Charles Schwab Corporation (SCHW) said on Monday that it expects fourth-quarter earnings to be between 2 cents and 4 cents lower than its third-quarter earnings of 17 cents per share. The decrease in earnings will result from pressure on revenue due to lower interest rates and lower trading volume. The Zacks Consensus Estimate for the fourth quarter currently stands at 17 cents per share.
 
Though markets are in a recovery mood, Charles Schwab’s daily trading volume in November has dropped 27% from the prior-year period and 11% from Oct 2009. The company also expects to waive about $108 million in fees on its money market funds, up from a previous forecast of about $100 million. Management fee waivers on its proprietary money market mutual funds could increase by about $30 million from total waivers of $78 million in the prior quarter.
 
Schwab is highly sensitive to interest rates. Low interest rates have been a drag on the company’s revenue since the Federal Reserve lowered its benchmark interest rate to a record low of near zero last December. Near-zero U.S. interest rates have forced the company to waive fees it charges clients for managed funds. Until the economy improves and interest rates begin to move up, which we don’t expect to happen in near future, the company will continue to face a drain in its revenues.
 
However, things remain solid at Charles Schwab from a financial perspective, having improved noticeably over the last couple of years. Earnings continue to benefit from management’s aggressive efforts to control cost. Return on equity (ROE) improved dramatically for three years since 2004 and reached 55% in 2007, but declined to 31% at the end of 2008 mainly due to the economic slowdown and challenging market conditions. Improvement in certain metrics has been hindered by numerous fee cuts, but we continue to see these moves as important in the long run from a competitive standpoint.
 
We suspect that results will continue to be impacted by the challenging market conditions and weakening economy, while the stronger client activity resulting from increased market volatility and management’s aggressive efforts to control cost will provide some support during the coming quarters. As such, we maintain a Neutral recommendation on the shares.
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