Having worked for a bank for over 10 years, I follow quite a few financial stocks. There were two things that my years in banking taught me. First, change is constant. Second, you need to get to know your client, because if you don’t, your competition will take them away. Bankers need to learn a new rule as well, competition doesn’t just come in the form of a traditional bank anymore. Increasingly brokers, credit card companies, and online banks are wreaking havoc among traditional banks. One great example of this disruptive force is The Charles Schwab Corp (NYSE:SCHW) Corporation.
Know Your Competition
One common theme among banks is the need to diversify their revenue stream. Banks like BB&T Corporation (NYSE:BBT) and Capital One Financial Corp. (NYSE:COF) have capitalized on this idea by diversifying into insurance and investments in BB&T Corporation (NYSE:BBT)’s case, and traditional deposit accounts with Capital One Financial Corp. (NYSE:COF).
Brokers have also caught onto this idea by offering both deposit accounts and loans to their customers as well as brokerage solutions. Some brokers like E TRADE Financial Corporation (NASDAQ:ETFC) jumped on this idea a bit too early and felt the brunt of bad loans. However, companies like TD Ameritrade Holding Corp. (NYSE:AMTD) have the benefit of increasing their lending to brokerage holders without the complications of mortgages, home equities, and other loans.
Charles Schwab Corp (NYSE:SCHW) seems intent on continuing to dominate the discount brokerage business, while also disrupting the banking business at the same time. Schwab’s increased brokerage assets, bank accounts, and loans, argues that this company is becoming a one-stop financial shop for many.
The Brokerage Side Of The House
Some companies find it difficult to continue growing their existing business, while also trying to expand into new ventures. However, Charles Schwab Corp (NYSE:SCHW) seems to be handling this expansion fairly well. The company saw 9% growth in new assets, a 2% increase in new brokerage accounts, and has 8.9 million active brokerage accounts.
Schwab’s attempt to toe the line between broker and bank is producing margins that are less than some brokers, but better than some banks. In particular, BB&T is a more traditional bank and reported a pre-tax margin of 27.53% in their recent quarter. Capital One, which is becoming more of a traditional bank through its purchase of ING and HSBC assets, reported a margin of 19.61%.
On the other side of the coin, E*Trade reported a negative pre-tax margin in two of the last four quarters, and TD Ameritrade Holding Corp. (NYSE:AMTD) Ameritrade managed a margin of 36.74%. By comparison, Charles Schwab Corp (NYSE:SCHW)‘s pre-tax margin in the quarter was 25.66%. What should really get investors excited though is the company is predicting this margin may rise as high as 30% this year.
One Thing That Makes This Bank Different
Schwab’s future growth engine could be the traditional banking business. One of the biggest advantages the company has is, the fact that they ask more detailed questions of their customers than traditional bankers. This stems from the fact that Charles Schwab Corp (NYSE:SCHW) is gaining bank accounts from brokerage clients and not from a customer walking in off the street to open a checking account.
The holy grail of banking is a number called the cross-sell ratio. The short version of the ratio is, it’s the number of products and services that one customer has with the bank at any given time. If a customer has a checking account, a savings, a CheckCard, and Online Banking, they would have a cross-sell of 3. The checking account is the standard, and each additional service is counted as a “cross-sold” service. The reason this is so important is, the higher the cross-sell number, the more sticky that customer becomes.
Traditional banks like BB&T Corporation (NYSE:BBT) have a hard time increasing their cross-sell, because traditional bankers just don’t ask as many detailed questions as brokers. Capital One has a similar issue as they gain many customers through credit cards, and then try to sell other banking services.
Brokers like E TRADE Financial Corporation (NASDAQ:ETFC) and TD Ameritrade usually get the customers’ brokerage account but their heavy reliance online accounts puts them at a disadvantage. Charles Schwab Corp (NYSE:SCHW) uses this same tactic, but because the broker is less dependent on online only customers, there is a greater chance for the company to sit down (in person or over the phone) with new customers.
The fact that Schwab added 32.26% more in total deposits on a year-over-year basis speaks volumes about the company’s ability to attract good relationships. By comparison, only Capital One outperformed this measure with a 65.71% jump in total deposits last year. However, Capital One needed multiple large acquisitions to make this happen. Looking at BB&T’s deposit growth of 6.51% and E*Trade’s deposit growth of 7.3%, you can see how far ahead of the pack Schwab is running.
Schwab also increased its mortgage and equity lending by 14% year-over-year. Capital One Financial Corp. (NYSE:COF) also outperformed again through acquisitions with an increase of 54.81%. However, even TD Ameritrade Holding Corp. (NYSE:AMTD) Ameritrade’s 9.44% increase in total loans couldn’t match Schwab’s growth. Relatively speaking, BB&T’s loan growth of just over 6%, and E*Trade’s increase of 5.59%, aren’t in the same ballpark as the rest.
Bank On This
As you can see, Schwab is a force in the brokerage market, and is leveraging these relationships to grow their banking business. With 888,000 bank accounts, Schwab isn’t playing around. The company’s $82.4 billion in bank balances is a relatively small amount. However, Schwab has $2.08 trillion in total client assets, which represents a massive opportunity to cross-sell these customers on Schwab bank.
While Schwab’s shares aren’t necessarily cheap at 22 times projected earnings, if the company can continue growing its banking business, this could be the fastest growing bank that no one sees coming.
The article The Fastest Growing Bank Isn’t A Bank After All originally appeared on Fool.com is written by Chad Henage.
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