(Bloomberg) — Charles Schwab Corp. shares suffered their biggest intraday drop since the depths of last year’s regional-bank crisis after the investing giant warned it will have to shrink itself in order to protect profits.
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Going forward, Schwab is planning to rely more on off-balance sheet arrangements to house customers’ deposits, Chief Executive Officer Walt Bettinger said on a conference call with analysts. By relying on partners like Toronto-Dominion Bank, such deals would allow Schwab to more efficiently use capital, he said.
“These various actions should lead — again over time — to a bank that is somewhat smaller than our bank has been in recent years, while retaining the ability to meet our clients’ banking needs, lower our capital intensity and, importantly, protect the economics we’re able to generate from owning a bank,” Bettinger said.
The warning hearkens back to a year ago, when investors started to sour on Schwab after the Federal Reserve’s moves to rapidly increase interest rates saddled the company with paper losses as the value of its bond investments took major hits. At the same time, consumers were yanking their deposits held with the bank as they searched for higher-yielding alternatives, causing the company to seek out more expensive funding sources.
The company is now looking to pay down some of that high-cost debt it took on, though it might have to use some of the excess capital it would have used for buybacks to do so, executives warned on Tuesday.
The company will also begin to restructure its balance sheet in order to shorten the duration of some of its investment portfolio. Bettinger cautioned that such a move could lead to more earnings volatility in the near term, but it would reduce the company’s need to rely on supplemental forms of borrowing.
“This definition of a transition year is being realized,” Bettinger said. “All of these issues position us for a strong period of growth in client metrics and financial results in the coming years.”
Shares of the company plummeted 8.9% at 11:56 a.m. in New York, the biggest intraday drop since March 2023 and one that made it the worst performer in the S&P 500 Index. The stock had risen 9.1% this year through the close of trading on Monday.
Crowded Space
The latest moves come after the investing giant reported that fewer clients in the second quarter opened new brokerage accounts than analysts were expecting.
New brokerage accounts in the quarter rose to 985,000, the company said Tuesday in a statement. While that’s up from 960,000 in the same period a year earlier, it’s less than the 1.04 million that analysts in a Bloomberg survey were expecting.
Still, Schwab reported $1.33 billion in net income for the three-month period, beating a $1.23 billion average of analyst estimates. Earnings per share for the quarter were 66 cents, which also topped expectations.
The retail brokerage space has gotten more crowded as consumers flocked to the markets during the pandemic and have stuck with their new trading habits. Schwab has maintained its more traditional approach to retail investing as compared with crypto-friendly competitors like Robinhood Markets Inc., but will roll out an alternative investments platform for qualified, self-directed individual investors this year. Bettinger said on the Tuesday call with analysts that six out of ten new clients are under the age of 40.
The Westlake, Texas-based firm announced in May that Mike Verdeschi, a three-decade veteran of Citigroup Inc., will take over as chief financial officer from Peter Crawford. Crawford helped Schwab through last year’s financial turbulence, which hit the banking division.
Schwab, founded by Charles “Chuck” Schwab more than 50 years ago, oversees more than $9.4 trillion in total client assets.
Shrinking Bank
With the off-balance sheet arrangements, customers would still open a bank account with Schwab but their money would actually reside with a third-party bank. Such a deal would mean Schwab wouldn’t have to hold as much capital as it would if it kept the deposits — which are considered liabilities for banks — in house.
With the moves, Schwab would look more like rivals LPL Financial Holdings Inc. and Raymond James Financial Inc., whose stocks outperformed Schwab’s last year because investors appreciated that both companies faced less funding risk, according to analysts at Keefe Bruyette & Woods.
Executives are still planning to lean more on lending as they look for additional ways to boost returns in the coming years. For instance, the company is still planning to expand its offerings like residential mortgages, home equity lines of credit and pledged asset lines in order to win over more clients.
“Most of our significant competitors have the ability to assist clients with both their investing needs as well as their borrowing needs,” Bettinger said. “We believe firms that do not offer lending services are at a strategic disadvantage. That will show itself more and more over time, so we are committed to offering quality lending services.”
(Updates with latest share price in eighth paragraph, further information about off balance sheet arrangements in 15th.)
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