Higher Interest Rates Benefit Charles Schwab

On the heels of my blog yesterday recommending a swift exit from bonds and certain equities, the Dow Jones Industrial Average surrendered another 353 points today bringing the Federal Reserve inspired decline to a whopping 559 points in just two trading sessions.  Interest rates continued to rise as well with the yield on the 5 year U.S. Treasury rising to 1.31% vs. 1.25% and the 10 year U.S. Treasury yield rising to 2.43% from 2.35% yesterday.

In this environment, it is easy to list securities that will face headwinds from higher interest rates and doing so doesn’t add a lot of value for my clients.  Stocks in the housing and utilities sectors are obvious examples.  The difficult task is to find an investment which will perform better in a rising interest rate environment.  To this end, I wish to point out the business model for Charles Schwab (SCHW).

The Charles Schwab Corporation (SCHW)

20.48 Up 0.01(0.05%) 4:00PM EDT

Charles Schwab Corporation, in addition to its discount brokerage business, is one of the largest managers of money market fund assets in the United States, with 3.3 million money market fund accounts and $167.9 billion in assets under management as of December 31, 2012.  As interest rates have fallen on money market fund eligible investments with maximum maturities of 397 days or less over the past few years, Schwab has been forced to waive most if not all of the management fee it charges investors to manage their assets.  The following text can be found in the footnotes of every Schwab money market fund Prospectus, “The yield presented reflects the waiver of all or a portion of the fund’s fees.  Without such waiver, the seven-day yield would have been lower.”  Current money market yields range from 0.01% to 0.06%.  Schwab has effectively waived its entire fee for if they hadn’t, their funds would offer a yield less than zero or a negative return.  Who would invest in that?

So how does Schwab benefit when interest rates rise?  If the yield on short term securities rises to 1.00%, Schwab can again charge as much as 0.50% on its assets under management as its fee.  Do the math… 167,900,000,000 x .005 = $839.5 million dollars per year in additional revenue that drops straight to the bottom line as profit.  Doing some pro forma accounting, apply a 35% tax rate to the incremental earnings and divide the result by the shares outstanding of 1.28 billion and you get an increase in annual earnings per share (EPS) of $0.65 per share solely attributable to the rise in interest rates.  Trailing 12-month earnings are $0.69 per share so in my example, Charles Schwab earnings will nearly double to $1.34 (.69 + .65) in a world where higher interest rates will hurt most other companies.  This represents the potential for tremendous out-performance.  It is no coincidence that Schwab shares have risen 24.5% since interest rates put in their recent low yields on May 2nd and then began heading higher.  Further evidence of strength can be found in the shares which have been unchanged at $20.48 over the past two trading sessions whereas the Dow Jones Industrial Average has fallen 559 points or 3.6%.

For an example of my timely market observations, view my blog post yesterday: Hey, Where are you going with that punch bowl?  (https://christinemederaccountingadvisory.wordpress.com/2013/06/19/hey-where-aer-you-going-with-that-punch-bowl/)  If you’d like additional clarity into your specific equity holdings and the market in general, please contact me at Christine Meder’s Accounting Advisory Services mederchristine1526@gmail.com to schedule a free 30 minute consultation or tweet me at @christinemeder1.  #unrbrand


About Christine Meder
Leveraging my insights and professional experience of 25 years in the accounting profession, I and my firm Christine Meder's Accounting Advisory Services provide our high net worth clients expert advice on their business activities and investments. In addition to performing traditional accounting functions in a confidential manner, I pride myself in giving clients a competitive edge whether it be in running their businesses or managing their investment portfolio. My studies leading up to completion of the EMBA program at the University of Nevada, Reno this August provide me with latest skills and techniques utilized across a broad spectrum of business functions. This breadth of education is complemented with experience as an accountant in the construction, mining, real estate and technology fields during my career. If you are looking for a trusted adviser or consultant in addition to someone you can rely on to properly keep your books, please contact me.

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