Will Schwab fail? Is @CharlesSchwab next to go down? With recent uncertainty at banks, Schwab is in the news for all the wrong reasons. Schwab's stock, SCHW, is down, and they issued a special statement.
Bridget Sullivan Mermel and John Scherer talk through the different issues at play when we talk about recent bank failure. How does Silicon Valley Bank compare to Schwab? Why does the amount of FDIC insured assets matter? What does the term "custody" really mean? Why is Schwab not making as much money these days? And why is their stock price probably down?
Here are previous episodes mentioned in the episode: FDIC insurance: https://youtu.be/Pk32qGGIJvQ
Safe, higher interest-earning investments: https://youtu.be/qAu0mv9blEo
00:54 Schwab level of risk
01:34 Why banks have failed
02:30 SVB versus Schwab
04:30 What custodian means
08:49 Schwab stock price down
Here's John's firm website: https://www.trinfin.com
For advisors around the US: https://www.acplanners.org/home https://www.acplanners.org/home
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Bridget: Hey, John. With the failure of several banks, people are wondering, is Schwab next? On this episode of Friends Talk Financial Planning, we're going to be talking about why people are saying that and pull back the curtain and talk about the reality of the situation. Hi, I'm Bridget Sullivan Mermel, and I've got a fee-only financial planning practice in Chicago, Illinois.
John: And I'm John Scherer. I have a fee-only financial planning practice at Middleton, Wisconsin. And before we dig into the safety of Schwab, I want to remind everybody to hit that subscribe button. By subscribing to our show, you help other people find this great information on YouTube. And with that, let's dig in. Several large banks failed, which has been front page news in recent weeks, and Schwab is a big part of your business and my business. What are you hearing from clients and what are you telling them?
Bridget: Yeah, so first of all, I want to make sure that we're clear. I think the likelihood of Schwab having any kind of big financial problems is extremely low. And I can't say “never,” but it's extremely low, so I want to get that out there first. And then also, I think it is important to talk about what's known as custody at Schwab. And in this episode, we'll talk about what custody actually means. But for us, it basically means that we work with Schwab all the time.
Bridget: So first let's talk about why these other banks have failed and what has made people say, “Oh, Schwab might be in that same situation.” Okay, so what happens with banks is they get deposits and then they loan out money, but if they don't loan out all the money, then they will buy safe treasury bills with the money. And as we all know, the interest rates have gone up lately, and so the value of these investments that Schwab and other banks have bought has gone down.
As long as they hold on to them until maturity, Schwab and others won't make as much money, but it's not a problem; they just don't make as much money. But if depositors start getting freaked out and start asking for all their money, then Schwab can have a problem, or the other banks have really had a problem.
Bridget: And so, one of the famous banks is Silicon Valley Bank. And first of all, one of their issues was that 95% of their deposits were above the FDIC insurance level, which we talked about in another show. So 95% were above this level, which means that before this happened we would say they were uninsured. Schwab doesn't have that situation. They have 80% of their deposits insured.
John: I think that's such an important point, just in general, not specific even to Schwab or Silicon Valley or anybody. There's been a lot of talk—I know that I've heard, and probably you as well—saying, “Jeez, is this fill in the blank institution safe?” And to the extent that you're underneath those FDIC insurance rules, and we'll link back to our former episode that we did recently on that, you’re insured by the government. There is no risk for, in this case, for Schwab, 80% of the deposits there is no risk no matter what happens.
Bridget: Right. The other thing is that though Schwab is a bank, they're also a major custodian. And so, if you are an analyst and you were looking at all the banks with a lot of positions in these treasuries that have not maintained their value, but again, are okay as long as you hold them out to maturity. You would see that Schwab has a lot of that. And so then again, you'd start thinking, “Oh, Schwab is in a similar scenario to these other banks that have failed.” But it's not exactly the same at all. The other thing is that Schwab’s major business is not being a bank.
Bridget: That's not their big business.
John: We use the term custodian, and that's probably under the jargon police. What does custodian mean? I think that's a really important thing to think about as we talk with our clients, and maybe if you've got money, whether it's in Schwab, or the other major brokerage firms which are in a similar boat, is that at Schwab when we make an investment, when we invest money for our clients at Schwab and for ourselves at Schwab, we're not giving the money to Schwab, so that they can do what they want to with it, which is effectively what you do when you give money to a bank.
I put a deposit at the bank. Well, they take it, and they loan it out for mortgages, or they buy treasuries, they do something with it, and we're trusting the bank to do whatever it is that they do and then give our money back. So it's literally giving money to Silicon Valley Bank, to Schwab Bank, to name any one of the big banks nationally. When we make an investment with and use Schwab as our custodian, in jargon, what the “custodian” means is they're executing the transactions.
They're sort of facilitating that buy. That's the one place we can go and log in. They collaborate or collate all that information, so you can see all those different investments in one place, but the investments don't live in Schwab. If we buy Apple stock, we own Apple stock. It's just custodied at Schwab, or that's the warehouse, if you will, where it lives. So it's a different thing.
Bridget: So the analogy that we've come up with is it's kind of like the storage spaces. If I rent a storage space and put my stuff in it, the people who own the storage space do not own my stuff. They own the lock on the outside, maybe, or they could put another lock on the outside, but they don't own the stuff. If they change hands or if they've got some financial problems, that doesn't change that I own my stuff that's in the storage space.
Bridget: I don't know how much regulation storage spaces have, but Schwab's got a lot of regulations. They cannot say, “Oh, you've got some money here, let me go do something with it.” In the case of storage spaces, presumably they're not using the stuff that I have in the storage space. And actually, I can usually provide my own lock, so it's similar to that. Schwab is like the owners of the storage space. When you have your brokerage accounts there, they're not using that money. Although your bank account, if you've got a bank account there, they would use your money.
John: Yeah. I think that's a great analogy of the storage space. Schwab does not own the things inside. I was thinking about this conversation, and it occurred to me that there's a similar example at many banks. We just had a client who still has a safety deposit box at a local bank, and we had to do some things with them for that safety deposit box. And think about how that differs from the bank deposits in your checking account or money market account. Again, if I have a checking account, I give my money to the bank. If I have a savings account, I give my money to them, they go and loan it out to other people, buy treasury bills, and then they give it back to me when I ask for it.
When I've got a safety deposit box, I can put whatever I want in it. If I had gold, I could put gold in my safety deposit box. So I've got an investment in the bank, but it's a different thing. And maybe that's more tangible, saying, “I've got that. If the bank goes bankrupt, my gold that's in my safety deposit box isn't part of their assets. That doesn't go to their creditors.” Might I have a problem getting it? Yeah, it might take a few extra days, and I might have to do some different things, but my gold is still going to be there.
That's my box that's in there. It's just being held by the bank. And that's a similar thing to what we're talking about with Schwab. That's my investment in this mutual fund or that stock, it's just being held by Schwab. As opposed to on the banking side, when I make a deposit into a CD or money market that is literally giving them that money, which is where we have the issue or the concern talking about if the bank fails what happens and the FDIC insurance, that sort of thing.
Bridget: Yeah. The other thing I want to talk about is why even prior to this, Schwab’s stock price was going down? What was the problem there? Okay, so the issue with Schwab is one of the ways that it makes money is by what sometimes you call loafing assets, which I think is a useful term here. And so previously, before you could start really making much on interest rates, when the prevailing interest rate was kind of zero, you'd put money into Schwab, you'd invest most of it, but then you'd have a cushion, and you wouldn't really worry too much about how that was invested because you knew you wanted to have that cushion.
John: And there were no other alternatives at the time.
Bridget: Yeah. What else are you going to do with. And so, Schwab actually took that little cushion, the bank part of the cushion, they swept it over, and you would tell them, “Yeah, I want it invested in this sweep account,” and then they would take that and invest it at higher rates. And that's actually how they made a bunch of their money.
So now with higher interest rates, one of the things that we say, and we'll link to the video that we have on this is don't have these loafing assets. Invest in something, even at Schwab. Invest it at a treasury in Schwab. So Schwab actually offers investments that make more, and you can just switch them over to that, so they have a lot less money that they're able to have that spread. That's just going down, because advisors like us and viewers are all saying, “Oh, I'm going to do something with this.”
John: Right. It's interesting as I think about, hey, I've got money at Schwab. What does that mean? That could mean I've got money in their Schwab bank account, which is a separate thing. It could mean I have money in the investment part, where they're like that warehouse or the storage space. It could mean that I bought stock in Schwab and own those rights. Different things for different languages. And that's part of the discussion here is what are we really talking about with this and maybe some interest. An interesting way to wrap things up here.
Bridget: So you could have Schwab stock in your Schwab brokerage account😊
John: Mind blown. With that, I'm John Scherer. I run a fee-only financial planning practice in Middleton, Wisconsin.
Bridget: And I'm Bridget Sullivan Mermel, and I've got a fee-only financial planning practice in Chicago, Illinois. John and I are both accepting new clients at our firms. However, if you live in another area of the country and would like to find an advisor near you that thinks a lot like us, you can check out acplanners.org.
John: And don't forget to hit that subscribe button.
At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.