(Bloomberg) — Shares of Charles Schwab & Co. suffered their biggest intraday drop since the depths of last year’s regional banking crisis after the investment giant warned it needed to downsize to protect profits.
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Schwab Chief Executive Officer Walt Bettinger said on a conference call with analysts that the bank plans to rely more on off-balance-sheet transactions to house customer deposits. By turning to partners like Toronto-Dominion Bank, he said, such deals will allow Schwab to use capital more efficiently.
“These various steps will result in a bank that, over time, is somewhat smaller than in recent years but will maintain our ability to meet our customers’ banking needs, reduce our capital intensity and, importantly, protect the economies of scale that can be generated by owning a bank,” Bettinger said.
The warning evokes memories of a year ago when investors began to cool on Schwab after the Federal Reserve’s rapid interest-rate hikes slammed the value of their bond investments and caused Schwab to take losses on its books. At the same time, consumers pulled their savings from the bank in search of higher-yielding alternatives, forcing the bank to seek more costly sources of funding.
The company is now looking to pay down some of the costly debt it has taken on, but to do so it may have to use some of the excess capital that would have been earmarked for share buybacks, executives warned on Tuesday.
The company will also begin restructuring its balance sheet to shorten the duration of some of its investment portfolio. Bettinger cautioned that such moves could increase earnings volatility in the short term but would reduce the company’s need to rely on additional borrowing.
“The definition of this transitional year is being realized,” Bettinger said. “All of these issues position us for a period of strong growth in customer metrics and financial performance over the next several years.”
The company’s shares plunged 8.9% at 11:56 a.m. New York time, its biggest intraday drop since March 2023 and the worst performance among components of the S&P 500 index. The company’s shares had risen 9.1% this year through Monday’s close.
Crowded Space
The latest move comes after the investment giant reported that fewer customers opened new brokerage accounts in the second quarter than analysts had expected.
The company said in a statement on Tuesday that new brokerage accounts rose to 985,000 in the third quarter, up from 960,000 a year earlier but below the 1.04 million that analysts surveyed by Bloomberg had expected.
Still, Schwab reported three-month net income of $1.33 billion, beating the $1.23 billion that analysts had averaged. Quarterly earnings per share of 66 cents also beat expectations.
The retail brokerage space has become more crowded as consumers flocked to the market and maintained new trading habits during the pandemic. Schwab has maintained a more traditional approach to retail investing compared with crypto-friendly rivals such as Robinhood Markets Inc., but it plans to roll out an alternative investment platform for qualified self-directed retail investors this year. Six in 10 new clients are under 40, Bettinger said on a conference call with analysts on Tuesday.
The Westlake, Texas-based company said in May that Mike Verdeschi, a 30-year veteran of Citigroup Inc., would become chief financial officer, succeeding Peter Crawford, who helped guide Schwab through last year’s financial crisis that hit the banking sector.
Founded more than 50 years ago by Charles “Chuck” Schwab, Schwab manages more than $9.4 trillion in client assets.
Shrinking banks
Through off-balance-sheet arrangements, clients open bank accounts with Schwab but their funds are actually deposited with a third-party bank. Such arrangements mean Schwab doesn’t need to hold as much capital as it would if it held the deposits, which banks consider liabilities, in-house.
Such a move would make Schwab more similar to rivals LPL Financial Holdings Inc. and Raymond James Financial Inc., whose shares outperformed Schwab’s last year as investors saw them as less risky to raise capital, according to analysts at Keefe, Bruyette & Woods.
Executives are looking for more ways to boost profits over the next few years and plan to put more emphasis on lending. For example, the company plans to expand its services to include mortgages, home equity lines of credit and secured assets to attract more customers.
“Most of our major competitors have the capabilities to support both the investing and borrowing needs of their clients,” Bettinger said. “We believe that those who do not offer lending services are at a strategic disadvantage, and this will become increasingly apparent over time. That’s why we are committed to providing quality lending services.”
(See paragraph 8 for latest share price and paragraph 15 for further information on off-balance sheet transactions.)
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