EUR 850.00 For Business Accounts Only

Morningstar | We're Tempering Our Near- to Medium-Term Earnings Outlook for Charles Schwab

While we still believe that Charles Schwab is one of the strongest players in the investment services industry, we're materially tempering our near- to medium-term outlook for the company's earnings. The largest driver of the company's earnings is net interest income that in recent quarters has composed around 60% of net revenue. Since late 2018, the outlook for interest rates in the United States has reversed with the market pricing in interest rate decreases instead of increases.Even if a recession doesn't occur in the near term, lower long-term interest rates, such as the yields on 5- and 10-year treasury notes, mean that the Charles Schwab won't be able to reinvest principal payments from its bank portfolio at materially higher rates. For example, the 10-year treasury yield was approximately 2% at the end of June 2019 compared with about 2.85% at the end of June 2018. There were some years, like 2012 and 2016 when the 10-year treasury averaged below 2%, but there's likely little opportunity in the current interest rate environment to materially expand the company's net interest margin.Absent an expansion of the company's net interest margin, client asset growth is the other major revenue lever for the firm. Approximately 30% of the company's net revenue is directly from asset management and administration fees, and net interest income and trading revenue are indirectly tied to client assets. While we don't know when a bear market might occur, we do know that it can take upwards of three years from the start of a bear market until the stock market recovers to its former peak based on the past six bear markets.Given how long interest rate cycles and bear markets can take to play out, we wouldn't be surprised if Charles Schwab's earnings decrease approximately 20% from current levels if we have a bear market and the U.S. enacts looser monetary policy. That said, Charles Schwab should still maintain healthy operating margins in excess of 30% even in a downturn, and it will have significant earnings momentum in a subsequent rising interest rate environment.