Charles Schwab's CEO Discusses Business Update for Institutional Investors (Transcript)

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Charles Schwab Corporation (NYSE:SCHW)

Business Update for Institutional Investors

February 2, 2012 11:30 AM ET


Rich Fowler – Senior Vice President Investor Relations

Chelsea de St. Paer – Vice President Investor Relations

Walt Bettinger – President and Chief Executive Officer

Joe Martinetto – Executive Vice President and Chief Financial Officer

Andy Gill – Executive Vice President and Chief Operating Officer

John Clendening – Executive Vice President Shared Strategic Services

Jim McCool – Executive Vice President Institutional Services

Bernard Clark – Executive Vice President Advisor Services

Steve Anderson – Senior Vice President Retirement Plan Services


Howard Chen – Credit Suisse

Gaston Ceron – Morningstar, Inc.

Michael Carrier – Deutsche Bank Securities

Rich Fowler

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Walt Bettinger

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Question-and-Answer Session

Rich Fowler


Walt Bettinger

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


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

Walt Bettinger

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

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

Now, bear in mind that a lot of the early converters are going to be existing Schwab clients moving to that program. So it may not show up in net new assets, but the revenue that we capture per dollar of client assets goes up in the area doubled.

So we expect to have revenue improvement that may not show up in the net new asset part as the initial grouping of many, many clients we’re talking with begins to convert. I think second half of 2012 to maybe see some NNA impact. And then we feel very confident we’ll move into ‘13 and ‘14 that it has potential to have an impact that is measurable.

With respect to breakaway brokers, again, that is, as we have said for a number of years, a long-term trend. We continue to see them looking at going independent. Again, I just want to segment the brokers who’d go independent. I would categorize them into three groups. There are very, very small brokers who go independent.

And although we look to serve some of those, we look to serve them within an economic model that makes sense for us. There is second population that looks to go independent and is not really ready to cut the entire cord from being commissioned. So they may want to retain a fairly significant commission waiting, 50% or 75%.

That is not a segment that we spend a lot of energy targeting. We tend to target the third segment, which tend to be larger breakaways, usually teams of at least two or more. And they’re committed to going, principally, if not, entirely fee. That’s really the part we go after.

So there’s three different types of populations who break away. And our emphasis is generally on the third segment.

Howard Chen – Credit Suisse

Walt, Howard Chen from Credit Suisse. Walt, the company has been over the last couple of years (inaudible) and Schwab has been the preeminent asset gatherer within the United States. But that growth has slowed down certainly a bit. So I guess...

Walt Bettinger

As a percentage.

Howard Chen – Credit Suisse

As a percentage.

Walt Bettinger


Howard Chen – Credit Suisse

So, as you and the team kind of look out, do you still feel the vast majority of that is still disimbalanced between money market and bank rates? Is there less money in motion? Are you hitting the law of large numbers? We just love an update from your thinking and all that.

Walt Bettinger

Sure. I think there’s a couple of things going on. There’s definitely the impact of rates. I think we’ve shared that if you track our net new assets historically against yield spreads between money market funds and bank deposit rates, there’s a high correlation – consumers making irrational decision to move cash to us if a money market yielded more than if they were to leave it in their bank, where often they receive their wealth from a sale of a house or a sale of a business or a bonus at work, something like that.

That’s definitely hurt us. I think there’s another issue that we have executed on, is we have done a fair amount of de-risking within our business. And by de-risking, I mean we have stepped away a fairly large number of relationships that didn’t make sense for us, whether it’d be on the advisor side of the business or even on the retail side.

We have made a lot of efforts to address an area where we didn’t feel that we were happy with the business model. And this is around the holding of alternative investments. So I would argue that there’s two issues, and you mentioned growth. There’s the issue of growth in net new assets, but there’s the real issue, which I think owners want to pay for, and that is growth with respect to revenue and earnings.

And when we analyze the assets that we’re not capturing and the Roca [ph] underneath those, or assets that we’ve actually invited out the door and the Roca [ph] or revenue on those and compared to the revenue that we make on the assets we are capturing, I think our strategy is working.

Now, I can go out and generate a lot more NNA. That’s not very difficult to do. But I’m not interested in NNA. We think we want to capture NNA that has strong revenue and earnings behind. NNA is the easiest thing to go out and capture in our business, particularly if you serve folks in the RIA side.

So I think our growth rates are sound with respect to the environment. They’re not as high as a percent of some. But we’re pursuing a very different strategy. We have a strategy that emphasizes the revenue on the assets, not simply the assets themselves.

Howard Chen – Credit Suisse

Thanks, Walt. And my follow-up. On the theme of just controlling what you can control, you all have done a great job of kind of re-engineering the expense base and the profile for low interest rates. But I get the question a lot about money market reform.

I know there’s still a very broad of outcomes. We just love your latest thinking on it.

Walt Bettinger

The interesting thing is, our money fund complex continues to grow. And in some ways, that creates frustration around the waivers. Why are the waiver is still at the level they’re at? Why don’t the waivers start to shrink? You’ve had a little bit of tick up in LIBOR, although most of that are scenarios where we’re not really investing much in money funds.

But money funds continue to grow. I mean, consumers want money funds. They need a need for them. The other thing we have to look at is that, although we’re waiving significant amounts of fees and money funds, $600 billion or $600 billion plus, we’re still bringing in a significant amount of revenue in that business. And so, it’s not that it’s an unprofitable business. It’s that it’s less profitable than it would otherwise be.

With respect to reform, there’s a lot of proposals out there. But all along, we’ve been saying that we felt eventually there would be under some of the more – even under some of the more, let me call them, aggressive or draconian measures, there would be carve-outs for things like treasuries or agency paper, maybe munis, paper that is very short-term, seven days and under.

And in our communications, because we’ve done research with our clients, if we were to get a VNAV or we were to get an overly burdensome level of capital requirement against money funds, we would convert our money funds to guvy Treasury. And our clients have indicated that that’s fine.

I suppose you could argue the worst thing that could come out of that over time would be that that yield spread between bank deposit rates and, say, a guvy Treasury, money fund versus a prime, you might get a smaller spread and it could have some effect on NNA over time.

Although, to do that, to believe that, you’d have to also believe that bank deposit rates won’t also stay depressed. I happen to think that bank deposit rates will stay depressed if money fund yields are lower than they were in the past because more funds have moved away from prime and gone guvy Treasury. So I think we’re prepared for what would happen.

If the capital requirements recently talked about are put in place, the capital for us would be very, very modest if we chose to go that way or, again, as alternative, we might simply convert the fund.

So I think we have optionality around that that we feel very confident in our ability to continue to have that product for our clients and continue to make significant money on it and, of course, in an improving environment, make an awful lot of money managing money funds.

Gaston Ceron – Morningstar, Inc.

Hi, Gaston Ceron with Morningstar.

Walt Bettinger

Hi, Gus.

Gaston Ceron – Morningstar, Inc.

Just reengaging a little bit with the Schwab story this year. So, forgive me if this has been kind of covered in previous meetings. But I wonder if you could help me understand a little bit more about where you see the distribution of the overall revenue pie.

My understanding had been that the company, for many years, have been sort of de-emphasizing, for lack of a better word, the trading side and kind of putting a lot of its eggs in the asset side. And obviously in the last 12 months or so with the optionsXpress move, you’ve tilted a little bit more to that side. Do you want more exposure trading in a long term or are you at the right place? What’s the right balance?

Walt Bettinger

That’s a great question, Gus. The reason why trading is important for us is because our clients who tend to trade a lot are also our most affluent clients. And this is where I think some of the confusion gets in around strategies. We’re not really pursuing trading to try to be number one in darts or number one in dats or something like that.

We’re pursuing trading to the extent it is a product or service that our valuable, affluent, who tend to be our most profitable clients, are looking for from us, because if we don’t provide it to them, they’re going – the risk exists that they will move that money to someone else. So we’ve put a lot of emphasis in there.

Our most valuable clients, we categorize it into retail side. We categorize as active investors. They have, on average, about $750,000 with us. Not only are they our largest traders. Interestingly enough, they’re our largest buyers of one-source mutual funds.

They’re the largest client grouping as a percent in terms of who do their mortgage through Schwab Bank. When we offer the credit card, they were the largest users of our credit card. They are people who are highly engaged with their money, but also highly engaged with Schwab. And so that’s really the impetus behind our efforts to continue to invest in and enhance our trading capabilities, whether it’d be on the derivative side with optionsXpress.

I think, this morning, Andy is going to give a little more detail on some of the things that have been teed up at our last meeting around our global investing capabilities. That’s really what’s behind it. It’s meeting the needs of our client as opposed to trying to be number one in darts with a large number of small value accounts.

Oh, yes, Chelsea.

Chelsea de St. Paer

Hi, this is from the Web. Can you speak to retail engagement in January? How was that holding up?

Walt Bettinger

I think it’s fairly consistent with what I shared around the way sentiment was in late 2010. I’d say pretty tough from a client engagement standpoint in January. We know the markets went up but you don’t get swings in retail client sentiment as fast as how a market moves within a four-week period.

So I would categorize sentiment in January as still fairly consistent with the end of ’10, lacking in confidence.

Chelsea de St. Paer

Could you provide any early feedback or results on how the first independent branch is going?

Walt Bettinger

Yeah, although I don’t know that I would draw any conclusions from one branch. But the first branch is well ahead of plan with respect to net new assets, prospects. They had a fairly small practice that converted over with Mary. But she’s well ahead of plan, which is exactly what we expect in one from our early pioneers in that program.

Other questions?

Michael Carrier – Deutsche Bank Securities

Thanks, Mike Carrier at Deutsche Bank. Just getting on the topic that you mentioned from the start in terms of managing for lower or for longer. If we look over the past few years, the balance sheet growth has been pretty impressive or pretty strong.

A lot of that has been driven by the clients. But when you look at it from a capital standpoint, your options around the cash flow that’s being generated given where the stock is, buybacks, you can grow the balance sheet, and then probably, more importantly, just given this regulatory environment, going with a new regulator, when you look at your capital ratios, how confident are you, especially if the balance sheet just continues to grow?

Walt Bettinger

Sure. I think we feel very comfortable with our cap ratios. Joe is going to go into a lot more detail. We voluntarily participated in very stringent stress test, which I think Joe’s going to cover details on.

I don’t think any of us view that the change in regulator to the OCC is likely to have impact from a negative standpoint within our capital. Mike, the first thing you might have been getting at was we make that conscious decision of what do you do with capital.

Do you keep growing the balance sheet, whether it’d be client directed or actually us doing transfers of money to the bank? Or do we use it to buy back stock given where the stock is? So we try to make that as a very conscious decision on an ongoing basis as to where we think the greatest long-term value is going to come.

Of late, we have moved some money from, without getting too complex around the capital issues; we’ve moved some money from the broker reserve portfolio where, of course, our yields are very, very low, low double-digits to the bank. It has a very minimal impact to us from a capital standpoint only, delta is between balance sheet and bank, and yet you pick up significant incremental NIM in the process.

But we try to make a very conscious decision with respect to what we’re going to do with that capital all the time. Do you continue to fund client balances moving onto the balance sheet or should we use it to buy back stock?

Michael Carrier – Deutsche Bank Securities

Thanks. And then maybe just on the expense side. I’m sure we’ll get to this in a little later. The flat expenses year-over-year, I think, relative to the past makes a lot of sense just given the environment.

If things do get more challenging, are there is that you can pull back if need be despite still bringing in the assets and organically growing like try not to make even to that.

Walt Bettinger

There are probably opportunities, but there are fewer and fewer opportunities the longer this has gone on. For those of you who followed the stock closely since, say, ‘08, we have taken a fairly substantial amount of expense out of the company and you get – I won’t say we’re all the way to the point because there’s always opportunities to be even more diligent, more stringent and find expenses.

But those opportunities are getting smaller and smaller without cutting in to the client implication. So I think what we’ve resisted is decisions along the lines of saying when we answer the phone on average in 21 seconds and we could create an extra penny of earnings in 2012 if we let that go to 29.

Those are the decisions that we have resisted making because we’re not really sure that that extra $0.01 of earnings in a period in which our stock price seems to be somewhat disconnected from its long term potential is worth impacting the client experience in the long-term organic growth on the franchise.

Those are the kind of decisions I think that you’ll look at given the extent to which we’ve reduced expenses over the last four or five years. But we continue to look at it and we’ll always do so throughout, no matter how long this four-letter lower or longer it is.

Michael Carrier – Deutsche Bank Securities

Could you maybe just talk a little bit about how you think about ETFs and they’re long term impact on the OneSource franchise?

Walt Bettinger

Sure. To date, ETFs have not been cannibalizing our OneSource growth. We continued to have success with OneSource, although in fairness, a lot of the OneSource growth occurs within some of our advised wrap-based programs.

And of course, that’s really the strategy for ETFs. We didn’t come out with very low cost ETFs with zero trading commission because we thought we’re going to make a lot of money in selling pure ETFs to traders and investors. We did it because we wanted to expose retail traditional investors to the benefits of ETFs and help them become educated so that we could utilize them inside advisory wrap-based programs like Schwab Managed Portfolios, ETF and Windhaven.

So that was the strategy behind the ETFs and I think it’s worked quite well given the growth that we’ve had in those two product lines. So I think we may have – I think in John’s presentation, he’s going to talk some more detail about the growth in those products particularly in Windhaven.

So that’s really the strategy there. We’re not seeing cannibalization at any measurable level of OneSource as a result of ETFs. In fact, I recently met with a number of the CEOs from some of our OneSource partners and the ones who are delivering quality results for investors are continuing to get flows from us on a regular and consistent basis.

Michael Carrier – Deutsche Bank Securities

Well, I just had a follow-up. Maybe in a little off the wall question. Just over the course of last year, particularly late in the year, you had a lot of questions in financial services about the viability of wholesale funded institutions, big dealers. And then tons it looks like your stock and your stories penalized by all the excess liquidity that you have.

So I’m just curious from your point of view, do you see any way to kind of bridge that gap longer-term to kind of take advantage of that value that you have in all that liquidity? Is there something else that maybe can be done that we’re not thinking about?

Walt Bettinger

My guess is we’re all thinking about it. As you would expect, look at on a regular and ongoing basis, all types of alternatives that might exist around the size of our balance sheet, our ability to continue to grow it organically, as well as the fact that we still have, unlike some of the other competing firms, we still $160 billion in money market funds that under the right scenario could potentially head toward a balance sheet that has exceptionally low funding cost associated with it.

So we look at those things as – I’m sure you would want us to and expect us to – on a regular and ongoing basis. Now, in fairness, the environment is very different than what the environment was when some deals in the past were struck. And you also have to look at it, I think, very carefully, not just from a financial engineering standpoint.

You have to make sure that anything that you would look at would make strategic sense, too, because as we all know, earnings generated through financial engineering in one environment tend to disappear like dust in the wind in a different environment.

So, anything that we look at has to make sense strategically, not simply in the short-term might create some financial engineering upside. But we’re looking at those things constantly all the time and having conversations about them all the time.

Unidentified Participant

Just a quick follow-up on the cannibalization question. How do you know that the ETFs and other funds aren’t cannibalizing your proprietary funds in the OneSource?

Walt Bettinger

We look at the origin of the flow into the ETF where the money was before. You could argue. If the money was sitting in cash and went into an ETF, there’s some potential it might have otherwise gone to OneSource. But I think what the question you’re specifically getting at is, “Are people selling OneSource funds to buy ETFs?” And that’s not the case.

They’re not doing that so we look at where the money originated before it went into the ETF. Actually, a lot of the money that’s gone in ETFs are proprietary ETFs is new money to the firm.

Unidentified Participant

And then second question related to the bank. Do you target an ROE for the bank? And I guess how important is it to you to hit that kind of target without sacrificing profitability on the other side of the business?

Walt Bettinger

We do target an ROE for the company, overall. I’d say more than just pure focus on the bank, because, again, for us, the bank is principally a tool from which to monetize yield in elastic sweep balances. It’s not something in and of itself. It’s a monetization entity for us to a great extent. So we look at ROE at the firm, overall.

Now, we do, again, try to take the long term perspective because as you get, at some point down the road into an improved environment, the ROE of the company is so high as it has been in the past in better environments. The ROE is so high, we just want to be really careful not to be overly short-sighted about the fact that in the term it’s not maybe at the level that we would ordinarily like.

It’s still, I think, very respectable where we are today but it just gets so high in an improving environment. We just want to be careful not to shortchange that upside.

There’s another question here from...

Unidentified Participant

Could you just walk through your different businesses and talk about any areas where you’re seeing fee pressure of any kind whether it’s in the mutual fund side or on the ROE side?

Walt Bettinger

Yes. So, on the retail side, I’ll just go through the primary business points. On the retail side, we’re not seeing a lot of price pressure. There are a couple things that go on in the retail business. There are published prices and then there are discounted prices. And there is, I’d say, a reasonable amount of discounting going on, on trade commission pricing that is off the published price.

So, although you don’t see sort of a visible price for going on, there’s a lot that goes on behind the scenes in terms of one off, hundred off, thousands off discounting.

So, you see a bit of that there. We’re not seeing pressure around other revenue sources like one source fees, things along those lines. One the ROIA side, there’s been a long term trend over the last 10 years in which the revenue per dollar on client assets is going down as advisors have moved more and more toward beta-oriented type of products away from so much active management. And so you’ve seen that.

And, of course, every time in retail you have to lower pricing from a competitive standpoint. You end up lowering the pricing for the clients of ROIA despite the fact you probably don’t have price sensitivity there.

But we’ve been largely able to stabilize that in the last few years. Now, in fairness the ROIA business takes a bit of a hit from the money market waivers that’s just proportionate because their clients aren’t on the bank. We’re very careful to keep those clients largely out of the bank because ROIAs move money in huge volumes at once. And it can create a lot of complexities from a capital management standpoint but they have taken a bit of a hit from the money fund but we’ve been able to largely stabilize that revenue in the last few years but, you know, it is definitely down significantly from where it was 10 years ago.

And I can envision that being a continuing challenge. I think I’ve talked in the past that in the ROIA business you have to find we think for the future new additional ways to deliver great services to our ROIA clients and their end-clients that generate revenue whether it’d be through pledged asset loans or other types of enhanced capabilities. Surely making money on trading and a little bit on cash could be challenged out into the future.

The 401(k) industry continues to have downward price pressure as there’s greater understanding of the fees delivered to participants or 85% of the assets in that industry are an actively-managed funds and the majority of those are in retail price actively managed funds. So there’s continuing pressure but I would say behind a fair amount of that.

And once Steve talks about Schwab Index advantage hopefully you’ll see that we’re putting even more and more pressure on that. At the same time those cost are going down, our strategy actually grows our revenue in that business as oppose to going the other way.

We have time for one more question if there’s one more here from Justine [ph].


I’m just wondering when you do your pulse of customers, what’s the biggest reason they buy ETFs? Are they focused on fees, focus on tracking air? And second of all, does brand matter at all at that point? Have you been successful to sell Schwab ETFs with no previous brand in it?

Walt Bettinger

Yes. I think cost in a confidence that they understand the product is probably the big issues behind the growth in ETFs. And with respect to brand, our strategy, when we roll them out was, as I mentioned, the big strategy was around awareness so that we could offer them an advisory wrap [ph] solutions.

Our secondary strategy was we were and I think are remain the largest custodian of retail investors holding ETFs. I don’t remember exactly how much – I’m fairly sure it’s over $100 billion in ETFs. We felt that with the exception of the flows that were probably headed toward Vanguard, we could convert virtually all the rest of the flows into Schwab.

Now, I exclude from that the ETFs that are the more exotic, the high leverage ones, which we, of course, chose not to build Schwab versions of. And that’s exactly what we’ve done. If you look at the flows in the ETF asset classes, where we built Schwab product, all the net positive flows end up between Schwab and Vanguard.

And we have effectively taken all of the other ETF managers to either flat to negative flows in all the asset classes we offer Schwab product. It’s not a lot of revenue but 10 is better than 0 basis points, I guess, is the best way to put it.

All right. I’m going to go ahead and turn it over to Joe. Thanks again so much for being here. I’ll be around through at least the first break if there are other questions that you want to talk about. Thanks again for being here today. Great to see all of you. Thanks.


Joe Martinetto

Thanks, Walt. So, I’ll add my thanks to everybody else’s for folks taking the time to travel out here and be here in the room in person. Or for the folks that are attending on the webcast. So, thanks for investing your valuable time in hearing a little bit more about the story.

So, for those of you who’ve been on the road, I wanted to be able to give you a weather upcast or forecast given that it is Groundhog Day. But I hear there’s some confusion between which groundhog is predicting which outcome for weather going forward. And given our conservative nature here about making forecast that we aren’t really too convince we’re going to be able to deliver on, I’m not going to be able to do that.

I can tell though that I’ve got great confidence that I know Rich Fowler saw the shadow of a hedge fund manager this morning. So, I know we’re in for at least six more weeks of volatility. You can take that one to the bank.

While we’re talking about volatility, yet again, I’m up here talking about trying to adapt the business model in the face of an economic environment that continues to evolve. And so, we are making changes in terms of how we think about the choices that we make in terms of managing the company, along with the things that we see in terms of our opportunities going forward.

Walt’s talked a little bit and you’re going to hear it through the course of the day about some of the great opportunities that we see in front of us. And we want to be able to continue to make appropriate investment to drive the business forward while also acknowledging that we have some pressures here in the near term and we’ve got to balance our spending with our ability to deliver appropriate returns here in the short run.

So, I’m hoping, in the course of the conversation, that you’ll get a sense not only of the decisions that we’re making. But also a bit of what we’re thinking in the background as we’re making those decisions so you’ll have some context for how we’re thinking about moving the business forward.

Let’s step back into 2011 here for a minute because it’s important context. As we came in and set up last, the planning environment, we were hoping for a period of relative stability. We had talked about looking at treasury rates that were relatively flat for the year in a 6.5% market appreciation.

And for the first half of the year, the markets largely cooperated. Second half of the year was a different story. We saw that S&P drop on average about five percentage points over the second half of the year. The decline from June to December knocked about $85 billion off of our clients’ asset portfolios.

On top of that, as Walt already mentioned, we went from 10-year of about 3.5% and within a reasonable range of that in the first half, to end the year at a 188 basis points. So, clearly, a little different environment that what we projected as we set up our planning scenario.

In the face of that, we still managed to hit our financial commitments or come pretty darn close. We talked about, in that flattish environment for interest rates and markets, targeting a 10% revenue growth on 8% expense growth. What we delivered, stripping out some of the non-recurring items, 9% revenue growth on 6% expense growth.

So, knowing that we were falling a little short on revenues as we moved in to the second half of the year, we were able to keep some control on expenses to do a little bit better there. And actually, in total, we’re a little bit better on net income than we would have predicted even for a better environment. So, we hit our commitments.

Well, we are in a period of pressure here in the near term as we face what’s going on in the economic environment. And we do have some challenges in terms of making those trade-offs.

I’ll spend a little bit more time talking about how these trade-offs will work, but again, it’s a balancing act here of reducing projects, spending a little bit while continuing to make investments that we think are important to drive the business forward. You’re going to hear things from Steve Anderson about the 401(k) business and the investments we’re making in the new 401(k) model. Things like that are not only important for driving growth, they cost money to deliver.

And I think you all understand that. But to be able to continue to make that investment, we have to maintain a reasonable level of project spending. So what we’re talking about is about a 20% decline year over year or a little bit more than that.

So we’re coming off some of last year's – some level of spending, and we’re bringing it down, but not anywhere near the level that we cut it to back earlier in the crisis. So we’re pretty confident that we’ve got the balance right there.

And then Walt talked a little bit about the challenges that we were facing and how we’re approaching the core operating expenses, and I’ll talk a little bit more about that as we move forward as well.

As we try to break 2012 down in a little bit more detail, interest rates of course are probably people’s first set of questions here, so let’s take that on right upfront, don’t have a lot new to talk about in terms of impacts of net interest margin from this environment. So we talked in the fall about seeing a net interest margin settle in around 160 basis points as we move through the year.

If we saw the tenure treasury stayed relatively flat around 2%. And we’re still looking at that kind of an outcome, and that’s the environment that we experience. We talked also about what happens if rates start to fall a little bit.

So if we saw a tenure move down to 175 and stayed there, we’re still thinking that the net interest margin would trend gradually down toward 140 basis points. Now that 160 as we’ve talked about in the past, there’s a couple of different factors that are running through that number. We got there pretty much on average in the fourth quarter because we experienced a large amount of pre-payments in our investment portfolios, and those pre-payments led to advancing amortizations with some of the premiums on that portfolio.

In that activity, if we see pre-payments begin to slow, we’ll start to stabilize in terms of impact on the portfolio. So over time, that impact will be lessening as we move through time, but what will happen is, we’ll be left with the portfolio, then it will be invested at lower average yields.

So that’s how you move from a period where you take that quick move, but you’re able to basically maintain kind of a flattish environment through – or flattish net interest margin through the year.

So it’s driven by changing effects of that premium amortization toward the front end, but a portfolio that’s stabilizing more at a yield level as we move to the back end.

The declining scenario, we have some accelerated amortization all the way through the year, as well as a bigger impact in terms of portfolio movement on the yield balances. So that’s how that number comes together.

Now, there’s a lot of assumptions embedded in making a projection on net interest margin. So it’s not exactly a linear Science here. A lot of it has to do with what goes on in the primary mortgage market versus where rates are in the treasury market and what those spreads are looking like and whether those primary mortgage yields are getting pushed down far enough to spur that pre-payment activity.

So it’s not going to be as easy as saying, we saw few days here where it was down below so we’re going to start to try to factor that in and take a little bit off of that and it’s just a little bit more complex than that.

So I think these are pretty good guidelines for what we had expect. But there’s a little bit of path dependency here that we’re going to have to try to manage. So I’d ask people to just stay in touch with us as we move through the year, and well try to keep people updated on our thinking as this evolves.

Walt also talked a little bit about money fund fee waivers. And we did hit a high water mark there of $168 million in the fourth quarter. If rates stayed about where they are, right now, we think that we’re going to see fund fee waivers stay in about that general area.

Again we’ve seen a little bit of firming in the short end of the curve which should be helpful for trying to manage that fee waiver line. But we also continue to see new cash balances come into the money funds.

So when we only focus on the fee waiver, we’re focusing on that one negative aspect, it may be growing, but the fact that it’s growing, if it’s growing because of balances, should mean that we’re also going to have more residual revenue left at the end of that waiver. So we got to be a little bit careful here about not just focusing on the negative and remembering that if the balances are growing, and that’s what’s driving the waivers up, that’s not necessarily a bad thing because we probably have revenues growing along with it.

It’s not just about interest rates as we look at 2012. We continue to win in the market place. We brought in $10.5 billion in new assets in December alone, we think we’re going to be able to approach $100 billion mark from that new assets in the year. We’re doing a number of things to try to optimize the earnings potential to the balance sheet. We talk to you in the fall about a movement of around $5 billion of cash balances from the broker to the bank. That was completed here already between the fourth quarter and the first part of January. So that movement is already done.

We’ve got a few other things that we’re contemplating that are similar to that. First, we’ve got about $2 billion of option express cash that we’re looking to bring onto the balance sheet in the second quarter. And we’ve already talked about that before.

We’ve got across a couple of different maneuvers [ph] about $6 billion of additional money that would have been at the broker or is already at the broker that will land at the bank over the course of the year. So, that split across a couple of different activities.

One part of that is driven by an additional bulk transfer that we would expect to occur about Q3, early Q3 at this point. And that’s about half of that $6 billion. The other half is changing some features on accounts. So, for people that would have automatically been defaulted to brokerage cash, we’re going to change that feature to new accounts that open and the money that comes in with those new accounts, now defaults to the bank.

And that’s about another $3 billion and that’s going to triple in over the course of the year starting in Q2 as we make those changes to account agreements. But in total, it’ll end about $6 billion of extra balances at the bank that would have been at the broker if we hadn’t made these changes by the end of the year.

We’re also doing a number of things in the lending front. So, you’re going to hear more in detail from some of my colleagues as they come up around our transition to quick in loans and the impact on mortgage origination. The infrastructure improvements that we’re making to support the Powell lending program, the launch of a new advisor direct lending program, which is in pilot at this point.

So we’ve got a number of things to try to put a little bit of help under the yield side of the balance sheet as well.

We’ll talk about the success we continue to have in bringing in people into our advice offers. And John Clendening is going to spend a whole session talking about the wealth and products that we have and the financial impacts of that. But it’s also important in terms of driving revenue growth as we look forward in 2012.

On the expense side, I think we’ve talked a little bit about the project cuts that we’re looking at. The numbers are here. We’re going down from about 180 last year to 140 this year. We’re also asking our business heads to absorb all of the increases that come from volume related increases and expenses inside of their existing run rate. So, how do they that?

We have on-going expectations around people being able to deliver more and more efficiency, year-over-year. We don’t spend a lot of time generally talking about the money that we invest and being able to deliver those kinds of efficiencies because, frankly, it’s not really exciting stuff. So, we don’t generally break that out and talk to you about it.

But we generally have projects. And a significant amount of our project is spending goals to driving that efficiency. And that’s how we’re able to deliver those kinds of savings year-after-year and how we’re going to be able to deliver it again as we look into 2012.

So while the low-hanging fruit is pretty well gone at this point, I wouldn’t say that the well is dry, if I try not to make some metaphors there. There are always opportunities to find some additional expense savings. We just have to look a little harder and work a little harder of getting it. But we continue to make that one of our key priorities as we move forward.

We bring this altogether in an environment that, again, same planning scenario we’ve talked about now for a number of years, 6.5% market depreciation because that’s about average, although we never seem to actually get the average.

Flat interest rates and darts up pretty significantly 20% year-over-year. But I’d remind people that’s because we’re including the impacts of optionsXpress in the forecast going forward. We’d expect to be able to see revenues up 8%, on expense growth at 6% and maintain the 30% profit margin a little better than that.

I don’t have to spend a lot of time on the environment where rates are going up. I think everybody here that follows along with the story can probably recite the various metrics as well as I can. I’ll leave it with saying that if rates go up, the impact on revenues and profits are significant and immediate.

Finally, I talked a little bit about the net interest margin case of moving down to 140 basis points and the treasury drops to 175. We didn’t put the scenario on the page, but in that scenario, we would expect to see revenue runs slow to single digits. And, of course, we have to evaluate what’s the appropriate level of spending against that kind of an environment.

Moving on quickly to the balance sheet, there shouldn’t be a lot of surprises here. Our total assets do continue to grow driven by increases in client cash balances both at the bank and at the broker. We’ve got very little reliance on external funding. Our capital ratios remain very strong.

As Walt said, I’m going to get into a little bit more detail on the capital ratios here. We did run a couple of other alternative scenarios. So these are not exactly the ones that were specified by the Fed. We’ve talked about this in the past. We’re a thrift holding company. We weren’t required to participate in the stress test process. We’re doing this voluntarily.

We ran a couple of other scenarios so we ran a sustained downturn scenario which would be typified by negative GDP growth for a period, rising unemployment, significantly declining home prices. So a pretty significant declining kind of economic environment.

We also ran a stagflation scenario where inflation starts to get ahead of itself here. The Fed is forced to go in and act, starts raising interest rates, chokes off growth. Unemployment again starts to move up.

So we’ve passed those scenarios through our various models. The results for the tier-one leverage are shown on the chart. Now, the chart, green means above 6% or our internal target. Yellow means that we’re above 5% but below 6%. Red would be falling below 5% and this is for scenarios where we don’t anticipate raising any additional capital.

So, in all of the cases, we’re pretty comfortable. We’re staying above regulatory minimums while in the one scenario, the sustained downturn, we do drop below our internal targets, but stay above 5%. Now, I think pretty much everybody in the audience knows the regulations around holding companies also include a number of other risk-adjusted measures.

We didn’t bother to put those on the chart because we’re so high on the risk-adjusted measures, everything’s green and it’s just not interesting. The tier-one common number that the Fed has also recently picked up, that’s a risk-adjusted number. So that 5% number that they talk about, we also stay well above that in all of these scenarios.

So, again, very confident in the capital base that we’re running at today. So if we’re so comfortable with our capital, why did we go out and raise preferred? Try to hit off a question here.

For a couple of reasons, one is, it gives us a little extra buffer on that tier-one leverage ratio. $400 million of preferred gives us just under 40 basis points of incremental tier-one leverage and that gives us some flexibility. If we see the balance sheet change in a way that we didn’t anticipate, we’ve got opportunities to be able to accommodate it and we’ve got the flexibility already built in to the balance sheet.

Second, it’s helpful from a financial perspective. If you take that $400 million and contribute it down to the bank as capital, at a 7.5% leverage ratio, it can support a little over $5 billion of assets. Those $5 billion at a 130 basis points of incremental spread to the broker dealer turns into about $40 million of after tax income.

If you compare the $40 million to the $28 million of dividends we’re paying, you can see that it’s helpful to earnings. So that’s the basic math.

Now, I’ve got to issue a little bit of a caveat. Clearly, the capital is already on board. Some of the balance movements are going to take the course of the year to get in effect. So it’s probably not going to be a material driver of earnings this year, but by the time we get to 2013, the impact will be fully embedded in the run rate.

A quick move to credit and I feel fortunate that we don’t have to spend more than a minute or so on credit. We don’t really have a lot new here to share with people. We’ve talked about our exposures in the money funds to some of the areas that people are most sensitive to and we don’t have a lot to update there.

Nothing’s changed. We didn’t go out and buy a lot of paper that would cause us to have additional disclosures. So good news there. Credit statistics in the bank lending portfolio remained incredibly stable. So, again, we have really good results there and appropriate reserves against the balances in the portfolio.

So it seems to be my lot in life or maybe just my lot as a CFO to stand up here and talk about making adjustments in the face of challenging economic environments. I seem to say something like this pretty much every year. But that’s exactly where we find ourselves and exactly what we’re doing.

We are making those tradeoffs to try to make sure that we’re investing appropriately versus the growth we see, preserving the client service levels so that we don’t do anything that damages our ability to grow that franchise growing forward. We’ll also managing against the near term pressures.

We’ve seen as Walt was referencing, in a period of time of relative stability where the basic model works. It delivers. We don’t need rates to go up, we just need them to stabilize the core earning power of the franchise begins to turn into revenue growth and earnings growth. And that’s largely what we’re expecting as we absorb these near term pressure this most recent move in interest rates and we’ll start to move back out of that as we move to the back half of the year and start to see improving financials from our – in earnings perspective.

So, I’ll open it up for to questions. Let’s get the mics out.

Question and Answer Session

Unidentified Participant

Joe, could you tell us how you think about interest rate risk as far as how it affects the balance sheet whether or not what your targets are as far as duration on the asset side and how you think about matching?

Joe Martinetto

Yes, we talked about this. We still target around a two-year duration on the bank portfolio. Our challenge of late has been with the pre-payments coming in we’ve actually been seeing that portfolio shorten up because of the high degree of pre-payments bringing cash in. So it shortened up the assets that are on the balance sheet as well as thrown more cash at us more quickly.

So, in the past, I’ve talked about trying to buy 45% fix, 55% floating as a way of maintaining that duration of late. We’ve been trying to buy more in the way of fixed assets not to move the duration of the portfolio out as much as to get back out to the target duration on the balance sheet.

So, again, it’s not that our philosophy around risk management or our targets have changed as much as it is. We’re just having to make some tactical adjustments in the portfolio management to try to keep ourselves in sync with the targets we’ve already set.

Unidentified Participant

And is there any duration on the liability side? Is that a factor in any way?

Joe Martinetto

It does. It absolutely does. We take a chunk of the asset duration part of the lending books so I only, generally talk about the investment portfolio because the piece people want to look at but there are also some duration assets inside of the loan book. So we will take all of the arms that are produced, the three ones, the five ones, the seven ones. We’re also taking the jumbo 15 year product that’s produced at this point.

So, it looks a lot like some of the same types of CMOs that we’re buying in the market, it’s got a little bit better yield spread on it. So, we do take some duration also in the asset book so it’s the combination of the lending book plus the investment book that gives us the duration that offsets what we seen in the liability structure.

The liability structure, I guess I’d sum if off, many of you I think probably also cover banks as well as brokers. We look at the interest-bearing sweep [ph] balances as moving about like you would expect to see in interest checking account.

So, it’s got a relatively long duration to it in a relatively insensitive kind of re-pricing structure. So, it does give us an opportunity to push a little bit further out the curve to be able to put some duration on the asset side to offset the duration that we believe we’ve got on the liabitlity side.

That’s part of the reason that the bank exist to be honest with you. The broker is forced into a couple of things. Money that sits at the broker that isn’t lent, the clients goes into a reserve portfolio for the benefit of the clients and you’re only allowed to invest it in U.S.

Government Securities, domestic bank deposits or repo back by those instruments.

You’re also forced into mark to market accounting and that’s probably the bigger impediment because it’s really hard to take duration at the broker dealer because once you’re in mark to market land, you’re going to swinging your income around.

So, by moving some of the money over to the bank it gives us an opportunity not to just take advantage of a broader universe of investment selection but also to better match that duration characteristic that we believe see in the liabilities.

Unidentified Participant

Thank you.

Joe Martinetto


Chris [ph]

Thanks a lot. Joe, could you comment at all about the impact potentially of harp to on your portfolio, what percentage of your securities, I believe it’s somewhat low, would be impacted that, in terms of acceleration or pre-payment. And any differential in the yield versus for those securities relative to the rest of the portfolio?

Joe Martinetto

Yes. So, it’s the good news for us as a lot of the growth in balance sheet has occurred in later times. So, we don’t have as big of a percentage of pre-2009 as we have post-2009 papers. So, a lot of the impact of part two won’t be as severe on our portfolios. Maybe on a more a typical portfolio.

I’m sorry, what’s the second half of the question?

Chris [ph]

I’m just wondering if it’s a small percentage though, is it there a meaningful differential between the yield on those securities relative to the rest of the portfolio?

Joe Martinetto

Because again, it’s largely come in in large lumps in the past couple of years, I think the piece that isn’t a subject harp two really is the bulk of the portfolios to the yields that are embedded that you see are largely the yields imbedded on those assets.

Unidentified Participant

Hey, Joe. Could you just give us a broad update on your transition to the Feds?

Joe Martinetto

Our transition to the Feds is going well. We were a little different animal than what they normally see. So, I think there’s learning going on on both sides as we’re trying to bring them up to speed in the businesses we run, how we view them, how we run them, how we control them. That’s really important from their perspective. Participating in the stress test exercise voluntarily is a way of continuing to further some of that dialogue.

So, I don’t think anything has come up that’s been particularly surprising or alarming at this point, but we’re still working on building that baseline of understanding. They have largely completed a lot of their discovery reviews and now they’re starting into their more normal cycle of examination. So, we’re moving forward in that process but really nothing material to report on that front.

With respect to Basel 3, that’s still a bit of an evolving picture. So, the liquidity requirements, we were actually, we believe today fully compliant with fully phased in Basel 3 liquidity measures. That’s largely because of the type of balance sheet we run.

We have a very large investment portfolio both at the bank and at the broker. Significant liquidity already available and that’s not really a challenge for us in the near term. And quite frankly, I’d love to see loan generation get to a point where it actually did become a challenge. But we’re ways off from having to make changes of the business model to continue to meet those ratios.

From a capital perspective, I think we’re probably still a little cautious. I mean, we haven’t seen yet the final proposal of rule-making as to how the Fed is intending to implement their version of Basel 3. We keep hearing rumors that it’s going to come out. I think the last version we heard was late Q1. So, we’re in a little bit of wait and see, I think, along with others.

We continue to have that pressure point and dynamic of trying to watch that leverage ratio because I think we believe the Fed is going to continue to view that as one of their core measures while being well in excess of anything on a risk adjusted basis. So, we’re trying to walk that fine line of negotiating a number that we think is consistent with our risk profile, consistent with regulatory standards, but not carrying a lot of excess capital that we can’t adequately deploy on a return on.

Unidentified Participant

That’s great. And my follow-up, just a helpful update of NIM. I just want to confirm a couple of things. One, that 160 does that incorporate the additional transfers that you spoke of throughout the year?

Joe Martinetto


Unidentified Participant

And then two and three, could you provide a sensitivity if these pre-payments stay elevated around this 25% to 30% and what that might mean for the NIM.

Joe Martinetto

Well, I think to stay elevated, we would probably have to see continued movements down in treasuries because you’re going to have see a continued movement down that’s going to spark additional pre-payment activity. So, it’s a little inconsistent to say, “Treasuries are going to flatten out and we’re going to see pre-payments at this level.” I don’t think that’s how the structure is going to work.

So, we do expect that we’re going to see relatively higher pre-payments in the first half of the year as we continue to process through that boomlet that came with the most recent move down as a result of Operation Twist. But we also believe that as we get to the second half of the year, if rates stabilize that pre-payment activity will also stabilize.

So, that’s how you get to the 160. The 140 is more of the case where we do see rates continue to move down. We continue to see elevated pre-payments. That continues to force us not only to pull some of that premium forward, but more money into the market at lower and lower rates.

Unidentified Participant

Makes sense. And then the final one. To Walt’s point about just cautious retail engagement, what are you kind of thinking in terms of margin, balance growth, and utilization for that NIM?

Joe Martinetto

You know, that’s – we talked about this before, margin is really an optimism product. So when times when markets are better, and retail engagement is higher, we’ll talk about greed versus fear, all right? That’s the dynamic. People see opportunities in the market, and they’re willing to borrow money to take advantage of them.

And when we got period of pretty extreme volatility like what we’ve come through, it’s harder for retail investors to get that sense of confidence that they want to be in the market in a leveraged kind of way.

So margin, unless they’re stabilized, right around that $10 billion kind of level, and they’re still sitting there. I expect if we get to a period of relative stability and a healthy level of valuation in the market, that we’ll start to see them take back up again. I think we need some period of sustained consistent kind of returns that isn’t characterized by the kind of volatility we saw in the second half of last year.

Not a lot of material picked up the margin.

Unidentified Participant

Could you just reconcile for me the year-over-year flat expenses with that slide that showed the 6% up expenses, is that 6% match the flat including options expressed? Is that...

Joe Martinetto

Yes, it’s overlaying options expressed on top of flat Schwab.

Unidentified Participant

So 6% reported flat including (inaudible)?

Joe Martinetto

Well, flat Schwab prior to options expressed, 6% including options expressed, and that will be the reported.

Unidentified Participant


Unidentified Participant

Questions on the line product, and I wasn’t – I wasn’t following Schwab when you guys had the credit card portfolio, but why wouldn’t you – you know, have credit cards because I would obviously help them a lot and further engage your clients if you’re doing it with inside of your clients, and then also just other line products, you know, it seems that you have all these banks that are really struggling and you guys have your clients love you, they want to be more engaged, why wouldn’t you invest a little bit more maybe on your line of credit, credit cards and stuff like that?

Joe Martinetto

Yes, so we’re not making investments in lending products and trying to broaden this into things that we know. We are comfortable being a secured lender. And that’s where the bulk of our experience is.

There’s always a trade off, trade off in expenses, there’s also tradeoffs in terms of how you structure your balance sheet and how much capital you’re going to hold against that, and the kinds of returns you expect to earn.

We’re able to operate the bank at a very low efficiency ratio because we don’t do a lot of things that aren’t part of the way we view the business. We have fairly low credit charge offs, which again allows us to produce superior returns in the face of maybe a lower net interest margin that we’d have if we took on some riskier products. So we’re trying to balance that credit exposure versus what the return dynamic looks like.

Credit cards in particular is, you know, credit card is a scaled business, it’s really controlled by a few players, and it’s very hard to jump into that market and be able to compete effectively against people who have some massive investments in scale. So that’s one where I think we look at it and say from a payments perspective, we may find a way to offer a product like that down the road, but I wouldn’t expect us to carry that portfolio or build that business internally.

It’s just – you know, it’s too hard to break in this far behind the scale curve. I think Chelsea got one from the Web.

Chelsea de St. Paer

Two-part question, what are the considerations you think about when deciding between issuing common preferred or debt from new capital. And then on the recent preferred, how did you take into account return on capital when evaluating that capital raise?

Joe Martinetto

The different forms of capital served different purposes. Debt is long terms liquidity, it gives you operating flexibility, but it doesn’t help your regulatory capital ratios. If you’re looking for flexibility in your regulatory capital ratios, you have to move into things that count as equity in that regulatory scheme. And that’s basically common equity.

And you know, we hope and believe preferreds are still going to qualify. We did a pretty plain vanilla deal with some degree of comfort, but we also put a regulatory call in it just in case for some reason, it’s not deemed to be good capital. But you have a limited number of choices at this point in things that count as capital from a regulatory perspective. So when we were looking at trying to build a little extra flexibility in case we did see some movements on the balance sheet, we were limited in terms of looking at preferreds and common as opposed to considering debt.

So now, you’re down into basically a cost in return kind of trade off. And that 7% preferred is a relatively lower cost form of capital that we wanted to be able to lock in at point in time that we think the rates in near historic close and that we’re not going to regret having that capital for a substantial period of time.

Common equity, if you just do the basic math, it ends up being a higher cost form of capital. So, in essence, it’s a way to put a little bit of leverage inside of that common equity without resorting to debt financing, which doesn’t help the capital ratios. So, that’s the basic trade-offs that we’re evaluating as we were thinking through preferred versus debt at this point in time.

Thank you.

Unidentified Participant

Hi. Just a more peculiar question, the security or health maturity balance line, that’s – and again, forgive me if you’ve mentioned this in previous updates, but that seem to have healthy fair study. What can we kind of expect going forward whether – which is available for sale?

Joe Martinetto

I would expect at this point that it’s going to move basically in line with the overall size in the balance sheet of the bank. So, as the bank grows, that takes a chunk of the investment security portfolio.

Again, we’ve got – because we have such a large investment portfolio, we’ve got a tremendous amount of liquidity and we’ve got the intention and the capability to hold a significant amount of those assets to maturity.

So, we take advantage of – to hold the maturity classification for that core chunk of the portfolio. There are some shorter-dated papers that we use and think of more in terms of the liquidity management context, and that tends to be what falls into the available for sale portfolio. But those core long-term holdings tend to be held, and they hold the maturity portfolio.

Closer to the mic here.

Unidentified Participant

Hi. What’s the 10-year and yield you’re seeing on the incremental agencies are adding to the investment portfolio right now?

Joe Martinetto

Yes. I’m looking at the bill right now just to make sure I’m entirely current because our markets are moving around. So. I’m sorry I can’t hear you up here.

So, 135 and 120 on average, does that include the mix and fix in floating? So, if the fix rate paper is going to be still up in the high twos and the average maturity – the average that lies on that, four years? Okay. Justin [ph]?

Justin [ph]

On your preferred offering, I believe you originally filed to do closer to 700 million. I believe the price is 400 million and the trade-off ended up at 103. Should we expect to issue some more later in the year? And why didn’t you do close to 700?

Joe Martinetto

We didn’t file for a size. We were trying to take advantage of a point in the market where we’re seeing a couple of deals get done and we’re trying to come in at the back with some of that momentum.

We would have taken a little bit more size if we could have found it at the price. I think we ran in to a little resistance because we’re not a frequent issuer in that market. We’re trying to get in and out of the market in a day at the price. We got pushed back a little bit and took what was available at the right price point.

So, we’re’ happy with the 400. We saw an adequate capital and we’re still looking at the opportunities. It’s hard to say whether we’re doing more or not. We’re a little bit opportunistic in terms of thinking about that market.

Chelsea, you have another?

Chelsea de St. Paer

Could you explain how you can get to the 8% revenue growth? We understand that option expresses part of it and darts are up, but what else factors into that specially given the 10-year currently trading less than 2%?

Joe Martinetto

Yes. So, again, you hit the bottom and that interest margin here pretty fast, if you can hold on to 160 basis points. So the growth that we’re able to drive in the client balance is, of course, the year actually helps as we move forward as earning assets improve.

We’re also getting help in the asset management fee line. So, to the extent that we’re able to move people into more advisory services, the advice component of that asset management, fee line also contributes to the growth. The darts are up 20%. So if you put it all together, that’s where you get to that 8% revenue growth. But it’s a little bit of help from all of the line items as we move forward.

Oh, another one.

Chelsea de St. Paer

How are you thinking about capital management in 2012 in terms of buy-back, repurchase possibility?

Joe Martinetto

Yeah. At this point, I’d say it’s still too early to commit to any kind of buyback that we’re not generating a lot of excess capital. Our expectations for growth at the bank would have us deploying the bulk of the capital that we expect to generate to continue to support the growth in the balance sheet overall.

So, maintaining that 6% leverage ratio with a little bit of buffer is really the primary objective for capital management today. We’re not to the point yet where we’re generating excess capital that we’re thinking about being able to repurchase substantial amounts of capital.

So, unless we can get some clarity out of the regulations that allow us to look at those targets and approach them a little bit differently, that’s the answer for now.

Okay. Another one? You should call (inaudible) sooner, you wouldn’t have to do them all in a row.

Chelsea de St. Paer

Can you provide us with some thoughts on where we stand with the regulators on being a SIFI, systemically important financial institution?

Joe Martinetto

So there’s not really anything I can provide in the way of update. We are not captured in the reg. We have not been notified that they intend to look at us as a SIFI. The guidance that they provided in terms of some of the statistical measures doesn’t look like we trip them.

So we don’t have any reason to believe that we’re high on their radar screen for classification as a SIFI at this point in time.


Michael Carrier – Deutsche Bank Securities

Just maybe one follow-up on that last question on the capital. Yeah, maybe if we look at 2013, because 2012, it seems like you’ve got the transfers going on. You got a lot in terms of capital use.

But in an environment where, say, that tenure is at 2%, the balance sheet, it starts to come down and take maybe 5% growth, in that environment when you look at the cash flow that you are pushing off, could you envision potentially doing buybacks, obviously, if you get the regulatory approval?

But if the balance sheet is not growing and you’re still putting off the – you guys will?

Joe Martinetto

Yeah. If the balance sheet growth slows to that kind of a range, we could absolutely envision it. And nothing has changed philosophically around our intent to manage capital for the benefit of our shareholders.

If we’ve got excess we’re generating, we’ll look to return it. Now, again, we’ve had the conversation with many of you. We’ll debate what’s the right form of return. So should we look at buyback? Should we look at enhanced dividends? How does the market compare those things? What’s the tax structure at the point in time?

So we’ll debate all of those things actively. But the core belief that we should return excess capital to shareholders, if we’re generating it, we’ll do it.

Michael Carrier – Deutsche Bank Securities

And then maybe just a follow-up on that because it seems like over the past two years, the transfers every once in a while they come up and there’s another 4 billion or 5 billion that you can transfer over. Not just you guys, the whole industry.

But when you think about where that money is coming from or what could take place in the future, how do we think about that? Meaning is it after these transfers is that most of which can be brought on or is it just as the cash continues to grow, as the client balances growth, then there’s more opportunities to come in.

Joe Martinetto

Yeah. You’re probably not going to find this to be a completely satisfying answer. But we are pretty well executed against the core strategy that we set out years ago. So, clients with less than $500,000 in household assets, their sweep option is one of the balance sheet products as opposed to a sweep fund. And so the sweep fund movement over to the bank is largely completed.

We’ve got some things that we’re doing around optimizing the broker versus bank split and that’s what you’re seeing and that could go on in small sizes over time. But that core strategy that we laid out years ago is pretty close to complete. So if we didn’t change that or if the environment didn’t change in a way that forced us to change that, then you would expect to see that the balance growth would probably move more in line with what we see in terms of client acquisition.

That said, if we see money fund reform that makes it more valuable to hold more money on the balance sheet as opposed to in the form of a money fund or if we decide that for whatever reason we want to make choices to try to change where we’ve drawn those lines and moving more balances, we still could see substantial balances move over time. But it’s going to be a balancing act of what are we hearing from clients, what’s going on in the environment, what do we have the capacity to process.

So I’m not going to be able to give you a hardened, fast answer that says, “All of the money funds will move on to the balance sheet” or “None of it will move on to the balance sheet.” The fact of the matter is, over time, we’re going to continue to look at the environment and try to optimize as best we can.

Unidentified Participant

Joe, just a follow-up on a different topic. Any places that you see where value propositions can be tweaked or places as we look out in 2012 where you might have been waiving fees to kind of attract new business that are now coming off just an update on some of those broad initiatives will be helpful.

Joe Martinetto

I might just defer that question because there’s a whole bunch of that commentary in a number of people’s presentations that are already coming up. So, if we don’t get there, you can call me on the conclusion but I think you’re going to see a fair amount of that topic covered over the course of the next couple hours.

Chelsea, I think we got time for one more so let’s see it.

Chelsea de St. Paer

How can we think about net interest margin longer term if rates are near zero in the late 2014 the way the Feds commentary?

Joe Martinetto

Yes. We haven’t produced those numbers for public consumptions. So, generally, I would expect that we would see some ongoing continuing pressure but it’s going to slow pretty dramatically the same way that we did see when we saw the new stabilized more in that three and a half kind of area.

We saw the changes in the net interest margin stabilize to the point where the growth in the balances were more than offsetting that impact. So, generally, I’d say that we’ll follow a path that’s fairly similar to that but at this point, we’re not ready to put out a number for 2014, that interest margin, okay?

So with that, I think let’s get – send everybody to break. It’s about 10:10 now. Let’s plan on being back about 10:25. Thank you.


Andrew Gill

Let’s go ahead and get started here. I hate to cut short a break. Great. Well, I’m Andy Gill and I’m excited today to talk to you about the Investor Services business. What I hope to provide is a little bit of context around 2011. The significant investments we made in the client and how those will help propel our growth for 2012, the additional investments we’re going to make in 2012 and how we are delivering growth in spite of a low interest rate environment.

So let’s go ahead and get started. Just as a review. And I think many of you already know this. Our retail investor enterprise is about 6 million brokerage accounts, 661,000 bank accounts, about 700 billion in assets. We have 305 branches across the country and we represent approximately 68% of our overall revenue and 67% of overall firm pre-tax profits.

So I promised a little bit of context around 2011. We had a pretty significant year of delivering business growth. Assets, 25 billion and net new assets up 90%. That includes 7.3 billion from optionsXpress, which obviously is a one-time event.

Revenue up 12% to 3.1 billion, almost 3.2 billion. That includes four months of optionsXpress results and pre-tax profit of 928, 29% margin up 19%. And again, that includes four months of optionsXpress. Obviously, we’ll have a full year of those results in ’12.

What’s important behind the numbers, and I want to talk a little bit about, is the client highlights that we delivered and the initiatives that we deliver, which we think are significant and will help us propel growth for 2012.

First, we added 160,000 new households delivered through our advertising, delivered through referrals from our current clients and delivered from our acquisition delivery out in the branches.

And importantly, and John is going to speak a lot about this next. So, I’m not going to cover much of it. But I think it’s an important context, it’s 16% of all of our assets are now enrolled in a fee-based advice solution.

And that’s significant if you think about that 10 years ago, we had zero. So, tremendous growth in terms of fee-based advice. And I think it ties to a little bit of what Walt was talking about earlier around clients confidence coming down, clients looking for Schwab to have a point of view, clients looking for Schwab to provide help and guidance.

We maintain the highest level of client promoter scores that we’ve reached. So, Walt talked about that in December we hit 38 in our client promoter scores. That’s significant because our client referring new business to us is one of the ways that we grow, one of the ways that contributed to that 160,000 households last year.

And we continue to reduce client attrition among those clients with more than 250,000. Remember these are the clients that are working with our financial consultants in the branch. And we’ve reduced that attrition to below 4%.

We also had significant investments and really building out leading capabilities for your clients. We launched StreetSmart Edge, our new active trader platform. I’m going to talk a little bit more about that later in the presentation. We completed the acquisition of optionsXpress September 1st and we are excited to bring the innovation that that group has built, the simple, yet really powerful tools for derivative traders.

And we introduced an integrated brokerage and bank experience on the iPhone, iPad and Android. We’ll talk a little bit about how that’s been received and some of the significant growth we see there.

And we enhanced our acquisition capabilities. We launched a brand new prospect experience on We also introduced peer-to-peer ratings and we’ll go in a little bit more detail on that.

So, let’s dig in to 2012. Walt talk about, Joe talked about that we made significant investments in 2010 and 2011 around building some leading capabilities. For the investor services, we’ll continue to invest in building out those leading capabilities in 2012, but we’ll also turn our attention to building awareness and adoption of the significant investments we’ve made over the last two years.

We’ll talk – at length around our active trader platform, our global platform, our derivatives business. We’ll talk about how we’re taking that deep knowledge of our clients and translating that into solutions that they need today, that they’re telling us they want today. We’ll also talk a little bit about how we’re going to work on that building awareness and delivering adoption of those key capabilities.

The results of it thought is we expect significant growth in 2012. Total assets, our plan is 9% growth there. Assets in advised up 8% and Roca [ph] of 5% but it’s not just about the numbers. It’s about engaging clients.

And one of the areas we will be working extensively this year and I’m actually going to read to you because it’s pretty key to the way we’re operating the investor services business is positioning Schwab as the best choice for investors seeking a firm with a listen-first approach who understands their individual needs. And John and I are going to be talking about the different ways we’re going to bring that awareness to our clients and activate the solutions that we have developed over the last couple of years and that we are developing this year.

We believe that focusing on that will also bring third party validation things like J.D. Power, recognition of our self-interactive business, things like the Barron’s active trader best in class. And then improving ratings in broad publications like Smart Money or Kiplinger. And also on mobile, it’s easy to see how you’re doing because there’s stars on the platform that tell you how clients like the apps that they’re downloading.

So, I want to move our focus now to the investments we’re going to make in 2012. I want to talk about three key areas where we’re making investments, where we believe clients have said they have significant needs that they’re looking for Schwab to deliver against.

The first is technology platforms. The second is client engagement and third are acquisition-driven growth. So let’s talk about those.

Ben and I have both talked to you in the past around a goal we set to become best in class in active trader. And that we define that as best in class as really focusing on five key capabilities; domestic equity trading, global equity trading, foreign exchange options and futures and it’s not just focusing on those capabilities to attract traders. As Walt said, these tend to be our most affluent clients. They tend to be our most engaged clients. And often their needs, their expressed desires become the foundation to allow us to provide more capabilities to our core clients.

So, think of them as sort of the leading edge and capabilities that we can provide to all of our investor services clients.

I want to dig in a little bit more in the next couple page but we invested in three areas; the trading experience, options and futures and global investing and foreign exchange. And we believe we created meeting capabilities in each of those key areas. Let’s dig right in.

So, on StreetSmart Edge, this is our software-based platform that is an update, completely new build but allows us to compete across all of the different competitors that focus on active traders but we’re not standing still here. We’ve had tremendous adoption on StreetSmart Edge about 67,000 downloads already and feedback has been fantastic.

We launched in February. We had four additional releases throughout the year and we’ll continue to release new enhancements on that throughout 2012 but we’re not just focusing on the software platform. We’ll also be piloting StreetSmart Edge in the cloud for our Mac users. When we started development on StreetSmart Edge, it was predominantly a PC-based client base but we also look across the way and see that the Mac platform is growing and we wouldn’t be able to serve those clients.

We’re enhancing our Web training experience on later in second quarter and you’ll see a pretty significant increase in the information that we’re able to deliver for clients right at the point of decision. We’re continuing to invest in efforts to be able to tell the story, to build awareness and to reach out to those affluent active traders that are really driving growth.

One of the other key areas we identified was the derivatives business. And here as we talked about in the past, we made a decision that options express had optionsXpress had built tremendous capabilities that fit very well with what our clients needed.

And so, on September 1st, we completed the acquisition of optionsXpress and we begin very quickly to work on integration. Within the first 90 days, we delivered the ability for Schwab clients to see Options Express account in along with their other accounts. We made it easy for them to open up a new account.

And in first quarter, we’ll enhance the ability for a client to instantly move money from their Schwab account to their Options Express account. So, starting to build those linkages.

Later in the year – Joe talked about the sweep move of sweep cash at Options Express to the Schwab bank. And then later in the year, we’ll be looking to bring some of the incredibly innovative tools that Options Express has built for clients to make derivative trading simple. And we’ll be bringing those to clients.

It’s no surprise that we’re focused on the Options business. Their eight exchanges, soon to be 10. They’ve created wonderful new products for retail clients. Spreads have tightened up. And that’s created a market that is growing 18% compound annual growth rate since December ’08.

We want to take advantage of that growth and our clients want to take advantage of that growth in ways that help them make the best decisions. And that’s where we feel like the Options Express business really has the potential to help drive that growth.

But they’re not standing still. Later this year, we’ll see on the Options Express platform enhancements that help people pick a strategy based on their point of view on the market, bullish or bearish. So, they’re not standing still in the innovation. They’re continuing to deliver for the Options Express today and we’ll benefit on the Schwab side – the Schwab clients will benefit from that innovation as we integrate the two capabilities.

The derivatives trader, part of the reason we focus on them – and Walt talked a little bit about this. But let me just give you some additional context. Six x as much revenue per household as our average investor services client. Five x, the number of trades annually and three times the number of statement equity.

So, they are a very profitable client. They are a very important client. They are very engaged client.

The other area we focused on in terms of technology platforms was the global equity trading. We announced earlier this year, in agreement with Broadridge, to be able to provide trading capabilities. And later in the second quarter, we’ll introduce the ability to trade in multi-currency, 12 countries, and eight currencies.

But in typical Schwab fashion, we don’t want to just give people the ability to trade. We want to give them the information they need to trade successfully. And so, in November, we introduced Schwab Equity Ratings International, which allows our clients to be to see, in addition to the third party research we have, to be able to make better decisions.

And so, research and advice, our trading capabilities, and then in the second quarter, we’ll introduce 24 by 7 client service support at the same time we introduce multi-currency trading in those 12 countries.

Over the last two years, we’ve seen an 89% increase in foreign equity trades in the 40 plus countries we trade over the phone today. In addition to a tremendous increase in the number of calls to our global desk. So, global trading really is something that our clients are asking for and we’re pleased to be able to bring that.

In mobile and tablets. We talked a little bit about that at the beginning. We’ve seen a tremendous adoption of our iPad, Android and iPhone tab applications. And in addition to adoption, I think what is most impressive is that when clients adopt our platforms, we see a 10 point CPS increase. So, they are becoming more engaged with us and we are increasing the satisfaction that we are able to deliver for those clients.

The mobile channel now represents 50% of all the deposit or the checks deposited at Schwab Bank. And that’s fantastic. Joe talked a little bit about our ongoing ability to drive cost out of the system. This is one where in clearly meeting a client need, to be able to deposit checks anywhere, anytime, we also were able to re-architect the processes we use to deposit checks. And by the client taking on some of that early responsibility for entering all the information, we actually reduce the cost in the overall process.

We’ll continue to invest in capabilities around mobile. Schwab bill pay will be one of the key areas that we introduce in Q1, that is the most requested feature. And we’ll keep clients up-to-date on what we’re going to do.

In the actual application with what’s coming next. So let’s talk a little bit about client engagement. One of the things that – in listening to our clients, we realize we needed to help them understand in this prolonged down turn, we needed to help them understand in context where they were in meeting their goals.

And so we invested in a series of financial planning tools for our financial consultants to use in conversation with their clients. Things like retirement, college planning, mortgage refinance. These allowed our financial consultants to engage clients, to have a conversation around their goals, and then to make sure that they were in solutions that delivered against those goals.

And you can see on the right that when our financial consultants have been able to have those conversations, we’ve seen a tremendous increase in engagement. We think that over time, we’ll be able to engage more and more of our clients around these financial planning conversations to really give them an idea around where they are.

And that combined with what we talked about in the summer, our reporting around how their portfolio is doing and showing them what risk they are taking, give clients more information to know how they’re doing, and what they can do next.

In addition to financial planning, in the conversations we’re having there, clients have been asking us for Schwab’s point of view. And so to enable to those conversations with our financial consultants, or our portfolio consultants, the Schwab center for financial research has just launched Schwab viewpoints, a topical way to talk about the things that matter today. (inaudible), what effect does it have on my portfolio today, what action should I be taking given the job, those claims, that last week?

We’re rolling out the viewpoints specifically to support those client conversations. And give our financial consultants, portfolio consultants the ability to have – those conversations about the market and what it means for clients today.

Joe talked a little bit about the bank and about mortgages. Earlier – or let’s see, this fall, we announced our partnership with Quicken Loan. And we’re really excited to be able to partner with Quicken Loans as the J.D. Power leader, and highest in customer satisfaction.

Quicken will give our financial consultants confidence to go out and talk about our mortgage products in a way that is consistent with the way Schwab deals with clients.

In the past, we’ve been worried about – when mortgage volume spikes, whether we’d be able to really service it in the way that we want to. We feel very confident with Quicken loans that we’ll be able to do that.

And then finally, I want to talk about acquisition driven growth. If you look at the – talked to Chuck [ph] advertising over the last few years, we did a very good job of instilling the sense of value that Schwab provides to all clients.

We did a very good job of explaining our core offer to clients. And helping them understand what we had.

What we want to do now is tilt upstream a bit and focus our advertising in communicating and building awareness among our affluent clients, and our active trader clients around the capabilities that we’ve invested in for them specifically.

And we’ll also be combining that big broad advertising with a series of local efforts to make sure that we’re bringing in those clients with greater than 200,000. We’ll also use promotions just as we have this year as part of the marketing mix to be able to get people off of defense, recognizing it’s a competitive space out there right now.

I talked a little bit about the fact that we invested in a brand new public site, [ph]. This is a fundamentally different prospect experience where we’re showing people rather than telling what it’s like to be a Schwab client. We want to build confidence in their decision to come to Schwab.

And one of the best ways that we’ve seen to do that, is in client speak. This is a peer-to-peer rating that we put on where our clients can tell us exactly what they think about our products. Interestingly, prospects who look at client speak are converting at a higher rate than those who don’t because it’s a validation, it’s not just Schwab telling them about the services, it’s their peers telling about it.

In fact the new site over all, has seen a 12% increase in engagement which is leading to more lead opportunities for our folks in the field and our folks on the phone.

So let me wrap up with this. The investor services business has delivered strong growth in 2011, we’ve invested in capabilities that matter most to our clients, things like our active trader platform, our derivates platform, mobile and tablet. Increasing client engagement through portfolio performance reporting, through financial planning, through Schwab’s point of view. And we continue to increase our ability to tell the story on the Web, in mobile and in that.


Question-and-Answer Session

Unidentified Participant

It’s been awhile since we got an update on you know, the initiative to attract younger customers, I know probably a lot of what you touched on, mobile, the banking and checking stuff, you know, goes down that effort, but I was just hoping for a bit of a fuller update there.

Andrew Gill

Well you hit the key high points. We continue to attract younger investors, that’s been a significant part of the growth of the 160,000 households that I talked to you about.

And the things that they are responding to, are things like mobile, things like the new website, client speaks is a good example, that’s where they like to get information, and things like our Schwab manage portfolio’s mutual fund, ETF and Windhaven. We’re seeing many more of those clients want more help and guidance, want the ability to understand Schwab’s point of view, and understand how we can help them make decisions on how to get invested, even things like financial planning, how can, you know, where am I in my plan? How close am I to reaching my goal?

We see engagement among our younger investors in our portfolio performance reporting? So once they are invested, how much risk am I taking to get the return I’m getting.

Unidentified Participant

My second question, just on the derivative front, can you discuss maybe what’s changed post the MF global fall out in terms of both, you know, opportunity or types of questions that you’re all, you know, fielding from, from your clients?

Andrew Gill

Well obviously, MF global is in incredibly unfortunate situation for the whole industry. Options expressed has a futurist [ph] business today, clears through R.J. O’Brien, so those clients were not impacted.

We continue to see very good interest from Schwab clients opening up options expressed to clients – or options expressed accounts, and wanting to trade futures, as well as continued growth in the options expressed sort of core business.

I think that clients will continue to ask good question around the segregation of funds. Certainly the regulators are asking good question around the segregation of funds, but fundamentally, we don’t see a diminish in interest in futures.

In particular, I think, derivates traders look at options and futures together, they open up two accounts, they trade them, looking at the strategies, which product best delivers against the strategy that I’m pursuing.

Michael Carrier – Deutsche Bank Securities

Thanks. Two questions, first, you know, when we look at asset managers, there’s not a lot of flows in the industry, but they tend to focus on the products that work, so in this environment like equity income, dividend-type funds, there’s a lot of campaigns around those products. You know, in the past, it’s been international, so you know, when I think about which Schwab can do, or what you do from an advertising stand point, not necessarily Schwab’s products, but just in terms of what’s working, you know, in the industry.

Like what do you do on that front? And is there a more, you know, that can be done, whether it’s, you know, on the website, to the clients, to the advisors, you know, to try to attract the products that you know, they might not be as risky in this environment, but they still offer attractive yields, you know, and you still get some equity exposure.

Andrew Gill

Yes, so we typically do not take a product centric approach. We start with, what do the client needs? And then what are the solutions that we have that can deliver against those needs, rather than saying, here’s a hot product and we’re going to advertise that because we’ve got it.

But I think where you are going is, as we think about tilting that advertising towards the affluence space, what are some of the things that we can do to attract there? One is, believe it or not, and John will talk a little bit about this, there is pretty low awareness still that Schwab offers advice.

You know, we’ve had a history of being a discount brokerage, and we’ve moved well beyond that, you know, I’ve shared earlier, 16% of our assets are in fee based advisory solutions.

But we need to build awareness of that. And so we’ll pick some of the – you saw us this year, advertising Windhaven as an example of a solution that really delivers against that. John will talk a little bit more about that.

We’ll advertise those solutions, and market those solutions, but more importantly, because I do not believe advices is really advertising, people come in saying, “I got to have this advice solution.” We’ll have those in conversations with our financial consultants, whether it’s through a financial planning conversation, or portfolio conversation.

Michael Carrier – Deutsche Bank Securities

Okay, and then one other product area, there’s like risk manage products, but they tend to be – that partner up, not you, but like an asset manager, we have to partner up with an insurance company, just to protect, you know, the downside.

Andrew Gill


Michael Carrier – Deutsche Bank Securities

So anything, you know, out there that you know, you’re seeing interest or you can offer, you know, where – you know, clients at least, you know, have some protection on the downside?

Andrew Gill

Sure, Mike you know what, because I really like John and this would steal a majority of his thunder, I’m going to let him answer that question. But if he doesn’t answer it, you come right back at him.

Michael Carrier – Deutsche Bank Securities


Andrew Gill


Chelsea de St. Paer

From the Web, can you provide more detail on how the business model with Quicken, loans and structured? So does Schwab get a referral fee, or what other economics are involved. And then how do we expect this to impact our balance sheet growth.

Andrew Gill

Balance sheet growth, I’m going to let Joe answer it some point in time, and in terms of the business model, we are – we will take interest from the clients, or if the client comes to us through the Web, which many of our self-directed clients will look on and find the information.

They then call Quicken Loans directly, and it’s Schwab bank from Quicken Loans. So we are referring the client to the Schwab offer at Quicken Loans, and Quicken is doing the servicing of those and underwriting of those.

You want to answer the balance sheet question?

Joe Martinetto

Give me a second, I’m up? Okay, so – webcast, I guess I have jumped down to the – at least get me on the Web – the balance sheet, from a structural standpoint, we are not – so we’re going to be paid a marketing fee for entering into the arrangement.

And so it’s going to show up in a slightly different line, but the economic should look similar to what we had with our – previous arrangement with PHH. So you’ll see that, it’ll move a little bit in the lines, but the economic impact should be fairly similar.

From a balance sheet perspective, we have the right to basically buy the same – to get acceptance with the client community.

Unidentified Participant

Okay, just a quick one on the financial targets Andy, the broker expansion that you’re thinking about in 2012, is that a function of just more fee based advice moving up? Or is that just...

Andrew Gill

That’s things like business process management. We’re not going to get up here and talk about those as highlights, but those are going on in order to be able to provide additional services to clients. So those will be the primary ways we do it, fee-based advice. I was agreeing with you. Yeah. So, fee-based advice tilting towards affluent and active trader. And then, third, always looking for those opportunities to wring more cost out of the processes that we have so that we can invest back in the client.


All right. At this point, I’d like to bring John Clendening up on stage. And he’s going to take us through our advisory products. John?

John Clendening

Thank you, Andy. Good morning, everybody. Great to see you here.

I wanted to get us rolling by asking you to put your mindset back several years, to 2001. So, 2001, I think it’d be pretty fair to describe Schwab’s retail franchise with just four words – self-directed discount broker.

Of course, in 2011, the dot-com bubble had long burst and investor services were working really aggressively to try to figure out how to respond, how to respond to the new economic reality that was taking root at that time, but also respond to a fairly decided and swift shift in client mindset.

Clients have figured out that long were the days where they can invest in just a couple of equities sort of sit back and watch those equities appreciate. And so, at that point, the case for a new approach or for some change was really, really quite clear. In terms of our value proposition, the value proposition that had served us so very well during that bull market had become a little bit less differentiated.

And on top of that, that same value proposition, it’s also become less relevant to a number of our clients. If you think about one key aspect to that, Schwab had always been known for terrific service, and we still were. From the standpoint of, we’re very happy with the self-service we’re providing on that was terrific for clients very well-received.

But we think about the rest of our service model from a phone point of view and also from an in-branch point of view, our service model really was almost purely reactive. You put all that together and the state of the business actually was not that healthy at that time.

We’re competing for a very, very narrow segment of the investor market. On top of that, our revenue streams are very dependent on trading revenues, which were smaller at that point, but also certainly much more volatile than we would have liked. And from a Schwab point of view as well, we had also seen that we’re less meeting client needs never before.

If you look on the chart in the lower right, you can see what client attitudes were at that time. So clients were dissatisfied with their performance. It may be surprising that only 45% said that in 2001. But they also didn’t know what to do about it.

So that was the situation of the business in 2001. Also speaks, obviously, to significant opportunity; opportunity to rethink and remake the retail part of our business; in part, the new approach advisory services.

And so I know you’ve gotten feedback and updates on that over the past several meetings, but this is a chance to step back and for me to have a chance to share a bit of the holistic strategy around advisory services approach, talk a little bit about what that approach is, and some results that we’re seeing.

So, today, skip forward to today, advisory services, as Andy mentioned, are a substantial part of the investor services business today. There’s that 0 number that Andy talked about up to 15% of revenues last year. So, a big uptick.

The number itself is right about $500 million in revenue. And that’s just the advisory services fee portion alone. It does not count for the underlying assets in that service. On the right side, and this has been referenced earlier today as well, we’ve seen some substantial growth here.

So we’re thinking about new enrolments into a for-fee advisory service. You can see that growing last year at about $1.5 billion per month, so about an $18 billion Advisor Services business. That’s launch one. Launce two is Schwab Private Client, an opportunity for the client to partner with Schwab in an ongoing relationship around their investment.

So the reception at that time, I think, it’d be fairly characterized as cautiously optimistic. The optimistic part was around, hey, that makes sense on the face of it. That strategy seemed to make sense. It seems like there’s an opportunity for Schwab. The cautious part was primarily around execution – can Schwab actually get that done, can they begin to remake themselves and go toward these advisory service offers.

And a big chunk of that, of course, was will we have the skill, can Schwab have the skill to do that.

So, since that time and never more aggressively than in 2011, we were working really hard to build those underlying capabilities in a couple of way. Now, I’ll give a couple examples around 2011. The first is around specific security analysis and coverage.

And so, last year, we launched Schwab Equity Ratings International, very supportive of the strategy that Andy talked about around participating, helping our clients participate better in global investing. Second category, on market coverage.

So, last year, we launched currency coverage, we launched fixed income coverage and also global coverage. The third is around client touch points. And I think this is particularly in that, with the client touch points that we’ve built over the years, we’re able to take an attractive client base and a set of client and turn that into real distribution power.

So, a couple of examples here. Back in 2005, Investor Services launched the financial consultant relationship model. And today, round about 70% of all of our client assets and investor services are serviced by a financial consultant to a named financial consultant with the clients 70% of assets.

Another example I’ll share is the expansion of workshops. So, workshops have always been important at Schwab, certainly was important during that bull market that I referenced earlier. We’ve made a renewed commitment to make sure we’re spending as much face time as we can with investors, both clients and prospects.

And so, last year, we had about 100,000 clients and prospects in Schwab branches talking about the markets and the offerings that we have here at Schwab.

Now, this is important for two reasons. First is, when we think about the capabilities that are shared on this page, they’re really important in better meeting client needs. So the majority of our clients are not hard core self-directed. And they have a reasonable expectation that if I go to an investment firm like a Schwab or somebody else that they’ll have a perspective on the markets.

They also expect that of a point of view about what to do. So, while these services here don’t have a fee on them, they’re very important to meeting client need.

But here’s a connection of what I make as well to the for-fee portion of this business. These capabilities are built over a decade-long timeframe and taken as a whole, build the credibility that’s necessary to boost future acceptance of our for-fee Advisor Services offers. So it’s crucial to further growth of the for-fee component of our business.

Now, speaking of that, we monetize the opportunity that I’ve mentioned with our suite of advisory services offers. Over that same tenure period, we’ve built a complementary lineup that consists of several components. Don’t worry about reading them all now. I’m going to cover these in a fairly clarified and simple form in just a moment.

I would draw attention to the lower right, Windhaven Investment Management. A number of you will remember that we purchased Windhaven back in November of 2010 and happy to share that the results have been pretty solid. So, when we closed with Windhaven, they had roundabout $4 billion in assets under management.

And today, so just a bit over a year later, we have more than doubled that to $9 billion. Windhaven is also an offering that is relevant for retail, but also available to our RIA clients and advisory services. But in any case, fairly growth in AUM, which I think speaks to that distribution power that I mentioned just a bit ago.

So, we’ve got a number of for-fee advisory services. I thought really long and hard about how do I put these into a two-by-two matrix. I’m an ex-consultant. You put the entire world on a two-by-two matrix.

I tried that for about two hours and realized I really couldn’t do it. It actually was not going to be more clarifying to do that. So, instead, I’m going to break this down into more natural groupings and then walk through how they contrast with one another in a way that, again, lead us to this sense of a complementary lineup.

Let me start first with SAN and SPC, those services that we first launched with. Together, they still are the largest two of our services. And yet, they compete for a very, very different client type. So, in the upper right, I’ll start with SAN, Schwab Advisory Network.

This is built for the client that really is looking for an investment advisory to do it for me. It’s that really interesting finding that expert they can turn over management of their portfolio and have that investment advisor do it for them.

This offering tends to attract a client with fairly complex financial needs. Often that means wealth management sorts of services, which includes trust planning, estate planning, things that are really very customized the individual investor, and so we feel really best delivered with a local expert.

Now, again, this is through referral to our Advisor Services RIA, about 200 or so that are in this program. That’s a particular unique need that SAN meets.

SPC, on the other hand, is for the client that really wants to continuously involve not only in the general way in the investments, but also around the decision-making on that portfolio. And so, they take the point of view and says, “Hey, I want an advisory to partner with me.” Their needs also tend to a bit less complex. And so, we can service that client’s investing needs with a centralized phone-base team.

So, two offers, they both share in common the tendency to work with the client’s entire portfolio. So they tend to have nearly all the client’s assets under management in that portfolio, but, again, very different in terms of the needs that are met.

The next are our discretionary wrap-based advisory services. So we have three of these in the lineup and they’re also meant to both complement SPC and SAN, but also themselves being complementary to one another. I’ll start first again in the upper right, Windhaven Investment Management in the purple.

This is for the client that is really looking for very active management. They want to see a highly dynamic portfolio. So the investor says, “You know what? This idea of buy and hold and strategic pies and that sort of thing, that doesn’t work for me. I want to see an investment management actively working on my behalf.”

This client also is looking for and is linked very closely to this a pretty high degree of portfolio sophistication. They want to see very broad global diversification. To the question on risk earlier, they want to see that the advisor, the investment manager is very attuned to managing for the downside. They also take a view typically in this solution around more of a long cycle view. That’s the client typically looks for with Windhaven.

And so, Windhaven has these characteristics that appeal to that particular client type. Let me draw a comparison now to the lower in green, Schwab Managed Portfolios Mutual Fund. So this is for the client that isn’t really looking for that dynamism. That’s something it doesn’t really fit their needs, their mindset. They’re quite happy to know that they’ve been properly diversified in a product type or a security type they’re very familiar with, the mutual fund.

They may not yet be familiar with ETFs, for example. We see a lot of our OneSource flows actually going into Schwab Managed Portfolios Mutual Fund as Walt alluded to earlier in his Q&A session.

So this offering doesn’t have any attachable adjustments whatsoever. Our focus is purely on selecting the right actually manage mutual fund. And as you can imagine, that fits the need for a client with a little bit less sophistication of their portfolio, but wanting to be diversified.

Now, Schwab Managed Portfolios Exchange Traded Funds, or ETF, it’s pretty well in the middle there. I just want to point out though that the attachable adjustments that are made are really quite modest.

So, first was around SAN and SPC. These tend to operate, generally speaking, more at a portion of the portfolio level than do those offers. We certainly have some clients with all of their money with us into one of these three. But they tend to be just a component of the relationship.

The third leg of the stool is around managed accounts. So our platform here primarily focuses on the client that’s looking for filling a particular strategy, sort of sleeve level type approach. And you guys are all familiar with the typical client needs here around managed accounts. So I’m not going to go into that.

On the right, our program is and our platform is pretty robust. And as you’d expect, we’ve got a slate of equity managers, fixed income managers. Back in late 2010, I think it’s late or mid-2010, we also added an exclusive to Schwab, which is the PIMCO Muni Bond Ladder that sync quite well for us.

And we do find also that some clients really want to consume the sort of set of strategies in these managers more of a diversified all-in-one portfolio type of way. We also have a handful of diversified portfolios as well. You can see from the chart that the account sizes here are pretty robust, given the minimums, but also given the client mindset and affluence that gets attracted to this type of product. Like Windhaven, our managed account platform is also available to Schwab Advisor Services RIAs.

So, three sets of offerings that make up the lineup. And we believe that sort of all told together, the lineup itself is pretty well positioned versus some of our competition. We’re worried about all of our competitors, of course. Here, when we evaluate ourselves, we tend to focus more on full commission brokers since they’ve been added longer and they’ve got, obviously, a lot of assets that they’ve been able to convince clients to take up into an advised offer.

So, with that reference point in mind, what clients tell us about the value that they appreciate in our advisory solutions tend to be a couple fold. First is around the idea of receiving consistent quality. And that’s around knowing that while they’re working with an individual financial consultant, typically, that there’s a whole firm behind them that has a consistent view around good advice as opposed to sort of maybe being dependent on just one broker and the idiosyncratic nature of that.

Secondarily, they love the fact that we have lower minimums. So, it’s much more accessible. It’s easier to try it out for the first time if maybe a new user, if you will, of advisory services. You may have noticed on the chart that S&P mutual fund has a $25,000 minimum in an IRA.

So, well, you might say it’s a very low barrier to acceptance or low barrier to trial. Clients appreciate that. Start with us at a certain amount; hey, it’s working well, I’ll bring you some more of my money.

And then lastly, there are a couple of features of our pricing strategy that clients have typically told us they really like. The first part of that is transparency. So, our price list is the price list relative to these offers. As you know it at other firms, you often have to put yourself in a situation of negotiating the best deal you can possibly get.

And we hear from our clients that they really appreciate the fact that they know what the price is and they don’t have to worry about decorating or cat and mouse is the best thing of experience for the person on the other side of the table. That builds trust. Trust in the person but also trust in the firm.

And that, of course, works best because our prices are also really attractive. A typical client can save let’s say $100,000 or $2,000 generally speaking when compared to working with the full commission broker or others in the industry. And that’s certainly real money in a market that’s been a bit sideways for some years now. And it’s also very tangible, that idea of saving a couple of thousand dollars.

What I’ve done here, just so you know is use some real data that tries to make an Apple’s comparison to the relevant Schwab comparable. So what I’ve done at the bottom here is laid out per creole [ph],the typical realized price for comparable. So, realized, meaning that it takes you to account that negotiation factor and then overlaid with the price should be at Schwab and then converted that to a dollar amount.

As you can imagine, if the client isn’t savvy enough or really good at negotiating, the savings can be a lot better, for managing size, $4,000, same manager $4,000 less. So, the services themselves appear to be pretty well positioned to us and relative to some of the competition. And as a result of that, along with build out of capabilities that I mentioned earlier and our focus, which Andy touched on earlier, we had some pretty fair results so far.

On the left, I just laid out some of the industry compatibles. The first one there, Schwab private client, I really debated. Do I want to show, “Hey, we’ve been working at this for 10 years. We’re number five”? But the reason I did is the following; so SPC competes in what’s called the rep as advisor to a sub-segment.

And when you think about the fact that our comparison points here have thousands more brokers than we do in investment services, it seems like a decent sample to say, “Hey, we’re number five and on the heels of number four there.”

In the other case, it’s much more one, two, or three, if you will, and so a pretty strong position in terms of the results that we’re seeing. Windhaven in our estimation is number ETF money manager in a separate account today. And the growth rates have also been pretty strong. It’s right about 12% over the past several years, a bit higher than the industry average.

And we talk a lot about win-win monetization. You’ve been hearing that for a long time now. Walt mentioned earlier in his opening remarks. And these advisory services are a terrific example of that.

Now, the chart on the left is a little bit complex. I’m going to ask you to not try to digest it. Let me just show more of a simplified statement that we’re trying to get across here. So, as you can imagine at Schwab, we’ve got a number of – and a lot of self-directed clients that are really confident, that are really skilled. And they also have the time to manage their own portfolio.

But like other firms, it also have a lot of self-prepared clients who really don’t have this characteristics. What happens when that’s the case? Well, we tend to see a lot of clients with extreme equity concentrations.

We also see clients that are on the side. So, they’re way, way in the cash. Yes. I hear stories all the time and talk to folks in the field. But here’s a client with $2 million in cash. And so, they’re not participating the market or on the side-line because they don’t know what to do. They have that lack of confidence that Walt does shared earlier.

In addition, we have a lot of clients that are not in situation, we’re doing a timely manner of investments and we believe on confidence. And they end up not participation global markets. So, they’re very U.S. focus.

So, the question we ask, knowing that the answer would be 100 sort of reverse in all those with the discretionary offering, what about SPC? It’s non-discretionary, we’re working in partnership. Do we have the effect we’d like to see in better diversify the client’s portfolio?

You can see that which is really 100% flipped on all those characteristics that I’ve shared with you. So, as an example, really, 100% client in SPC has any national holding even though that’s non-discretionary. So, we have a real tangible benefit that clients receive when they’re in an advisor solution.

The emotional benefits though are perhaps equally as – these are people, we could pull thousands of these, obviously. But the one on the lower right I think is the one to really tune in to. That’s his idea that when I work with Schwab in an advisory situation, I have a sense of a peace of mind. That is really important for us since one of the things we take most seriously, when we’re having a conversation with our clients about this part of our business.

So there is a win there. It’s a real win. There’s an emotional win there for clients. And the win for the firm is also really quite strong as – a lot of economic leverage and the Advisor Services part of our business. So, decompose that into a couple of ways.

The first is probably the most obvious. And so, when a client who’s a $250,000 client, who’s a buy and hold investor lose from that situation on average to one of these advisories. We see about two to – let’s say two and a half x lift and broke on that same set of dollars of assets. So, the uptick in Roca is material.

On top of that, the revenue stream is now recurring. And so, there are some additional value and the fact that the revenue is recurring as opposed to transaction more of it. On top of that, we also see that we go from a strong industry attrition rate on the lower left there around about 7% to a far lower attrition rate, 4.8%, so about a third reduction in nutrition.

And then lastly on the right, clients are more loyal to the firm as measured by the client promoter score, also by – kind about a third. So, we make more Roca, so unit, economic, lift. But on top of that, we see clients leave less and refer more business to us. So, that’s the win for the firm.

Oftentimes, the question is raised how much more opportunity do you guys have in advisory services. And as you know, we don’t share specific forecast, but I want you to get – just give you a couple of handles on how to think about that. And I want to start first with the comparison to – a definition around broker-dealer advisory assets.

So, what do I mean by that? On the upper left, there are $2.3 trillion at broker dealers, only broker dealers, no liaison here, just broker-dealers that are in a fourth grade advisory relationship. Our share today is about 5% of that, so a pretty fair amount of upside from that point of view.

Another way to look at it, on the upper right, so what about our share of the internal market, so if you think about the internal market at Schwab here, the slides shares just in terms of households. We have 2.7 million households and investor services, about 6% have taken up one of those advisory services. So a lot of white space, if you will, to still capture from that measure.

Lower left, how do we stock up versus full commission brokers? I mentioned they’re probably the best reference point for us. Part of that is because they got higher penetration than we do. We’re not, you know, happy about that. There’s more work to do there. But I assure this, we have this perspective that there’s more opportunity to get.

So, typical full commission broker, 25% assets in advisory solution. We had probably worked out 16%.So, potential from that as well.

And lastly, client demand and client interest. The market volatility that we’re all living through and have been living through has caused more and more client to rethink their approach. The mind-set today is want to say, “Hey, I really like to at least for the majority of clients, I’d like to get at least periodic, if not, on-going advice from an expert.” And as again, Walt referenced earlier, the flipside of these numbers is two-thirds of our client’s feel that the only – they feel that they’re not confident and only somewhat confident in their investment.

So, an opportunity from a – definitely a better client needs as well. So, to take advantage of that opportunity, I just want to share a handful of the things they have underway for 2012.

Andy talked a bit around marketing and promotion; I’ll just start at the bottom on this one. We realize that like the industry at Schwab, these services are typically sold, not bought. We’ve done some experimentation in print. We’re not taking that to some test and learn with advertising or Windhaven solution in the context of an application.

So, like Wall Street Journal, USA Today, you can see some rotation that really gives the consumer a chance to play a little bit more with what would it be like to be with Schwab and Windhaven.

Moving up, distribution, Walt talked about independent branch services. We’re going to hear a lot about Schwab index advantage from Steve in just a little bit. Overtime, these, of course, widen the internal market, as I refer to it earlier. We’re going to have more opportunities to work with clients in an advisor capacity.

New products. So, we are actively working on a variable annuity product. The reason for that is that guaranteed income – the interest in that has been higher than it is today for some obvious reasons. As we do that, we’re going to focus on finding a way to participate in that market that is consistent with our commitment to quality, to value and transparency. So, nothing more I can say at the moment, but we are actively working it.

And then lastly, some important initiatives that Andy also touched on, they’re really considered to be important conversion catalyst, if you will, for advisory services. The first is around performance reporting. So, there’ll be hundreds of thousands of in-person one-on-one conversations in 2012 from the financial consultant and the client. Again, these clients represent 70% of our assets.

A fair number of those will involve a Roca conversion on how you’re doing, what is the performance that you’ve been achieving, doing this on your own, and critically how does that relate to the risk that you’re taking. These are real eye-opener conversations for clients that often lead to client to catalyze themselves into doing their investments in a different way. Often times that’s around advisory service.

And then second, Andy spent some time on planning capabilities. For us this won’t be the 110 page thud financial plan that works well for a lot of clients. These are meant to be more bite size and we really take the mindset more around how do we enable a conversation with a client that at the end of that conversation they’re going to be in a better spot whether that’s in advisory solution or if it’s in something else but how do enable a conversation that gets the client more tuned into their investment.

So those are some of the things that we have in place for 2012. To summarize the advisory services part, the retail business is substantial, it’s growing. It’s a great example of win-win monetization and we’ve got a number of things in place to try to accelerate momentum into 2012.

And with that, I’d like to turn it over to some questions. Who would like to go first?

Question-and-Answer Session

Not at all surprised. Howard is the first questioner. Okay.

Howard Chen – Credit Suisse

John, I was intrigued by that slide that shows the value proposition of your product s versus some of the full service products and maybe some of them were priced at half, some of them were 30% below. So I’m just curious philosophically how do you go about assigning value propositions when you kind of develop and push out some of these new products?

John Clendening

You bet. So, couple of principles that we put in place are the following. First is we try to look at what we think price – we might be run a particular offer relative to convincing a sufficient number of clients to be attracted into the offer and to make it economic sense. We’re trying to weigh certainly margin but also uptick in the offer.

Second is we look at competitive reference points and, of course, we’re really mindful to what we believe is a fairly strong cost advantage in this industry. So, in some ways coming from where we were in 2001, we felt like a penetration pricing type approach made the most sense and that’s why you see some of the of the offerings at a pretty sharp value. And it’s worked as we would have thought it would have worked. So we try to combine those elements and thinking about how to end up pricing a product.

Howard Chen – Credit Suisse

And maybe just a follow up to that. Can you talk about how you’ve evolved some of the approach of maybe giving kind of a teaser like you did? I think maybe two years ago you would have to go on to manage fee accounts and then when you stop that teaser program, the retention that you see or don’t see.

John Clendening

You bet so. What Howard is referring to is there’s a time period, I believe it’s particularly focused on SPC, is that right? SPC. So, we’d essentially had a year or 12-month fee waiver or six-month fee waiver.

If you put yourself back into when we did that and what was going into the markets, i.e., they were imploding and investor confidence may have been even lower than the charts that we just saw, it made a lot of sense to us to try to add, again, another bit of momentum around a penetration-type strategy by taking away price as a barrier.

We’ve done a couple of look backs into, “Hey, what did that do for us?” And we found that, “You know what, it made economic sense for us.” But that was a particular time of the market. I don’t know if we’re at that time right now. We would certainly evaluate that going forward but I think the headline would be, you know, we did it; it made sense when we did it. And looking at the economics, it made sense. Have we seen some clients coming out of those offerings we have? What we tend to see that it’s really within the bounds of having that then an effective offering for us.

Howard Chen – Credit Suisse

And then a separate other quick question. In terms of that share in the in-house market share that 6%, I mean, have you looked at that if you just looked at households that had over 250,000? What would that look like? People who actually would qualify for some of your advice or...?

John Clendening

Sure. So, a couple things. So, if you think about that bare minimum at $25,000 in an IRA for Schwab managed portfolio’s mutual fund and then lift that up to just $50,000 for brokerage in that product, the vast majority of our assets actually do qualify for one of these offerings today.

And so, the number would be I’d say 80 something percent, 90% even potentially would qualify for one of the offerings that we have today. The available market from that point of view is quite strong.

Certainly the penetration rates are higher with affluence. Walt made the pointed earlier that our affluent clients tend to be our heaviest users to kind of use that expression. And we do see the uptick is higher just like we saw in the bank, the uptick is higher for these sort of solutions.

So, it’ll be higher than the 15%, 16% number but certainly not approaching the full commission broker certain number.

Next person in the middle.

Unidentified Participant

Of the billion and a half dollars that you’re seeing flowing into this segment every month, can you break down how much that is from new to the program versus existing having tried it and adding to it? And then so the second part would be if you went back and looked at it like an aged account basis what do you see as far as, for instance, if you never grew another sort of new client how much additional penetration would you expect based on the sort of the sort of aged clients if you will in terms of just where they are at versus where they tend to get to?

John Clendening

Okay. Let me tackle the first one. I think I’m going to come back and ask you to clarify the second part I’m tracking with you.

On the first, the number that we shared is actually strictly new enrollments so new to offer dollars. And on top of that, there’d be a benefit of the client that is already in the service and chooses to bring more into the service. That’s actually top spin on that number.

We’ve got a pretty fair opportunity there. I would also share with you one of the experiences that we’ve had relative to having an attracted minimum is, is it oftentimes the client does start near the minimum.

And so, Windhaven is a good example of that where you see a lot of – the average, you know, the couple of hundred thousand range but if you sort of look at those that choose to start with $100,000 is a pretty fair number.

And so, one of our major initiatives is to make sure that we capture more and more of the share and essentially resell the client into the portfolio. So to strictly answer your question, that didn’t include new money of existing clients from the offer.

And the second one if you don’t mind, if you would mind just restating the question in the second.

Unidentified Participant

I guess the basic question is where are you if you didn’t add any new customers based on what you...?

John Clendening

To the offers?

Unidentified Participant

Yes. Forgetting new clients to the program. If you just looked at based on your history with the existing customers and where they tend to get to versus where they’re at. How penetrated is that or what’s the sort of upside?

John Clendening

Okay. I think you can characterize in a couple of different ways. So, when we look at share of wallet of these sorts of clients, we know that there’s a fair amount of assets yet to consolidate. And by the way, when a client signs up for an advisory solution largely due to the conversation that’s been happening at that time that’s also a catalyst for bringing in assets from the outside.

And so, when we look at share of wallet for this clients there’s ample opportunity to continue to win more client assets from that point of view. In addition, we will look at sort of the organic growth rate if you will, that we’re seeing in these offers so the net new money compared to net new money you get in a none advisory solution, there’s a fair multiple in terms of that number not prepare to share the number itself but it’s a fair multiple when compared to folks in a non-advisory offer. Let’s get the next question.

Okay. Oh, sorry, one more question.

Unidentified Participant

It’s actually – just two questions. First, you know, when we look at that 16% new in terms of the advise assets when you look at that relative to the full on service brokers so that 25%, I guess like two things there like is your client base just given you know, the mix, the diversification versus – can you get to the 25? And then maybe more importantly, when we look over the past 10 years, either you’ve been able to do that on average maybe 1.5% a year if we just take the 15 or 16 versus zero.

Is there anything that can make that either faster or slower meaning 10 years, no returns in the equity markets or clients, more eager to get that advice? Or how does that play out when you get to that 25% low.

John Clendening

You bet so. On the first question, there are clearly some differences in the mix of clients with a full commissioned broker versus at Schwab. We are going to have some of that hardcore self-directed investor here.

But what’s interesting around our client base and I just want to emphasize, Walt had said about this earlier. What unifies in a lot of ways the acceptance of the various services that we provide or maybe better said what sort of signifies the adoption rate often can be around the client type itself.

So, we see there are clients that are active traders. So here’s our active trader roster. What’s their penetration rate or what’s our penetration rate of advisory service into that active trader client base. We see the adoption rate. That’s not as high as others but it’s pretty darn high too.

And so, we don’t see that the industry sort of hard definitions around client decision making like self-directed, validator and delegator actually hold in reality with the client. That tells us that we probably can get to a pretty high increase in the penetration rate that see today. And of course they’ve been left in their penetration rate as well just like we asked. That 25% is not a ceiling for them. I wouldn’t imagine that they would talk about in that way.

As far as what are the kind of the macro drivers that end up influencing demand, is that the second question?

Unidentified Participant


John Clendening

So, this cuts first in a couple of different way as we recently did an investor sentiment survey and there’s an interesting gap right now between the majority of clients and I’m going to focus just on them but the majority of clients still would put any incremental dollars into the markets.

So in spite of what’s going on, in spite of their lack of confidence they’d still put incremental money into the markets. The gap that’s created is, the question is what do I do with it. So, in – certainly in the environment now we’re more than two-thirds or so of clients are not confident and are looking for help and guidance. This is a bit of a sweet spot for us. Windhaven maybe a really good example of that.

So we’re having a conversation with a client in Windhaven and you’re speaking about the approach that Windhaven takes around, “Hey, we’re focused on downside risk protection. Let me give some context around how we manage portfolio.” Bear in mind that you need to be thinking about this portfolio in the context of a cycle but these things all seem to strike a better resonate cord in the markets when sort of the markets sort of going this direction.

I presume a little bit of counter cyclicality to it as well. On the other hand, markets are doing this. I think you’d see the NNA numbers also improving so we have more of a – efficient if you will.

Unidentified Participant

And then just on the variable annuity, I know you said you don’t want to get into many details but would that be something that Schwab would be offering or you would pair up with another program. I guess I’m asking because some of the insurance companies have stopped taking new money because of the rate environment and like some of the risks.

You’ve had in the past like all the certain other products like a lot of the broker dealers offered them with the structured notes which were competing products with the variable annuities and those ended up too. But is it something that you guys can compete maybe on price or something that’s a little different than a variable annuity or is it in the same concept?

John Clendening

Well, let me get to the first part of the question. So, we would imagine, we got to build this out. So what we’d imagine that we’d make available of variable annuity with a partner. We’re not going to go and create an insurance capability be somewhat akin to how we’ve been or done the bank if you will.

As far as product details I’m not at a state where I can get into those now, except for reiterating that we look for a better value, we look for more transparency and some of that means more simplicity than what’s been on the market today. That will strike a better cord in the context of that planning conversation that I referred to earlier.

So with that, I think we need to go to break, Rich? When do you want folks to come back up? Fifteen minutes? Ten off. Thanks, everybody.


Jim McCool

Give me a minute or so to grab this great lunch. I probably should ask – we should feedback to Rich, are we feeding you all well? You know, for a good – day here. We need (inaudible).

Good California, healthy.

Okay, welcome back, Jim McCool, and I’m going to spend the next 20 minutes or so, talking about the – sharing with you some facts about our accomplishments and our continued story of growth and momentum in the institutional services business that we saw last year, number one.

Number two, I want to spend some time highlighting and talking how we think about some of the initiatives that we began in many cases in the last several years, and how they can play out in our growth plans for the future. And then following Q&A from all of you, I’m then going to bring up Steve Anderson who will then take you through a deeper dive on our most recently launched Schwab and those advantages. And then he’ll come up in the stage and continue to take your questions as well.

So that’s the agenda. Many of you have seen this slide before, this is again a recap of who we are, institutional services, almost a trillion in client assents in total between the businesses that make up institutional.

Our largest component of institutional is the Advisor Services business, we serve the registered investment advisors, we serve companies with their 401(k) stock plan components and programs. And all total, those are the businesses that make up that nearly one-trillion in assets.

One and half million direct serve and the 401(k) business today, relatively flat number over the last couple of years, and we can talk about that perhaps later. But that’s a little bit who we are, and who we serve and continue to serve. Our ongoing stability and commitment to our strategies over the year, in large part is what’s enabled the institution to attract over $121 billion in net new assets throughout last year. The operating discipline we’ve deploying over the last several years likewise has helped us, even in this environment, to grow the revenues year-over-year by 7%.

Of the new firms that came to us, principally, the advisors turning independent, 166 new firms and their teams that came over to Schwab this part year. That’s about a 2% jump from where we were the year before. So, continued growth in that area.

Now, what pattern we’re starting to pick up as well, is that for the first time, we saw that the number of advisor firms who came from the independent broker-dealer space actually increased and is higher, slightly higher than the breakaways from the full wire house of firms.

And this is a trend that we expect is going to continue when we talk about all the advised assets and the wire house that end up in a broker-dealer space, including banks and trust companies. We’re beginning to see more signs of those advisors, again, breaking away, going on their own, being independent. And that plays well for our future in growth within Schwab.

Another factor, with respect to the Advisor Services business is that on 166 teams, about a third of those were joins. So, our efforts over the years of matching up these breakaways with existing firms is also paying off, where a breakaway doesn’t just have to start their own but they can join up with an existing firm who is working with Schwab. That’s a win-win for the breakaway as well as for Schwab in continued retention of assets and growth of more assets.

On the right side, moving over to the initiatives, we’ll talk a little further on here about some of the most significant investments we’ve made over the last several years, Schwab Intelligent Integration. Of course, you’re going to hear Steve Anderson talk about Schwab Index Advantage. And then I’m also going to cover some updates on the recent acquisition we closed in the fourth quarter last year with Compliance 11, which is part of our designated brokerage business.

In over the years, in fact for the last five years, we have now added some – a significant number of new accounts from 3.2 million to 4 million accounts. Now, we define accounts institutional as a sum of our brokerage accounts, investors using bank accounts and of course, our retirement plan participants. So, consistent growth in new accounts, matched with consistent growth in total assets.

On the bottom left, we can see the trend that’s also emerging and how we’re connecting a greater percentage of those investors that we build relationships with inside of our institutional businesses, particularly in the retirement and stock plan businesses, and how we end up converting those into added relationships, new households to Schwab in retail.

In fact, we’re now at 17% of the new households that came in to retail last year, first began a relationship by virtue of their company or their 401(k) or stock plan relationship by here in institutional. And then binding all of these together is a very strong expense and very scaled business, where from year-over-year we saw another decline – another improvement I should say, in our operating expense ratio to just over 11 basis points expressed as total cost over our total assets that we serve in institutional.

And this diagram really gives you a picture of the different businesses that make up and fuel that growth, that business we’ve talked about, about diversifying the revenue streams and growth streams that we have at Schwab.

We reach a wide variety and large pools of investors and sources of growth. At the top left, those who are looking to establish a relationship, particularly in the high net worth, ultra-high net worth side. We have a leading business through Advisor Services.

Schwab continues to have a dominant market share, in fact, the number one market share in the space serving registered advisors. That’s about a $2.7 trillion space that we see and we have a 25% share, a little better than the 25% share. And that’s still about 2x over our nearest competitor.

Of course, on the left side, we see the impact of our retirement business services, both full bundled, as well as those administrators, independent advisors, and record keepers that serve in, principally, the smaller retirement plan space. On the right side is our corporate services areas. (inaudible) at higher risk to run their stock plan or does it in a brokerage, which we’ll talk about in a bit, including mutual fund clearing and investment only.

Together, it’s these different businesses that make up institutional. That’s what generated the $121 billion of net new assets. That’s what generated $1.5 billion of revenue last year. And ultimately, that 70% household figure I just mentioned a moment ago, had translated to 28,000 new households within retail in 2011.

So, I’m going to talk about, primarily, we’re going to call out four different initiatives here that I’m going to spend a little time with. And then Steve is going to do a deeper dive on the Schwab Index Advantage.

Three of these initiatives began several years ago. It’s one of the most significant investments we’ve made at Schwab by then for the Advisor Services business. And then I’ll cover the corporate brokerage initiative through the acquisition of Compliance 11 here.

And this slide should look familiar. This is our Schwab Intelligent Integration. This really began several years ago when I stood in front of our advisors and said, “Based on where the market is going, based on the pressures with expense, with regulatory, with just a more complex place to do business, we have got to charge ourselves here at Schwab to find a way to dramatically change the way you do business. To take the cost, to improve your scale, to improve your efficiency.”

And that’s what we began setting forth to do two years ago. We are now beginning to deploy those results of Schwab Intelligent Integration.

People ask me, “So, what’s the big deal? Is this about plugging different technologies in? Your portfolio management system in with you custody system and your client relationship management systems and other tools and applications advisors use? Anybody can plum these together.”

What Schwab has done though is uniquely different. It’s about bringing these together in a way that brings together intelligent workflow that looks at it from the perspective of how you marry people, technology and business processes. And the impact is unmistakable.

It’s a better client experience and ultimately, its objective is very clear-cut for us and for the advisors. We know that the more time that they can spend outside attracting new clients to their firm and taking care of their existing clients, that’s a win for them and it’s certainly a win for Schwab.

This objective, this multi-year investment that we’ve been making in Schwab Intelligent Integration is wrapped all around how do we in fact, take that cost out so they could spend more time attracting and acquiring new clients.

A lot on this slide here. There’s actually three flavors, as we would describe Schwab Intelligent Integration. And it’s designed to match up with the variety of different advisors that we serve, the 6,500 or so advisors that we serve in the industry today.

At the top is what we call our Open View Integrated Office. This is really turnkey package. It’s designed for the breakaway advisor just starting to practice. They’re looking for something that’s ready to go.

It integrates their custody services here at Schwab, with the portfolio management system with the client relationship management application all ready to go, immediate. It’s designed to make it easy for someone who’s breaking away and moving to the independent status.

The second area is the larger advisor model. The overview of the Gateway is designed for someone who wants to imbed some of the new workflows or the applications and the architecture that we built, to make their own systems more efficient. To take advantage of that leap ahead that we are taking with bringing technology and better service and flow to those clients.

And then finally, the bottom part of just workflow libraries. Libraries that allow an advisor to bring a better process to their frontend as well as the backend of their office. These rollouts are beginning in 2012, all about retention of assets and all about helping advisors grow new assets and therefore growing our business here at Schwab.

The next area that we’re building that began late last year – excuse me, is our next generation trading platform. This is an application where we have not invested in until most recently. It’s older technology, but we’re not just replacing those technology, we’re taking this opportunity now. And this will be a multi-year effort as well, to leapfrog and go above where our competitors are today and trade technology for advisors as their needs are getting more complicated.

That’s our next step in making our offices more efficient and also to respond to the increasing demands that their clients are placing on them for more sophisticated trading capabilities, solutions and workflows and ultimately, a better experience.

Way too much on this slide, but if I had to step back from what the next generation trade application is all about in platform, it’ really moving away from a standalone system that’s not integrated with the Schwab Advisor Center. This is the Web application that advisors use for serving their clients that we support.

We’re moving away from a standalone, older, 10-year old technology into a state of the art application that’s fully integrated into, their Web application that they use for all their other services in running their business and serving their clients.

This is beginning to rollout this year and there will be additional modules that will be deployed throughout this year. So, it’s not a big-bang type rollout. And it’s one that we have 90 advisors right now working with us in an advisory committee if you will, building and giving us the feedback and how do we design this best to optimize their experience and their needs on this.

Joe spoke earlier about some of the strategies surrounding the bank. And this is consistent with our operating priority around monetization of assets and specifically, how do we use the bank in a more effective way for the benefit of advisors. There’s two examples I’m going to call out here.

The first is pledge asset line. The growth on the left is simply a reflection of increased demand from our clients, particularly high affluent, high net worth clients in which they’re finding that they would much rather prefer to use a line of credit from their portfolio as opposed to lines of credit through their home or their real estate. And it’s a much easier way to do this.

The demand here has now grown over to half a billion in outstanding lines with just the advisor segment alone. We find that hard to do because it’s not an automated process. And that’s exactly the investment we’re making now. To build a platform that allows us to scale to do this more efficiently and provide a better experience for the advisor and their end client.

The advantage of this also is that as we build this out for our – principally our advisors, we’ll be able to extend the same capability to our high-end, high affluent clients in retail. So, this is a cross benefit application. Again, using our bank to help monetize balances and create a better experience.

One of the reasons also that we’ve seen such strong growth here is because of the rise of the breakaways, the breakaway brokers who are going independent. Many of those with a major with a major wire house firms have clients who already have this pledge asset lines. And we’ve had to build these solutions in order to provide a support, a service for the client ongoing here at Schwab. So, this plays into our goal of continuing to attract the advisors turning independent from all the different sectors in addition to giving us good revenue and economics on the client.

The second angle or the second aspect of our bank with respect to advisors is beginning to address the problem of succession. And from an advisor’s point of view, we have about 19% of the advisors that we see are over age 60. And the most often requested form of succession is internal. How do we finance an internal succession?

The challenges are, for the firm, is it ties up working capital that otherwise could be used for investing and growth or other opportunities for that firm. And that’s difficult to do. The problem is also found when banks typically don’t understand how an advisor’s business works. But yet, here we are at Schwab having built this business of serving RIAs for the last 20 years along with our own bank, Charles Schwab Bank.

We believe we know more about the advisor community than any other bank. We ought to be able to connect those two resources and provide a solution now for advisors.

The benefit, as we this, is retention, loyalty. To the extent that we help facilitate internal succession and transfers from within the firms. We believe that’s also a path to ensuring that those assets that those firms have built up will continue to stay at Schwab. So, another avenue of how we see the bank grow in an increasing importance for institutional and our advisor business in particular. We move over to the corporate brokerage services initiative, particularly with our acquisition of Compliance11.

Last year, at this time, I gave you a little preview of the business we called designated brokerage. And as our quick refresher, this is a business that we’ve been in actually for 15 years at Schwab. The service is all about companies who need to monitor and oversee their employee’s trading and other regulatory type actions. And that’s, of course, becoming a much bigger group now because of the rules and the environment that we all live in.

So, this is the example that I shared last year. I said, “This is where we believe we can take this headwind in terms of increased regulatory complexity and actually take that as an advantage specific to our designated brokerage business. This is an area that is growing. And we see continued growth happening here.

Now, over the years, we’ve built some very unique solutions just on our own inside our designated brokerage business. And by the way, this business, just for a little context, is about ready to cross over the $100 million revenue mark here at Schwab. The kind of investors that they attract actually mirror what you heard earlier about our most active and most engaged investors.

These are high-balanced investors. They tend to use a lot of the services at Schwab. They tend to have anywhere from 2x to 3x, the amount of margin that they generate, pre-tax margin they generate as well as net new assets they generate. So a very attractive segment of investors has been coming to Schwab over the last 15 years and we’re simply trying to grow more of it now in this environment.

And so, what we’re doing is we are combining those features that we have today with an expanded set of services that implorers are looking for, gift monitoring and other reporting obligations, through Compliance11. This is a small software company we acquired based in Chicago.

We’re bringing these two features together. Our leadership and (inaudible) brokerage, with the enhanced capabilities that Compliance11 offers, and this year, we’re going to market in a much stronger way now to package the bundle, the combined offering and capabilities that we now have through this acquisition.

We actually see four different engines as we call it of future growth associated with this particular acquisition. And the first is acquiring new firms to Schwab, just like we’ve been doing in (inaudible) brokerage. But we think we can do it, actually, at a faster rate now.

This business is estimated to be a $300 billion market place and outside consultants and others have judged it to expect to double over the next three to five years. So, again, owing to the regulatory environment that we are all working in. And so, we certainly see that as one of the first primary engines of growth in this business.

The second one is we have a number of clients we’ve acquired now through Compliance11 and we have right now very little market penetration with them. So we have an opportunity to now bring Schwab into that story and offer a more complete service and, of course, a strong brand behind Compliance11.

Third, within our existing base of clients. We see that the increased set of offers that we could now bundle and put together is allowing us to go back to our existing clients and seek to get an even greater market share by trading a better experience for their end clients, their end employees of these firms.

And the fourth one we realized is that within that rank of 6,500 advisors that we serve, a great number now require these same services because of this regulatory environment. So, the cross-sell actually into the Advisor Services world is one that’s already starting to show up on our plans and our request from existing clients.

So, when I summarize, all told, this has been a challenging environment. We’ve made the right decisions. We accelerated our investments in 2011 by a factor of some 38% in the investment spending alone in 2011. A lot of that, in fact, a great percentage of that has allowed us to throttle back our investment and other spending in 2012.

So we will continue to deliver on these initiatives that we began talking about several years ago, new platforms, broadening our services. We will be able to deliver positive revenue growth. And for 2012, we expect also to deliver positive revenue growth while growing our total expenses at a rate lower for 2012.

So, the power of the discipline, the operating discipline, taking advantage of last year’s acceleration in investments, ratcheting down continued momentum is the story that I leave with you for institutional services.

So, with that, questions. Yes?

Question-and-Answer Session

Unidentified Participant

Jim, can you just walk through what are the economics on the Pledged Asset Lending side? And then, secondly, what do you see is maybe the revenue potential for that product?

Jim McCool

So the economics of that would get back into what we earn in the bank, in our portfolios there. So I’m not sure that we’re going to be publishing prices and yields on that. But this is a positive spread that we earn and is one that helps us monetize and increase the revenue over what we earned today in the Advisor Services business.

Walt Bettinger

(inaudible) the rates on the PAL product to be roughly akin to what we earn on margin. So it’s a margin alternative and looks very much like margin in terms of yield.

Unidentified Participant

Do any of your RIAs feel like some of the things that John spoke about are competing with them and their products? Or do they not see it that way at all.

Jim McCool

Yeah, there are Advisers that compete in the same zones of clients that we serve in retail that the advisors themselves often roll in the industry with the Schwab Advisor Network. So it’s a way of bringing all of us together that we think helps manage that tension. But on the total balance, we only have it on the edge within some.

Unidentified Participant


Unidentified Participant

Hi. Does your next-generation trading platform on the institutional side have the same derivatives and global trading capabilities as what you’re building out on the retail side?

Jim McCool

We’re going to be following. After that gets built in, we’re right behind kind of. And right now it doesn’t.

Unidentified Participant

On the backend, is it the same team that works on both platforms?

Jim McCool

We share all those technology and resources in one technology group here at Schwab.

Unidentified Participant


Howard Chen – Credit Suisse

Jim, last year you shared with us just, I think, a bit of a renewed push on the $10 million to $50 million emerging advisors program. What’s going on with that customer set and some of your initiatives there?

Jim McCool

Yeah. Thanks for bringing that up. I didn’t talk about that. First off, the reason why we’re going after that or accelerating our efforts or increasing our efforts, I should say, in the core advisor segment $50 million is the economics are strong.

They tend to use higher revenue generating assets, a better revenue flow for us. We’ve built a very good service model there. And by the numbers that we have, we believe we have a leading share of those advisors already.

And so, our message was to increase the awareness within the rest of the industry, particularly the breakaways, that this is a good place for them to come. We wanted to overcome what we heard with some barrier out there that advisors were breakaways, especially we’re thinking, well, if you’re a really big advisor, Schwab is really good, and we are. But we’re also really good at helping the emerging advisor, if you will, to grow their practices to become quite successful.

In terms of growth rates, I don’t know, Bernie, if we’ve – Bernie I see in the back – I don’t know if we’ve had growth rates we had published on that segment publicly. Do you have anything to add to that?

Bernard Clark

It remains one of our faster-growing segments, is we’ve talked about frequently advisors on our platform tend to grow faster than the industry norm. In fact, they tend to grow mid to high-teens. And often in the emerging segment at different periods of time, we’ll see them even exceed that growth rate.

So we’ve been quite pleased. But Jim mentioned something that’s very important. We’ve been industry leading in that segment as well. In fact, you can carve up almost any delineation of asset size and you can see that we’ve led into those places.

So we call it core now. It’s something that we’ll continue to have prominence in what we’re doing and again addressing their needs for their size and what they have. That small segment has a specialized need with the emergence of a lot more regulation. And we’re going to have to help them think about that. And in many cases, we’re going to have to think about how we will help them to consolidate or use their parties in that capability.

Howard Chen – Credit Suisse

Great. Thanks. And then, separately, Jim, on the lending initiative to help facilitate RIA succession now, is the strategy that a term loan will make the Schwab advisor relationship sticky? Or is there some greater contractual relationship over time in terms of...

Jim McCool

Well, first off, we’re in pilot, Howard. So we haven’t formalized all the terms and conditions on this. We’re working. We’ve already done one and we hope to be doing more this year and working together with the bank.

I would first offer that when we would be offering the service, I think we already have a relatively sticky stable relationship. Otherwise, we wouldn’t be comfortable in offering this.

So the opportunity here is as it passes through different generations or different owners, can we continue to maintain that. Keep it all, quote, “internal” to their successful leadership team. Okay.

Topic, Steve Anderson, I don’t think you’ve met before on the stage at least. And Steve and I and his team have been working on this whole 401(k) initiative. We call it Schwab Index Advantage. What I want Steve to be able to share with you is how we not just are talking about it, but how we expect it to change how 401(k)s are thought off.

This is not a marginal, at the margin type small change in the industry. This is moving the 401(k) needle to a whole different perspective – changing the focus to that off low-cost, simple and with advice, and the impact of those.

So, at this time, I’ll bring up Steve to share with our efforts and progress on Schwab Index Advantage.


Steve Anderson

Thank you, Jim. And greetings. It’s a real privilege for me to be here representing the team that’s been working on Schwab Index Advantage for, gosh, well over a year.

It’s about a year ago on this very stage that Walt introduced the concept as far as the major investment that Schwab was making in the 401(k) industry. And what I’d like to do today is talk a little bit about, first, the nature of the buying community, our clients; looking at our clients and how they view the market through their eyes, both plan sponsors and participants.

Secondly, I’d like to get into a little bit of detail in regards to the product. And then, third, probably most important to all of you, how we view positioning this product and our strategy going forward with our existing business and also our growth strategy going forward.

To set context, we’re in a market where there’s about just shy of $3 trillion of assets in play, 15 million participants.

And if I might reflect on the gentleman who, so to speak, is the father of the 401(k) and refer to a quote that took place in November of last year, Ted Benna, back almost 30 years ago, a little over 30 years ago is credited with finding that aspect, that provision in the IRS quote from Ted in November – “I would blow up the system and restart with something totally different. Blowing up the existing structures is the only way to simplify them.”

Pretty powerful statements from the individual accredited with starting that, which is now a major savings vehicle within our society. Let’s explore why Ted is making that comment and where Schwab Index Advantage comes into play as we address some of those concerns that he highlights so well.

We certainly don’t anticipate blowing up the industry, but as Jim said, we believe we have a solution that can dramatically change how plan sponsors and participants look at their plans.

Let’s take a look at the client experience and let’s do both from a plan sponsor perspective and also a participant perspective. Here are some of the things that you’re dealing with, and put yourself in that situation, if you would, just briefly.

Number one, there’s got to be a very attractive benefit. To compete in the space today, you’ve got to attract and retain key people. The 401(k) plan is an integral part of that. Your match is an important part of it.

Secondly, you personally are taking on a fiduciary role, serving on that committee personally as a fiduciary, following the guidelines, the regulations of ERISA, a highly regulated area. Typically, you’ve got to have a consultant to help the committee understand what to do and what not to do.

The third area is that of fund management. Which funds do you put in the plan? Which ones do you think out? Walt mentioned, think about this, 85% of all of the assets in the 401(k) is at fees. You’re held to an accountability of having reasonable fees in your play. What is reasonableness mean? How reasonable are your fees?

So, what do you do? You do benchmarking studies. You go to the market with the request for proposal. You’re constantly looking at your pricing structure and ideally pushing your provider, much like Schwab, down in their fee structure.

So there’s a lot of complexities at the plan level. And, usually, when you think about protecting yourself as a fiduciary, where do you turn, because you have to make decisions for the benefit of your employees. You turn to standardized education, glossy material, classroom environments, maybe a Web-based program that they could learn from. You try to educate individuals in terms of what decisions do they make.

And I’m going to touch on a little bit of that topic further. Let’s shift gears, though, and now look at it through the eyes of participants. Probably the most important. Certainly the most important. If we take a look at almost any study today, over the last few years, there’s been a heightened concern around retirement readiness, within the baby boomers, within those that are already at that retirement stage, individuals who have taken on another job during retirement.

How ready is our society for retirement? Pension plans have gone away. And even those, I mean, we think back to the day where the end all, but they were not. We’ve got a whole new dilemma now with longevity, lack of savings, that we need to help individuals prepare for their retired plans.

Now, that’s on kind of how they’re feeling, that emotional aspect in the reality of their savings. But another key component – and these are foundational, understanding what we’ve done with Schwab Index Advantage – another key component is behavioral finance, behavioral economics.

Many individuals, many employees who are in 401(k) plans today had no intention on being an investor. They know they need to save. So they enter into the plan, how much to save, how do I invest, though, is not something they’re very good at, nor do they spend a lot of time with that.

So, a few years ago with the DOL, Department of Labor’s endorsement, there were automatic provisions that allowed plan sponsors to make, in essence, decisions for their employees to place them in the plan, to put them at a deferral rate to increase that deferral rate.

And what we’ve seen is possibly through a lack of interest on their part. Participants, employees stay in the plan once they’re included. And if they’re increased they stay with that. In fact, even if they’re defaulted into a certain type of investment such as a target date fund, they stay there. Great staying power within decisions that employers make in behalf of their employees.

So that’s a key component. Now, as we take a look at what we’ve learned over the years of being in the business and, really, the industry has learned, there’s two key components that really drive results. Excuse me.

John touched on this a little bit as far as cost even with our own retail-oriented products. If you can drive cost down, that’s more that you have to work with in terms of savings. In the 401(k) space, when we’re looking at the underlying expenses, we’re talking about active management.

And if we can build a very diversified portfolio and take the cost on average in the market that we play in from about 86 basis points according to (inaudible) down to 20 or 25 basis points with a 100% passive index approach. Those are dollars right in the pocket of participants.

In fact, just simple math over a 30-year period would allow somebody put about $115,000 of additional savings in their account with just normal deferrals and then match, and the differential, that 66 basis point differential in terms of how you would equate that.

If you multiply that then by that 15 million participants currently in plans, that’s a huge impact on society. But again, it’s dollars in the pockets of individuals that makes a big difference.

The other area that we see that makes a huge difference – and we see that even with our retail clients – is advice, advice for individuals that typically don’t get advice if they happen to raise their hand and there’s about 10% of all participants in the 401(k) space that actually asks for help through advice, a consultation or a Web-based tool, typically see that their savings rates almost double.

And you can diversify yourself all you want, but if you’re not saving dollars, you’re not going to get through retirement. So that saving rate is the key.

If we look at some other studies, there’s also a higher rate of return that those individuals have yield over the last few years. They’re more diversified. They typically go for maybe three or four funds to eight funds. Greater staying power. Advice makes the difference. And when you combine low cost with advice and you create a product that’s based on that, it’s a whole different philosophy than what the industry is now today.

So let’s go a little bit further into what are the products look like today, what does Schwab’s product look like today, and why is Schwab Index Advantage just so different. Let’s focus on the left hand side of this slide if we could, because this is today’s model, and, yes, we are as guilty as anybody on the Street that’s providing 401(k) plans to be doing exactly what I’m going to describe and what Ted Benna was referring to in the quote that I shared with you at my opening.

If we take a look at the wide array of varieties, decisions, the participants are forced to make today, here’s what they’re looking at. They’re looking at wider range of investments, actively manage funds. They’re looking at passive funds. They’re looking at collective at collective trust funds that you’re going to include, both the active and passive.

Most importantly we’re it gets confusing is in the asset allocation tools or products that are in plans today. And it’s typically not just one, two, but probably three different approaches to asset allocation where you’re trying to educate somebody as far as what do you have as for your options.

You have target date funds. You have risk-based portfolios. You have managed accounts. You have point-in-time advice. And many times, you’re mixing all of those together, which really gets pretty confusing at times. Then you have also the capital preservation options.

As I mentioned earlier, when you put that fiduciary hat on and the best way for you to protect yourself is through education, historically what we have done, if you were in that committee, you would say let’s have those enrolment classes. Let’s have classes on investing.

In other words, what you do is you have a paper map, a roadmap that you pull out of the glove compartment and say you’re point A, let’s get to point B, follow the directions here in terms of your risk tolerance, your asset allocation, make those decisions along the way. And it’s through education which we have learned just does not work.

Let’s contrast that now to what we’re doing with Schwab Index Advantage, where we are eliminating many of the items that we see on the left. Some of the best decisions, I think, we’re making are what we’re not putting in Schwab Index Advantage. We are going to go with 100% all indexing. Using this year, all index mutual funds. Next year, we’ll be rolling out one that’s 100% ETFs.

The second component which is required – it’s not optional – is a personalized managed service, one that looks at age, income. It’s going to look at account balance, savings rate, projected Social Security benefits, and map a individual into a portfolio in a glide path that’s appropriate for their stage in life. They too then can add information that makes it that much more comprehensive.

Now that exists in the market today. But what is truly different is the bold step that we’re making in saying that if you go with Schwab Index Advantage, this is where we’re going to enroll. We’re going to place participants in the managed service on day one. Not a target date fund, not a risk-based portfolio, not a capital preservation.

We want to do what is right for a participant at the very outset. Not wait for them for three or four years for them to raise their hand and say I want advice. We’re going to put everyone in the advice solution day one. Those that have the time, the interest, the knowledge to want to invest themselves, those do-it-yourselfers, they will have that opportunity to opt out at that point in time or any time in the future, or to opt back in to the managed service.

We know though the vast majority of participants who are placed in a service of this nature based on what we’ve seen over the past years, they’re going to stay in the service, because they’re going to feel as though they’ve got somebody doing it for them. They’ve got a professional service that’s supported by communications going out, one-on-one consultations, if need, and a Web-based tool and, certainly, quarterly reports that reinforce the value that’s being provided.

Most individuals that would attend an education session today. If this in fact were one for Schwab and you’re an employee and I were here going over an hour-long program about all the features of the 401(k) plan, the different asset allocation opportunities, at the end of the meeting, chances are you’d come up and say, “You know that was a very good presentation. I learned a lot. But do me a favor, tell me what I should do. Help me out here.”

It’s not the education. People really want the direction and make decisions for them. And that’s what we’re looking at here with this offering.

The third component, it is built in to this simplified bundled solution, is a savings product that individuals understand. Few participants today understand the nuances of stable value, but they do understand the stability of FDIC insurance from a bank, a bank deposit product and through Schwab Bank, we’re introducing Schwab Bank savings as the capital preservation vehicle within Index Advantage.

So, again, key components. It is dramatic shift from what Ted Benna described as wanting to blow up the industry. We don’t think we need to do that. We think we’ve created a very simple solution that can really gain traction in the market. And that’s what we’re seeing.

It’s bundled. It’s difficult for others to want to go down this path to. If you look at our competitive set, many of our main competitors are active managed funds. For them to go down this path, it greatly undermines their overall strategy.

So, again, we feel as though it’s sustainable, it’s different, and there’s nobody that’s playing in our space that has built a product of this nature.

Let’s look at some of the economics and this gets into that win-win monetization aspect that Walt referred to as one of key strategies as a corporation. Now, the magic to this is, if we take a look at the active management, which has really been the financial underwriter for the last 30 years of the 401(k) industry. And we strip out all the active management involved.

We can drive the asset management fees down to about 20 basis points, 25 basis points for a very diversified portfolio, with upwards to probably about 15 different asset categories to build that out. When we do that, that drops the cost right down on the asset management fees.

It allows us to shift, part of the value proposition from the active management to paying for a fee-based managed account. That is a fee-based managed account where Schwab is providing more of the service, more of the value. And as such, you’re going to see on the next slide, we drive more of the revenue.

So we’re dropping down on the expenses all in. You’re going to see probably in the range of an individual with about a 60 to 70 basis point all in cost, a very diversified portfolio with professional management. When you think about it in terms of a retail product, that’s a very attractive price point.

But let’s take a look at the economics as far as what we’re doing. This is where there’s that fundamental shift in today’s environment. The provider, whether at Schwab or one of our talented competitors, the vast majority of the work that takes place in the 401(k) space is at the provider level.

They’re acting as the record keeper, they’re doing all the accounting, they’re handling all the calls, they’re servicing the plan, they’re consulting at the plan. There is a lot new through if our underlying (inaudible) and the revenue.

In this situation that we derive revenue from will have the bank savings product which would serve as a bank product much as any other deposit product source of revenue. And then as needed we would have a record keeping fee but our goal and intent is to minimize the record keeping fee to as low as possible which really changes the playing field in terms of how you compete because usually you’re measured by cost on what is your record keeping fee.

And when you go out with a low or no recordkeeping fee it’s a very different value proposition that you’re talking to a plan sponsor about when you talk about reasonable lesser fees it changes the whole dynamic there.

So, again, it dramatically changes the revenue seen that we have seen in the past in terms of increasing the Roca [ph] that we’re going to drive and what is otherwise a very competitive area. This is a classic area that Walt referred to earlier that we could bring in net new assets all that you would want at very low margins if we really wanted to compete upmarket and bring in a lot of assets. You can do it for almost nothing.

And there are plan sponsors that would love us to do that but we don’t. We’ve been very disciplined in the last three years in terms of how we priced and we built our business.

As Jim mentioned, we introduce the product a little over 20 days ago in New York. We went in with a series of different interviews and a press release. And many times when you have a press release, you’re excited, you get it out there and it goes out and then the next day there’s new news that trumps it. And all of a sudden that press release doesn’t look quite as good as you thought it might because it just didn’t get the traction you wanted.

With this, we had 21 interviews, organizations, separate organizations that wanted to meet with us. We had over 30 different publications pick up on it and they are still writing about it. Just this past Tuesday, the Wall Street Journal had an article on the influence of fees and the fee disclosure on the 401(k) space and they highlighted Schwab Index Advantage as being a unique offering in the marketplace.

So, as well as I would like to think that Jim and I did with our interviews and promoting the idea, it wasn’t us. It’s the concept. The concept is being well-received in a perfect time in the market right now. When you take a look at the differential between active management, passive management and who’s been up performing what, passive management is definitely a key trend we’re seeing in the 401(k) space.

When you talk about doing things for individuals that they otherwise won’t do for themselves and you know it’s the right thing for them to do, it makes for a good story. And when you cut down on the fees, that’s probably giving some of the best traction right now because the deal, well, I don’t know if you know but in the last 24 hours they came out with their final regulations in terms of plan sponsor fee disclosure which is now on July 1st of this year where all providers will need to provide great transparency to the plan sponsor which we have done for years.

But more importantly 60 days after that, plan sponsors will need to communicate at the participant level, the underlying fees in their 401(k) looking at one year, five-year, 10-year, rates of return compare it to a benchmark and fees as a percentage an OER of assets but also based on a dollar amount on a per thousand.

So, it’s going to be transparency that has never been seen in 30 years of the industry. If you think that individuals were concerned about the possibility of a $5 ATM fee when you get to push the button and say, “Yes, I accept,” think how they’re going to react when what they believe is a free benefit because it’s embedded in the OER of active manage funds, when they realize what they’re paying on their account balance is in a 401(k)?

How many of you know the fees you’re paying in your 401(k) account? You’re all in plans. In a few months you’re going to know. And you’re going to understand the nature of the other fee disclosure. So, it’s an important trend that we can pick up on as we introduce Schwab Index Advantage.

Now, let’s take a look at it from a market strategy perspective. Where are we today and where can we go with this? In the 401(k) market today, these are the top 10 providers and we see these players day in, day out when we’re competing for new business.

And certainly as you take a look at Schwab in the ninth spot, we have an opportunity to take market share with this offering. Certainly, it is a passive approach that could play well against one of our competitors that have embraced passive investing for a while but they’re not even going as indexed as we are. And when you couple it in with our pricing strategy and to manage service, it’s very difficult for others to compete if you look at most of these organizations with what we’re doing. So we’ve got a trusted name providing a very unique solution I believe at the right time.

Now, one of the things that we’re going to have to really do a better job of that we haven’t done in the past is have a more aggressive direct to plan sponsor marketing approach and sales approach. We’ve relied heavily on third party consultants and advisors who really dominate this space probably about close now but 90% of our business comes through third party advisors where they’re consulting doing search work, they’re looking at the underlying plan, they’re helping out in the investment side of things.

We’re going to continue to embrace the consultant community it’s an important aspect of our current business and we’ve got wonderful relationships with those professionals but we also need to be telling the story directly to the marketplace, directly to individuals in the finance side of house and the HR side of the house which is interesting on some of the media pick up.

We had an excellent article in treasury and risk publication and then in CFO because this concept really appeals to the financial side of house from a decision-making perspective. And usually you have both HR and finance on the committee making the decision together. So we’ve got a compelling story there.

Now, the fee-base aspect of this is really important because of the transparency that’s going to come about. And we’ve started to see a pick up any way in terms of plan sponsors that are going out and checking that reasonableness of their fee. Now that this is going to be much more public in terms of their participant level and to the public they want to make sure that they have got their fees as competitive as they can.

So we’re feeling those pricing pressures today. We also feel this is an opportunity for us to kick start the sales of Index Advantage at a perfect time as the fee disclosures come out.

Let’s go a little bit further into the market segment if we could. In the 401(k) space, we’ve been very deliberate in the markets that we choose to compete in. Jim mentioned earlier that we don’t compete in the smaller market. We have great partnerships with third party independent record keepers much like we do with advisors that are very proficient in this space. They tend to be very active in the below 20 million category.

We have chosen to compete on plans that are 20 million on assets and above typically up to one billion of assets. Now, we compete above that and we have some of our very best prominent clients north of one billion. But if I take a look at our sweet spot where we can – work day in and day out and make a difference is that 22 billion range.

In that market today, to all retail offerings, the ratios of that way because we tended out to attract more professional-oriented firms, physician groups, law firms, we happen to represent probably 30 of the top 100 law firms in the nation.

Engineering groups, professionally-oriented groups, and if I take a look at our manufacturing base where the managed account could be a very solution-oriented approach for a plan sponsor in that manufacturing base, we only have about 14% of our market.

So we have an opportunity really to expand the nature of the plans that we compete on. So we really view this as expanding the market where we could go after a wider variety of demographics within the plans as far as the plan sponsors and to make up their employees so expanding on that.

Now let’s put it in numbers. So, I know that most of you based on some of the other questions you asked, the numbers are important. Let’s understand this segment of the market because when you look at the number of plans and in really many of the participants, they’re below 20 million. But we really feel this was the segment we can compete very aggressively because we’re strong incumbent with a very disruptive mile of coming in.

When we look at, at the market that we’re in, there are approximately 9,000 plan sponsors. It’s a pretty much known universe. Those are – that’s from various databases, it could be a little bit higher than that, a little bit lower but about 9,000 plan sponsors. And what we know over the last few years with the market turmoils that we’ve had, and downward pressure in terms of internal staffing, there’s probably been a turn-over rate of plan sponsors at about the 3% range of those that really want to go actively go out to bid, and change providers either because of fees, or service or both.

So when you look at that, that’s about 300 plan sponsors, give or take, 3%,. We know from our own bidding, that we’re involved in the vast majority of those opportunities today. Given an example, last year, we made it to the finals of about, it was 87 of those opportunities.

It finals you down to maybe two, three or four providers. Of those 87, we had a win ratio of 48%. So we feel as though we can compete aggressively today, with our current model, more importantly, where we can grow the business in a very aggressive way going forward because of the whole change in what we’ve doing.

The key for us now, if we only have a 3% turnover rate in the market within that space, how do we get it to 4%? 5%? 6%? Where it used to be if we go back about seven or eight years ago, so that there’s more plant sponsors willing to turn over and go to something new and better because it is different.

The dilemma for them today, is that we could all stand up, we could have four different competitors here, and we’d have an hour and half meeting sharing all the services that we can provide, the bells and whistles, end of the day, they would get us all confuse because we’re all saying the same thing. Nobody really stands out with a different story. And Schwab index advantage is that different story, low cost, better outcomes.

So it’s a very different model that we’re working on, that we think that we can bring that search mode up to a great percent than it’s been. The same time, we’re working on new businesses. It’s so important that we focus on our current clients. They are our very best prospects for adopting Schwab index advantage, they already trust us, they know us, we have great relationships with them, very high client promoter scores.

And to the extent, over the next year, two years, that we can move, transition those clients in adopting index advantage, as Walt said earlier, it’s not going to help our net new assets, but it has a big impact on our revenue with very little adjustment in our expenses.

So not only will it be the new market, and going after new plan sponsors, it will be working with our current plan sponsors, certainly embracing decisions that they’ve made in the past where they are today from a producer [ph] perspective, they’re getting to see the vision on where the market could go with an alternative business approach.

And last, just to highlight again, is that, there’s a great partnership between the retirement business and our retail business. We work very closely in communicating with plan – with participants on the value that we can provide within our retail offering. And as Jim mentioned, 17% of all of our new households, flow through either retirement plan, or stock option plan.

It’s a very critical part of our overall business strategy. So do we really need to blow up the 401(k) market? We don’t think so at Schwab. But we do need to make some radical changes with the product that we believe is at the right time, with the right story, that’s going t drive better results, through lower cost and that manage service in culmination.

With that, let me open it up to any questions you might have, on the business, on the product, and we’ll take it from there.

Question-and-Answer Session

Unidentified Participant

Steve, I think most – everyone would agree this is a pretty revolutionary idea, it makes a lot of sense economically, but sometimes, the inertia of these markets can be very, very powerful. So I guess, you know, if we come back in a year, how would you define success as we kind of see this play out?

Steve Anderson

You know, it’s a question that I’ve been wrestling with because I know it’s a new offering, but inertia – there’s a flip side to inertia, inertia is individuals not wanting to take the action. The other thing that can happen in the market that we’re in, is, if something gets traction, it can get traction is a hurry, and our hope is it would.

I’m going to probably measure success more in terms of our sales pipeline because the sales cycle in our business is typically anywhere from six months on the short side up to a year or more on larger opportunities.

So I’m going to measure it more by how do we look at our pipeline? How many plans do we have in that pipeline, how many assets, how many participants, and really building the momentum because as I stand here now, we’ve got a pipeline now, a very healthy pipeline of plan sponsors that are looking at our traditional product, and we’re going to do the best job we can to introduce our new product in their decision-making mode. So it’s going to be a transitional aspect in terms of how do we build that pipeline, get the word out because this is an organic growth play that we feel as though it can gain momentum over years.

And we actually feel that with the ETF version that we’re going to roll out next year, that’s going to be even more disruptive because there’s nobody that plays on our space that will have that capability of trading during the day with ETFs driving cost down even lower, with the same features I just talked about. So we feel a gain in momentum as time goes on.

And to the extent, we get some great traction over the next year, it is the type of thing that can break through inertia and really get some fairly high volumes. All you have to do is go back maybe, gosh, about 20 years, 25 years when we went through – for those of you that maybe are my age, it used to be in a balance forward program where you get a glimpse of your account every quarter, maybe you don’t remember that. So bear with them.

When things move to a daily valuation, there a lot of nay-sayers, they say – nobody wants to see their account every day, they’re going to be trading too much. But who today does not have daily access to your 401(k) plan? Everybody does, and that happened in a matter of years.

We’d like to think that this could also have that type of traction. The market will tell us though, an initial read, from consultants, from the media, from some of the plan sponsors, we had the opportunity to do business with, the story we’re sharing is really resonating. So it’s going to be my responsibility to Walt and the team, to make sure they’re getting that traction, that we feel, much like the message that Jim and I shared, it’s more about the message than anything else.

Unidentified Participant

Sounds good. And then my follow up, given the product is fairly disruptive, Steve, I mean how are you preparing for any potential disruption in terms of either that, you know, traditional 401(k) offering, and second, just broader one source relationships for the company and what are you hearing, you know, in real time from folks?

Steve Anderson

With any partnerships, such as with our one source, I think open communication is the best policy. They have known for a year as the strategy, what we’re doing. There is certainly a place for active management with the advisors, with our retail offering, but if you think about the nature of 401(k) plans, they’re a long term buy and hold.

And to the extent, over a long period of time, how many active managers are actually going to outpace their benchmarks. And if you can put that 65 basis points, or maybe even more in your pocket, just be lowering your cost, and having a very diversified approach in an institutional product, I think plan sponsors are going to be very interested in that type of approach.

So communication is paramount with our partners there. Disruptive? We want it to be disruptive, we absolutely do. But disruptive to our competitors, not to plan sponsors, not to participants. I think the hallmark of a lot of what you’ve heard today when it comes to the product side is, what’s in it for the client?

And there’s a lot in this for the client. There’s still – for those that want to do it themselves, they’ll have every opportunity to do so at a much lower cost. For those that need the help, and many do, it’s going to be a very comprehensive service.

Over here in the front?

Justin [ph]

For this segment, I guess in ’06 and ’08 when you used to break out the corporate and retirement services as a separate entity, operating margins were probably in the mid 20%, I’m assuming you’re not there now. Is there kind of stated target or what it realistic for this segment to get back to?

Steve Anderson

Justin [ph], this is my first time on stage, I’m not going to make a mistake answering that question just yet, I’m going to look over to Joe. Joe, to what extent do we really break that out?

As far as I know, we haven’t. So I want to be able to be invited back up by the way.

Joe Martinetto

So you’re right, we don’t break that out in terms of segment information anymore. It is fair to say that much like the rest of the business, the retirement business is impacted by the low rate environment, there’s a chunk of the client bounces the sitting cash, cash spreads are depress. So we definitely felt some margin pressure in that part of the business over this part of the cycle.

I think it’s important to note, and Steve has given you a couple of reference points, one on what the revenue yield looks like, and basically, an almost doubling of our take on those fees. Two is, some of the commentary around cost. This isn’t a markedly more expensive offer to deliver to market.

So we do expect over time, we’ll see better margins in this part of the business which will allow us to be more aggressive in terms of how we go to market, but we’re not prepared to make predictions or break that segment margin out today.

Steve Anderson

Joe brings up a good point, I mean let me just add a comment here more on our market. With this offering, we can be more aggressive going up market, going after some major corporate players that are interested in moving in this direction. And there had been some significant, multi-billion dollar plans that have moved to an all passive approach in recent months, and we think we can lead that.

And we can do so with plan level economics and revenue, that allow us to do it in a sustainable way which would be very difficult today. To compete in that space today, you almost – you have to do it at the expense of your other clients, and we have just chosen not to go there.


Chelsea de St. Paer

What are the advantages or disadvantages of a plan sponsor choosing the 100% mutual fund version versus the 100% ETF version that’s going to be coming out?

Steve Anderson

We’re really fairly indifferent on whether it’s indexed, 100% indexed with mutual funds or with the ETF. I think the advantage with the ETF is going to be being able to drop that cost down that much further in terms of the underlying cost.

And that’s one of the key elements of this, dropping it down. An then for some of those plan sponsors that may want to have that inner-day trading capability.

Joe, do we need to wrap up? All right. Well let me bring Joe back up. Thank you so much for the opportunity to be with you today.

Joe Martinetto

Thank you, Steve.

Steve Anderson

Thanks, Joe.

Joe Martinetto

So I’m not too worried about his getting traction on this because he’s a pretty good sales guy. I’ll try to keep the conclusion pretty brief here. But bottom line is, we’re pretty excited about what’s going on today.

When you look at the core of the business, we’re well positioned. We’re winning in the market place, we’re bringing in assets, but on top of that, we’ve got some really important initiatives that we’re in the process of delivering to market today.

And Steve obviously just talked about the 401(k) offered, John talking about the positioning that we’ve got around the advice offer. Some of this is capabilities that we think some of our competitors are going to have a hard time matching, or they’re just not going to be able to get there based on internal conflicts, or price points.

We spend some time talking about expense management. It’s a really important topic, but it’s also deeply embedded in the way we run the company.

And a large part of that, is because how important it is to the strategy, so you’ve heard pieces of it today. But being able to deliver that low-cost solution, being able to keep our expenses down, let’s set price products to points where others can’t necessarily match us.

Let’s just bring offers to market that drive the growth of the business forward, and it also lets us keep harvesting that savings of continuous improvement, that we can plow more money back in the development of new products and services going forward.

So it’s not a project for us, or something that we’re going to break out and try to do one time. It’s an on-going process and the discipline around how we run the company.

So thank you again for your time and attention today.

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