Charles Schwab says it could ride out a deposit flight

Charles Schwab Corp., one of a host of financial firms that have taken a drubbing since the collapse of several regional banks this month, is pushing back against fears that it could face some of the same problems as paper losses on its bondholdings mount.

In an interview with The Wall Street Journal, Schwab’s chief executive said the brokerage giant could continue to operate even if it lost most of its deposits over the next year.

"There would be a sufficient amount of liquidity right there to cover if 100% of our bank’s deposits ran off," said Walt Bettinger, Schwab’s co-chairman and CEO, referring to the company’s banking unit. "Without having to sell a single security."

Instead, Mr. Bettinger said, the company could engage in a number of strategies to plug any funding shortfall, including collecting interest paid on bonds it owns, borrowing from the Federal Home Loan Bank and issuing certificates of deposit.

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The downfall of SVB Financial Group the parent of Silicon Valley Bank, has sent investors rushing to look for other banks that have also lost deposits and are sitting on paper losses on their bondholdings. Schwab’s shares are down 26% since March 8, the day SVB spooked bank investors by announcing an emergency capital raise.

Ticker	Security	Last	Change	Change %
SCHW	THE CHARLES SCHWAB CORP.	81.25	+0.44	+0.54%

Schwab "mismanaged the balance sheet," said Porter Collins, portfolio manager at Seawolf Capital, who has a short position on Schwab, meaning he is betting the shares will decline. "The problem is they made a big rate bet, and it’s gone the wrong way on them."

Schwab isn’t SVB. For one thing, SVB was focused on the cash-burning world of venture capital, which hit a down cycle last year. Many of Schwab’s deposit customers are individuals who come to Schwab largely for its investing platforms.

SVB also encouraged customers to keep all their money there. About 90% of its deposits were above the cap for government insurance, making customers prone to flight at the first sign of trouble. At Schwab, on the other hand, less than 20% of deposits are above the cap.

But SVB, Schwab and numerous other banks invested a big slug of that cash in long-term bonds. Then the Federal Reserve raised interest rates faster and more sharply than many of those firms, including Schwab, expected. Those increases slashed the value of the banks’ bondholdings, such that selling them now would result in significant losses.

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In Schwab’s case, the firm had more than $11 billion in unrealized losses on its hold-to-maturity bond portfolio at the end of 2022, exceeding its tangible common equity of just over $6 billion. Most of those holdings were government-backed mortgage bonds, which are generally considered safe. The company also owns Treasurys, asset-backed securities, corporate debt and certificates of deposit, according to a regulatory filing.

The question now is what price Schwab could have to pay for that decision.

Schwab executives expected the Fed would raise rates 0.75 percentage point in 2022. Instead the Fed raised them nearly six times as much, by 4.25 percentage points, in a continuing battle against the highest U.S. inflation in decades.

Mr. Bettinger said Schwab executives knew what would happen to the value of its securities portfolio once the Fed began to raise rates, and took steps to prepare for it.

Schwab said it has about $100 billion of cash flow from cash on hand, interest payments on bonds and net new assets it expects to bring in during the next year. The company said it can raise an additional $8 billion a month in CD sales. It can also tap more than $300 billion in liquidity from the Federal Home Loan Bank and other short-term facilities, including the government’s Bank Term Funding Program, which was unveiled earlier this month after SVB collapsed.

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Schwab occupies an unusual corner on Wall Street. Long known primarily as a low-cost broker to individual investors, the company has expanded its financial-services offerings and added millions of clients. At the end of last year, it was the 10th-largest bank in the U.S.

Most of Schwab’s deposits are gathered by its brokerage arm, where the firm sweeps investors’ cash into its banking unit.

Schwab has to put that deposit money somewhere, and its lending arm is relatively small. The firm puts more than 80% of its deposits to work by investing in various liquid debt securities.

That means Schwab’s bond portfolio is huge compared with its overall balance sheet, a fact that was highlighted by bank investors this month as SVB failed. And Schwab, like many other banks, has been losing deposits as rates have risen.

Schwab had $366 billion in deposits at the end of last year, down 17% from the end of 2021.

Mr. Bettinger said the company was expecting that, too. Some customer deposits might have left Schwab’s balance sheet, but only because customers shifted them to money-market funds and other higher-yielding investments in their Schwab accounts.

"Clients aren’t moving bank deposits out of Schwab," he said. "All they’re doing is realigning their investments, as they should."

While clients have continued to move their cash, the pace of those outflows slowed during February and is following a similar trend in March, Schwab executives said this month. Schwab won’t specify its deposit figure until the end of the quarter.

Estimated unrealized bond losses for banks as a share of tangible common​equitySource: JefferiesNote: Includes bonds from banks' held-to-maturity portfolios

The shift to higher-yielding investments will run its course by the end of this year, Schwab executives have said. It could happen sooner, Mr. Bettinger said, if the Fed pauses its rate increases.

Steven Chubak, analyst at Wolfe Research, said Schwab will pay for its choice to hold the long-term bonds even if it is able to dodge the current market meltdown. Schwab will need to use more-expensive funding to replace deposits, hitting earnings, he said. Tougher capital rules for midsize banks, currently under consideration from regulators, could limit Schwab’s ability to buy back its own stock and exacerbate any pressure on profit.

Wall Street analysts expect Schwab to earn $4.07 a share this year, according to estimates compiled from FactSet. That is down from an expectation of $4.88 at the end of December.

The company earned $3.90 a share in 2022.

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Mr. Bettinger bought 50,000 Schwab shares last week. Several other Schwab executives and board members also added to their positions.

"Many times, when you’re in a crisis, there’s very little you can do," Mr. Bettinger said. "It all comes down to what actions you had taken in preparation for that. We felt we had already prepared for this type of thing."