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The Charles Schwab Corporation (SCHW)

April 25, 2013 11:00 am ET

Executives

Richard Fowler

Joseph R. Martinetto - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Walter W. Bettinger - Chief Executive Officer, President, Director and Member of Policy Committee

Analysts

Richard H. Repetto - Sandler O'Neill + Partners, L.P., Research Division

Brian Bedell - ISI Group Inc., Research Division

William R. Katz - Citigroup Inc, Research Division

Howard Chen - Crédit Suisse AG, Research Division

Alexander Blostein - Goldman Sachs Group Inc., Research Division

J. Jeffrey Hopson - Stifel, Nicolaus & Co., Inc., Research Division

Richard Fowler

And we are live. Good morning, everyone, welcome to the Spring 2013 Schwab Business Update. This is Rich Fowler, Head of Investor Relations for Schwab, coming to you once again from beautiful San Francisco on yet another top-down day.

Thanks, as always, for joining us. We know it is still earnings season and that folks in financial services also continue to cope with an ongoing stream of challenges. We also wanted to acknowledge our friends in Boston as their city continues its recovery with truly inspiring determination.

With me here today are Joe Martinetto, our Chief Financial Officer; and Walt Bettinger, our President and CEO.

Per our usual practice for these interim business updates, we'll spend a focused hour with Walt and Joe, sharing their perspectives on life at Schwab right now, starting off with some prepared comments and then Q&A until it's time to wrap up.

Joe's going to start us off again but let's spend a minute on the forward-looking statement page, the main point of which is to remind everyone that outcomes can differ from expectations, so please keep an eye on our evolving disclosures. And then let's cover how we'll take some questions. Once again, we'll do so via the webcast console and by the dial-in as well. You don't already have that, the dial-in is (800) 871-6752. The conference ID is 10769792. When we start the Q&A session, we'll ask the operator to remind us how the process works.

So we have the administrative stuff out of the way. We have our 2 best-in-class business leaders ready. We're audible to the outside world. So Joe, over to you.

Joseph R. Martinetto

Great. Thanks, Rich. So I never enjoy these phone calls as much as I do because -- I forgot to push the button. There you go.

So I never enjoy these phone calls, maybe it's because I can't work technologically as much as I do the live presentations, I thought maybe it's because I don't get to see everybody's smiling face but I dug a little deeper and I think it's probably because I have this great fear that, when you're out there on the phone, I can't actually see when I've said something that sends you all scrambling to type a note and sends the stock price moving. So I will attempt to be complete in my comments to see if we can't head off any of those kinds of events today.

In February, just walking back to the last time we were all together, we talked about stepping up our spending on client-related investments. At the same time, we also said that if the environment weakened, we were in a position to manage our expenses to deliver on results that would be consistent with the baseline scenario that we shared with you at that point. Given what we've experienced in trading and the interest rate environment, we've made a number of adjustments to our expenses to ensure that we'll be able to demonstrate the financial leverage in our business model for the remainder of 2013.

Even having trimmed our spending plans, we're still making significant investments and, over the course of the past few years, we've closed the gap between the more severe reductions we enacted during the worst of the financial crisis and more normal levels of spending. That means you should expect to see a widening of the gap between revenue growth and expense growth going forward, with more of our success at driving revenue growth falling to the bottom line.

So why have we been talking about spending more aggressively? Because we saw and continue to see an opportunity to drive growth, and it's hard to argue with the results. We put up some of the strongest net new asset numbers in the history of the company, bringing in $91 billion of core net new assets in the last half year. Clearly, we're winning in the competitive environment.

Even in the face of a weak trading environment and an interest rate environment that softened over the course of the quarter, we managed to turn the growth in client assets into an 8.5% increase in revenues. Asset management and net interest revenues were able to more than offset the softness that we saw in the trading line, which was down year-over-year. Asset management continues -- the asset management fees continue to be a bright spot. Net enrollments of $4.7 billion in advice solutions in Q1 was up more than 70% over Q1 of last year.

Finally, if we look quarter-over-quarter, all 3 of our major revenue lines contributed to sequential growth.

While we've been talking about ramping spending aggressively, expenses were up a little bit more than we would have liked in Q1. Compensation expenses, in particular, were impacted by a number of factors. Some of these factors included the transition from a trailer-type plan to a pay-as-you-go plan for our financial consultants, that led to elevated incentive pay, which should work down over the course of the year if those trailers are all paid out.

We've also been transitioning to an HSA-type medical plan and the adoption was much stronger than we thought it was going to be. That led to a bigger upfront contribution to the HSA accounts for our employees than we anticipated. Again, this will not repeat for the remainder of this year but if you're thinking about models into coming years, this may be a seasonal factor in Q1 that does stay with us.

We saw changes in our -- in retirement provisions and some of our restricted stock and option agreements, which covered all of our employees and we had to adjust our accruals to true up with those new provisions. Again, this will not repeat as we move forward.

Finally, net sales were up, especially in advice products and mortgages, which led to elevated compensation. Now this one I'd be happy to explain going forward because, to the extent that it continues to occur, we're going to also be generating revenue off of those products. So the ongoing revenue story would be a positive for us.

Moving on to some of the other expense lines. Margin was in line with the ramp-up plan that we talked about and was helping to drive some of the accelerated acquisition numbers that we were able to put up. Other expense lines remained well-managed and, even with the big increase in compensation, net income was up 6% over the prior year.

Moving on to the balance sheet, we saw growth there slow from the rapid pace in Q4 as clients who brought in cash in Q4 deployed that money into the market. We've seen some further reductions in cash levels here in April related to client cash payments.

Bank deposits were up in the quarter, mainly due to a $1.8 billion bulk transfer from the money funds. There's another approximately $4 billion bulk transfer from the broker-dealer planned for Q3. Even with the growth, the bank has paid a dividend to the parent for the past 2 quarters and we expect that to continue at least through the remainder of the year.

Our capital ratios are shown at the bottom of the slide. The leverage ratio did continue to decline in Q1 as the average asset level caught up with those big inflows that we saw late in the fourth quarter. While our buffer to our internal target is a little bit smaller, we do remain in excess of that internal target and we expect that Q1 will be the low point for the year. Outflows for tax payments as well as incremental earnings should both help push the ratio up from here. And since we're talking about capital, we aren't required to publish our stress test results but, like last year, we ran a number of scenarios including an adverse scenario that was more conservative than the most adverse regulatory scenario. In all cases, we stayed above regulatory minimums without requiring any additional capital raises.

Moving on to the rest of the year. We expect still to be able to grow revenues in high single-digits even with a trade outlook that doesn't call for any lift in the near term. Our outlook for our net interest margin is unchanged, so growth in balances should contribute to growth in revenues and we expect for the remainder of the year to end in mid-140s if rates stay around current levels. We did a little bit better than we'd indicated in Q1 as we took advantage of some of the higher rates in the beginning of the quarter to fill our fixed allocation and slower prepayments and a lower FAS 91 charge also helped to prop up our yields.

With the fixed rate purchases, we extended the duration of the bank investment portfolio modestly. We've been talking about a 2-year target duration for quite a while, so even though the extension's only out to 2.3 years, I wanted to make sure to call it out. But I also want to emphasize the change in the duration doesn't change our risk profile but was in fact necessary to just maintain our interest rate position, given the large inflow of cash that we saw in the fourth quarter. You folks know we don't run a hedge book but we use the investment portfolio to maintain our desired interest rate risk position. The sweep deposits that we brought in, in the fourth quarter have some of the longest duration characteristics on the liability side of our balance sheet and so we needed to let the assets move out a little bit to offset that increasing liability duration. If we hadn't extended, we would've been, in essence, coiling the spring even a little bit more tightly.

Moving on to asset management fees. They continue to be a real bright spot. I earlier mentioned the $4.7 billion of enrollments into advice solutions, which was a very strong number. And we continue to see clients invest in securities across the board. Our net money fund revenues are projected to be a little lower than we'd indicated, given the softening we've seen at the short end of the curve.

With regard to expense management, we've taken a few actions. We expect to run the company on flat headcount at least through the remainder of the year. With some of the onetime Q1 items not repeating in compensation and with the normal seasonal decline of payroll taxes, compensation expense should drop about $50 million in Q2. We've also trimmed project and marketing budget somewhat but overall spend levels are still expected to be up year-over-year. These measures should be enough to allow us to push our pretax profit margin over 30% for the year.

If we combine that 30-plus percent pretax profit margin with high single-digit revenue growth, we're still on track to achieve the mid-70s EPS result for the year that's consistent with the baseline scenario. And while we've trimmed spending somewhat from that baseline, we're still investing aggressively in our clients and we're able to close the gap on compensation, in line with our initial plans.

So our strategy is working. We continue to gather assets at an industry-leading piece. We're turning asset acquisition into revenue growth, 8.5% in Q1, which is also an industry-leading mark. We've taken steps to slow expense growth somewhat, to be sure that we can demonstrate the financial leverage in the model, both now and in the future, while still investing aggressively.

So that's it for my section. At this point, I'm going to turn it over to Walt, our CEO, and let him pick it up from here.

Walter W. Bettinger

Thanks, Joe. Thank you, Joe. I false started on the button myself, so we're 2-for-2 this morning. Thank you for joining us, everyone and, Joe, I think you've done a wonderful job of summarizing our current situation.

Before I begin covering my slides, I'd like to suggest that there are 4 key points to the Schwab story as of today. The first is that the company has never been in a stronger position in its 40 years from a client standpoint or a competitive standpoint or, for that matter, from the likelihood of future organic growth. The second point is that, as we all know, the environment, at least as it affects Schwab, has weakened. Trading is relatively light, and both short- and long-term interest rates have declined to a meaningful extent over the last couple of months. The third point is that, just as we said we would in our February Analyst Day presentation and as Joe has already explained, if the environment did weaken, we would make expense adjustments to ensure that we would still be in a position to deliver on our commitments to shareholders for 2013. And then the fourth point is that we have every expectation that our strong organic growth is going to continue unabated. Every major client metric, from new asset acquisition, client retention, Client Promoter Scores, fee-based advisory sales, they're all either at or near record levels, facts that contribute to our optimism about the future.

Now, over the past several years, we've executed on a purposeful strategy to ramp our spending on client-related initiatives. We felt that, coming out of the financial crisis, that a number of our competitors were somewhat weakened. Now whether it was due to the low equity market, asset levels in the latter part of the decade that would affect asset management fees for certain firms, whether it was light trading volumes, whether it was parent-level branding issues, we felt that the time was right to invest aggressively for the future. And I think it's fair to say that, that strategy has been quite successful and, of course, you don't have to take my word for it. The metrics back that up.

So we put together a multi-year plan in 2009 to maintain a relatively heavy level of investments through 2013 and then begin to moderate that in 2014. What's changed is that we're going to begin a modest decline in some of our 2013 spending now, probably shaving off somewhere in the area of 2 percentage points off what had been our planned growth rate in expenses for the year. So something -- we were planning something close to 9% in expense growth year-over-year in '13. That's probably going to come in something closer to 7% year-over-year. This is going to ensure that we deliver on our 2013 earnings commitments to shareholders despite the weakening environment and, for 2014, we expect expense growth to be quite muted.

So let's take a look at the client environment, their mindset and their results. As you can see from this slide, clients are feeling better about their personal financial circumstances but, in fairness, they remain relatively unsure about how to invest. They're living in a world of extraordinary low yields, international uncertainty and, of course, 0 interest rates that appear to be propping up equity markets as a result of the Federal Reserves' long manipulation of rates on both the short and long end of the curve.

Now, in an environment like this, there are few factors that are more important than trust and many of the investments that we've made over the last 4 years are really based on building increasing trust and confidence among our clients in their decision to work with Schwab and our client metrics support that success.

Our retail promoter scores are at record levels. Although we don't show it on this chart, our value-weighted Client Promoter Score, in other words, those that apply a higher weight to our larger, more economically valuable clients, are in the high 50s, near best-in-class for any industry. And of course, we know that trust and confidence converts to asset flows that generate revenue. With net new assets of about $43 billion in the quarter that just ended and over $90 billion over the previous 6 months, dwarfing the results of any of our publicly traded competitors who are subject to consistent, transparent reporting of their results as well as audited results.

Now one footnote that's important to make, we talk about assets -- as you all know, we offer mutual fund clearing services to certain other firms in the financial services industry. This is a very modest-sized business. Our revenue can be measured in a couple basis points per dollar of assets. As has been planned for over a year, in the second quarter, we expect one of our mutual fund clearing clients to move a little bit less than $80 billion back to their own platform, now that it's able to handle more of the functions that we've provided for them over the last couple of years. I think about $7 billion of that has already moved thus far in April and, of course, we'll break all these details out for you in our public reporting.

And then just the last footnote maybe around assets is we know this is tax season. We've seen a fairly significant level of tax payments from client accounts. That said, our gross asset inflows from clients remain very strong in April to date and we're very pleased with where we stand month-to-date on an NNA.

Now as the slide illustrates, clients remain actively engaged with their investment portfolios and largely invested. You can see that cash levels are very close to long-term traditional levels. That said, clients have uncertainty. They're increasingly turning to their trust in Schwab for help with their investment strategies and, as Joe referenced and this slide illustrates, you can see that our net dollar-based enrollments into fee-oriented advisory solutions are up over 70% year-over-year. Now this is a critical part of our retail strategy because it builds our asset management revenue, it diversifies our revenue stream away from net interest margins or volatile trading revenue. Yes, it had a modest negative impact on our expenses in Q1 but, as Joe stated, we would like to have that challenge on an ongoing basis because of the significant revenue stream that these conversions create. Now maybe even more important from the client lens is that our research shows that when clients who are enrolled in these advisory solutions, when we look at their performance, they tend to either have better performance with similar volatility or equal performance with lower volatility levels than our clients who are purely self-directed. In other words, better outcomes for the client.

And of course, these are only metrics and metrics are only metrics if they don't produce revenue. In our business, there are many ways to generate asset-related metrics without revenue growth but, as you can see in this chart, our outsized asset growth also converts into outsized revenue growth relative to our publicly traded competitors.

Now, even though we're moderating our rate of expense growth in 2013, we do maintain a full slate of projects and initiatives designed to further widen the gap with competitors in terms of gathering revenue-generating assets. Let me just walk through maybe 1 under each one of these categories and offer a little bit more color on each of them.

A couple of months ago, we introduced Schwab ETF OneSource. It's another first in the industry, another Schwab innovation. It's the first broad-based, no-commission platform of ETFs from major ETF managers that includes compensation paid to the builder of the platform so that we can offset some of the lost commission revenue. Client response to the program has been outstanding. The net flows to it have exceeded our early expectations. It's probably a little bit early to share detailed metrics on this effort but it does appear that flows into ETFs at Schwab are increasingly moving to the ETFs that are available without a commission and away from ETFs that still require a commission to buy or sell, the exact outcome that we were striving for in the development of this program for our clients.

Moving over to the monetization side. We recently made some major changes in our bank lending efforts. We moved our mortgage-lending relationship from one partner, one vendor over to Quicken Loans and, as a result, our loan volume has picked up significantly. Our promoter scores went from the low single-digits up to the high 60s, a truly amazing turn around in a very short period of time. And as a result of that improved quality and client experience, first mortgage originations in Q1 2013 were about $2 billion. That's more than double the volume in the same quarter a year ago. So another one of our initiatives designed to better meet the needs of clients while at the same time offering Schwab additional revenue diversification.

Last, let me just comment a little bit on mobile. We continue to invest significant sums in our mobile and tablet capabilities. In today's world, fewer and fewer of our clients are sitting down in front of a PC to do their investing or to review their portfolios. The power of mobile and its ability to transform the quality of the client experience, we think it's only in the very, very early stages. You should expect to see more and more capabilities delivered to all of our client groups, whether they be retail, advisors or 401(k), all over mobile devices. Today we have over 0.5 million retail investor households using our mobile application; that's almost 20% of our entire retail household population using mobile devices today.

So let me go ahead and transition a little bit, maybe adding some additional color to some of Joe's comments about how we see the future unfolding. As I've indicated, we've made significant investments over the prior 4 years. We were operating with a plan to begin to scale some of those incremental investments back beginning in '14 but, with the softened environment around trading and interest rates, we're going to pull back a little bit on '13 spending to ensure that we deliver the level of earnings we committed to, something in the mid-$0.70 range. And of course, that's based on the environment staying constant with where it is today.

And when we look forward into 2014, again, assuming that trading and interest rates stay relatively constant, we would expect to achieve strong revenue growth and widen our margins. Whereas in 2013, under these assumptions, rates and trading and all staying constant to where it is today, we could see our revenues grow 100 to 200 basis points faster than expenses. I think when you go forward to 2014, that widening could be significantly greater, again, assuming consistent trading and interest rates to the levels they're at now.

So let me just do a quick summary before we go to Q&A. I just want to go back over my 4 key points for everyone. The first one, Schwab franchise has never been stronger from a competitive standpoint in our 40 years, never stronger. The environment, as it relates to trading and both long and short rates has definitely softened over the last 90 days. We remain committed to delivering the earnings per share that we projected for our 2013 plan, again, assuming the environment stays constant with where it is today. And then the fourth point, we are confident in our ability to maintain our client growth momentum while delivering significantly better margins in 2014, again, assuming the environment remains constant. And I guess no conversation with Schwab management would be complete without reinforcing the fact that we retain all of the significant upside in our revenue and earnings in a rising interest rate world. The coiled spring remains intact. Our managerial discipline with respect to expenses remains intact. And of course our ability to organically grow the franchise also remains intact.

So let me go ahead and stop there, Rich, and we'll turn it over to you to manage our Q&A part.

Richard Fowler

All right. Thanks, gentlemen. Operator, do you want to walk us through the process for asking questions, please?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Rich Repetto.

Richard H. Repetto - Sandler O'Neill + Partners, L.P., Research Division

I guess my first question is on the expenses, Joe and Walt. You kept saying if the environment stays the same. So I'm just trying to see if the environment improves, let's just say in the back of the year, or deteriorates, do you have that ability to adjust the expenses as quickly as you did this time to still get to that 70% range? And then, also, could you define muted for 2014? Is it half of the 7% or something closer to near 0%?

Joseph R. Martinetto

So I guess I'd make a couple of comments there. So the ramp up is obviously easier than the ramp down. If we end up in a better environment, it's pretty easy to pull some of the initiatives out of moth balls and get them going to -- spending money is rarely a challenge. But the downside case, also, I'd say we still have flexibility that it's something I think we've been able to exhibit multiple times over the course of the last few years. That if we see a changing environment that's not dramatically different, I think we would expect to be able to make adjustments to stay in line with that mid-70s EPS number that we've committed to. As we look out into 2014, one of Walt's slides made reference to a 300- to 500-basis-point widening in that gap between revenue growth and expense growth. So you would expect to see, I think, a pretty significant widening in that differential. We're going to have to wait and see exactly what happens in terms of revenue growth but if you did just kind of a baseline roll forward and you ended up with a revenue projection that was consistent with the kinds of numbers we're talking about for this year, that would imply expense growth in low single-digits as opposed to high single-digits as we look forward to next year.

Richard H. Repetto - Sandler O'Neill + Partners, L.P., Research Division

Got it. And Walt, just 1 follow-up, industry-type question or, actually, it's company-related as well. But -- so last week in The Wall Street Journal, Larry Fink of BlackRock was quoted as saying he expect the SEC to go to the floating NAB for prime money market funds. And I guess it seems like a win, no capital buffers and -- at least the article didn't mention anything. And so, I guess, the 2 questions related is, it didn't address what you had proposed sort of the differentiation between institutional and retail money market funds. Do you expect that? And is -- what was reported, is that reasonably accurate, what you're expecting from -- on money market reform, as well?

Walter W. Bettinger

So I think that there is careful consideration going on at the SEC with respect to the different behaviors between institutional and retail investors. The notion that they should be subject to the same rules, I think, naïvely ignores the difference in behaviors. I'm not going to sit here and say that comments that others made are self-motivated or not. I don't know that. But the behaviors are clearly different between retail investors and institutions. And we continue to be optimistic that, when the SEC determines to publish initial guidelines subject to comment, that they will take into consideration the different behaviors between those 2 groups. We -- I think what you described is half of what my op-ed from last fall encouraged and yet we remain optimistic that the -- both halves of it, both retaining stable NAV for govie treasury funds as well as differentiating between institutions and retail prime holders will be part of what the SEC ultimately proposes.

Operator

And your next question comes from Brian Bedell.

Brian Bedell - ISI Group Inc., Research Division

Joe, can you just -- I guess to follow-up on the revenue and expense calibration question for 2014. If we do get a steepening of the yield curve during 2014, and obviously you're very levered to that, are you -- obviously, there's a propensity or an ability to spend more money but given your comments on the 2009 to 2013 type of investment cycle, do you still see the emergence of another investment cycle that would essentially keep that revenue to expense gap in that 300 to 500? Or do you see -- obviously expenses sort of remaining in that same zone but revenue's obviously falling to the bottom line?

Joseph R. Martinetto

Yes. So, again, I mean, it's hard to give specific expense guidance without having the revenue scenario also be more specified but I would say that we would expect that revenues will grow -- marginal expenses will grow at a pace significantly slower than marginal revenues from here. So -- and there's obviously a little bit of pressure that comes from things like bonuses, maybe some small incremental investments but, away from that, we would expect that incremental revenue growth would significantly drop to the bottom line.

Walter W. Bettinger

Hey, Brian, just to jump in real quickly. Again, as I indicated in my comments, we put together a multi-year plan that by '14 was designed to begin to moderate the incremental level of investment. And I think our view is, as Joe has indicated, with minor areas that self correct if revenues were to grow much more than we anticipated, we're looking to stick to that plan, which means that expense growth in '14, notwithstanding the small things that may automatically adjust, we would expect to be quite muted without regard to whether the environment improves meaningfully for us on the revenue side.

Brian Bedell - ISI Group Inc., Research Division

Yes and it sounds like a lot of these -- obviously, all the growth issues that you've been investing in are sort of for this cycle and for the long-term growth as if you don't have new, large growth initiatives planned for 2014 other than what you've already done.

Joseph R. Martinetto

Well, I think I'd put it a different way. We always have a new cycle of things that we're looking to invest in as some things complete but other things come into the portfolio. So I think we're at a level spending that we're pretty comfortable, allows us to continue to make those investments. What we don't have is a big backlog of things that we've deferred. So we don't have a big infrastructure nut that we're going to have to find a way to fund. We've been able to keep that as part of our ongoing management even through the challenges of the past few years in the cycle.

Brian Bedell - ISI Group Inc., Research Division

Right, right, okay. And then my follow-up would be just on the balance sheet. Maybe a question sort of wrapping up both the capital ratios and your balance sheet size. You mentioned the bulk transfer of $4 billion that you're going to do from the broker. Joe, if you could just remind us of what kind of accretion you expect from moving from the broker-dealer to the bank? And then more philosophically, you're still depending [indiscernible] bank capital to the parent longer term, say, over the next couple of years. How do you expect to deploy that capital? Is that going to be more oriented towards balance sheet -- bank balance sheet growth or is there potential capital return to shareholders longer term?

Walter W. Bettinger

Yes. So on the first question, on the incremental spread, the difference between the marginal investment at the bank versus what we're earning at the broker today is sitting around 120 basis points. So that's what I would say you'd expect to see if rates don't move as we move that money from the broker over to the bank. I would remind people that, that doesn't drive any consolidated capital requirements because that money's already sitting on our balance sheet. It's just moving from 1 pocket where we can't earn quite as much over to another pocket where we have better investment opportunities. So that's a net positive on the revenue side with no impact on capital ratios and consolidation. I'd say longer-term, the story on capital repatriation really hasn't changed to the extent that we can get to a point where we're generating excess capital beyond what we need to support the growth of the franchise, we would look to return that in a reasonable period of time back our shareholders. Obviously with the big Q4 inflows, we saw a little bit more pressure on capital ratios. So I'd say we're probably a little ways off from really being able to debate any kind of meaningful return but, should we get to the point where that capital formation is outstripping the need to retain it to support the growth of the business, then we'll look to return it to shareholders as I think we've done in the past.

Brian Bedell - ISI Group Inc., Research Division

Okay. And then the target's still 6.28 to 6.25 on the bank?

Walter W. Bettinger

It's 6.25 at the bank and 6 in consolidation.

Operator

Your next question comes from Bill Katz.

William R. Katz - Citigroup Inc, Research Division

Very intrigued by your -- the growth of the ETF OneSource business and, just sort of stepping back a little bit, could you just sort of walk through to the extent that, that business drives incremental growth, if you will, what the economic impact is to Schwab over time?

Walter W. Bettinger

Sure. I think that the -- what we try to design with the ETF OneSource program, first, we did build through the lens of the client, that it's going to attract clients to Schwab because of the quality of the lineup and the fact that there is compensation paid to Schwab, it's a sustainable approach as opposed to simply a marketing strategy. The revenue level that we receive compensates us fairly for the forgone commissions that we would otherwise have collected if we did not have the no-fee program. What we're seeing in -- again, very early days but what we're seeing is that the flows into the ETF OneSource program are coming out of commission-oriented ETFs or commission equities, but we're seeing a fairly significant amount of those flows come from the commission-oriented ETFs, which I guess you would expect. It's not like there are any major asset classes missing in our ETF OneSource program. It's not like there are not competitive operating expenses or spreads available in the ETFs in the OneSource program relative to the commission ones. So clients are making.

[Audio Gap]

a rational decision and saying I'd much rather buy in the ETF OneSource program than commission-oriented ETFs. And of course I guess I'd throw out one other comment. The I think misguided notion that some commentators have made that offering ETF OneSource would result in higher cost to investors ignores the fact that, unlike mutual funds, ETFs are available for purchase through open markets and, therefore, all ETF managers have to maintain competitive operating expenses lest they no longer be chosen in the broader world for investing. So we are very confident the program will have no negative impact to consumers and actually will only create value for consumers. The last point, Bill, is that the strategic importance of a distributor like Schwab now being involved in the economics traditionally retained 100% by manufacturers may, over the long-term, be the most important aspect of ETF OneSource. But that will play itself out over time.

William R. Katz - Citigroup Inc, Research Division

Okay, that's helpful. And then just one follow-up for me. A couple of your competitors have talked about a bit of a delay in sort of the FA pipeline recruitments and/or a bit of a pickup in the competitive dynamics to bring those FAs in. Can you talk a little bit about what you're seeing in terms of the pipeline for new FAs as well as the pricing around that -- those acquisitions?

Walter W. Bettinger

You're referring to breakaway brokers?

William R. Katz - Citigroup Inc, Research Division

Yes, I am.

Walter W. Bettinger

So our view for years has been the same, which is that this is a trend that will play itself out consistently. It will periodically have times in which it has minor bubbles, either up or down, depending on what's going on at the -- often at the parent level of the firms that these individuals work for but that the focus should be less on a quarter-to-quarter calculation of how many people or firms are breaking away and more what is the overall trend of RIA's winning in the market and FAs who choose to be, in an entrepreneurial world, deciding to go off and be independent. Our strategy has remained the same. We do not buy FAs into the RIA world with checks, with financial incentives. That is a rat-hole, I believe, to go down and begins to make RIA custodians take the first step toward looking like the full -- the wire houses who pay FAs to bounce around from one firm to another. So that is a rat trap that we chose not to go down. Some competitors did and we're not going to go there in the future. We'll ride the mega trend of FAs who want to be an entrepreneur moving into the RIA world and be pleased with that rate of growth.

William R. Katz - Citigroup Inc, Research Division

Okay. Just one last one. Just to clarify, you mentioned on the mutual fund clearing business, there's still roughly another $40-some-odd billion to go. Is that typical pricing for that business or is there any difference in pricing relative to your legacy business?

Walter W. Bettinger

It's about -- there's about $80 billion from this 1 client that will move. We expect a little less than $80 billion in the second quarter, $7 billion of it has moved. The pricing in that business is, again, a couple of basis points and this client is priced at the market, if not maybe a little below given their size. So it's a very, very miniscule economic impact.

Joseph R. Martinetto

Excuse me, let me just make a comment. That's all built into our plans, also, because we've known about this deconversion for over a year.

Operator

Your next question comes from Howard Chen.

Howard Chen - Crédit Suisse AG, Research Division

Walt, you highlighted the traction from some of your ongoing growth initiatives but just, given you have -- that the firm -- the company's got so many irons in the fire, I was hoping you could just update us a bit more on some of the other new initiatives you have in place like the completion products, passive 401(k), IBS and the newer retirement annuity offer?

Walter W. Bettinger

Sure. From the completion product you mean some of the fee-based advisory solutions?

Howard Chen - Crédit Suisse AG, Research Division

Right. Windhaven and Thompson [ph].

Walter W. Bettinger

Sure. So Windhaven continues to have a strong reception in the marketplace. I believe we're up over $16 billion as of the last report I saw on that. Of course it fluctuates a little bit with the equity markets but continues to have exceptional results. ThomasPartners will be available nationally next month. We believe there is a fair amount of pent-up demand and interest in ThomasPartners. So we expect that program offering for our clients to be very, very well-received, again create better outcomes for our clients while generating additional investment management fees for us, further diversifying our revenue stream. Independent branch model continues to go well. We continue to go slow, as we've reiterated at each opportunity. The early independent branches that have now been open for a year or more have had strong results. You may recall our goal was for them to do about $10 billion of net new assets over the course of a year and the number that they seem to be coming in at is more in the $20 million to $30 million. I did say million, not billion, didn't I? $10 million a year and they're coming in more like $20 million to $30 million. That said, we'll continue to go slow because we understand the implications of this strategy and the risks inherent in it. Our index-only 401(k) is very, very well-received, particularly at this point among our existing clients. The interesting aspect of the index 401(k), as we have talked about previously, is that consultants who often control the decision-making aspect of 401(k) and whose business model is based on selecting active managed funds, hiring and firing funds, as you might expect, are threatened by the index program because it removes the need for that selection, periodic hiring and firing of active managers. So I think this is one of those issues that creates a speedbump as opposed to a long-term dilemma for this program because it is in the best interests of participants and employers, in our view, and ultimately they will see through the consultants' views who are trying to block employer access to this program. But the reception among our existing clients is outstanding and, in the marketplace, it's gathering momentum also. And then you asked about the annuity. The annuity is -- it's fairly new. We're pleased with early results but, again, we're talking about modest numbers because it's only been out for a couple of months. But we're pleased with the quality of the product and we think, over time, it will have success in meeting needs of our clients.

Howard Chen - Crédit Suisse AG, Research Division

And we can see the accelerating NMA trends but was hoping you could discuss any interesting things that you see across the balance from -- is that gross inflows from new client acquisition versus increased wallet share from existing clients versus better retention from competitors being more rational? How's that balance evolving?

Walter W. Bettinger

I think it's all 3 of those, Howard. That's a good question. I think it's all 3 of those but the 1 that particularly seems to be accelerating is wallet share. So we continue to win in the marketplace on a net transfer of asset basis across our competitor set but what we see having a significant impact in our flows is many clients, if not maybe most clients today, have assets at a number of different firms and yet I believe we are consistently winning, "Where do I put that next dollar", which is where we really want to win because that's a sustainable competitive advantage as people decide more and more to concentrate their wallet share with us. So that probably is a larger impact among the 3 that you mentioned although we continue to have success in all of them.

Howard Chen - Crédit Suisse AG, Research Division

Great. And then just final question for me. For you, Joe, just to follow-up on balance sheet capacity. Given -- I hear the broader message loud and clear but just given all the moving parts with April tax season, the record asset gathering, the bulk transfer you mentioned and just the improving profile and the budget, I was hoping you just drill a bit down -- down a bit more on how you see the balance sheet capacity progressing as we look over the next few months.

Joseph R. Martinetto

Sure. As I said, I think that Q1 leverage ratio is going to be the low point in the quarter. Our plans would expect some continued growth in line with, I think, more consistent with what we've seen historically, taking out that Q4 blip. At this point we would say we'd be able to handle that and see some modest increases in leverage ratio throughout the course of the rest of the year but the increases in that leverage ratio are pretty modest. So kind of getting back to some of the earlier commentary, I'm not sure in this year we've turned the corner to a point where we're generating enough excess capital to really be able to say we're talking about, thinking about returns beyond what we've been able to do in terms of dividend for a while. We do then build some additional flexibility should we see some bigger movements beyond what we've already got baked in but we are thinking at this point that we probably hit the trough on the leverage ratio, all other things being equal and would expect to start, at a slower pace, amassing some capital from here.

Richard Fowler

Operator, I'm going to cut in with a couple of questions from the web console. Both of these are for Joe. Maybe first one, Joe, folks are interested in where we are on the regulatory front with the bank and how we're thinking about our situation vis-à-vis CCAR [ph] and do we have any worries about eventually maybe getting pulled under that regime, et cetera?

Joseph R. Martinetto

So at this point it appears that we're going to be treated like a capper bank, not a CCAR [ph] bank. So we'll still be running the scenarios and submitting a formal capital plan beginning next year but it's going to be in the capper regime as opposed to the CCAR [ph] regime, so a little bit different in terms of public disclosure and the timing of review and the impacts of that review from the regulatory point of -- perspective. So to the best of our knowledge at this point, no one has had any discussions with us about pulling us into a CCAR-type [ph] regime. It does look like the capper structure is where we're going to land from a capital management perspective.

Richard Fowler

And we feel comfortable based on where we stand that, that doesn't create new issues for us or anything else to look ahead to.

Joseph R. Martinetto

We're again very comfortable with our capitalization. The stress test results that we've run internally would indicate that we've got adequate capital for some very severe scenarios that we've been able to run. So our comfort with our capital level is very high.

Richard Fowler

And this is another Professor Martinetto explains it all for you moment but I think it'd be useful for folks to hear you talk a little bit more about how we think about our deposits and duration rate sensitivity. How do we segment them? Kind of what process do we go through in thinking about that? And then the follow-on was, when we look at our deposit base, how do we think about the proportion that might be enhanced if fiduciaries or maybe in general more susceptible to movement, rate movement or other types of quick in- or out-flows.

Joseph R. Martinetto

Okay. So I'll handle that piece first and then get back to the segmentation. I think we've been pretty careful in the construction of the balance sheet to try to get client cash to places where it's best sat to be managed from a spread from a liquidity from an interest rate risk perspective. So the vast majority of what sits on our balance sheet is retail money, not advisor money. Advisors do have a propensity to move money little bit more quickly and to the extent that they can draw that money out faster because they're moving multiple accounts at once as opposed to single accounts, they can accelerate liquidity demands and, if they do that, then you don't have as much flexibility to get out the yield curve a little bit and invest that money. So for a lot of reasons bringing that advisor money onto the balance sheet, putting capital against it if you get can't get out the curve, it may not make a lot of sense economically to do that. So, again, the vast majority of what sits on our balance sheet is retail-oriented money. The vast majority of the advisor cash is sitting over in money-fund type products where they're probably better served from that liquidity demand perspective. So now getting into how do we think about the individual product segmentation, I don't think we're that different from the way that most financial institutions look at the product sets. You tend to do a couple of different types of analyses. One is you're trying to judge what your repricing characteristics look like or the beta of the product in terms of changes in rates relative to changes in the economic environment. The second half of what you're looking at is how long do you expect to hold on to that cash? And so you're melding that run-off type analysis with the repricing characteristics and, by every individual product, you end up with a set of assumptions because, again, these aren't fixed deposit maturities. You have to make assumptions about how long you're going to have that cash and how's it going to reprice and, as you look at the tiering of our products, you end up with some different duration-type assumptions. Sweep balances do end up being some of the most rate inelastic and some of the longest-lasting cash balances and so that implies that they've got a pretty long duration. Things like high-yield investor checking tend to be a little bit shorter because people are using them more transactionally in their financial management. So there tends to be a little bit more turnover on that cash balance. So as I said in the commentary, the vast majority of that money that came in Q4 went into sweep, that extended the overall duration of the liability part of the structure. We had to let the assets move out a little bit to offset that or we would've frankly been increasing our rate sensitivity, which is not something we want to do at this point.

Operator

And your next question comes from Alex Blostein.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

I just want to go back for a second to the balance sheet discussion. Appreciate you guys commenting that Tier 1 leverage has probably hit the low point but when you think about the guidance that you provided as far as revenue growth, et cetera, how should we think about the average earning asset growth over the next, I guess, this year and next year. And then, I guess as a follow-up to that, can you remind us again your appetite and potential need to issue more preferreds and how much room do you still have in your capital structure from a regulatory perspective to add preferreds to the capital deck?

Joseph R. Martinetto

Okay. So I guess a couple of things. Client cash levels are sitting at about average for what we've seen in the long run. You saw that chart in Walt's part of the presentation. So we don't think we've got big movements related to people truing up relative to the cash into the markets or out of the markets. So that said, we would expect client cash balances to grow about in line with the pace of client acquisitions. So to the extent that we can drive client acquisition in the 8% kind of range, maybe a little bit better, maybe a little bit softer, but you would expect the balance sheet to grow pretty much in line with that kind of client acquisition range. So that's, that piece of it. On the preferred piece, we do still retain some flexibility should we need to issue. We think we can probably get up to about 15% of the capital structure being comprised of preferred securities and so that means we've still probably got $500 million or so of capacity today and that will grow over time to the extent that retained earnings also grow. So we've got, I think, plenty of capacity should we see a big inflow to potentially issue some preferred. I'd also say though that, that 6% internal target is just that. It is a target and to the extent that we see a large inflow for a short period of time or something that we think is somewhat anomalous, we might be willing to operate for a short period below that number to allow ourselves to recover over time as that works its way through. So that's I guess how we think about capital management in the moment.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

Got it. And then a broader question for you guys on just general retail training. It looks like activity rates continue to come down year-over-year whether you look at dollars or you look at trades per account and I was wondering to kind of hear your thoughts on whether or not you think there's something more structural changing in the business and whether it's more people putting money to work into asset-based allocation programs, where there's just less need to actively trade and again your business model is pretty well positioned to capture that. But as we think about the industry broadly, do you think that's the trend that it'll just still continue despite the fact that, yes, volatility might be low and yes, it might pick up, but there's just a different mindset on how people invest?

Walter W. Bettinger

Well, we have felt that there was an evolving different mindset for a number of years, which is the reason why we structured our strategy over the last decade to be in the position we're in. So we do believe that -- there's an evolving mindset. That's not to say that if you don't get a running bull market that you wouldn't see trading spike because everybody's a great trader when the market's going up. But sure, we do believe that there is somewhat fundamental change in the view of investors toward lower-risk approaches, toward lower volatility type of asset allocation and maybe not that surprising based on what's gone on over the last 13 or so years that, that would be the case. That's not to the say that trading isn't important. Trading is important and there are some modest percentage of people who are superb at trading and do so under a true strategy that yields reasonable returns for them. But the idea of trading for the masses as a way to build their investment, well, I think is a waning concept.

Operator

Your next question comes from Jeff Hopson.

J. Jeffrey Hopson - Stifel, Nicolaus & Co., Inc., Research Division

So maybe a little bit of a follow-up on those same type of questions. As you look at the money flowing into your advice platforms, is there anything you can say about the nature of those particular clients in terms of age and tenure, of size of accounts, et cetera and then, to the extent that money is being invested, it sounds to me like you're saying that it's perhaps coming off the sidelines but going into not super risky but some intermediate type of risk account perhaps? And in terms of cash flows, are we seeing any money, say, come out of bank deposits into, say, longer-term investments?

Walter W. Bettinger

There's a lot there, Jeff. So I think that what you see going on with, in part, the growth into the advisory solutions is a recognition on the part of clients, particularly clients who are, say, closer to a traditional retirement age or even at a traditional retirement age that getting professional help is important and that getting professional help that is designed to -- or at least whose goal is to cut off some of the downside is critically important. Investors are not able to invest today as we all know for significant yield and income and therefore, there's a desire not to lose meaningful principle if you are close to retirement or in retirement. I think that's playing in, to some extent, into the desire to move into professionally managed portfolios, particularly those that are effectively risk managed, and I believe programs like Windhaven or our private client program or the work that independent investment advisors do on behalf of clients have that -- have those types of characteristics. I don't know that we've gotten involved in breaking out details behind the people that are moving into advisory offers. With respect to money moving from bank, I think cash levels are relatively stable. They're not elevated, they're not far below history. What's happening is people are simply deciding that this part of my portfolio that maybe I had managed myself would be better suited to get some professional assistance with. I think that's where the flows are coming into the advisory side when they're with existing clients. And then, as we capture additional wallet share from existing clients, as I referenced earlier in one of the questions, I think that money also, to some extent, is finding its way into advisory offers.

J. Jeffrey Hopson - Stifel, Nicolaus & Co., Inc., Research Division

Okay. Can I follow up? On the Schwab branches, and I know this is still very early in the development, but what have you seen in terms of channel conflict, which I think from early on you thought there would be little but is there sense that, yes, in fact you're getting client money kind of in between the sources that you would have -- the other channels I guess.

Walter W. Bettinger

We've not seen any evidence of channel conflict. In fact, to the opposite we've seen positive reaction both among our company stores. One of our independent branches had such an influx of clients that we actually helped out with one of our company store employees going to that independent branch to assist them. And we've seen positive response from advisors, also, bearing in mind that independent branches have the exact same retail solutions as our company stores. So we're seeing referrals into our Schwab Advisor Network program into RIAs from our independent branches. So from an RIA viewpoint, objectively, it's simply additional potential distribution for them. So as we indicate we did not expect conflict. We're not seeing it. In fact, quite the opposite, we think it's a nice move that fills in the gap between company stores and independent advisors.

Richard Fowler

Okay. We're at the top of the hour so I think we're going to keep to the schedule and get folks on their way. Thanks, as always, for participating in these with us and to the extent you guys want to follow-up on anything, by all means let IR know and we'll go from there. So thanks again, everybody. Have a great day.

Operator

This concludes today's conference call. You may now disconnect.

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