Online brokerages like
Charles Schwab Corporation
(
SCHW
) rely significantly on net interest income as a source of value.
Schwab competes with firms like E-Trade (
ETFC
), Ameritrade (
AMTD
),
Wells Fargo
(
WFC
) and Bank of America (
BAC
). As interest rates fall, the net interest earned by assets falls
as the company earns a lower interest rate on assets in its
possession. During the financial downturn, the net interest rate on
loans and securities declined to 1.7% in 2009 from a high of 4.6%
in 2007. As the markets recover, we expect Charles Schwab's income
on interest rates will rise in the coming years given adding a nice
boost to the business.
While we anticipate Charles Schwab's interest rate on deposits,
loans and securities will reach closer to 4% by the end of Trefis
forecast period, Trefis members expect the rate will be around
4.3%, suggesting an upside of almost 5% to our price estimate for
SCHW stock. If its net interest rates reached around 5%, this would
imply a $22.50 price estimate and 20% upside. This demonstrates how
reliant this business is on net interest income which we estimate
accounts for over 50% of Schwab's value.
We currently have a
Trefis price estimate of $19.89 for Charles Schwab's
stock
, about 5% above the current market price of $18.65.
Consolidation of Banking Industry
Reducing competition could potentially give banks and brokerages
the ability to decrease the net interest yields, as volume growth
offsets the decline in net interest income. A decrease in
competition in the banking system leads to higher spreads as there
are less financial institutions who are available to extend loans,
thus being in a position to charge higher interest rates.
Costs of Borrowing Expected to Rise
Schwab's cost of borrowing depends primarily on the interest
that it pays out on deposits from banking clients, payables to
brokerage clients, and its corporate debt. The average interest
that Schwab pays on these sources of financing is primarily
dependent on the overall Federal Funds Rate which has been targeted
at 0% - 0.25% since December 2008. In comparison, the Federal Funds
Rate was mostly recently at a high of 5.25% in June of 2006 and
6.5% in May 2000 with the rate reaching a low during the
intervening period of 1% in June 2003. Based on the history of the
Federal Funds Rate and long-term expectations for economic
recovery, we expect that the Federal Funds Rate will rise to near
historical averages and that Schwab's borrowing costs will
increase.
Trefis Community Forecast
Trefis members forecast Charles Schwab's net interest income
rate on deposits, loans and securities will increase from 2.3% in
2011 to 4.3% by the end of the Trefis forecast period, compared to
the baseline Trefis estimate of an increase from 2.2% to just about
4% during the same period. This implies a slight upside of 5%
from our current estimates; however additional upside exists if net
interest rates climb to historical levels of closer to 5%.
See our
complete analysis for Charles Schwab's stock
.