Schwab Charles Corp Q1 FY2024 Earnings Call

Good morning, everyone, and welcome to the Schwab 2024 Spring Business Update. This is Jeff Edwards, Head of Investor Relations and I'm joined today by our Co-Chairman and CEO, Walt Bettinger; President, Rick Wurster; and CFO, Peter Crawford. As you saw in the earnings today, we had a nice strong start to the year, so there's plenty to cover today. But before jumping in, let's quickly cover off a few of the typical housekeeping items. The slides for today's business update will be posted to the IR website at the start of Peter's remarks. Q&A is still one question, no follow-up, and let's try to limit the six and seven part questions if possible. Of course, we always encourage you to jump back in the queue if additional questions come to mind. And as always, please don't hesitate to contact the Schwab IR team regarding any clarifying or more tactical questions. And finally, the ever-present wall of words that showcases our forward-looking statements and reminds us that the future is indeed uncertain, so please stay up to date with our disclosures. And with that, I'll turn it over to Walt.

Thank you, Jeff, and good morning, everyone. Thanks for joining us for our April business update. So we began welcoming the majority of our employees back to the office last October 1st. As a result, I began traveling the country, hosting town halls and round tables to meet many of the employees who joined us both before or during the pandemic and hear from them. In addition, I shared some of my perspectives on the economic environment, the strength of the Schwab franchise, and my confidence for the future. After having lived and worked through many economic cycles, I shared with our people that right when things often seem the darkest, they tend to turn around and begin to appear brighter. Of course, I didn't know last fall just how accurate that would turn out to be. It's a wonderful lesson in not overreacting to things that are outside our control. As I sit here today and, of course, recognizing that there are certain environmental and geopolitical risks that remain, the green shoots of a turnaround are appearing, and we're seeing it positively impacting virtually every area at Schwab, from investor engagement to net new assets, to client cash realigning, to capital building, and, of course, to revenue and earnings. Combined with the timelessness of our client-first strategy and the hard work of our incredible Schwab team, my optimism for the future is strong. We didn't simply wait around for a better environment. Our teams have been hard at work on key areas like the Ameritrade integration, enhancing our digital capabilities and platforms, and delivering world-class service our clients have grown to trust and expect from us. So let's go ahead and dig into the first quarter of the year. Inflation remained at relatively moderate levels during the quarter, down substantially from just over a year or two ago. Even as the market reduced expectations for the pace and extent of Fed easing due to stubborn inflation readings, the equity markets continued to move higher during the quarter. Investor sentiment continued its recovery with the bull-bear spread maintaining its recent strong position. Not surprisingly, traders also began to become more active per our Schwab Trading Index or STAX, looking for opportunities to benefit from the improving sentiment. Encouraged by the improving environment, our clients became more engaged in the markets. Daily average trades were up 15% over the prior quarter, client borrowing or margin balances were up 9% in one quarter alone. Total client interactions with Schwab were up 17%. As they engaged more, they also took the opportunity to seek our help more often, with net flows into our investment advisory solutions up almost 70% quarter-over-quarter. All these metrics reinforce the confidence our clients have in us and support our optimistic view of the future. As we progress through the quarter, we were gratified to see a resumption in the strong organic growth we've been able to produce for many decades. Core net new assets for the quarter were just shy of $100 billion, with March particularly encouraging with about $45 billion of core NNA, a 6% annualized growth rate. New brokerage accounts grew to over 1 million in the quarter, the first time that we've exceeded 1 million since the initial quarter of last year. Our progress in net new assets was due at least in part to a slowing of the expected level of asset attrition from the Ameritrade integration. We continue to expect to see some degree of attrition throughout the year, but overall attrition from former Ameritrade clients continues to moderate and remains below the levels we anticipated when we announced the acquisition in late 2019. A major factor in the falling attrition is that clients are becoming accustomed to the Schwab platform and recognizing that many of the prior Ameritrade platform features have been built into the Schwab platforms. Speaking of retail client promoter scores, we achieved record levels as measured in the first quarter. Our overall score was 69, and interestingly, with our premier fee-based advisory solution, Schwab Wealth Advisory, we reached a promoter score of 80. Achieving this lofty score in a solution where clients are paying fees for our advice and guidance reflects just how far we have come at Schwab from our roots as a purely discount broker and the appreciation our clients have for the investments we've made in building our modern wealth management capabilities. We still offer world-class service for self-directed investors and incredible value for fee-conscious investors, but the diversification of our model is building. As I mentioned earlier, we're also tracking promoter scores for former Ameritrade retail clients who converted over to Schwab. We see an initial dip in those scores, probably to be expected given the changes they face. They must learn a new mobile app, a new website, and the like, but their scores begin trending toward our historic scores for Schwab clients. Ninety days post-conversion, their scores increase on average about 25 points and after nine months, their scores improve about 45 points. These results reflect the quality of the integration and conversion work done by our dedicated teams. While mentioning the strength of our offerings for retail investors, we continue to be recognized for the quality of our platform and service. I want to mention a special recognition of our success in our 401(k) and defined contribution business. PLANSPONSOR Magazine recognized Schwab with the highest number of best-in-class awards for the seventh consecutive year, more than two times the awards awarded to the second place finisher. We were also honored when JD Power named Ameritrade and Schwab as number one and number two in their satisfaction survey for self-directed investors. Ameritrade's number one ranking reflects the highest they have ever scored and was aided by the multiple Schwab enhancements we made to the client experience. This recognition illustrates the power of the combined platforms and our decision to go with the best design. I understand this approach added some time to our integration efforts, but I'm confident it will pay dividends for years to come. Before I turn it over to Rick, I'd like to comment on the final client transition group converting over to Schwab next month and summarize the Ameritrade integration. Next month, we will convert the last 10% of Ameritrade client accounts and assets, which is crucial and unique as it comprises our most active traders and power users of the thinkorswim platform. The conversion experience should go smoothly since their experience is unchanged; they'll continue using the trading platform they've historically utilized while also adding all the features and benefits of Schwab. Clients in our transition groups are engaging with Schwab and the expanded array of capabilities we offer. These clients are now beginning to bring new assets to us, and their trading volumes now exceed the levels they were doing pre-conversion when they were exclusively at Ameritrade. While all integration-related asset attrition is not over, we expect to perform in line or better than the levels of client asset and revenue attrition we projected when we announced the acquisition in late 2019. In my opinion, combining the best of Ameritrade with the best of Schwab sets the bar for anyone serving retail investors and independent investment advisers alike, providing a powerful combination for future growth. So Rick, let me turn it over to you.

Thanks, Walt, and hello, everyone. Now we're coming out of the first quarter with strong momentum in our four strategic priority areas as we continue to focus on driving scale and efficiency, win-win monetization, meaning the personalized needs of our client segments, and delivering brilliantly on the basics that our clients expect. Let me start with scale and efficiency. Scale and efficiency has been a key enabler of our success and our ability to disrupt the industry. Looking back to 2013, expense per account has come down 23%. In inflation-adjusted terms, we've cut the expense to serve an account roughly in half. At the same time, we have an expense advantage against our competitors. This means more of our clients' wealth is working towards meeting their goals. This is a hallmark of our business model and a driver of the virtuous cycle because it means we can reinvest back in our clients over time. With our consistent focus on expense discipline and scale combined with the synergies from the Ameritrade conversion and continuously improving our operations, we are able to drive down costs. Looking forward, we'll fully realize our planned synergies from the Ameritrade integration and invest in AI and technology enhancements to add to our expense advantage while ensuring we continue delivering a no-trade-offs experience to clients. Enhancing our wealth and lending offerings remains an important win-win monetization opportunity. We're making progress on both fronts. Our clients continue to seek our advisory solutions in record numbers, seeing a record $14 billion in net flows into our advisory solutions, a 60% increase over last year. We have seen continued interest in our flagship wealth offering, Schwab Wealth Advisory, along with increased interest in Wasmer and Schwab personalized indexing. Schwab Wealth Advisory attracted a record $4.4 billion in net flows for the first quarter, with approximately 30% of those enrollments coming from legacy Ameritrade households, demonstrating the power of the opportunity as we introduce more Ameritrade clients to our breadth of offerings. Demand for our Wasmer Schroeder fixed income strategies continues to be strong, with $2.3 billion of net flows, a 55% increase over last year. As Walt highlighted earlier, clients in these wealth offers are our happiest at Schwab, achieving our highest Client Promoter Scores. Looking forward, we are investing to add capabilities to our wealth and advice platform to support our accelerated growth. Turning to client segmentation, we will always meet the needs of all investors, but we continue to provide tailored offers for specific client segments. The specialized experiences we launched for retail high-net-worth clients, called Schwab Private Client Services and Schwab Private Wealth Services, are just two examples. Our high-net-worth client segments are growing fast at Schwab, representing three-quarters of our total retail client assets today. The specialized service models we launched last year are serving these clients well. In Q1, the team serving these clients answered calls on average in less than 10 seconds, and 80% of calls were resolved by the initial representative without needing to transfer the client. We are adding to our product and advice capabilities for these clients, with an anticipated rollout this year of an alternatives platform for retail investors. Additionally, we've launched our investor advantage pricing for clients and are working on more lending capabilities to meet their needs. We continue investing to provide a trader client experience unparalleled in the industry with our Schwab trading powered by Ameritrade offer. In Q1, we saw robust trading activity, including strong continued engagement from our Ameritrade clients. We doubled the number of Schwab households using thinkorswim. Our trading offer has never been stronger in terms of execution, platform, service, and the combined research we offer through Schwab and Ameritrade. We want to delight our clients with exceptional experiences in every interaction with us at Schwab and to be the easiest place in the industry for clients to do business. This includes digital interactions like our streamlined onboarding for RIAs, where they can now open and fund multiple accounts in just minutes. For pledged asset lines, we process a pledged asset line in minutes for most loans. Client feedback on this process has been fantastic. We've worked hard on our digital experiences to welcome Ameritrade clients by incorporating the features that matter most to them, enhancing our move money and self-service capabilities, and incorporating DocuSign into our commonly used forms. We're providing access and intuitive experiences when and where our clients want to engage with us, whether in one of our 380 branches, over the phone, where clients can expect their calls answered in less than a minute, or online through our Schwab Intelligent Assistant. With clients' eyes as our foundation, investors continue to turn to us for their wealth management and investing needs through all market cycles. We are ready for the final Ameritrade conversion group and to push forward on our four strategic focus areas to serve clients. We believe we are well-positioned to meet evolving client needs and deliver organic growth in line with our historical levels. With that, I'll turn it over to Peter.

Thank you very much, Rick. You all heard Walt and Rick talk about our increasing momentum in the market driven by our no-trade-offs positioning and the satisfaction and loyalty of our clients; the significant progress we've made with the Ameritrade integration; the success we're having in unlocking the substantial opportunities the combination enables; and our progress and plans around our four strategic priorities, which we're confident will allow us to continue growing with our existing clients and new firms. In my time today, I'll review our solid first quarter financial performance, provide an update on some key factors influencing our near-term story, and share high-level thoughts on the rest of 2024, though recognizing that it's still early in the year, so we won't be sharing updated mathematical illustrations until July. The important point is that we sit here today, one year after the events surrounding the regional banking crisis; we are in a very strong position with nearly all key business and financial indicators improving, in some cases substantially. We've seen meaningful progress back towards our historical pace of organic growth, a continued moderation of client cash realignment activity, with the pace slowing even faster than our expectations. A further reduction in the usage of supplemental borrowing, revenue and earnings have bounced back from the prior quarter with much room to grow throughout this year and beyond. Continued expense discipline, with head count down modestly from year-end and a full 10% lower than last year. A continued increase in our capital levels, both our regulatory levels and those inclusive of AOCI. Back in January, Walt and I both said that 2024 is likely to be somewhat of a transitional year financially, but along with steadily improving results, the bridge from a challenging 2023 to a very promising future. One quarter in, that transition is well underway as our core earnings power is less obscured by near-term headwinds and our long-term financial formula—growth in the client franchise driving scale and improving financials and capital return—re-enters the picture. As Walt mentioned, Q1 has been characterized by a supportive macro backdrop, increased engagement, and solid organic growth, reflected in external benchmarks, such as the S&P 500, as well as key drivers of our performance, including trading activity up 15% from Q4 of 2023, margin balances up 9% sequentially. That constructive foundation paved the way for our financial performance to improve significantly from Q4 with $4.7 billion of revenue driven by a 5% sequential increase in net interest revenue and a record $1.3 billion of asset management and admin fees, an adjusted pretax margin of roughly 41%, up nearly 500 basis points, and adjusted EPS of $0.74, up $0.06 from the prior quarter—a demonstration of the leverage our model provides as the headwinds we've faced begin to abate. Looking at the balance sheet, total assets dropped by 5%, driven by the pay down of parent-level debt and the continuation, albeit at a slower pace, of the client cash realignment activity we've experienced over the past two years. We saw notable reduction in activity from January to March. The overall level of realignment in the quarter was over 80% less than Q1 of 2023. Our capital position continues to strengthen with our consolidated Tier 1 leverage ratio rising to 8.8% and our adjusted Tier 1 leverage ratio, inclusive of AOCI, now at 5.7%, well above the anticipated new well-capitalized standard at our banks well ahead of the earliest anticipated implementation date. Last quarter, we talked about the slowing pace of client cash realignment, but we also shared the expectation of typical seasonal activity to start the year, and that's been the case. While clients engage in the market, the number of newer realigners and the size of realignment events continue to trend lower, bringing us closer to the point where any residual activity among existing clients will be offset by contributions from new accounts, making client cash realignment a story we expect will soon move to the back pages. As we turn from the solid quarter to a very bright future, we expect our net interest margin to expand through 2024 and 2025, approaching 3% by the end of 2025, driven primarily by the pay down of supplemental borrowing. The actual pace of paying off that borrowing will depend on the level of deposit growth and margin balances. Increased margin loans expand both our net interest margin and revenue. We are happy to carry some of these borrowings at roughly 5% to support lending activity generating closer to 8%. On the expense side, we maintain spending discipline, targeting flattish expenses year-over-year. Even as we grow accounts and assets, average head count dropped roughly 3% from Q4 and is down nearly 10% year-over-year. The ultimate path of expenses will depend on volume-related factors such as trading and equity market valuations, which correspond to revenue. We expect strong revenue and earnings growth with an exit velocity in Q4 substantially higher than where we are today and the potential for continued sequential growth in 2025 and beyond. One final point: the long-term NIM expectation communicated is based on the dot plot forecast, anticipating interest rates to decrease over the coming years. If rates stay higher for longer, it's good for our business. A continuation of higher rates means higher yields on the floating assets, margin loans, and pledged asset lines, allowing us more time to capitalize on higher rates once we resume investment activity after debt paydown. If we don't see 150 basis points of easing by the end of 2025, our net interest margin could exceed 3%. Despite long-term rates moving higher, our capital ratios have continued to grow with our banks now all above the well-capitalized level, even with AOCI included. We expect our consolidated adjusted Tier 1 leverage ratio to reach the upper 6% range by the end of 2024, at which point we'll consider potential options for resuming capital return. This paves the way for a return to our long-term financial formula, combining our position as the premier asset gatherer in our industry with a track record of consistent 5% to 7% organic growth, industry-leading client loyalty, a leadership position in the fastest-growing segments within wealth management, and significant opportunities. Our diversified revenue model allows us to convert asset growth into revenue growth from net interest revenue, asset management fees, and trading. Over the next several years, a major tailwind will be NIM expansion, alongside disciplined expense management highlighting our low-cost structure, a significant competitive advantage, and a scalable business that enables margin expansion and investments for growth while combining strong organic and revenue growth with meaningful capital return as capital levels rise. This formula has worked in the past and remains relevant today. With that, I'll turn it over to Jeff to facilitate our Q&A.

Operator, can you please check the queue and see if we have any questions?

Our first question comes from Ken Worthington with JPMorgan.

You paid down $2.4 billion of Federal Home Loan Bank borrowing, $9.1 billion of CDs this quarter, so $11.5 billion in total. Is this the pace of borrowing pay down that you would expect for the next couple of quarters? To what extent are the higher markets and greater asset levels, and the solid volume helping to boost the pace of payback versus your initial expectations?

Yes, Ken. Our priority is to pay down the supplemental borrowings, both CDs and the FHLB, as quickly as possible. The pace of paying that down is driven by both the levels of transactional cash and the mix of that cash between the bank and broker-dealer. We'll do it as quickly as we can. If we see more contributions from new accounts and deposit growth, that will accelerate the paydown. When markets are higher, we typically see clients more likely to change their asset allocation towards equities, which can negatively affect cash. However, clients are more engaged and likely to add to their accounts with funds from outside Schwab, supporting our position.

Our next question is from Steven Chubak with Wolfe Research.

I wanted to ask a question on the sweep cash growth algorithm. Given sorting is in the late innings, the second derivative on sweep cash is steadily improving. Could you speak to the proportion of new cash dollars being deployed into money market versus bank sweep and how that informs expectations for when sweep deposits could stabilize and inflect positively?

Yes. For new accounts, they tend to mirror the existing accounts over time, initially coming in with heavier cash portions. However, we see some new accounts realigning before bringing that money to Schwab. This last quarter, we saw that transferred accounts had a higher portion of net new assets than last year, indicating we're winning business from competitors. As our existing clients realignment moderates, we expect it to be offset by contributions from new accounts, leading to a resumption of deposit growth over time.

Our next question comes from Alex Blostein with Goldman Sachs.

Could you expand more on the capital return priorities as you make your way back to higher capital ratios? Would the preference be for a larger buyback, similar to what we saw in the past, or something else?

Certainly. Capital return remains a crucial part of our financial formula. We've paused buybacks to grow into our expected new capital requirements. Our forecast anticipates capital levels growing to those excluding AOCI previously. Once that happens, we'll consider options for returning capital to stockholders. We look at our dividend, common buybacks, and preferred redemptions, considering the overall landscape, including interest rates and the amount of supplemental borrowing we have. Capital return is essential for us.

Hi, operator. We have a few questions that have trickled in over the course of the day on the console here, so maybe let's insert one. This one is for Walt. Could you spend a minute talking about the role of AI in Schwab's go-forward strategy?

You're right. There's tremendous hype around AI, but we believe it has long-term potential for us in serving our client segments. AI can impact service efficiency and enhance digital experiences. We believe the combination of AI and human interaction will deliver the best results for clients. We've been active in using AI for security and fraud detection for years, and we are constantly working to stay ahead as it is also leveraged by bad actors. We see significant opportunities for productivity and efficiency improvements, like providing real-time knowledge support for all of our reps, closing the experience gap. Generative AI will take time to mature. It will require collaboration with regulators to ensure we deliver without bias. AI is a big opportunity to delight clients.

Our next question comes from Brennan Hawken with UBS.

Given that today is April 15 and we have our taxes due, could you give us an update around the trends you've seen regarding tax payments month-to-date and how this tax season compares with prior seasons?

Sure, Brennan. We're not through tax season yet, but it appears to be proceeding consistent with expectations. It closely resembles tax seasons prior to '22 and '23, with more of our clients' cash held in money funds. Many tax payments are made through redemptions of these funds, not surprisingly.

Our next question comes from Devin Ryan with Citizens JMP.

You guys have about $350 billion more in money market balances today compared to the beginning of 2022 when the Fed policy shifted. If interest rates drop from here, how sticky are those balances? Do you think outflows from money market funds will be a net opportunity for Schwab?

Yes, I want to split this into two pieces. You're correct; money fund balances are significantly higher than last few years. If money flows out, it depends on where they go. If they move into equities or mutual funds, it depends on the vehicle. If funds go to our balance sheet, it’s positive for revenue. If interest rates fall modestly under 100 basis points, we will see some shift to bank sweep and broker-dealer cash solutions from money funds over time, but not immediately. More dramatic impacts will occur if rates return to those of 2020 and 2021, which could lead to significant reductions in cash in these funds and from there into transactional cash, providing dry powder that could mitigate potential revenue impacts.

I'm going to push out one more of those console questions here. This one is for Rick. It was great to see interest from the Ameritrade side in terms of enrollments in Schwab Wealth Advisory. Could you share more about what other advice solutions they're gravitating towards?

Before diving into specific wealth solutions, I want to comment on integration. We've gone through four transition weekends successfully, with our fifth coming shortly. The operational standpoints have gone exceptionally well. As Walt mentioned, the more time Ameritrade clients spend at Schwab, the happier they become, reflected in their expanding Client Promoter Scores. We are now in the exciting part where we introduce the combined capabilities to both sets of clients. We saw a doubling of Schwab clients using thinkorswim in Q1. Our wealth platform is strong, and we've introduced Ameritrade clients to our offerings through a holistic approach. Ninety-seven percent of legacy Ameritrade financial consultants opened forms of wealth or advice solutions in Q1. Majority of assets are going towards full-service wealth solutions, especially Schwab Wealth Advisory and Schwab Advisor Network, enabling RIAs for our clients. They are also engaging with Schwab Personalized Indexing and Wasmer Schroeder, demonstrating the powerful combination we anticipated.

Our next question comes from Brian Bedell with Deutsche Bank.

Maybe back on the balance sheet, Peter, in relation to tax season. Assuming we would see balance sheet contraction in April due to tax season, can you discuss client behavior in investing in assets and the trend from money market funds versus transactional cash? How confident are you that earning assets could rebuild throughout the year back to Q1 levels?

Without making predictions around where we'll end the year, the actual pace of deposit growth depends on various factors that are hard to anticipate—interest rates, investor sentiment, new account formation, and cash contributions from new accounts. Clients tend to buy equities in strong market periods, but engagement increases overall. When they are more engaged in the investing process, we tend to win business. That's why we've seen strong account transfers this quarter, and we hope that continues.

Our next question comes from Bill Katz with TD Cowen.

Peter, coming back to expense guides, Q1 tends to be seasonally strong due to FICA and payroll increases. The annualized out is over $11 billion. How should we consider the full-year bogey and incremental margins on revenues?

Bill, we'll provide an updated expense outlook in our July update. We're targeting flattish expense growth, having been disciplined with hiring. Cost discipline is our focus, and we expect to capture remaining synergies from the Ameritrade integration by the year's end. We'll maintain a flattish level of expenses for the full year.

Another question from the console here, this one from Chris Ryan at Barclays. Walt, could you start with this one? There are competitors with attractive deposit matches driving cash inflows. Is this worth a competitive response for Schwab?

Let me first say that the least innovative thing any company can do in our industry is buy business by offering cash. This is a strategy some firms employ, but it is not a sustainable strategy. There have been rare circumstances where we've responded to offers for certain clients. When we do, we've retained clients we valued for about 15% of what competitors might offer. Some clients have moved assets but have no intention of trading; they often intend to bring them back once the holding period expires. We watch this closely, but it is not an innovative or sustainable strategy. Growth comes from delighting clients and offering no trade-offs. We are optimistic about our future with this approach.

Our next question is from Kyle Voigt with KBW.

Given steady progress on supplemental funding pay down, could you provide insight on the ideal structure of the securities portfolio regarding fixed/float mix and duration over the medium term.

We are still assessing this. We will likely be in a position to resume reinvestment, but I would characterize balance sheet changes as evolutionary rather than revolutionary. We will manage the size and duration of our available-for-sale portfolio carefully. While overall changes are TBD, steps will be taken to ensure proper management.

It looks like we have time for one last question. Given the continued interest, let's take one from the console. Walt, you could start off with the general approach clients are taking regarding their cash and the evolution of those realignment trends recently.

The supplemental metrics tell a significant story: client cash realigning is largely a 2022 and early 2023 narrative. Over the last six months, balance sheet cash decreased by $8 billion, while adjusted large-cap stock purchases increased by $25 billion. The concept of realigning has played out. We proactively encouraged clients to move non-transactional cash to higher-yielding assets early, resulting in a successful transition. Currently, the realigning narrative is not a noteworthy aspect of our story. Additionally, there were past periods where attempts were made to correlate growth in purchase money funds to client cash realigning, but Peter emphasized that they were not correlated. Cash went down $8 billion while purchase money funds rose $80 billion. The story of client cash realigning has played out.

Great, Walt. I'll turn it over to Peter to close this up.

Thank you, Jeff, and Rick, and Walt, and thank you all for joining us and hearing our thoughts on the state of our business and the opportunities ahead of us. We're grateful for the momentum we're building and the progress we're making on the integration of Ameritrade, unlocking the potential of the combined firm, the resumption of our historical organic growth rate, and unlocking that core earnings power. We are aware of the work ahead, but excited about the future and looking forward to sharing more at our Investor Day next month. I hope to see many of you there. Thanks, everyone.

Thank you. That does conclude today's conference. Thank you all for participating. You may disconnect at this time.