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Charles Schwab Corporation (SCHW)

Business Update for Institutional Investors

February 2, 2012 11:30 AM ET


Rich Fowler – Senior Vice President Investor Relations

Chelsea de St. Paer – Vice President Investor Relations

Walt Bettinger – President and Chief Executive Officer

Joe Martinetto – Executive Vice President and Chief Financial Officer

Andy Gill – Executive Vice President and Chief Operating Officer

John Clendening – Executive Vice President Shared Strategic Services

Jim McCool – Executive Vice President Institutional Services

Bernard Clark – Executive Vice President Advisor Services

Steve Anderson – Senior Vice President Retirement Plan Services


Howard Chen – Credit Suisse

Gaston Ceron – Morningstar, Inc.

Michael Carrier – Deutsche Bank Securities


Rich Fowler

Okay. I think we’re going to get started. Well, good morning, everyone. I am Rich Fowler, the newly podium-less and, therefore, noteless head of IR for Schwab.

And those of you who know me, I know what you’re thinking. You’re thinking every time I’ve been here for years, Rich uses notes. Can he do this? Should he do this? Is his brain going to freeze? And, frankly, I’m kind of curious about that myself. So let’s see what happens.

So, again, welcome to everyone here in the room and on the webcast, to the Schwab Winter Business Update. We certainly appreciate the effort to make the time today, particularly for the folks who’ve had to travel out here to be in the room, out here on the West or as we call it the Correct Coast.

We’re relieved that we’ve got another nice day for you out here, what I would call a top-down day, although I have to admit that even for me, it was chilly enough on the way in this morning to where I was reminded to appreciate that we live in a civilization that is capable of producing heated car seats.

So, again, a good start to the day. Let’s tuck in to what we’re going to talk about. I think as is pretty well understood by now, we run these business updates as a way of keeping the investment community up to speed on management’s perspectives and priorities as the environment evolves. I think it’s pretty fair to say that we’ve had a lot of dialog recently in some more sort of external input as it were of thinking around how to deal with what we call lower for longer.

And in a fortuitous confluence of events, that’s exactly what we’re going to talk about today. So, I expect that you will hear about today and, hopefully, we’ll have a lot of interaction around as executive management’s thinking around how we drive the company forward, how do we drive ahead in a year like 2012 with this notion of lower for longer as part of the environmental picture.

Let’s turn to the agenda. Walt, as usual, is going to start us off. Professor Martinetto will then walk us through the financial picture. Andy Gill, who has been in front of the group before, is going to spend some time with us, giving an overview of what’s going on in investor services.

John Clendening, who has not been in front of the group before, will then walk us through a deeper dive on advisory services at Schwab, something that we haven’t had a chance to do with this group, and we thought the time had come just to drill down in that a little bit more and help build a greater understanding of what’s going on there.

Then, after the break, Jim McCool, who you all know well, is going to talk about what’s going on on the institutional services side. And then, Steve Anderson, a newbie for the group, but certainly not to Schwab, is going to walk us through the Schwab Index Advantage, the new index based on 401(k) plan that we just launched in January.

So that’s the lineup for today. We should spend a couple of minutes on administrative stuff before I get out of the way. Forward-looking statement, while the words, fundamentally, as always, we do our best to share our thinking with you guys as of this moment in time, including expectations for the future.

Things will change over time. Please stay up with our disclosures including our filings, obviously the business updates. You may even want to talk to IR once in a while. And I’m, of course, as disheveled and hopeless as ever, but fortune has smiled upon me in terms of having some great VPs.

The prior one, Mike Candice [ph] is here with us. And of course Chelsea de St. Paer is the current VP of IR. So you don’t want to talk to me, certainly, on Chelsea down.

So, let’s see. Silent cell phones please. Refreshments are in the back. Please help yourselves whenever you care to. Restrooms are out the back and to the left. I’m sorry about my voice, the tail-end of cold.

And Q&A, the last thing. For Q&A, just for the folks on the webcast can here questions, we do have mike runners. So when you get called on, if you please just wait for the mike to get to you. We ask folks do maybe a question and a follow-on and we’re work our way around the room.

And we will take questions on the webcast. I think there’s a box on the console, “Ask a Question” and Chelsea will collect those and share them through the course of the sessions.

Finally, if you get bumped off the webcast or something happens, the ever popular dial-in, 800-871-6752, conference ID, 43603292. So, again, 800-871-6752, conference ID, 43603292.

That takes care of the administrative stuff. I’m going to get out of the way and I’m going to ask Walt to come up and start us off.

Walt Bettinger

Good morning. It’s a great crowd here this morning. I’m sure it has nothing to do with a weekend of sunshine and mid-60s here in San Francisco. Hopefully, some of you will travel, have a chance to stay the weekend and enjoy.

I have to admit. When Rich said lower for longer, it’s the first time I’ve ever heard him say that without a string of four-letter words prior to lower for longer. But I think that’s probably a fair assessment.

You may have noticed when we put the agenda up that Andy Gill is going to speak today with all of you. Up until Friday, Ben Brigeman is going to be here and speak about investor services. Ben has an issue with one of his shoulders and he was scheduled for a medical procedure actually scheduled tomorrow at the Cleveland Clinic, near where Ben lives.

But he was under so much duress with it last week that they actually moved it to Wednesday, which would’ve been yesterday, and there was no way for him to fly from Cleveland to get here in time to make the presentation. So, Andy is going to ahead and present along with John.

I also wanted to share with you what Ben would have shared with you if Ben had been here today, but it’s fallen to me because of his inability to do so. Ben is going to be leaving Schwab later this year. This is something that Ben and I had been working on for over a year. He and I have worked together for almost 16 years. We have a very, very close business relationship.

As many of you know, Ben has done a wonderful job for us. He has traveled extensively over the last 15 years and certainly the last five, in which case, that five years is the longest tenure of any individual leader in our retail business since I joined Schwab back in the mid-90s.

But his family in Ohio and all of the issues that go along with that, Ben has made the decision to leave the firm later this year. He’ll be staying on for a number of months as we go much further into 2012, assisting us with the transition.

As we had built and planned, Andy Gill and John Clendening will be overseeing the investor services area. Of course, Andy has been chief operating officer. John already has been overseeing many of the areas that are part of investor services, like our advertising, marketing, things along those lines.

So we expect a very, very smooth and positive transition. And, again, Ben will be staying around for a number of months assisting us in this process.

I also wanted to mention and address an issue that I’m sure you’ve seen in the press in the last 24 hours. And that is the FINRA filing with respect to some wording in our account agreement. We have enormous respect for our regulators and we certainly do for FINRA.

What we have is just a fundamental disagreement between, I’d say, two reasonable parties about the interpretation of the Supreme Court’s ruling in AT&T Mobility and whether that is precedent or whether FINRA has precedent over that Supreme Court ruling.

And so, there is a process by which we resolve disputes between a regulated entity and its regulator and we’re under way in that process with Federal Court to determine the best way to resolve the dispute between us and the regulators.

What I think is very important to emphasize is that, this is an issue between us and regulators, not Schwab and clients. And we’re particularly sensitive to the fact that we don’t want any smaller clients to feel that they’re under some obstruction or barrier to being able to file arbitration claim if they feel that they have a viable arbitration claim if we’ve made a mistake or something along those lines.

So, until we get this issue resolved between FINRA and Schwab, we’re going to reimburse the arbitration filing fee for any client who chooses to file arbitration, no matter how large or small their claim might be. But we just want to make sure that no investors, particularly small ones, while we work out this issue with FINRA, feel like there’s any barrier to getting appropriate restitution in the event that they feel that’s warranted.

So let me go ahead and get under way, talk a little bit about 2011 before I’ll transition to 2012. 2011 as everyone is aware is a very, very difficult environment, exceptionally volatile. And yet, during that environment, we continued to invest in our business building the business, building the earnings power. We’ll go into more detail around that throughout the year.

Our emphasis right now is primarily around the things that we can control. That’s things like non-interest bearing revenue diversification, continue to build that, staying consistent in our client-oriented strategies, because they continue to work and making sure that we keep that long-term focus in terms of earnings power with a confidence that we will be able to deliver that to our shareholders as environments over time eventually improve.

Taking a look at 2011, you can see some of the metrics. We continue to grow whether it was brokerage accounts, new assets. The core up, a little bit over $80 billion, 145 total, but that does include a large clearing amount, which we always like to break out for you, because the revenue on it is much smaller.

Our client asset is approaching $1.7 billion at the end of the year. I think the last one is the one that we are most pleased about and that is hitting a record-client promoter score in our retail business, which, of course, is around 2/3 of the firm’s revenue and 2/3 of the firm’s earnings, hitting a record in December of 2011.

And then, just the last point, emphasizing the ongoing organic growth within the franchise since the beginning of the crisis, over $300 billion in net new money. That’s more than all of our publicly-traded competitors’ reported numbers added together.

In terms of financial, Joe, of course, will cover more details. But I just wanted to touch on these highlighted numbers. Revenue up 10%. Income was up actually about 11% or 12% from 2010 depending on whether you make adjustment for charges. I know it was 90% on a reported basis because of significant charges we had related to litigation settlement in the prior year.

But 11% or 12% is the realistic growth in terms of core earnings year-over-year. Again, faster growth on the bottom line even in this environment, even with the investments we made, faster growth than we grew revenue. Margin is around 30%. And we made a significant investment in projects in 2011.

And you could see that manifested in the introduction throughout 2011 of a lot of new services and capabilities, a few more coming out in the ‘12. We’ve tried to set up today with a number of folks here to talk about the implementation of many of those new capabilities. $180 billion, that was the largest project amount that we had spent going all the way back into the Internet period.

From a planning standpoint, just to add a little context around 2011. When we were sitting here a year ago and in making those significant investments, it was a much more favorable environment. As we know, the tenure was 100 to 125 basis points higher than it is today. Of course, the tenure is as close to proxy for what we make in gross yield in terms of our NIM.

It’s not complex math to say that things like Operation Twist and the issues in the Euro zone took 100 to 120 basis points off the tenure and with a $100 billion plus balance sheet, you can see the amount of impact that that made to what would have been our revenue here in 2012 and to a great extent, to earnings.

But we did decide to scale back that project spending a bit in ‘12. I think we’ll go into a little bit more details. It’ll be closer to $140 million this year, as we made a series of expense moves to maintain flat core expenses from 2011 into 2012.

The last point I just want to make on this slide is, we spent a lot of time talking about interest rates and the implications. We do not need interest rates to go up to deliver strong improving results. We simply need interest rates to stop going down, because we have this organic growth, we have the new assets coming in.

We have client converting in significant numbers into higher revenue solutions like fee-based programs. Our advisor business continues to grow. So we just showed that six quarter period that many of you are aware of from early ‘10 to mid ‘11, when rates stayed relatively flat, and we grew revenues 22% and operating income 77%.

So, one of the things I’ve asked of all the speakers throughout today is that we make the stage and no spin zone. And part of being a no spin zone is, it’s a really difficult environment. I have been out in the field for probably 3/4 of 2012 talking with clients and with our front line employees.

I’ll leave 6 o’clock tomorrow morning to go back out in the field and spend the better part of the next two weeks talking with clients and our front line representatives. And the environment is not a great environment. Difficult from an investor standpoint, and that’s notwithstanding, of course, the strong January where we know the markets were up 3% or 4%.

Lack of confidence. You can see the chart here, a fairly significant fall, and are you better off than a year ago, 44% the end of ‘10, 26% the end of ‘11. Confidence and ability to make decisions on the far right makes for a difficult environment, particularly for trading and self-directed investors, as confidence continues to fall. It potentially offers some benefits in our advisory base solutions and helps our RIA business, but a tough market, particularly for self-directed investors.

So, in that, where we tried to maintain all of our focus on is execution, executing on our strategies and our operating priorities, our five consistent items that we’ve talked about with you for a number of years – diversified clients acquisition, win-win monetization; of course, by that, we mean it’s good for the client and good for Schwab and, therefore, shareholders; long-term client retention, expense discipline and effective capital management.

I’ll put most of comments around the first three. I’ll probably touch a little bit on the last two.

So, these are key efforts set up for 2012 and a lot of times, in our beginning year analyst meeting – I’ll cover this in a bit of depth – we actually thought it would be more effective today to have many of these covered in an even deeper extent than I would go through. And that’s why we have Andy and John and Jim and Steve here to cover these.

You can see them broken out among our priorities – acquisition, monetization, monetization retention. I do just want to touch on the independent branch services because I don’t think we’re doing a specific presentation on that. We’re still on target for somewhere around 12 to 15 locations open by the end of ‘12.

We have three signed franchisees right now, a couple of others that are almost complete. The interest in this is a bit overwhelming. We have over 1,700 applications for this program. And what we’ve chosen to do is be very, very careful about the people that we bring to our independent branch system.

There would’ve been, of course, an opportunity to make it grow much, much faster given the level of interest. But we think particularly in these early couple of years of this program, it’s important that we get people that we have absolute 100% confidence. Not only it will carry our culture and our client first orientation, but also will deliver great results; net new assets, building of this independent location.

So that is on track. But we are being very, very diligent in terms of the extent to which we’ll allow that to grow, despite the level of interest. Also, I’ll add that the interest is coming as it was and we discussed in our last time together from a diverse audience.

About half of the individuals expressing interest here are coming from the independent branch world and the other half coming from full service world, people who are possibly independent RIAs today, and beside they want to be part of the Schwab brand. It’s a quite diverse population of people expressing interest in that program.

Most of the other ones on here we will talk at a fair amount in depth. So I will hold off on stealing anyone’s thunder. And I know, as I mentioned, Steve is here specifically to talk about Schwab Index Advantage that many of you have asked about and have interest in. The early reception to that in the market place, to steal the word I used earlier, I would also have to categorize as overwhelming interest on the part of employers and sponsors.

We clearly recognize the near-term importance around earnings and that’s why we make the difficult trade-off decisions. That’s why we grew revenue in 2011 faster than expenses despite the challenging world that we’re in. It’s why we made the tough decisions in 2012 to hold our core expenses flat within our franchise, despite the fact that that meant making cuts and other reductions.

We didn’t make a big to-do about it. We didn’t brand it. We just went out and did it, which is what the management team at Schwab does. We dealt with the issues so we could maintain flat expenses.

The same time, what we’re really doing is building for the long run. People that own our stock and invest in our company are taking a long-term perspective. We recognize that and that’s exactly what we do from a management standpoint. We’re looking to build earnings power in this business for the long haul to reward those long-term shareholders.

And this is just another version of a slide we’ve shared with you in the past. We track our operating earnings and then we track what would be our earnings based on the second quarter 2008 market environment. I think it was about a 2% fed. You can see, I guess, we have up there the 1370 S&P average during that quarter and earnings trailing right around or just below – or tracking high 30s to $0.40 under that type of environment.

It took a hit, of course, in Q4 because trading was down, investable assets were down. So, revenue we made on market based equity assets was down. And we also had in there some option to express integration charges and the premium amortization that Joe will talk at length about.

But the core earnings being built that eventually will be exposed from net interest margin, you can see it continued to grow, from $0.19 to $0.24 in only two quarters. So, the earnings power of the company grows. The part in the blue line, of course, we’re confident we’ll come back as we now come off another drop in rates and, hopefully, an environment that seems a little bit more flat.

Expense discipline is what makes it work for us, particularly in this type of an environment, and we remain committed to that. This is a consistent chart that we’ve showed you over the years as we manage the business in an efficient way to take advantage of the scale to where we can grow revenue faster than we grow expenses.

So, I guess, just a couple of summary comments to make. We feel very good about our operating strategies. And it continued to work, bring in new clients, clients moving up into higher revenue based solutions that are in their best interest, continue to be very disciplined around our investing while building this base, cognizant of near-term results, and looking every quarter to prove to our owners that management is going to deliver the results that they expect as the environment improves.

So we continue to presumably earn the right for the long-term perspective by making disciplined near-term decisions. And, again, I think to summarize there within our focus on the long-term.

Let me stop there and left some time available for Q&A from the audience. And we want mikes, is that right, for – okay. Do you want people to identify themselves for questions, Rich?

Question-and-Answer Session

Rich Fowler


Walt Bettinger

Okay. And Chelsea, you have something from the Web that you may. Okay.


In terms of the 401(k) business, are we at a point, I guess, where the numbers are big enough to actually move the needle in terms of net new assets and in terms of the breakaway brokers you’ve described that is a long-term process? But, with the recent changes in commission rate, et cetera, any change in the movement of those assets?

Walt Bettinger

On the 401(k) side, just to put a little more context on it, we not completely but to a great extent slowed our marketing and sales effort over the last year and a half while we invested a significant amount of time and energy in building the Schwab Index Advantage.

So, we have paid the price, I guess, you could argue, in terms of our recent metrics in net new assets because of that. I would expect by the second half of this year you would start to see some building impact in terms of net new assets from the efforts around Schwab Index Advantage.

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