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Executives

Richard G. Fowler - Senior Vice President, Investor Relations

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

Walter W. Bettinger, II - President and Chief Executive Officer

Charles Schwab Corporation (SCHW) Interim Business Update July 27, 2009 11:00 AM ET

Richard G. Fowler

Good morning everyone, and welcome to the Summer 2009 Charles Schwab Interim Business Update. This is Rich Fowler, Head of Investor Relations for Schwab. And with me here this morning are Walt Bettinger, our CEO; and Joe Martinetto, our Chief Financial Officer.

Just take a minute to remind folks who may not have been on our first version of this back in January, what we're doing. We're starting to augment our traditional semiannual business updates in the spring and fall, with brief or more concise updates in the summer and winter quarters following our earnings release. We've heard feedback from the investment community that a little more frequent interaction with the executive management. We hope for just to stay in touch better as the year progress.

So, this is our second update. And we again appreciate feedback on these and in terms of how they work for you guys as an audience and by our means, let us know here in Investor Relations afterwards if you have any suggestions. And we look to continue to refine these as time goes on.

We do these view these as a forum for sharing broader perspectives. So as always we'd ask that more granular questions around specific line item issues et cetera in the earnings story continue to come to Investor Relations and we'll work with you guys on those as we always do. And we want to focus this time with Walt and Joe on the bigger things that are going on, and help you guys stay in touch with what we see is our focus and priorities as we head into the next quarter.

Let's talk about some housekeeping here for a second, the agenda itself. You'll see is very straightforward. We'll start off with Joe. He'll give the financial perspective. We'll spend a few minutes with Walt. And then we'll move into Q&A before wrapping up at the end of the hour.

The calling number in case you case you get bumped off the webcast for any reason; 877-852-1721; again; 877-852-1721. The password 15977589; again 15977589. Let's move to the wall of words for a second. We'll just remind ourselves that everything we talk about today is based on our understanding of the world as of today and things inevitably will change. So as always we are due to stay in touch with our disclosure documents, stay in touch with the firm, make sure you keep up with stuff on an interim basis.

And with that I think we're done with housekeeping and ready to turn it over to our CFO, Joe Martinetto.

Joseph R. Martinetto

Thanks Rich. Let me look at wall of words reminds me, we probably had to just put up a big statement in here because Rich says if nothing else changes or a lot of the things being, the disclaimers around every statements that we make here.

Jumping right into the financials, I don't think that we need to spent a lot of time on some of these information as everybody had a chance to read a picture of that little bit of perspective here.

Client trades continued to be healthy, healthier than we probably thought they were going to be as we came into the year. I think people that remember back to what we had said will recall that we had expected that we could see some modest trailing off in trade instead we've actually seen trades up about 13% so far this year, year-over-year.

Then new client assets at about $43 billion; this is a metric where we think that $43 billion is a very strong in the context of the market that we've been living in. Although admittedly probably trending towards the bottom end of that 8 to 10% range that we've been talking about and even the 8% could be a bit of a stretch call for us depending on how the second half of the year plays out.

With the improvement we've seen in the market off-late which definitely has an impact on our ability to get those assets coming into the door. We are hopeful that we'll get a normal pickup here as we move toward the end of the year and we'll get to that 8%. But we'll definitely need a little bit of help as we get further out into the year to be in that range that we had indicated. Although we expect that we'll be close if we do miss.

Client assets, you can see here down about 12% year-over-year, that's in the context of an S&P. It's down about 30%. So clearly as we continue to bring those assets in the door, hoping to offset some of the pain our clients have felt is we've seen the market declines continue to have an effect on overall client assets.

As we move down into some of the other metrics, we can see new brokerage accounts continuing to grow, although at a slightly slower pace. But even with that total brokerage accounts up about 4% over prior year.

Net new households, their number was more negative at the end of the first quarter. I'd made a comment there that we've seen pick up as we moved in the March when we did our last update. In the second quarter we actually had net new households and retail up 39% in the second quarter over a year ago. So some really positive signs of metrics beginning to manifest themselves here.

Client participants again up about 16% in a market that's certainly with what's going on with employment, putting it's own challenges up for the participant market as well.

So moving onto the financial picture here. The headwinds we've been talking about for a while are now becoming apparent in the financials. So revenues are 17% in the quarter, 16% year-to-date. And I think we've probably banging the drum loudly enough on what interest rates and market valuations are doing. But this is that the reality of how that's planning through the financial statement.

On the expense side, we're on track to achieve the cost reductions that we've been talking. That's 6% reduction in the second quarter included a couple of unusual items for the expense reductions efforts that we took in the second quarter as well as the large FDIC special assessment that they work through there.

If you look at the metrics down at the bottom of the page around margin, EPS growth, ROE, without the context of where we've been, these would simply be viewed as very healthy performance. And that's how we're viewing them that clearly we're out from where were in terms of profitability. But, still continuing to put up numbers that are very sound and represent a company that's performing very well in what's turned out to be a tough market. Especially, when you put this in the context of some of client fundamentals that I have added on the previous slide, and I know Walt's going to go into a little bit more here.

But, it's those client fundamentals that continued to give us the confidence to manage for the longer term and you are going to hear us talking more about that as we move forward.

Just a quick reminder here. I think everybody on the call is probably got this page memorized as well I do. So, there shouldn't be any changes from what we should do in the first quarter. These are the couple of scenarios that we laid out at the beginning of the year. Let's spend a few minutes talking about how we've evolved as we come to the midpoint of the year. And then we'll talk a little about more about what we're thinking in the second half of the year might look like.

As we look at the S&P, I think we're all encouraged by what we've seen here in terms of reactions and stock prices as we moved up from the lows of that March period. But I want to make sure we remind everybody that we did spend the majority of the first half of the year below where we ended the prior year. And to just put a point in your mind here, we would now need to the end the year just add S&P of around a 1,000 to get back to just even on an average versus where we were in the prior year.

So, encouraged by what's going on in terms of the improving the prices, but really what we've done is just gotten ourselves back on track to that flattish scenario that we talked about earlier in the year.

Moving on to interest rates, which may even be the more leveraged driver for as reached in the near term here. I think everybody knows what's going on with Fed Funds. That's not a story I need to belabor or walk here. We continued to have an extraordinarily low level of interest rates being maintained by the Fed.

If you moved down to the chart in the lower left hand side of the page, the three month treasuries; so this is a picture that maybe is a little bit better for us than where we were at the beginning part of the year. When treasuries were so extraordinarily low and we first put that money funds fee waiver number of around $200 million in the year. A lot of that was predicated on those rates staying pretty low and the impact that was going to be felt in our government and treasury funds.

So, we have a little bit of improvement in that market, which has certainly helped to offset some of those of money market fee pressures. But if you move up to the upper right hand side of the page, and you look at what's going on with three months LIBOR, this metric has been less helpful. I think I was pretty clear telling people that there are a lot of assumptions in those money market fee waivers estimates that we put together. This was certainly one of the numbers that we had to make estimates on, as we pull those estimates together.

We had anticipated seeing three months LIBOR continued to move down as we move through the year. But we hadn't expected it to probably move as far as it's gone. So started the year around a 125 basis points. We were thinking it was going to be more around the 75 basis points area at this point in the year. It's now more around 50. So, that's a factor, that's a little bit worst than we would have anticipated is we're getting to the mid point of the year.

It also has an impact on our ability to invest our cash at the bank and the brokers. So as we talk a little bit more our outlook for the net interest margin is another factor we need to keep in mind. And then just in the bottom right hand side part of the page, the credit default swaps is just being a rough indicator of what's going on with spreads overall in the term market. So to the extent that we're putting money out the curve trying to take advantage of a little bit of duration. Our ability to get page spreads out there have also been decreasing as we move through the year to the mid-point here.

So putting all of that together, I am talking a little bit about where we are in net interest margin and the money fund fee waivers and where we think we're going here. The net interest margin I think I need to do a little bit of resetting expectations. So honestly, we use that as a bit of shorthand for giving people an idea of how net interest income was going to work for the reminder of the year. And we probably didn't anticipate the magnitude of the changes that we have seen in the overall sides of our balance sheet when we decided to use that metric is the indicator.

We ended the second quarter with the net interest margin of 216 basis points and are definitely trending a little bit lower on the overall net interest margin, then I think we set people's expectations around. But the miss if there is one isn't nearly as material and the context of net interest income as it is and net interest margin. So, we've got a lower net interest margin on a much larger balance sheet than we'd anticipated at this point in the year.

So, net, net interest income is coming up pretty close to where we thought it would be. Although, it's being driven a little bit differently, larger balances being offset by lower spreads on those balances.

We do expect that we could continue to see if interest rates don't come up a little bit more compression in the net interest margin overall. So, we haven't hit bottom on that yet. Exactly, where bottoms are is going to depend on a lot of factors out there in the market. Although, we do expect that decline to slow, all other the things being equal.

Money fund fee waivers down at the bottom part of the page. So, once again this is an issue of timing and mix. So, back on the previous slide, where I talked about the treasury market doing a little bit better and the LIBOR market doing little bit worse, we had anticipated that we would have the fee waivers kicking in a little bit earlier as those government treasury funds were starting to experience the waivers earlier in the year. And that actually took a little of bit pressure off the first half for the year.

But with LIBOR being where it is, we do expect that we're still going to see about $200 million and waivers over the course for the year. And that implies that number is going to be more back weighted to the back half of the year than what we've been talking about. So with $36 million in waivers in total in the first half for the year, we've got a substantially bigger chunk coming into the second half than we probably indicated when we talked about one-third in the first half and two-thirds in the back half. That mix has moved a little bit on us.

So... and I think this is a point where I think we acknowledged that as much as we'd like to believe that we're going to see values in the market and interest rates could come up and we'd appreciate that as much as anybody. We seem to be on a track of year that looks more like at the top part of the page than the bottom part of the page. If interest rates do come up, we do continue see values in the market. We will see improvements in our financials from these kinds of metrics, but all things consider the top part of the page seems to be about the path that we've been on as we move through the first half of the year.

So, how much will we benefit if we see interest rates come up in markets rally. We've taken those same sensitivities, updated them for the size of balance sheet and turned then into dollars just to make sure that the people are doing the math correctly here.

The first 100 basis points increase in Fed Funds is a proxy for overall interest rates. Adds about $400 million to our net interest income, an amount that it is pretty simple as Fed being 70 basis or points so we've been talking about now applied to a roughly $60 billion balance sheet.

In addition, the fee waivers largely go away as we move to that first 100 basis points of interest rates. So, put those two factors together, we get about $600 million revenue lift and the first 100 basis points in Fed Funds.

The second 100 basis points produces about the same impact on net interest income. Although the asset management adamancy which is obviously not going to be consistent with that as we've been worked through the money front fee waivers in the first 100 basis points. But if you had those first 200 basis points together, you get a about a $1 billion of revenue from those first 200 basis points of interest rates, which is a big number.

Above that 200 basis point, we do expect that the impact on the net interest margins starts to slow some. You'll all recall that once we get above that 200 basis points, we're able to manage the trade-offs between what we earned on net assets, what we pay on liabilities to produce a much more consistent net interest margin than what we've experienced here and this is really extraordinarily low period of interest rates.

Down at the bottom, we've also updated the impacts for market rallies or declines, but at same percent moving the markets still implies about a 3% move in asset management and admin fees which translates into about $60 million in annualized revenues.

So, clearly helpful to see the market recover to the extent that it does from here. But the spring is definitely more tightly wound around interest rates right now. That's the more leverage driver for us in the short run.

A couple of quick comments on capital and liquidity here. You can see at the top of the page on the right hand side, total assets now are just over $62 billion. That's being driven by client preferences or clients who are continuing to bring money in the door and are staying, at least particularly in the retail business, largely in deposit kinds of products or cash on the balance sheet.

And to the extent that they've got a desire to stay in those kind of products, we want to be able accommodate them and continue to give them a great value on those products. So, the growth that you see there in total assets largely driven by growth in high yield investor savings, high investor checking largely on the bank.

The increase in long-term debt, I think everybody knows we issued $750 million of senior debt and you can see that increase in the debt as well as in the parent cash balance. The thinking here was to give us some added flexibility around management, the balance sheet that to the extent that we are seeing these large client shifts in money, largely instill at this point, we want to make sure that we've got plenty of liquidity on hand to be able to if needed, put some capital down into the bank and continue to facilitate those client demands.

Stockholders equity showing a nice increase up to just over $4.6 billion. Some of that growth was driven by the earnings in the second quarter, some of that was also driven by decrease in the accumulated other comprehensive loss related to the fixed income portfolio. So, the negative marks in the second quarter declined to about $360 million from $500 million at the end of Q1. So about a $140 million of benefit from improvements in March in the overall portfolio.

One more point I'd make while we're still in this page is the tangible common equity ratio down at the button at the page. You can see that even though we have that accumulation in stockholders' equity in the second quarter, that ratio has still declined, largely driven by the fact that the balance sheet growth was pretty large. I get a lot of questions about when we're thinking about reentering the markets for stock buyback. The answer is when we get more comfortable and confident around where we're shaking out in this market around balance sheet growth and our ability to continue to facilitate that growth.

That number is moving around soon not as still as we're getting that client demand on the deposit side and that definitely factors into our thinking around when and how we would reenter the market around share repurchases. So for now I think we're still on hold there as we think through exactly how this markets going to end up.

On credit there is not a lot to say here, that the top part of the page we continued to put up exemplary numbers around our loan portfolio. So we've got the details up there for people that want to take notes to bottom part of the page.

Another comment about the Alt-A holdings. We did take some additional charges through the income statements, impairment charges on the holdings of all day. What happens from here is really dependent on what happens in the overall housing market that to the extent to the outlook continues to deteriorate we could see some additional charges continue to run through the income statement. If the housing market finds from the footing, we would expect that those charges would begin to abate. So that's the tough for us to make predictions on. It's really driven by the overall housing market as a whole.

Before I turn the page, this is probably an appropriate point to talk about in other risk factor that I know is a lot of peoples' minds around the auction rate securities. I think we've given some rough indications in the market. But I want to try to box that exposure for people. So, here to be really specific, individual investor holdings of auction rate securities, they will purchase the Schwab prior to the early 2008 market collapse, currently totaled about a $100 million of face value.

So let me repeat that. Individual investor holdings of ARS purchased through Schwab prior to the early 2008 market collapse currently totaled about $100 million of face value. So that gives you some idea of relative to some of the other numbers that you've seen out there in the press either related to us or others in the market of the size of our overall exposure. So, I wanted to make sure people had that point as they were looking forward.

Finally, as we look forward here, we continued to see some of the headwinds in the market that we've been talking about as they manifest themselves here in the earnings statement. And unfortunately, about like we had thought to the extent that we kept interest rates as low as they are and markets relatively flat at the end of the year.

The client metrics though continue to give us a sense of confidence that we're doing the right things as we're managing for the long run and continuing to make the appropriate investments to grow the business and grow the company for the long view here.

I think Walt has got a lot more to say about that. So, with that I'm going to turn it over to him and then we can take questions at the end of his presentation.

Walter W. Bettinger, II

Good morning, everyone. Thanks Joe. Thanks for joining us on our, I guess semiannual webcast update. I appreciate everyone's time during this time here when many folks are out of the office.

Joe spent a fair amount of time talking about our recent results, as well as maybe some of the prospects for the future as the environment evolves. But I want to try to spend my time on is reviewing our focus on building our business for the long-term, and also sure a little bit of insights with all of you about how we think about the environment and how the environment may affect some of the decisions that we make.

Certainly, we recognized that we're in a very, very unique environment right now. An environmental that is in the tails of the bell curve and we illustrate that by some of this information on the slide about as of the end of the second quarter equity markets off around 40%. We know that's improved a little bit since then as well as the continuation of the extraordinarily low interest rate environment.

When we think about our business, we try to build the business model and therefore our financial results more around the middle of that bell curve. So, you can see for example with interest rates, 88% of the time over the last 50 years. Fed rates have been over 2% and of course, generally they're in that range between 2% and 8%.

What we don't want to try to do is overreact to this tail environment. We know that there are decisions that we could make, that would generate some short-term financial benefit to our results. We look at those types of decisions we analyze them. But ultimately with the majority of those decisions we've come to the conclusion that their income system is building long-term shareholder value by serving our clients effectively.

And I think that that is reinforced by our results and our continuing excellent organic growth. Joe shared some numbers. I'll just share a few other numbers about what's going on inside the business in terms of that organic growth.

Joe referenced net new households in the second quarter, up almost 40% over the second quarter of last year; the 43 billion or sale of net new assets in the first two quarters.

Net transfer of assets that clear in our mind, the clearest indication of how we're favoring competitively very, very strong, almost at the same level year-to-date as they were in 2008 of course soften equity market that is much-much lower. Our ongoing growth in new client, so 400,000 new brokerage accounts in the first half of the year, 150,000 new bank accounts, 90,000 net new retirement participants. That's about 650,000 new clients added to Schwab in two quarters.

And then also our reference to success in our Advisory Solutions that we make available to our retail business growth though as we do directly as well as those clients that we refer to register investment advisors.

Clients opting for advice solutions are up 30 to 40% over where they were a year ago; clearly indicating that clients are looking more help given what many have experienced in the last couple of years.

At the same time, as we've been focused on building our business for the long-term, we've also had been playing offense. I guess maybe a Schwab form of offense given some of the interpretation of our decisions. But a Schwab form of offense is offense that strives to delight clients and innovate on their behalf. Many of you have heard me talked about in the past investor updates, how we look to innovate in a way that will deliver more value and better service to our clients. And we put up just a small list of some of the things that we've done in the last two quarters around products and services, capabilities and platforms.

A couple of them I'll highlight our index fee reduction. We made a change earlier this year to get ourselves competitive in the marketplace with our index funds. We introduced a new version of Schwab.com during updated, highly rated and receiving strong positive response from our client base. We continued to innovate across the banking spectrum with our high yield savings account as well as an award winning 2% cash back credit card with no caps or limits or tricks or asterisks around it.

We recently have introduced a number of enhancements to serve the independent investment advisors to make up such a critical part of our company; assisting them both with their firm profitability by waiving some software charges and also providing them another means by which potentially they can have a conversation with clients on offence, by waiving some of the cost of moving clients over to their management.

And then we introduced a new website for our 401(k) business, which already has won awards as the top rated 401(k) participant website.

And then lastly I want to call out to bring some clarity to some comments that may have been made inaccurately about our efforts around marketing and advertising. We continued to invest heavily in building the business for the long-term there. For example, in June of 2009 we increased our marketing spend over June of 2008 by almost 40%. So we continued to invest in that area to build the business again for the long-term.

Now why do we care? We care about building the business for the long-term so that we become a company that is successful in all parts of a cycle. We may not be able to control the interest rate environment and the impact that has as much as we might like overall revenue, but what we can do is delight our clients, serving them well throughout the cycle, and as a result continue to grow the firm organically and be positioned much better to deliver results when the economic environment is in the middle of that bell curve rather than at the tails.

What we've shown you on this chart the S&P 500 going back to 2004. And what I'd like to do is overlay with it a chart that shows our client promoter score or many of you be familiar with it more as a net promoter score. It's really the measure by which we analyze the likely future, organic growth of our firm based on our clients' willingness to recommend us to those individuals that they have a relationship with.

And you can see the rather extraordinary turnaround in our results from 2004, when we were scoring in the negative 30% or negative 35% range, to where we are now as of the end of June at 28%, which is actually the highest that we have ever been.

For those of you familiar with this metric, of course, Fred Raychel is one of the key authors of it. And Fred has indicates to me not only as our turnaround from 2004, one of the most dramatic you've seen, but actually the split that began occurring in 2007, where our results continued flattened and then upward as the S&P went down, maybe even more impressive.

Again, why do we care? We care because the better we score in the promoter score area with our clients; the more likely they are to bring business to us. And I'll illustrate that with one maybe simple point. When the S&P 500 was last in the range of where it is now and this goes back to pre 2004, we were doing 2.5 to $3 billion a month in net new assets. Compare that to where we are now; let's say $6.5 billion of net new assets with the S&P in the exact same place. So it shows how we have been able to separate our company's organic growth from the market itself and deliver improving results no matter what the cycle is.

Many of you may have also seen our results in the recent JD Power survey. I won't go too much through that other than our relative results versus the rest of the investment industry are quite powerful and might be worth a quick look for those of you interested in following this metric.

Consistent with comments that we shared with many of you at the beginning of the year as well as in prior updates, we continued to maintain and execute with great operating discipline in 2009. We shared with you that we thought our expenses would be down 7 to 8% over last year. And as Joe indicated, we've continued to be very confident with that. We've made the difficult decisions; we made them early that we needed to make and anticipation of this rate environment. As an example we began the year with 13,400 approximate labor equivalents as of the end of June, we were at 12,100. And you can see without jeopardizing in anyway, the service that we deliver our clients as reinforce by a record net promoter score.

We continued to execute around risk management, our money funds are say free as closed out in the first half of this year continue to have very low relative loss experience in our bank loans and our balance sheet is very, very solid.

We've also made decisions around a real estate strategy I shared with you a number of updates ago a long-term picture we chose to accelerate that in 2009. We've now consolidated largely down to, for example two offices in San Francisco and I'm speaking to you from our new headquarters in San Francisco, which will deliver tens of millions of dollars and savings to us out for many years to come.

What we've chosen not put on the table when it comes operating discipline as anything as we indicate here that would degrade decline experience and jeopardize our long-term growth.

I've spoken about execution profits and environmental profits. And I think we're in the classic period now with the environment is in the tail part of the curve and we're not going to make decisions that are going to jeopardize our ability to continue to delight clients and grow the firm for lending environment goes back into the broad part of the curve.

And as consistent with that our strategic priorities for 2009 remain intact, we're focused on service and building trust-based relationships. We remained committed to investing in and building our brand and continuing to strive to share the differentiation, than the stability that we maintained relative to those we compete with.

Offering competitive pricing and innovation that is driven to benefit clients, while managing the firm with the deep emphasis around risk, technology, security functionality and making long-term investments that are going to be healthy for our business; The 401(k) area, rollovers where we continue to have we think industry leading results and some months over 60% capture on our rollovers in 401(k) plans, as well as continuing to add the right talent for our firm, for our culture and for our objectives.

So that's a quick update that I have. And Rich, we're going to turn back to you to some Q&A.

Question-and-Answer Session

Richard Fowler

You bet, you bet. We've been getting a few questions in while you guys are speaking. Let me remind everybody that the way we do Q&A on these is through the webcast console. I believe on the left hand side your screens, you'll see the dialogue box for submitting questions. And so if you would go ahead and send those in that way, they'll bring over to me here and then we'll get them into dialogue.

So, with that let's start off with what we've gotten so far. Maybe Walt you could start this off here, many of our investment products are priced to be disruptive relative to other financial services firms out there. Could you comment on where you're seeing the best client demand for these products either on a cash management side or advisory and fee types stuff?

Walter Bettinger, II

I think what we're seeing it in both... I don't know that I could characterize one or the other as being more successful. We're clearly seeing it with a number of our bank products as the question asked illustrated by the net banking clients that we've added in the first half of the year as well as the response to a number of our balance sheet oriented products.

We know the clients as Joe indicated are comfortable in this environment being in balance sheet products for Schwab. But we're also seeing it, for example among our self directed investors and those seeking advice. I share a few metrics on the advise side, where our advise enrollments is measured by both clients as well as assets are up 30 to 40%.

And for example, in Schwab private client the largest of our advisory solutions, those enrollments were up over a 100% from the same period a year ago. Again indicating the clients are looking for advice, they trust Schwab, they believe the Schwab's advice will serve them well and they are opting to ask us to help them with their portfolio.

Richard Fowler

Okay, okay. Joe, maybe send this one year way. Could you talk about what we're seeing in terms of the LTVs on our originated mortgage portfolio on the HELOC and first mortgage side? Have we been refreshing those and if so what are we looking at the more recent views?

Joseph Martinetto

No, this is probably in response to the question that I mangle back in the January update where we haven't done an update on those LTVs for about a quarter. We are doing monthly updates of that now on an automated basis which means that market-by-market is opposed actually doing individual appraisals on houses. But even now that the first mortgage portfolio is called an LTV now on average, which is just above the 70%. The HELOC portfolio has picked up to just about 60%.

So while they are both high single digit percentage points higher than they were at beginning at the beginning of the cycle, they remained very contained even in this environment. I think that's by and through our loss experience as well.

Richard Fowler

Okay. Let me stick with you and do a couple of mechanical questions here just to make sure we're all clear on the picture that you gave. When we talk about the fee waiver story and the 200 million going through the year, how would characterize the situation using my famous phrase assuming up in changes going on in the 2010? Just want to make sure that we've got that sort of levels that with folks in terms of going forward.

Joseph Martinetto

Sure. So we do, we are still thing some ramp-up, although the fee waivers are ramping up pretty quickly at this point towards that run rate in 200 million. But that number of 200 million on the year, the run rate is obviously a little bit higher than that given that it's back loaded. If interest rates stay where they are, we do expect that we will carry that higher number run rate into the beginning part 2010 and ongoing until we start to see interest rates come back up.

Richard Fowler

In the course of extrapolating, the specific impact is going to be top. We'll have to stay in touch on that simply because things won't stay the same, balances will change and other things will change...

Joseph Martinetto

Whether we've learned in the first six month or right to make this estimate.

Richard Fowler

But holding everything constant and just that's the way the math works. Okay. Maybe also Joe, could you comment for us on the and maybe filling the picture on the revenue upside. How we think about... how that drops to the bottom line as we move forward, as we start seeing those revenues come back?

Joseph Martinetto

Yeah. So that 100 basis point improvement scenario, there is very little on the way of expenses that are required to actually produce that revenue with that the money fund fee waivers just a reversal of what we've experienced here on the other side. Net interest margin largely the same. It's just a benefit of higher rates. It doesn't take a lot more in the way of expenses to produce it.

I would say though that they are some modest expenses they are probably start to flow back in when we have a better picture on revenues. But we have been keeping bonuses for our team relatively constrains. So there is probably some increase in expenses that we would expect to see trickle back in on the compensation line. Advertising, we tend to try to keep it a relatively consistent percentage of revenues. So as the revenue picture improves, I would expect we see some modest increases in our marketing and advertising line.

And then finally, we've been very constrained in our investments and technology or projects spending as we referred to it. And I would expect, we probably also see some of that begin to trickle in as we started to see an improving revenue picture. But again I think those are... it's important then to note that things I'm talking about are things that are within our control and choices that we can make.

Richard Fowler

Right.

Joseph Martinetto

And not necessarily driven or required to produce that revenue with. So, we'll be making those trade-offs all the way through coming out of this cycle to make sure that we're making the right investments to continue to drive the growth in the long run.

Richard Fowler

Okay. Okay. Walt, let me you come back to you now. We've got a number of questions that has to do with various aspects of what's going on in advisor services. So maybe I could ask you to spend a few minutes talking about what you see going on there, including how we're doing with the advisors turning independent story. What's we're seeing going on the broader marketplace with brokers of the warehouses? Is it changing our expectations at all on that part of business? Any other strategic initiatives you want to talk about and so forth?

Walter Bettinger, II

Let me first talk about the advisors turning independent or brokers turning independent. As we've said many times and reinforced throughout the last year or plus, we think that that is a broad long-term trend. We've seen a little bit of a tickup in that in the first half of the year I think was about 74 teams of advisors moving over to ROA model with Schwab is custodian. But we have always felt that it would be more of just a long-term trend rather than a bubble that would occur.

The firms are currently employing many of those brokers, are not going to sit ideally back, they are going to offer retention packages as they have and make decisions there. And so we don't see and constantly tried to downplay the concept that that was a bubble.

In terms of the business overall is extremely healthy. Our promoter scores serving our institutional clients are very, very high, quite a bit higher than they are in the retail side. And we continued to have great success there.

For a period, I would say from about the middle of 2008 up until a couple of months ago we saw a decline in the rate of growth in net new assets from that business as many of the advisors are widely so spent their time and energies on reinforcing their relationships with their existing clients, serving their clients to what work with such a tumultuous market environment.

In the last few months, we've started to really see that net new assets start to... figure start to move again which were very encourage by and our relationships with our advisors are very strong and very positive. I spend a significant amount of time with a number of our largest 150 or so advisors last month and heard from many of them about how positive they feel, how their pipelines have never been larger in terms of prospects, but also recognizing that they continued to spend a lot of time serving existing clients and preserving their existing revenue streams which you would expect.

So I feel very optimistic about that business in the way our client advisors feel about us, as well as their prospects for future growth.

Richard Fowler

Okay. Thank you. Joe, I mean, certainly back to you now, talk about the balance sheet effects of the client sort of cash trades dynamics that we're seeing. And maybe you could explain for the folks what we're seeing in terms of choices clients are making, savings versus checking versus MMDA et cetera and how that might be influencing there dynamics that we're seeing on the spread side?

Joseph Martinetto

Sure. So, people will recall that we've launched high yield investor checking product, first is the new making product about 18 months ago if I remember right now and that was a great success in the market.

The growth in that product has slowed some as we've gotten over the initial implementation of the launch there. And also quite frankly with interest rates coming down as low as they have and to left compelling kind of offer to talk about a high yield checking account that's paying 75 basis points.

In the context of the market, it's still a high yield for checking. But it's just not as compelling an offer and certainly not much of an advertisable claim at this point. The high yield savings account, then we launched a bit of follow-on here.

Largely in response to clients, they were telling us that they think about their money in multiple ways that some people want that savings account, it's a long side to checking account and they were looking for both products. We did roll that out with a slightly higher rate than what we were paying on the checking account and maintain that relationship, but we haven't seen cannibalization of the checking account to fund the saving account. We're finding that we're seeing growth in both products.

As we move to the first part of the year, there was some pretty tough competitive dynamics out there around what people will pain to try to attract deposits. And we also to protect our position in the market, we're paying a higher rate on net savings account. But as we've seen that competitive dynamics continued to evolve in some of those really lofty rates start to come up with the market, we've also been gradually learning what we pay on net savings account to stay inline with the overall market demands. But we're seeing the clients pretty carefully there.

Savings has been a very large driver in the growth of the balance sheet here of late unless I get that wrong. And in the near-term here with large investment opportunity, it's not driving a lot of marginal revenue. This is one of those products that we continued to manage with an eye toward what's the longer-term opportunities are. That it's rats come back up, we believe we're going to be able to continue to expand the spread on the product can be very happy with value that we can offer clients as well as what the revenue implications for us are.

But it is definitely having a bit of an impact on our net interest margin here in the short run as the balances are getting bigger and the spreads that we're earning on that are less than what we've been earning on average on the rest of the balance sheet.

Richard Fowler

Okay. Okay, Walt back to you now. We have had, so few questions coming, just asking as us for maybe some further perspective on the ARS situation. Given the contained nature of this... of the client holdings there, would we think... how did we think about the possibility of just sort of finalizing that issue and trying to resolve it at this point versus I guess digging in our heels a bit and the conversations with the attorney general. So could you provide some perspective for folks on that?

Joseph Martinetto

Sure, Joe. Let me first say that we don't approach decision like this. We don't approach it lightly. We spend considerable amount of time speaking with our shareholders. We also spend a considerable amount of time speaking with our clients, including the clients who hold this $100 million approximately of face value of auction rate securities as part of making a decision.

I guess I categorized our decision to not settle with the Attorney General based on two things, one would be principal and the other would be President. Because there some of the questions have said, they have applied up a here cut to 100 million and try to quantify it as a fairly small number. But, I think the issue is deeper than that in those categories of principal and President.

We did not promote auction rate securities to our clients in any broad manner. We didn't compensate our financial consultants for the sale of auction rate securities. That's partly why about 90% of the auction rate securities purchased to Schwab were purchased on an unsolicited basis. So we have in many cases self directed clients asking for a particular product, us delivering that product to them with the best information that we had at that time. And to be asked to stand behind losses or illiquidity that our client may suffer based on circumstances that we had no knowledge of at the time or control over on a investment decision that they made as a self directed investor on an unsolicited basis, we think sets a very, very dangerous President.

And so we feel that the right thing to do in this circumstance is to continue the position that we have had which is to work very closely with all of our clients who hold auction rate securities to be in regular communication and conversation with them, to offer them where appropriate and where they desire some form of liquidity and access, but not to make some broad brush settlement approach that it tends to put us in the category of other firms to use our business approach to auction rate securities was vastly different that ours.

Richard Fowler

All right. Then Joe, maybe you can talk a little bit more about capital management and can I reinforce some of these messages. We're getting some follow-on questions there as well. And maybe the benefit from additional clarity here, when you talk about the bank meeting capital, the banks are very profitable. It continues to be very efficiently run, very sort of scaleable model for us at the same time it's growing. And that has ramifications for us. And I think we might want to spend a minute, just king of reviewing the tactics versus philosophy on repurchases as we look at this growth picture.

Joseph Martinetto

Sure. I think it's important to note that the bank meeting capital doesn't have anything to do with credit losses at the bank. It has to do with our success with our clients in this marketplace and largely driven by listening to our clients around the products that they want to have available to them in Schwab.

The biggest driver of growth in balance sheet at the bank right now is the high yield investor savings account. It was offered predominantly as a defensive product, something to give our feel and opportunity to talk to clients when they came in and said I wanted products with a higher yield or I'm going to have to take the money out and send it somewhere else.

We don't like the idea of money going somewhere else because we're going to gratify to get it back. So in the moment, we've decided that we're going to continue to offer a compelling guide to clients around the cash yields is a way of continuing to enhance and deepen those relationships for the long run.

That decision has led to about $5 billion of high yield savings growth as of the end of the second quarter on our balance sheet. If you think that we maintained a little over 6% leverage ratio at the bank, 6% on $5 billion is about $300 million of capital that the bank required to support that growth.

Some of that was generated by bank profitability on a standalone basis. But the bank still is not... I mean that's a big number for the bank in the short period of time to completely self-fund. So, we put some additional money down into the bank, but the fact that we put the money into the bank is driven by all of those decisions that were made around the client side of the business that led us to that point.

In the long run, we'd be hard press to see in an environment where the bank balance sheets going to continue to grow at the rate that it has here for the last couple of quarters. And to the extent that it does, we're going to maintain a discipline around making sure that we believe those products are going to allow us to earn an appropriate return on the capital that we're putting down into the bank.

As managers of firm, we take that discipline around capital very seriously. And we are... our belief that to the extent that we're generating the kind of growth that allows us to redeploy our capital internally, the shareholders would actually want us to do that before we would look to return it.

Now all of that said, did you net the bank out is a question around what that capital demand is going to look like. The remainder of the business is not particularly capital intensive. We aren't making big investments in assets that require a lot of capital. And as much as we'd like to the marginal loan growth to broker dealer which is a big driver there, that's come back sound, but it's certainly not driving big demand for capital and broker dealers.

So, over the long run, as this market stabilizes, and growth begins to moderate a bit at the bank, I would expect we're going to return to an environment where we're generating more capital than we can deploy and we would probably be more active in returning debt to shareholders. But a lot of things drive in the near term decision making around that capital management and we're trying to strike a good balance between being able to satisfy our clients and being able to put the returns at that our shareholders' demand from us.

Richard Fowler

Okay. All right. Yeah. So we've... yeah. So we've got about I don't know five plus minutes left here. There have been a few questions on a trend kind of gather these together in a group around lot of what we are talking about today is sustaining growth, sustaining momentum, we are going to ask about sort of house are taking really evolving at about that 8 to 10% organic growth number. Thus the law of large averages, large numbers sorry, catch up to us on that and then maybe sort of build on that to how we look at the competitive environment right now and I think our feeling about our positioning there. And then may be, commented on consolidation as well.

So I know that's kind of a mouthful, but things I wanted to make sure we've got to. So maybe if we can start with that sort of overarching growth story and how we think about driving that organic number, Walt, could you start this off?

Walter Bettinger, II

Sure. Well, as I indicated we feel very good about our competitive position. We look at the net transfer of assets is one of the cleanest and clearest measures of whether you are gaining ground or loosing ground from a competitive standpoint. And then our net transfer of asset figures very strong and very, very strongly positive.

We have results against many of our competitors that are at record levels as far back as we have data to track some of those competitors have changed, merged and adjusted their form. But as we try to make appropriate adjustments in our numbers, we see in a number of cases record results in transfer of assets. We feel very good about that.

In terms of net new assets, as Joe indicated we strive for somewhere between 8 to 10% growth on our asset base net new. We are going to be, it appears somewhat challenged with that this year at the lower end of that might potentially miss that by a little bit. We don't know it depends on how the second half of the year unfolds. There is no doubt that investors are less apt to be putting new money into the markets today.

We know that they are paying down debt. We speak with clients and are aware that they are more risk averse with their new money. Similarly, we don't see clients pulling significant amounts of money out of the market, but there is a hesitancy to put new money in and that has some impact in our net new assets. But, we feel very good about the overall trends. And again I think go back to the metric I stated earlier, that the last time the S&P was at this level, we were doing 2.5 to 3 billion of net new assets.

Today, we're doing say 6.5 at the same point in S&P. I think that further shows that we've diversified the vehicle by which we can attract new assets. It's not simply based on the market as it may have been the last time the S&P was here. We're also appealing out to a broader set of investors including those who are more risk averse, looking for either fixed income or even FDIC insurance type of investments.

Richard Fowler

So these are more transitory, you view these as more challenges around getting to that 8 to 10% numbers opposed to anything that would lead us to sort of reset our bar, is that fare?

Walter Bettinger, II

Yeah. Absolutely do. As I have indicated, we're in the tail of the curve now. And we want to make smart decisions that aren't based on the tail, but are based on where the environment is going to be 80% plus of the time. So we continued to feel confident with that 8 to 10% range through this cycle, understand that there are going to be times in the cycle we might do even better than that. And maybe times in the cycle where we may just do a tiny bit worse.

Richard Fowler

Okay. And maybe here as we wind down, if you guys could spend a second on the consolidation, we get that asked pretty regularly with investment. Our views on, let's call it the acquisitions/consolidation front anything new there? I think our story is pretty well understood. It might there just reiterating where we are.

Joseph Martinetto

I don't know if we've got a whole lot new to add Rich, that we've got a cost structure at this point that we think is definitely competitive advantage to the expenses. There are opportunities out there to continue to take advantages scale and grow the business. We'll definitely look at them and look at them hard. But that's the opportunity is have to challenge here that what we think we've got the capability. We also have the opportunity and those things have to come together.

Richard Fowler

Okay. Anything to add more on that front? Okay, I think we are pretty caught up here. If I missed anybody, we'll make sure we get back to you after the call. Any closing comments, Walt, any final thoughts?

Walter Bettinger, II

Sure. Well, I guess, hopefully we've been transparent and shared a lot of information about out results. We recognized that near term challenges, we recognized that the environment continues to be difficult, particularly in the interest rate environment and as spreads, the credit spreads have tightened up so dramatically over the last couple quarters. We know the impact, the short-term impact that has on our results.

But, I guess the overwriting point that I would make is that I don't think our company has ever been healthier than it is today. As measured from a competitive standpoint, from a metric standpoint, acquiring new households, new accounts; this company is absolutely executing and operating at a very, very high level.

And I fully expect that coral spring that a number of folks have talked about to be born out just as soon we get, just even the smallest uptick in interest rates out into the future. I have continued to believe in that chart I shared earlier about how the interest rate environment is over 2%, 88% a time in the last 50 years. And I continue to believe it's likely to be in that same range over the next 50 years and we'll take advantage of that.

Richard Fowler

Okay. With that we'll thank everyone for their time. And we'll be back, I guess back in touch with the regular fall business update around late October, early November. Thanks very much everybody. Have a good day.

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Source: Charles Schwab Interim Business Update
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