year.
SCHW is more broker than bank. It does offer some banking services as part of its portfolio, but that is really for investment accounts. It is a true giant of the space. Total client assets were $7.4 trillion across 34 million accounts, many of which are retirement accounts. Its clients hold almost $300 billion of money market funds. Bank accounts hold deposits of around $120 billion and 80% of these fall within the FDIC’s 250k guarantee limit.
SCHW is also one of the largest custodians for investment advisors. If you live in the US and work with an advisor, chances are they would have your assets with Schwab.
The CEO was interviewed by Reuters on Monday and said
“We have not raised capital and we are not in the market at this point for M&A transactions,” Walt Bettinger, CEO of Charles Schwab
The firm saw an influx of $4 billion in assets to the parent company on Friday as clients moved assets to Schwab from other firms, Bettinger said.
“Our available-for-sale portfolio is short in duration and high in quality, and our held-to-maturity is slightly longer in duration but still short compared to many people, and very high-quality,” said Bettinger
Banks can classify bonds as “held-to-maturity” (HTM) and are not required to count changes in value if the securities are kept until they are repaid, or they can keep the bonds as “available-for-sale” (AFS), which means they must count unrealised losses against capital, but are free to sell the securities at any time. Compared to many regional banks that have come under pressure in the last week, Schwab has higher unrealised securities portfolio losses in comparison to its capital levels.
This means Schwab is well capitalised and can meet withdrawals if they happen. The fact HTM holdings do not impact profitability negates the mark-to-market fear investors have due to rising interest rates.
I am not the only one that thinks the selling in Schwab is an overreaction.
Bettinger told CNBC earlier on Tuesday that he had bought 50,000 Schwab shares while billionaire investor Ron Baron said he “modestly increased” his position in Schwab.
SCHW is expected to earn $4.25 in 2023. At the current price of $56 that puts it on a PE of 13, well below the 5 and 10 year multiples of 21x and 25x.
When the market rerates this stock, and it will, it could easily get back to trading on a 20 PE which should put the stock price around $85 for a 50% gain. That is the price target I am looking for.
Risks – it is hard to see many. Risk has already been priced into the stock. The only selling here will come from additional banking failures but the Fed and FDIC are doing what they can to stop that happening. But there is always the black swan event that no one sees coming.
SCHW is definitely in the “too big to fail” category and as this news fades the stock should recover.
In volatile times there can be tremendous opportunities. As investors, we are always hoping we can buy a great company at a cheap price.
The market is offering that opportunity right now in SCHW
Warning
Stock values can go down as well as up. It is possible to lose 100% of your investment in a stock. Any advice given by Capital 19 is general advice only and does not take your personal circumstances into account and might not be suitable for you.