Charles Schwab Corp. (SCHW)
Interim Business Update
January 29, 2009 11:00 am ET
Rich Fowler – Investor Relations
Walter Bettinger – Chief Executive Officer
Joe Martinetto – Chief Financial OfficerPresentation
Good morning everyone. This is Rich Fowler, Schwab Investor Relations, and with me here today are Walt Bettinger, our Chief Executive Officer, Joe Martinetto, our Chief Financial Officer and together, we want to welcome you to our first interim business update. We think that’s the best name for us in the time being. As you know, we have traditionally held two analyst’s days or as we call business updates during the course of the year in the spring and the fall.
Over time, as we’ve talked to the investment community, our owners and analysts, we’ve gotten feedback that folks would appreciate a little more frequent interaction with executive management even if we don’t do an earnings call and so what we have decided to work with, at least initially here, is an interim update in the off quarter. So here we’re doing the winter quarter and we look to potentially doing another call in the summer to help keep everyone up to speed on what’s going on at Schwab and share management’s update and perspectives on what’s going on and hopefully keep the dialog going little more effectively as we go through the year.
So these are designed to keep you guys up to speed with the broader issues that the company is seeing. Obviously, we want to use this as a vehicle for sharing any important information that evolved since the last time we were together. They are not intended to go into, for example, in particular detail with regard to earnings or other more granular things about from the day-to-day lives we live in terms of keeping track of expense lines etc., so we are going to have, as we go through this today, if we can keep the dialog at that higher level. Investors relations is always happy to work with spokes on modeling, on the mechanics of the income statement, in arrears as it were, etc. so any questions along those lines you’ll continue to ask you feed our way and that we keep the questions for Joe and Walt today focused on those broader level issues.
We do hope that you guys find this useful. With this as I said, the first one of these, we’ll expect to continue them so we look for any feedback you’d care to share as we get through the day here and we look to improve of course as time goes on.
Let’s go to the agenda. It’s very straight forward. We don’t have to spend a lot of time on it. What we’re trying to do is spend some time with Walt first and then Joe provides some financial perspectives and then we’ll hold Q&A at the end. Those of you on the webcast, you probably already noticed there is a box at the bottom of the consul for entering questions, and that’s how we’ll take them through that email channel. On the call unfortunately, we’re not able to take questions so again we’ll appreciate feedback on how this works but if you do have questions, you need to use the webcast. Just in case you get bumped off for any reason there is call-in number if you don’t have it already. I’ll read that quickly,
877 467 9653, the conference ID is 816 15399.
So then let’s move on to the ever necessary forward-looking statement language. Again, this is our effort to keep you guys informed on how management thinking is evolving. We are in a classic sort of moving environment here so it’s more important than ever to stay in touch. Things that we’ll talk about today are based on what we can see today. That’s going to change. So as always, please keep in touch. Please keep in touch with our disclosures in order to make sure that we’re all sort of aligned around management thinking.
I gave you the dial-in numbers, so with that, I think we’re ready to turn over to Walt to kick this off.
Thank you very much Rich. Good morning everyone. Thanks for participating in this initial call. Joe and I are excited at the opportunity to spend a few minutes in just recapping 2008 and then sharing some of our thoughts on 2009 and of course look forward to the opportunity to answer the specific questions that you have at the end.
As we look back on 2008, a quick commentary on how the year unfolded from a financial standpoint for the company. Everyone is aware, painfully aware of the equity marked decline during the year with the S&P falling around 40% across. The implications in our company for that given our business model was a fairly dramatic move to cash on the part of clients particularly in our retail business and in our business where we serve independent investment advisors. To cite an example in the investment advisor business, advisors move to claim C&D cash at a rate that ended the year are almost double where they traditionally are, close to 20% of client assets and cash and given our pricing strategy and the approach that we take on cash, we were able to pick up revenue gain as clients moved into these cash positions that helped us to some extent the decline in other asset management fees as a result of market decline.
We also know that interest rates fell throughout the year and we are able to manage spreads fairly effectively down to about a 2% Fed rate and we didn’t get down to 2 and below 2 until later in 2008. However, once we get below a 2% Fed rate, our ability to manage spreads diminishes significantly and in fact, it's an acceleration relative to Fed declines in rates say between the low 4s range from early in the year and 2%. It's not linear and I’m sure Joe will go into that in more detail. So therefore, as you would assume as the year went on we got to the very back half of 2008. We are experiencing significant spread compression.
Also in 2008, we had very strong trading activity, high volatility in the market, days of dramatic up moves as well as, unfortunately, too many down moves, and as a result, we had strong trading and that helped offset revenue declines. And then the course throughout 2008, revenue declines were further helped by our strong organic growth. I think around $113 billion in net new assets during the year working out to about 10% of assets at least as of yearend. We had strong metrics about 900,000 new brokerage accounts, a couple of hundred thousand new bank accounts, 200,000 new full service 401(k) participants.
Our adviser business had a strong year with about $13 billion of net new assets from brokers who decided to move into an independent advisory model and of course that all added up despite a very, very difficult environment to 3% revenue growth and then record operating profits. So that’s the highlight of 2008, but as we transitioned in 2009, I think everyone is aware of what I would call maybe intensifying headwinds for the company's financial results.
So we move forward and look at 2009, the equity market certainly is an uncertain environment. We don’t know how the year will unfold. The early part of the year is very challenging. Many of us looking at the early part of January considered one of the worst in history and of course further equity declines tend to put pressure on our revenue. Interest rates spreads are definitely under duress. It is difficult for us as we sit here today to build scenarios that would have interest rates likely to rise significantly during the year. I think Joe will show some scenarios where we assume that they will remain relatively constant or maybe take off a little bit later in the year, but very few people that we've interacted with have indicated they expect much upward movement in rates during 2009. So that will continue to pressure our spreads.
Trading remains solid. It's definitely moderating a bit from 2008, particularly from the fourth quarter of 2008 which was a very, very active quarter, and so we’ll show some scenarios to you that illustrate differing levels of trading activity. Again, I would say it's fairly difficult for us to project that we would be able to maintain trading in 2009, certainly at the fourth quarter of 2008 rate and may be at the 2008 rate for the entire year.
What’s very encouraging though in 2009 albeit early in the year, is that we're seeing strong client fundamentals. So whether we’re looking at net new assets or accounts, advisors, continuing to be very active in terms of bringing business to Schwab, our 401(k) business off to a strong start. Very encouraging early in 2009 and we think that’s consistent with what consumers are looking for and that is financial services firms that exhibit stability and are very transparent both in terms of the way they interact with clients, but also in terms of their reporting of their financials, the strength of their balance sheet and also something that has been the hallmark of our firm certainly for the last several years and that is the perception of client advocacy. So as we work hard to ensure that each decision we make is measured against its implications for clients and whether it’s something that fundamentally will create benefit for them or is it adjusted decision that's good for the bottom line.
So let’s move in to 2009 and many of you who have attended our prior business updates. You've probably heard me talk about environmental profits and execution profits and of course that’s the way to talk to some extent about things that are within managerial control and things that are outside of managerial control. And as you would expect in 2009, we’re taking a very active role with respect to the things that we believe that we can control and influence to ensure that we not only deliver quality near-term results but that ultimately we keep our primary focus on the long-term health of the franchise, the long-term organic growth opportunities that are before us, and we believed those to be very, very substantial.
So we mentioned here ongoing discipline probably sound a bit like a broken record with that particular comment, but we think that discipline at Schwab is part of our DNA now. It's ingrained in the company. It's part of every conversation and every discussion that we have. It's not unique to the environment we're in. It's something that we look at throughout all times and I would say that the operating discipline that we've demonstrated in recent years helped to put us in a position with 40% or approximately 40% pre-tax margins in 2008 to in fact be prepared for what many would say is potentially the most challenging environment that could exist for Schwab with rates as low as they are and the equity markets at the level that they're at.
In 2009, we also are taking some further steps consistent with our strategy that will yield some expense savings. We highlighted some very broad numbers for you. I believe in December and again Joe will go into some more details, but we want to add a little color as to where we're capturing some of those and one area is with our One Schwab effort around the shared services. Quickly, the concept behind the shared services model is that we have three very, very unique businesses between the 401(k) side, the serving of advisors, and the retail business.
There is certainly some overlap in the 401(k) and IRA side, but three businesses where we've directly serve a unique client and as we serve those unique clients, there are unique service needs, there are unique relationship management needs, technology needs, project investments that all have to be focused on that end client and those are things that we have and will continue to maintain very specific unique dedicated for those particular clients.
At the same time, behind the scenes, there is work that we do that in factor as leverage opportunity, whether it's in the operational side or some of the production side, for example, statement generation, things of that nature and it just makes sense for us in those areas that do not directly interact with the client that we take advantage of leverage opportunities and look to operate more efficiently. So we brought together under two shared services units many of those functions that don’t add direct incremental value or unique value for those end clients. That’s one example.
The second example is that we’ve chosen, given the environment, to accelerate some efforts that were designed and are designed to yield long-term savings. Go ahead and accelerate those in 2009 taking advantage of the environment that we're in to generate lower long-term expenses. An example of that is we are going to move forward. Some of our efforts around the real estate or we may have talked about in the past with you our geographic strategy, consolidating operations, operating under a leaner, more efficient footprint. One example here in headquarters in San Francisco. Today, we’re in four different buildings. By the end of 2009, we will be in two buildings and we'll have a much higher occupancy rate as we consolidate from four down to two. So we’ll be doing some things there.
I think what’s extremely important when we talk about operating discipline is that operating discipline is not just about expenses and expense management, it’s also about the things that you choose not to cut into during challenging times. It’s critical in my mind apart of operating discipline as the things that you decide to stop doing or to do more efficiently. And what we wanted to make clear with the last bullet point here on the slide is that there are things that are not on the table, things that in the past maybe had been on the table.
At Schwab, we’re not going to do in this environment. Anything that would degrade the client experience and that’s a broad category, but you can think of it as things like price, remaining competitive with our price in the markets that we compete. The quality of our service as well as the unique service that we provide to each of those different clients is not going to be compromised.
We’re not going to degrade our speed to answer or degrade the dedicated teams that are assigned to our 401(k) or investment advisor clients. Relationship management, not looking to reduce staff that would result in the severing of relationships that have been built within the clients and Schwab employees and of course our ongoing investment in technology and risk management that without capabilities in those areas would also impede our ability to grow.
And then, lastly we’re not looking to put on the table anything that we think would have an impact on our long-term growth so some of the very strategic efforts we’ve discussed with you in the past like innovation design to benefit clients or particular investments that we’re making in the evolving investment advisory space. Our 401(k) business that is building households that will eventually convert over into becoming retail clients where we reached about 10% of our new retail household acquisition this year and we expect that number to continue to grow investments in Schwab.com, rebuilding our premiere website that is used by millions of our clients. So the long term investments are not on the table, not things that we’re going to cut despite the challenging environment.
So looking now forward into 2009, we just identified here some of those things that will be our strategic priorities. As I mentioned, continuing with our quality of client service and relationships. We’re going to continue to invest in our brand, in communicating what is different about Schwab and some of the firms that we compete with as well as the stability at Schwab. We might make some moderating moves in the level of our spend, but we’re also prepared to make the right level of investment to continue to build that brand and communicate that differentiation. One could argue that this is precisely the time that we should be making ever clearer to possible prospect or for the prospects in possible clients just what make Schwab unique and what makes us different.
We’re going to continue with competitive pricing and innovation. We’re not going to allow our pricing to move away from the competitive marketplace. We think that is a short-term prospective that is not healthy for the franchise long term and we'll continue to make investments in core areas like risk management and technology across the firm.
And then as I indicated lastly, there are certain long-term efforts that we’re involved in which don’t create as much near-term payoff but do create tremendous long-term benefits. I'll give a quick example in late 2008 in December with our focused effort on IRA rollover captured from our 401(k) business. We captured 60% plus IRA rollover capture from our historic Schwab plan 401(k) business in the Schwab retail IRA. So some of those long-term efforts we’re seeing pay off right now.
I recognize that this is just a snapshot in time. Of course, it's based on a very, very difficult environment, but I think what we’re looking at in 2009 is finding that right balance between rewarding our shareholders, our long-term shareholders who are committed to being owners of Schwab stock and at the same time making sure that we are positioned for the future. We’re proud of the place that we are as a company.
We’re proud of the stability of the organization and we think that this is an opportunity for us to continue to organically grow the business and deliver great results not just in 2009, but for many years to come and we’re looking to make the ongoing investments this year that will help ensure that. So I’m extremely optimistic about the company’s position. We recognize it's a tough year. We’re not (inaudible) about the environment and what interest rates are going to do to us here in 2009, but we also know that it's unlikely that interest rates will be between a 0% and 0.25% percent from the Fed standpoint on an indefinite basis so, Rich, with that, let me turn it back over to you.
Thank very much, Walter. We’ll circle back in Q&A in a few minutes. Let's now go to Joe and have him walk us through where the financial picture is getting to.
Alright, thanks Rich and good morning everybody. We can jump right into the financials here. I’m not going to spend a lot of time on the financials page because I’m sure everybody by now has had a chance to digest the earnings release. I did want to make a couple of points though. It’s more context for the rest of the conversation here. As we look at the full year of 2008, the fact that we were able to produce positive revenue growth, I think really speaks to the strength of the business model that we developed here at Schwab. And net income up 10%, EPS up 15%, again, all strong measures in the face of a very challenging market environment.
If we flip over into the fourth quarter, here’s where we start to see some of the market environment impacts begin to take their toll. Revenues were down 5% in the face of asset management fees and net interest income, both being down 16%. We were helped in the fourth quarter by trading revenues up 45%, driven by record darts in the fourth quarter. But again, as we look to the market valuation story and the lower level of interest rates, they’re definitely beginning to take their toll on the revenue stream here.
You also saw us though begin to take some action on the expense front. So, expenses down 5% in the quarter, even including a $25 millions worth of severance charges in that number. Predominantly driven by comp and benefits and professional services, as we’ve started to tighten up on hiring and we’ve got some more updates here in terms of what we’re thinking about on the expense front in a couple of pages.
So, moving on to the sensitivities of what’s being driven here in the environment. When we talked to you in the fall, we had said that we thought we could keep the revenue declines to a single digits kind of number, if the environment didn’t get any worse. And unfortunately, the environment has gotten worse, predominantly on the interest rate front. Market valuations are materially below, but I think when we met in the fall, the Fed had just cut to 1% and it’s now taken me to the step of getting all the way down to 0. That move to a 0 rate is well been eluded to, put some pressure on our net interest income and will definitely compress our net interest margin here. And now, we’re dealing with the potential of having to face some money market fees as well on waivers. So, I’ll quantify that because I know there are a lot of questions about that, and again, on the next page.
Before we move on to get into the details of the financials, I want to make sure everybody understands that not only did we have that strong net new asset growth last year of $113 billion, we’re looking for numbers of similar kinds of magnitude at this point. We’re thinking we can continue to grow in that 8% to 10% range organically, as we move into 2009. So, it’s an important factor, in terms of our thinking, that as long as we continue to be able to generate that kind of client metric, it shapes our thinking about that investment for the future.
So, moving on into the page that I’m sure everybody’s been waiting for, what we’d normally share with you back in the fall and even now we would like to aspire to, would be something that looks like our plan. In the environment that Rich has described as being, “in clearly in flux,” we don’t have a plan that we’re sharing with you in this case. What we have is really an expense budget, and revenue sensitivities.
The revenue sensitivities that we talked to you about in the past still hold true. The 10% (inaudible) market implies about 3% in asset management fees. The net interest income, where we see the compression of 70% to 80% for the 100 basis points, the low 2% is still holding true as well.
So, what we’ve done here is postulated a couple of different market environments. The first one is essentially flat from where we started the year. Now, and the S&P sold off a little bit here in January, but we implied an S&P level of about 900 through the course of the whole year, holding interest rates on the Fed side between 0 and 25 basis points in that environment, we think darts might be down somewhere in the range of about 7% year-over-year.
A more optimistic scenario, but we don’t think overly rosy, would be the S&P up about 20% with a rally in the second half of the year. So, that implies the S&P end of the year around 1100. We think the Fed would use the opportunity of an improving market and start to raise rates again. We’ve got rates rising in the second half of the year and only up to 1.25%. In that environment, we think darts would be essentially flat year-over-year. So, as we think about it, the impact in those two environments, the big question on money market fees, we’re putting a number out there in these two scenarios, but I want to make sure that everybody understands these are very assumption laden estimates. We can’t accurately predict what’s going to on with client behaviors, it’s going to drive balances. There’s assumptions about rates, rate relationships, spread, they’re all inherent in driving the estimates that we’re producing here.
We think it’s important to quantify it because we know there’s a lot of questions out there about the exact magnitude, so we’ve done our best. But, I do want to make sure everybody understands that there’s a lot of assumptions that go into making these numbers work. Even as simple as, in the interest rate environment that we put out here where we hold Fed funds essentially flat, we’ve got some embedded spread tightening at the short end of the curve worked into the model because we think that part of the market remains somewhat dislocated and over time we expect we’ll see some tightening. Now again, not back to the types that we’ve seen in the past few years, but something that is a little tighter than where we are today.
So, in the market environment where rates don’t go up, we’re projecting money market fee waivers could be as big as $200 million on the year. About half of that is driven by the treasury and government funds, but the prime funds also suffer some deterioration in fees as we move into the second half of the year. So, this is an impact that will build over the course of the year and will start to hit more and more funds if rates stay at this kind of a level. So again, inherent in that is the assumption that we’ll see some spread tightening. So, the assets that we’ll be buying, even in the prime funds, will be yielding at levels that won’t allow us to continue to get 100% of our fees from the money market funds.
I also want to stop here and make sure everybody understands how the math works on fee waivers. So, the fact that we’re saying that we’re waiving fees doesn’t mean that we’re that we’re immediately moving to 100% waiver of the fees on a fund. So, for example, in the treasury fund today, the yield on the assets is around 56 basis points. So, we’re giving clients a one-day yield of one basis point. That means that we’ve got three basis points of waiver today. So, as that fund reinvests at these levels, we will see increasingly larger levels of fee waivers that will again over the course of the year increase. And the impact in the first quarter is actually relatively small. It builds over the course of the second quarter and then into the third and fourth quarters in this environment is pretty well fully phased in.
You can see in the other environment where we’ve got rates coming back up to about 1.25, the waiver’s substantially smaller. So, to the extent that we get an opportunity where we can continue to reinvest at slightly better rates, the impact on the money market fee waivers becomes dramatically reduced for us. So, that’s the money fee story, the money market fee story.
Revenues in total in the scenario where market doesn’t improve, interest rates don’t come up we’re looking at a revenue decline of approximately 20%, so you should be able to back into those numbers from the sensitivities that we provided to you. The one gap that I think you would have had would have been the money fee waivers, so that’s why we’re putting that out there explicitly. In the scenario where we get a bit of a rally, we’re talking low double-digits of revenue decline potentially. And again, this is early in the year, somewhat assumption laden, but these are the scenarios that we are seeing at this point in the year.
On the expense management side, when we put the statement out in December about some of the pending work we were doing on the expense side, we talked about reductions of 7% to 8%, but a potential for reinvestment of some of that back into the business. What we’re now telling you is we would expect to be able to deliver that full 7% to 8% to the bottom line and we’re covering any reinvestment inside of the work that we’ve done to reduce expenses. So, the difference in the scenarios between 7% and 8% are very simple to the extent that we have more trades that drive some additional expenses. We’ve also got a little bit of difference in the bonuses that we would expect to pay our people. Otherwise, there is no difference in terms of what we’re doing on the expense management side. At this point, we’re largely teed up on the actions that we’re taking and we’ll have some variances for marginal business activity, but that 7% to 8% is what we expect to fully drop into the bottom line.
You can see what that does to margins and ROE. As Walt had said, when you start the year of course to a 40% margin, even with these kinds of market impacts, still being able to turn in margins of 30% to 35%. So, while clearly these kinds of metrics on the revenue front, declines on the margin, this is never good news. Still, looking to the strength of the business, the earnings capability, the positive story around earnings and the ability to produce strong margins in the face of this kind of a market, does give us some confidence about the strength of the business model.
We would expect one time charges over the course of the first couple of quarters of approximately $100 million as a result of the expense reductions that we’re taking here. So that may be a little bit smaller than people would have expected if the—relatively small percentage of the one year expense reductions. That’s because inside of that number we’re only anticipating employee reductions or further employee reductions of 500 to 600 people. So, we have intentionally in good times built the flexible workforce with contractors and offshore resources that we’re now going to scale back substantially there. It minimizes the amount of employees that we end up reducing, so the charges are actually probably not as big as people might have thought they would have been in the context of this larger than expense save. And on top of the people charges, the next biggest item is we’ll be taking some charges related to real estate, which is why we’re going to have them spread across a couple of quarters. We can’t get everybody moved to all the locations to be able to get the expenses on the real estate side into the first quarter.
I’m intentionally not calling this a restructuring charge because I just want to make sure people understand we’re going to just take this through the income statement. We’ll provide visibility in our disclosures around it, but we’re not going to go a GAAP non-GAAP kind of reporting around this. We’re just going to roll it through and report on a GAAP basis and let the charges run through.
On the credit front, and in capital management as well, the first couple of bullet points here, there’s really not a whole lot to talk about. I think we’re slaves to consistency and especially when it’s good news. There’s no subprime (inaudible) there’s no CDO exposure in our direct portfolios and we haven’t gone out and bought any of those assets here in the last quarter. The bank portfolio on the lending side continues to perform extraordinarily well. You can see the metrics here, but there’s really not a whole lot there to talk about even with the growth in the asset portfolio that we’ve seen.
I know most of you have seen the comments that we put in around the all day portfolio in the earnings release and I want to be able to provide a little bit more context here around that as well. When you see the balance sheet when we released the 10-K, you will see that the net losses had grown to around $900 million in the equity accounts, so we haven’t taken impairment charges, but the mark-to-market on the available for sale portfolio that is sitting in the equity account’s going to be up to about $900 million. The concentration in that is predominantly in the all-day securities, so on an amortized cost basis we’ve got around $800 million of all-day backed warranties, backed securities. The market value on that has declined to about $425 million. So, in comparison with the about $600 million number that you probably had in your head from last quarter, we’ve continued to see material declines in the market value of these securities.
I want to remind you of a couple of things, we haven’t bought any of these bonds in the last 2.5 years, so this is now becoming a relatively seasoned portfolio. A chunk of this valuation impact is driven by the lack of liquidity in the market and I think we all know what’s going on with market valuations in general as some of these securities continue to struggle to find buyers when they come to market. But I do also want to make sure that people understand that as watch what is going on, particularly in the face of these kinds of market valuation declines, we’re monitoring the portfolio very carefully and we have continued to see deterioration in the housing market in general. To the extent that that continues, we may ultimately see some charges flow through, particularly out of this part of the portfolio. We can’t quantify that. To the extent that we had a number that we could put out there, we would have already been taking the charges. So, I’m sure we’re going to get questions about, “Can you help us box this further?” The answer right now is no. If we had certainty, we’d be taking charges. We just want to make sure that everybody understands that the part of the portfolio we’re watching pretty carefully.
On a more positive note, we continue to build capital, we continue to build liquidity, as we’ve moved through this part of the cycle. The parent company is now sitting on over $900 million of cash. Our operating subsidiaries are well capitalized. They’re all liquid. As I said a little bit earlier, the lower revenue picture is never really a good story for the CFO to be telling and we understand that. But I do want to make sure people understand that we’ve remained healthy. Our cash levels are high, our capital levels are high, our margins are remaining in numbers that a few years ago we would have strived to achieve. We’re delivering those kinds of margins without cutting into the kinds of things that run the risk of damaging the trajectory of our client engagement. And we think that’s really important to reemphasize with everybody, particularly at this point in the cycle. Also, for those of you have seen us demonstrate the financial leverage in the business model, to the extent that we’re reducing expenses even further from where we’ve been running in the face of the transitory factors to the extent that we start to see interest rates come back up, we expect that we are going to be able to redouble those efforts on demonstrating that leverage going forward.
So, we remain optimistic in the face of some tough market environments, but as long as we continue to see that that strong client core group behavior, we think we’re on the right path here. I’ll turn it back to Rich, whoever!
Okay, alright. So let’s launch right into the Q&A. We’ve had them coming in as you guys have been talking, so thank you all for the questions and we’ll work to plow through these. Joe, I’m going to send a bunch of these first ones to you just to kind of revisit some of the things you walked through and make sure we clarify where folks weren’t sure they caught it. So, the first one we’ve got is the starting level for the S&P that’s implicit in those comments, is in fact year end 2008. Is that right?
Roughly around 900.
So we’re about 4% off of that at this point, although we might be a little worse given where it was heading this morning.
Okay. So then the next one I’ve got is in the flat case where we have the $200 million impact on the fee waivers. Does that include the assumption that we’re maximizing our investment in non-treasuries for example, in the treasury fund to get to the highest GO possible before any waiver, etc?
Rich, it does include assumptions around investments in the individual portfolios. It doesn’t include any actions we might take subsequently, in terms of how we build and design product or what we might do to try to encourage certain kinds of client behaviors. So, yes it does factor in things like moving the treasury fund to 20% agents.
In that basket? Okay. Alright. Here’s another question relating to the treasury money fund. Have we seen clients starting to move cash out of the treasury fund in January?
No. We did peak at about $34 billion in the net fund. We’re down to little over $30 billion now. I’d say that the client has flowed some here of late. We’ve been pretty steady around that $30 billion number for a period of time.
Okay. And maybe the last one before we get to Walt, this is I think more theoretical, but we did get a question about our thinking around potential legislation around the structure of money market funds going forward. How would we react if capital requirements start getting into the picture, etc? Would we be willing to put capital up or would we let the NAV fluctuate? How are we thinking about that at this point?
I think it’s way too early to provide a detailed answer to that. I’m looking at Walt to please jump in if you’ve got a different opinion here. And that was a very general kind of statement that the G30 made. I think there’s a whole lot that we’d have to understand about the details of what they would actually be proposing. We’ve been a very disciplined firm around capital management and we’d want to make sure that we were able to earn adequate returns if we did choose to put capital up. There’s also implications for the competitive environment and how—what will be the nature of cash products for clients going forward if those kinds of regulations end up getting put forward. I think what I can say affirmatively is, we’re going to maintain our competitive position on all aspects of the client value proposition. And if that implies that we have to make changes on the cash product front to do that, so be it, we will.
Okay. Alright. Walt, we shift to you for some of these now.
Rich, that answer was so good by general, you should just ask him all those questions!
I couldn’t agree more, Joe. That we’re going to maintain our competitive position. Markets change, markets evolve, client preferences change, regulatory environments change, but we will remain competitive throughout.
Okay. Alright. So, let’s turn to some other subjects here. Any change in the nature of where we’re getting our new client accounts or asset transfers from? What’s the competitive picture looking like as this environment unfolds?
Well, it has evolved a bit. We have seen an increase in transfer of assets from some of the full service brokerage firms to Schwab. We’ve also seen an improvement in our competitive position relative to some of the more web based or discount brokerage firms also. Where we have seen some pressure a bit that counterbalances some of that is client’s chasing yield with respect to some banking or recently designated banking institutions who are paying very, very high yields due to their desire to capture cash.
Okay. Next one, in terms as though we might be considering some price cuts based on what you had said earlier, is that in fact what we’re thinking and does the competitive environment demand lower pricing in certain areas? How do we think about all that?
I think the point I was trying to make is that we’re not going to allow ourselves to become uncompetitive as a means of trying to make short term financial results. And so we’re not, as I’ve said many times in the past, we’re not anticipating leading a movement down on web equity commissions. At the same time, as we’ve made clear for a number of years, with both our words and actions, we’re also not going to allow ourselves to get behind others from a competitive standpoint. The areas where we look today and will always look at, at pricing is if we have isolated places in the firm where we’re not competitive with the marketplace because we’re committed to being competitively priced with every product and service that we offer.
Okay. Maybe for both you guys, I know actually we’ve gotten these questions too, so-
Yeah, we’re failing on a daily basis. So, if you guys could come in and clean up after us please! What, if anything, are we doing to move clients away from lower yielding money market funds and how do we think about that process? What sorts of concerns do we have? What are we worried about? Um, or how do we think about any overt effort to move those choices?
I think what we want to make sure is that clients are aware of the choices that are available to them. Differing clients have different liquidity needs. They have different desires for their cash. Cash falls into many buckets. There’s short term cash I’m going to need tomorrow. There’s interim term cash often considered savings. And there’s long term cash as part of a strategic asset allocation. What we always try to do is make sure that the client is in the right product depending on what their goals are for their cash and their needs. And I think with the breadth of cash products we have from funds to banking and balance sheet to our CD-OneSource Program, I think you can purchase treasuries directly through Schwab without any fee. We have a fairly robust cash offering and we’re continuing to look at additions and supplements to that that we want to make given the evolving environment.
Okay. Okay, Joe, again some clarifying points. I think folks are interested in hearing about from you. How do you feel about the allowance on the mortgage side, given the unprecedented macro environment that we’re seeing, broader trends. Do we feel like we’re doing enough there?
Yeah. We absolutely feel like we’re doing enough there in the context of the credit that we’ve seen in the portfolio. So, that’s something we look at very carefully. We’ve continued over the course of the last year to ramp up some our analytics. We’ve brought in some new models to help us make sure that we’re assessing this carefully. But, every slice we take at that, we remain comfortable with the credit parameters and reserves that we’ve got in place against it.
And this continues to be a portfolio that largely consists of loans to existing clients. Isn’t that right?
That’s right. And again, as we do our various internal stratifications, and you have to take this with all the various caveats attached to it. The single biggest factor that we can identify among the pool of mortgages that we own on our balance sheet is whether they’ve got investable assets or not. So, clients that have a substantial investable asset pool tend to have a significantly better credit profile than those who haven’t gotten in the habit of saving that money. I can say that is the biggest determining factor in the portfolio that we hold. I think that also reinforces everybody we’ve cut off an awful lot of the tails of the distribution by not doing subprime lending, not doing low doc lending, not having a lot of the kinds of other factors that would have allowed people to get in trouble. But, you know, the plain good old mortgage portfolio that was pretty carefully originated at the start, then when you start looking through that for the drivers, it factors down to assets. But, that’s largely again because I think we’ve caught a big chunk of the tail of the tails of the distribution off. And that’s a factor why we’re performing so well in this market.
Okay. Walt, maybe we’ll start with you on this and Joe, chime in please. When we think about something like our marketing investment. What would we have to see in terms of decelerating growth or net new asset levels to pull back more meaningfully there? Is there a test we apply or how do we think about managing that investment?
We’ve already built into our 2009 plan a certain degree of reduction in our marketing and advertising spend. At the same time, we’ve built in some contingency in our plan, that if in fact that rate of client, household, and asset acquisition continues strong or even accelerates, that we could ramp that marketing advertising spend back up. So, we’ve already built some reduction in. We’re actually looking for what I would consider more likely the opposite, and that is whether we should accelerate back to a level that would closer to the 2008 spend, depending on the environment.
I’d reassure people being the number’s guided. We’ve got some very complex models around how we estimate what’s going to happen when we invest in marketing. We’ve got very rigorous measuring capabilities to make sure that we’re seeing the results delivered on the backend. So, the combination of being able to make good predictions around what’s the value of the dollar we’re spending and measuring whether we actually getting that value delivered in the (inaudible) cycle that we’re in the process of monitoring here. So, as long as we continue to believe marketing is effectively delivering those new clients, we’ll continue to make appropriate investment in marketing.
Alright. Okay, I the think that’s an important point and it dogtails with this next question. And Joe, I think, will start with you and I’ll give you (inaudible). Looking at the cases that we laid out there, we’re talking about cutting upwards of 250 million in expenses, the revenue decline could be substantially north, but then again depending on the environment. So, why is there not more cost reduction opportunity and is this the initial cut on expenses that could be expanded? So how do we think about putting that stake in the ground?
Joseph R. Martinetto
So this is a balancing act. And I think we talked about the trade-offs over the course of the last couple of years. The biggest driver for us is making sure that we’re maintaining an appropriate level of client service and appropriate level of value with our clients. And that we’ve made a mistake in the past of cutting too deep into some of those kinds of things. I remind people that even what the kinds of revenue declines were talking about with these kinds of expense cut was still talking about producing margins north of 30%. So, in the combination of believing that we got a core franchise that’s healthy, the market environment factors that are leading to these kinds of revenue pressures are largely transitory and it’s transitory in the nature of it’s name. We make interest rate low for a year, but we don’t believe we’re going to see interest rates low for multiple years at least not at these kinds of levels. So trying to preserve the core of our ability to serve our client becomes important. I would say in the background we’ve gone through the deep and the non-client basing functions. And from here we’re going to have to look at other changes to the business model that are less appealing for us to consider. So as we think about those trade-offs, this is where we’ve landed at this point.
A lot of point.
Joseph R. Martinetto
Add to that?
Walter W. Bettinger
I think you’ve summarized it well. We’re taking a balanced approach to the near term in the long term and we’re simply not going to allow ourselves to become uncompetitive with whether it’s pricing or quality of service. There is strong momentum in the business. That strong momentum continues here and the early days of 2009 and we think it would be an inappropriate trade-off to risk that for some near term revenue that we might get to generate by increasing price or adding fees to client accounts or carving service quality back to the point that we risked higher (inaudible).
Alright. Okay. Okay, we’re getting some questions about capital management here some of a kind of lump these together. Any implications for the dividend at this point in all of these moving pieces? How do we think about dividend policy at this point and then maybe to take another step on that front? What do we think about repurchases in this environment or going forward and incremental capital needs through the bank or elsewhere, again what do we expect on that front? So maybe, Joe you can start this off.
Sure, so I had said at this point we’re comfortable with our dividend. And we met with our Board this week and declare our dividend share for the first quarter. So I don’t see any material changes this dividend policy going forward here. And the capital management continues to be a bit of a tactical issue for us that the numbers that we’ve shared with you don’t incorporate any repurchases or capital management activities for the remainder of the year. If we got to a point when we started to feel like the market was recovering and some of the factors that we’re monitoring became less of a concern, we could potentially get to a point where we were engaging and share repurchased activity again, but we don’t want to signal that we’re thinking about something that’s going to happen here in the next couple of quarters.
In terms of the bank capital needs at this point, we’re actually thinking, you know the bank is highly profitable and generating capital and excess of what it needs for the core activities of what we’re seeing. Should we get to a point when we develop some kind of product to leave to grow to the bank, it may drive some capital requirements, but I hope we demonstrate it by our actions over the last few years. We’re a capital conscious organization and to the extent that we’re investing capital in any of our subsidiaries. It’s going to be because we believe we can get appropriate returns on that capital overtime.
Okay. Alright, we’re going to bounce around here a little bit. Walt, I will give you the question about how things are going in the RAA business and with the whole advisors turning independent stories. So, any sense of changes there? (Inaudible) building? Is it continuing? How do you think about describing what’s going on there?
Walter W. Bettinger
Momentum remains strong in terms of brokers looking at their alternatives with respect to going independent. I think we reported the 13 billion of net new asset last year and our pipeline continues to grow among advisers considering this option. At the same time as we’ve said it’s a big decision. It’s a decision to become a business owner and an entrepreneur and all the things that go along with that. So, we would expect to continue to have growth from brokers who decide to become independent investment advisors at the same time. We have tried to be balanced in our discussions of that, that we don’t expect that this is some massive transformation in which some huge percentage of brokers to decide to leave full service firms and enter the investment advisory states.
Okay. Another sort of competitive question here in the cash arena, are we seeing any evidence outflows to other competitors particularly as some of those in (inaudible), which might appear to be pricing more aggressively as you alluded to earlier? What is our outlook for the competitive lines getting cash loans?
We certainly have unique circumstance of competing against organizations who are receiving subsidization from tax pay or dollars that probably from the tone in my voice, people can interpret my feelings around that. So, there are competitors that are paying very high yields, chasing client deposits and as in any competitive environment those people to the extent they are willing and able to pay those high yields in the near term, are able to capture some dollars. But I think the big picture is that overall when you net what is going on there against the overall environment, we continue to fair very well in taking share within the investment environment overall. And I would expect for us to have appropriate competitive responses to that circumstance if it continues longer term, which in fact it may. So, whether it is partnering up with some of those people and leveraging their balance sheets or other actions that we’ll take. But believe strongly that you have the client trust, you have a relationship with the client and they are confident in your level of service, we can fill-in product gaps. But if you don’t have the trust and the relationship in the service, the best products in the world are no long term strategy.
Okay. Alright, so a few more mechanical things, Joe. Maybe just to make sure we have the opportunity with everybody gathered together as it were to just clarify some things. The 500 to 600 job cuts we’re talking about, are those going to be spread over the course of the first half or is that a first quarter event? How would we describe that? And then, let me sort of add to that, the severance that we’re talking about, how quickly would we expect to recognize the charges that we’re expecting?
Joseph R. Martinetto
Yes, the 500 to 600 people is a first quarter event and we would expect that people charges the predominantly concentrate in the first quarter. The charges in total that I was talking about will probably spread over a couple of quarters. The people charges would come faster than the real estate charges, that’s going to take again a little while to get configured in it. People out there know you can’t right off real estate if you’re occupying it. So you actually have to be physically moved. It takes a little while to get all of that logistic that we put through our goals to try to get the majority of the charges related to the reductions and the restructuring work into the first couple of quarters.
Walter W. Bettinger
What I might just want to add to that is that in every quarter for the last, I believe, eight quarters, we’ve had some reductions in staff as we made certain parts of the company smaller and reinvested in other parts of the company that we thought was more strategic and more critical for long term growth. So, when we identify the 500 to 600 employees in the first quarter, we don’t want that to sound like therefore beginning April 1st and forward, there will never have any reductions in staff because we with almost certainty, it will. Okay, with clarification?
Okay, and actually another seven year (inaudible). I always heard anyway, we did get the question around. When we think about any assessment, consensus etcetera, how are we going to talk to folks about the charges as part of the story? I know we’ve been trying to stick to essentially a net income model as it were for estimate purposes, is that still what we’re thinking here? Is that how we want to coach folks to show their data in first call?
Joseph R. Martinetto
I think that’s how we’re going to have to ask people to do it. The extent that we’re going to stick with GAAP reported and run this stuff through. I think that’s what we would ask people to put their own estimates.
Okay. Great. Here we have a commenting that what do we think about an environment? How is our thinking applied to an environment where we see further declined in the equity markets like a 20% down scenario essentially for the S&P? We’re again potentially strong regards, similarly potentially strong in that new asset? How do we think about adjusting our activities then?
Joseph R. Martinetto
I would say it’s early in the year. So, we have taken the steps that we’re taking at this point. And we’ll continue to watch the market of alls. That the market continues to deteriorate, we’ll evaluate where we stand and take appropriate action at that point in time, but it’s too early to say the exact steps that we would take it, that’s where we safe.
A couple more things about the business. Go ahead. Sure.
Joseph R. Martinetto
Simply because we did not show that there’s an area this morning doesn’t mean that we don’t look at that and do planning around that scenario. If you have that scenario of a further 20% reduction to market, I think the question said something about a 20% reduction in (inaudible) and no net new assets, well then, you have fundamental change under that extraordinarily dramatics in area, in terms of probably client engagement, new account opening, trade, I mean, trade volume, of course cause you said 20% down, so your need for servicing. You’re describing a scenario with that question that would be a fundamentally different approach that we’ve had to take around the management, the operations and the client facing side of the company.
There’s a simple one. How the new credit card offering being received?
Walter W. Bettinger
The new credit card offering is capturing quite strong response. I think we had something like a 2% response rate to some early mailings, which I believed for credit card mailing is quite high. It’s almost exclusively as we desire the existing clients. And I just would remind everyone that we are not taking any credit risk with that particular product. The credit risk resides with our partner. We’re simply paid a part of a piece of the charges and have the opportunity for clients to pull our brand out of their wallet 300 or 400 times a year.
We got time for just a couple more. Joe, one tactical question. Folks have noticed that they ask about securities holdings in recent period. So could you talk a little about the thinking there?
Yes. The balance of the recent deposits of the bank continue to rise, so to the extent that we’re gathering client cash, that money is going to get invested somewhere. The bulk of the investment activities has been agencies, so at the high end of the credit part of the market. We also have to keep it all in cash that there’s revenue implications to doing that. There’s risk implications to doing that. So, to the extent that we’re trying to strike a balance on risk, we have ventured back into the agency part of the market with our investments.
Okay. I got a minute. Thank you so much. Just a little bit here. I’m trying to keep folks mostly on schedule. Walt, I’m going to ask you to use this, a kind of wrapping this up. There was a question around, you know, the positive trend in asset close that we’ve been seeing and the likelihood of that getting better as the other models struggle. The only threat that this individual could think of is damage to the brand, and the question is what do you see is the biggest threat to our ability to continue to gather and retaining client assets?
Walter W. Bettinger
There’s the saying about if you don’t learn from history you may be destined to repeat it. And so I would draw down that saying that the greatest threat we believe to our long term organic growth is that we may compromises in the pursuit of a short term result that degrade the quality of our client experience. And I define that client experience, probably said did early around pricing, service, dedicated relationships, quality of our technology, a risk management. So, those are things that we can back to basics. We are committed to getting the basics right, serving our clients well, being their advocate. And by doing those things we think that our long term growth were exceptionally well-positioned. And that our financial results due to the tremendous leverage in our model as these headwinds at some point in time begin to diminish a bit, will once again be exposed.
Okay. We’re out of time, I think. So, we were to wrap up out now. Any final comments from anybody?
Joseph R. Martinetto
Yes, I think Walter did a great job wrapping up. I would just thank everybody again for their attendance and interest in the company. While we’re interested in it’s feedback so to the extent that you can provide us with your input on how this work for you, that would be great. We’ll factor into our thinking about how we do this then in subsequent quarters.
Right and we will. Michael, start sending out the slides as soon as we get back downstairs. For those of you interested with the notes, please send it back to Investor Relations and we look to get back together again in three months. Thanks everybody and have a great day.
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