The Charles Schwab Corporation (NYSE:SCHW) Q4 2023 Earnings Call Transcript

The Charles Schwab Corporation (NYSE:SCHW) Q4 2023 Earnings Call Transcript January 17, 2024

The Charles Schwab Corporation beats earnings expectations. Reported EPS is $0.68, expectations were $0.64. The Charles Schwab Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Jeff Edwards: Hello, everyone, and Happy New Year. Welcome to the Schwab 2024 Winter Business Update. This is Jeff Edwards, Head of Investor Relations, and I hope everyone is still on track for their respective resolutions. While it is the New Year, we are joined by the same Venable panel of presenters, our Co-Chairman and CEO, Walt Bettinger; President, Rick Wurster, and CFO, Peter Crawford. Obviously, a bit of a different structure to Winter Business Update this time around to be 100% virtual, but you’ll still get the same in-depth perspectives from the team regarding client trends and behavior, continued progress on strategic initiatives, and the tremendous opportunity we see on the horizon. Before diving in, let’s quickly review the rules of the road for today.

Q&A remains one question, no follow-up, though we certainly encourage you to jump back into the queue if additional questions come to mind. As always, please don’t hesitate to contact the Schwab IR team to work through any clarifying or some of your more tactical questions. And the slides for today’s update will be posted to the IR website following peers’ remarks. And certainly, last but not least, the forward-looking statements page reminding us all that the future is uncertain, so please stay up-to-date with our disclosures. And with that, Walt.

Walt Bettinger: Thanks, Jeff, and good morning, everyone. Thanks for joining us for our January Business Update. We’re here in Frigid Westlake, Texas, where I think it was 15 degrees when I hopped in the vehicle this morning to come to the office. But Happy New Year and again, thank you all for joining us. So as we close the book on 2023 and begin thinking about 2024, it seems like a natural time to reflect on the year that just closed. It was certainly a challenging year for our clients, for our stockholders, and for us. Perhaps it was the most challenging in my time at Schwab, certainly the most challenging since the bursting of the Internet bubble in 2000. And yet at the same time, I couldn’t be more excited about the opportunities before us.

In 2024, you’re going to see an emphasis on execution, but with consistency around our strong client fundamentals and strategy. I recognize that 2024 is going to be a transition year from a financial standpoint, albeit one with steadily improving financial results throughout the year and a very strong exit into 2025. It’s unrealistic to think that the challenges of 2023 simply disappear, because the calendar flips over. But when I look ahead to 2025, 2026, and 2027, I’m quite confident that the power of our client franchise is going to shine in terms of financial results. There’s much work to do in 2024 and beyond, and no one at Schwab is kidding themselves that everything is perfect right now. But my confidence is high. I’m incredibly encouraged by what I see, whether it’s our positioning, our client relationships, the solutions that we offer our clients, or the focus of the entire organization on the future.

If I could take you back in time to the mid-2000s, that was a period when Chuck first began speaking with me about the possibility of becoming CEO someday. And as a result of those discussions, I went on a listening tour of former very Senior Executives of Schwab. My goal is simply to ask them their views on the firm and our prospects for the future. It’s important to keep in mind that many of them had been let go or terminated in the turmoil that followed the Internet bubble bursting. They had experienced this incredible run-up in the value of the firm, followed by the pain of multiple rounds of employee layoffs and a stock price that had collapsed from the ‘50s to mere single digits. And although each of them used different words, they all basically said the same thing they were fearful that Schwab Best Days were in the past.

I tried to absorb their counsel and their feedback objectively, of course, I was balancing the personal challenges that they had each been through as I listen to their feedback. But I fundamentally did not believe that the firm’s best days were in the past. There were far too many strengths for me to believe that. And over a few years, with a lot of hard work by many people, I believe it’s pretty clear that we proved them wrong. As our stock price grew over ten-fold and assets, the clients entrusted us with grew similarly. I understand that today there are some who might be asking similar questions, but I am confident that our Best Days are ahead of us. In my opinion, after four decades in this business, there is no firm better positioned for the future.

No firm has our breadth of client solutions, investing, trading, custody, advisory workplace. And all delivered with an incredible value for investors and advisors. I expect us to make steady progress in both client flows and financial performance throughout this upcoming year, and then I fully expect us to deliver outstanding results over the following years. So let’s go ahead and dig in to 2023. It was a year of many twists and turns for our investor clients as well as for our stockholders. And all the while we made substantial progress on the largest acquisition related conversion in the history of our industry. Coming on off a difficult 2022 for investors, the first quarter of 2023 began with turmoil in the regional banking world. Investor sentiment bounced between negative and positive throughout the year before eventually ending quite positive.

Equity returns were strong in 2023, although largely concentrated in a modest number of stocks. For Schwab stockholders, it was a difficult year. Our stock lost about 17% of its value. The core reasoning behind most of this decline is our commitment to proactively following our through-client size strategy. Because throughout 2022 and 2023, we reached out to our clients and encouraged them to move their yield-sensitive, or what we sometimes refer to as longer-term investment cash, into higher-yielding alternatives. And they did, to the tune of several $100 billion. And an and aside although these actions have temporally impacted our revenue and earnings, we would do the same thing every time. The client loyalty that we build by being proactive will pay dividends in the long-term as clients continue to entrust us with their investment dollars.

Progress on the Ameritrade conversion was exceptional with about 90% of the client accounts and assets all accurately and successfully converted. And despite the substantial focus on this effort, we continue to make real progress on other client-related initiatives that help set the table for future organic growth. Let’s go ahead on this slide and take a deeper look into 2023 from the lens of our investor clients. The open market committee of the federal reserve continued to recover from the mistaken transitory inflation viewpoint they raised rates multiple times in 2023 before peaking at close to 5.5%, as inflation began to ease directionally toward the Fed’s long-term goal of 2%. And although equity markets continue to be volatile, ultimate returns were actually quite strong, with the S&P 500 rising over 20% and the NASDAQ composites increasing over 40%.

Investor sentiment was also volatile throughout 2023. It recovered rather dramatically in the fourth quarter of the year from a strong bear sentiment in the third quarter and ended the year with a solid bullish viewpoint. But despite this mixed sentiment, our clients remained highly engaged with the markets and with Schwab. Clients were net purchasers of equities last year by a 1.2 to 1 ratio, and although trading activity was about 10% lower than in 2022, it was still much higher than pre-pandemic levels. And net flows into our retail advisory solutions were a very strong $33 billion. Last year was a solid year in terms of client flows for our firm, particularly given the volatility of the markets and the negative sentiment that existed throughout much of the year.

Core net new assets were slightly above $300 billion, and core net new assets from clients who originally opened their accounts with Schwab were about $30 billion higher. The difference, of course, reflecting the attrition from certain former Ameritrade clients. Now in terms of the Ameritrade conversion, we’ve converted approximately 90% of the accounts and assets, that totals about $1.6 trillion in assets and 15 million accounts. And we’ll convert the balance in May of this year. There’s no question that this conversion has been a success. Attrition continues to track below the estimates that we shared in 2019 when the transaction was announced. Of course, we hate losing any clients, but we’re realistic that some attrition is to be expected, and also knowing that we would be proactively stepping away from serving certain former Ameritrade clients for a variety of logical reasons.

Stepping back a bit to look at the bigger picture, we are committed to our through client-side strategy, and it underlines our no tradeoffs execution. We believe the backbone of organic growth is delivered by focusing on four areas: value, service, transparency, and trust with both our clients, as well as our prospects. Now the ultimate measure of value for clients is the balance between the quality of service and guidance they receive and the revenue we earn that pays for this service and guidance. And we don’t believe any investment services firm delivers a better value than Schwab. The quality of our service is well recognized, and I’m going to go ahead and speak on that a little bit more momentarily. And the revenue we earn averages less than one quarter of 1%.

In fact, we’ve almost halved what clients pay us in one form or another over the past 20-years. When you compare that to what investors pay certain wirehouses or independent broker dealers or regionals, Schwab clients paid between approximately half or even in some cases close to a quarter of what they pay these other firms. Now that difference adds up to an enormous drag on client wealth creation over the years. It’s one of the key structural advantages that clients of Charles Schwab benefit from. And we’ve been recognized for many years as a leader in client service in the financial services world. And despite the complexities inherent in the Ameritrade conversion, we retained our world-class results in 2023 for client service. Our net promoter score in our retail business remained in the mid-60s, while our overall speed to answer phone calls was about 30 seconds, with retail averaging just below 20 seconds last year.

Now these metrics are very important as our reputation for service and creating client loyalty extends across all of our client-facing businesses. Delivering world-class service is a never-ending area of emphasis, requires training, investment in digital and self-service capabilities, as well as a philosophical deep belief in the nobility of service. Service has always been at the core of our success at Schwab and will always remain so. Transparency is also a hallmark of Schwab, whether it be defined as our open architecture approach to investing, the clarity of any fees or charges assessed to our clients, or the fact that we’ve been a leader in both guaranteeing the security of our clients’ assets, as well as their overall satisfaction. Our satisfaction guarantee is unique across the industry.

It’s provided our clients with the confidence they deserve as they make investment decisions. And although the payments we’ve historically made under this satisfaction guarantee are relatively modest, we believe deeply in the philosophy of guaranteeing our clients delight with our services and guidance. We often say at Schwab that we are less in the investment business than we are in the trust business. And this was never more true than in 2023. As clients wanted to access their client cash that we held at our banks, we ensured they had ample liquidity to move that cash into money market funds, bonds, treasuries or other investments. And while this happened more quickly than we would have expected given the unparalleled pace of Fed rate moves, our contingency plans worked as designed to ensure that we could always be there to support our clients.

As a result, during a period of heightened concern about bank stability across the industry last spring, our clients were able to have confidence in Schwab. We’re honored that both JD Power and Investor’s Business Daily gave our firm and our bank the highest scores in the areas of investor satisfaction and trust, respectively, last year. And we’re committed to maintaining and building trust with our clients in the years to come. Before I turn it over to Rick, I want to take a moment to remind everyone that our strategies, our philosophies, and our execution at Schwab are not random. We evaluate everything we do by screening it through a series of lens that apply our experience and knowledge about the investing industry, both today as well as where it’s headed in the future.

We categorize these viewpoints into three buckets and they may look familiar to those of you who’ve dialed into our calls in the past. Broad trends, client views, and the competitive landscape. If I were to highlight the viewpoints on these three buckets, it would be: first, we are ideally positioned to benefit from growth in the areas of the industry that have grown the fastest in recent years and project the most organic growth potential for the future. Self-directed investors and traders, RIAs serving as a fiduciary to their clients, and low-cost, tax-aware investing. Next, clients are looking for firms that offer a breadth of solutions that are personalized for them and make sense within the context of a financial plan. Ideally, firms should be able to assist clients with both sides of their balance sheet, investing and borrowing.

We believe the future will be won by firms that find the right balance between offering digital and mobile efficiency on par with non-financial services experience and of course paired with access to well-trained and credentialed professionals. Not surprising, given our viewpoints, we believe Schwab is optimally positioned for long-term organic growth. Rick, let me turn it over to you.

Rick Wurster: Thank you, Walt, and Good morning, everyone. Schwab is in a position of strength to deliver on the client expectations that Walt just spoke about. I’ll spend our time together this morning talking about how we delivered for clients in 2023 within the strategic focus areas that you see on this page. I’ll also share more about the investments we’re making to continue building on our strong foundation, so we can do even more to help our current and future clients meet their financial goals, which in turn will bolster our organic growth and our competitive positioning. I’ll start with scale and efficiency. Our number one priority in 2023 was to execute the largest integration in the history of the industry. And it has been a tremendous success.

As Walt highlighted, we brought about 90% of Ameritrade clients to Schwab, representing $1.6 trillion in converted assets, 7,000 RIA firms, and 15 million total converted accounts. While clients are getting used to navigating a new experience and a different way of doing things, they are also seeing the breadth of capabilities on our combined platform. We also focused in 2023 on reducing expenses. We captured approximately $500 million in annual run rate expense savings through streamlining our operating model, which included position eliminations from predominantly non-client facing areas, as well as reducing our real estate footprint. The remaining $400 million in Ameritrade expense synergies will be realized in the second-half of 2024 following the completion of the integration.

When we think about win-win monetization, we think about meeting more of our clients’ total financial needs, including more holistic solutions, lending capabilities, and access to high-quality, fairly priced products. This attracts and retains client assets and at the same time improves our economics. We generated strong results in our advice business with a 29% year-over-year increase in net advised flows, including $12 billion in net flows into our proprietary full-service wealth management solution, Schwab Wealth Advisory. This is a record for our firm. Wasmer Schroeder net flows were $6.7 billion, a record for the offer and a 90% increase over the prior year. And when it comes to direct indexing, we’ve enhanced our Schwab personalized indexing offer with expanded customization capabilities, a new account level digital dashboard, and digital enrollment.

We launched our fully digital Pledged Asset Line, or PAL, for RIA clients that gives advisors the ability to submit a PAL application in minutes, and clients can get approved in hours for straightforward applications and in just days for complex situations. We also launched Schwab Investing Themes, which allows self-directed investors to buy and sell themes of securities that align with their personal interests and values, all available through schwab.com as well as our mobile app. Finally, our goal in the third focus area is to see through clients’ eyes to meet the unique needs of each of our clients’ segments. Highlights from the last year include introducing our specialized asset-based segments for retail high net worth and ultra-high net worth clients, which we call Schwab Private Client Services and Schwab Private Wealth Services.

These tailored offers meet the unique needs of these clients who represent about 70% of our retail assets. Schwab Private Client Services includes access to a financial consultant, dedicated service, expanded access to specialists, as well as products and fee discounts. Schwab Private Wealth Service delivers all that plus prioritized service, enhanced support, expedited requests, priority access to wealth specialists and exclusive events, pricing benefits, American Express Statement Credit, bank benefits, and more. We also in 2023 launched Schwab Trading powered by Ameritrade, a reimagined trading experience made possible by the combination of the best of Schwab and Ameritrade. All clients can now access the thinkorswim trading platform, giving them access to a unique combination of powerful tools and dedicated service from experienced trading professionals alongside education for all levels of experience.

We also in 2023 enhanced our offer for all RIA clients. All clients can now access thinkpipes, our thinkpipes trading platform, which offers real-time charting, pre and post-trade allocations, and complex options functionality. In addition, we launched Ameritrade’s iRebal and Model Market Center on Schwab Advisor Center, and are taking a measured approach to ensure a seamless onboarding experience for new iRebal users, with general access rolling out early this year. Finally, we acquired the family wealth alliance to expand our capabilities to serve both single-family and multi-family offices. As we look ahead in 2024, we will continue to focus on and make investments in our key strategic focus areas to drive our organic growth, fuel our virtuous cycle, and help clients achieve their financial goals.

One thing I’ll point out about this page is that given our focus on continuing to make Schwab an easy place to do business, we are adding a fourth pillar to our strategic focus areas called EASE, which is about delivering exceptional and easy experiences to our clients. With 35 million client accounts, serving our clients exceptionally well will be a big driver of our organic growth. When we think about scale and efficiency, we’re laser focused on successfully converting the final Ameritrade client transition group and then capturing our remaining expense synergies. We’ll continue making investments in artificial intelligence to empower our teams to serve clients even more effectively. And finally, we will invest in automation and systems modernization over the next several years, allowing us to drive greater efficiency.

Win-win monetization remains an important opportunity where we can both delight clients and boost our revenue. Looking ahead, we’ll continue to make investments to enable clients to keep more of their financial life with us, including a continued focus on lending capabilities that meets the needs of more clients across both IS and AS. We’ll enhance our wealth and advice offerings, including making continued investments in Schwab Wealth Advisory. We’ll continue to build on our momentum with personalized investing solutions, and we’ll continue to broaden the breadth and depth of product offerings with new offers like alternative investments. And we continue to do work to integrate the workplace experience more into Schwab, allowing our workplace clients to benefit from all we have to offer at Schwab.

Within client segmentation, we’ll remain focused on meeting the unique needs of our client segments, including our higher net worth clients, traders, and RIAs. Part of this is providing differentiated client experiences, just as we’ve done this year with the new retail high net worth and ultra-high net worth offers that I spoke to earlier. This also means enhanced service models, specialized capabilities, our powerful trading platform, and our tailored education. Our fourth focus area is Ease. With the size of our asset base, we can drive growth by simply delivering easy and exceptional experiences to our existing clients. This is where you’ll see us continue to invest to make Schwab the easiest place in the industry to do business. And it’s important to remember something Walt highlighted earlier.

Our client’s frame of reference for Ease is not just other financial services firms, it’s the experiences they have on Amazon or Uber or DoorDash, and that’s the measure of ease we are striving to accomplish. We want every experience a client has with us to be an exceptional one. That means we’ll continue to make enhancements on all of our channels. We’ll continue to digitize client workflows and to make sure our clients have access when and where they want it, whether that’s on schwab.com or the mobile app, or when they call or chat with our service teams or walk into a branch. We believe that the combination of these efforts will help power our long-term organic growth. Guided by our seeing through client-size strategy, we are well positioned to retain our clients and to win new ones, fueling our organic NNA growth over the long-term.

I’ve spoken about Schwab’s unique strengths in this forum in the past. We have a top one or two position in the two fastest growing segments of financial services. Our strengths will help us attract assets from our existing clients, including our younger client base, valuable dedicated relationships, strong RIA growth, and our emphasis on ease. We’ll attract new clients for the combination of the strength of our brand, our proven retail acquisition model, and our continued commitment to serving RIAs. And with the four strategic focus areas I just talked through, we’ll be able to meet evolving client needs while making it easier for clients to keep more of their financial lives with us, helping us attract NNA over the long-term. Schwab’s future is bright, and before I turn it over to Peter, I’d like to spend just a couple more minutes talking about some of the exciting opportunities ahead.

One of our biggest opportunities is to fully harness the powerful combination of Schwab and Ameritrade. While it is still relatively early days, when we look at our Ameritrade clients, we know they are already benefiting from the breadth of Schwab’s capabilities, including both lending and wealth. 95% of former Ameritrade FCs have helped the client find a solution to their needs by enrolling them in a Schwab wealth solution. And former Ameritrade FCs accounted for about 20% of our record Schwab wealth advisory net flows in 2023. Today’s, former Ameritrade client advice penetration is at approximately 10%, which is above historical levels. Schwab clients are benefiting as well. We launched the new Schwab trading powered by Ameritrade experience in October, and at year-end, more than 80,000 Schwab clients had created new thinkorswim accounts.

And about 20% of new to firm retail clients opted to access a thinkorswim account. The opportunity ahead for us is tremendous. We have about a 12% share of the market, and we serve the two fastest growing segments. I just spoke about our early wins and increasing Ameritrade advice penetration. As we continue to win here, we believe we have a $500 billion plus share of wallet NNA opportunity ahead of us. And we believe the win-win monetization opportunities I’ve spoken about represent a 3.5 billion to 4 billion wealth management and bank lending revenue opportunity. To wrap up, our through-client size strategy continues to guide us into the next chapter. We’re in the final stages of the Ameritrade integration, and we’ve made meaningful progress across our key strategic focus areas in the last year.

Looking ahead, we are well positioned to continue our healthy organic growth, and the opportunities in front of us remain highly attractive, both for Schwab and for our clients. And with that I’ll turn it over to Peter.

Peter Crawford: Well thank you very much Rick. So Walt and Rick talked about how our no trade-off positioning continues to resonate with both clients and prospects. The continued progress we’re making with the Ameritrade acquisition, with the final transition group scheduled for May, our achievements and priorities around scale and efficiency, win-win monetization, segmentation, and our newer priority ease, and the large opportunity in front of us over the coming years. In my time today, I’ll briefly review our 2023 financial performance, provide an update on client cash realignment, and share some thoughts on 2024. The important point is that in the fourth quarter and really over the last nine months, we continue to see notable improvement across the various tactical metrics on which there has been a lot of focus lately, including the pace of client cash reallocation activity, the level of supplemental borrowing we’re utilizing, and our capital levels inclusive of AOCI.

And what that means is that 2024 is likely to be somewhat of a transitional year from a financial standpoint, but with steadily improving financial results that bridge from what proved to be a challenging 2023 to what we believe is a very promising future ahead. And so while environmental factors may not allow progress to follow a strictly linear path, we believe we’re moving ever closer to the point where the noise partially obscuring our long-term growth should dissipate and our relatively straightforward financial formula should begin to reassert itself once again powered by solid organic growth, our diversified business model converting that asset growth into strong revenue growth through the cycle; continued expense discipline, producing growing margins.

And as our tangible capital levels continue to grow, the return of meaningful opportunistic capital return. In other words, a resumption of the proven model that you are all familiar with and that has delivered for clients and stockholders for over five decades. As Walt mentioned, 2023 was an eventful year for many of our clients and certainly a challenging one for our business model. And so not surprisingly, our financial performance was off 2022’s record levels with a little under $19 billion of revenue and $3.13 of adjusted EPS. But despite those financial headwinds, we still produced an adjusted pre-tax margin of over 40%. Our fifth consecutive year doing so, which demonstrates the strength and resilience of our business model through a wide range of environments.

Now turning our attention to the balance sheet. The big story last year, of course, was the roughly 30% decline in client cash on our balance sheet, of which over 80% moved in the first-half of the year. This was the outcome of clients moving some of their cash into higher-earning alternatives, as Walt mentioned, that was often with our active support and encouragement. And importantly, that money is staying at Schwab, as evidenced by the approximately $200 billion increase in purchase money funds and over $225 billion increase in fixed income in CDs our clients hold. And we supported some of that activity by utilizing temporary or supplemental borrowing, including both FHLB advances and Schwab Bank CDs. And at just under $80 billion at the end of the quarter, those have fallen by more than $17 billion from the peak level reached in May.

And finally, our capital position continues to get even stronger with our consolidated Tier 1 leverage ratio rising to 8.5% and our adjusted Tier 1 leverage ratio, inclusive of AOCI, and therefore what our binding constraint would be if we lose the AOCI opt-out, at Schwab Bank now nearly 5.4%, meaning we are now meeting what will likely be the new quote well capitalized standard at our banks over four years ahead of the anticipated full implementation date. During last quarter’s update, we talked about the slowing pace of client cash realignment over the preceding months. And in November, our clients actually added to their transactional cash balances. And then in December, we saw an approximately $15 billion increase in transactional sweep cash.

Now, historically, December flows benefit from seasonal factors, but even so, when you compare December 2023 to December 2022, it is quite clear that this dynamic is receding as an important driver for us. You can also see that trend when you look at purchase money fund flows and specifically that minority of those net flows that are funded from client cash on the balance sheet. Now, as we turn our attention to 2024, our near-term financial performance will, as always, be shaped by external factors that are difficult to predict. Interest rates, equity market performance, and client trading activity. And then given the much larger sensitivity to client cash allocations, given where interest rates are today than they were, let’s say three years ago, that will, of course, be a significant factor.

So let’s talk about this one. And given the importance of this, let’s spend a bit more time here. There are really three main forces that will influence the trend of our clients’ transactional cash during 2024. Any remaining client cash realignment from existing clients, the contribution of cash we attract from new clients, which I’ll talk about in a moment, is the source of the greatest uncertainty moving forward, and seasonal dynamics that are generally similar every year, but can vary based on environmental conditions. We’ll start with the behavior of our existing clients. And as we’ve discussed, we’re clearly in the very late innings of the client cash realignment activity. You can see it in the monthly reporting we have shared, whether you look at total balances, balances per account, or cash as a percent of assets.

And that high level trend is supported by various dynamics you see when you look under the hood. We’re seeing stabilization of activity among both RIA and retail clients. Now we’ve talked about how cash realignment is an event, not a process. And we’re seeing a decrease in both the number of those events and the average amount of the cash being realigned. Now while we have a high degree of confidence in our ability to predict the behavior of our existing clients, it’s a bit harder to do so with new clients over a very short timeframe, like a year. Now, that contribution depends on the level of new clients we attract and the size of those accounts. And then how much of the net new assets comes in the form of cash and stays there, which will be influenced by investor sentiment, quantitative tightening by the Fed, inflation, savings rates, and so forth.

And then you throw in that this is an election year, which normally brings an elevated degree of volatility, makes these predictions even tougher. And what this means is that while we have seen throughout our history that over time, cash balances grow with the growth in accounts and assets, over a shorter period, like a quarter or a year, it’s harder to gauge exactly how much new accounts will contribute. And finally, the evolution of transactional cash over the course of 2024 is likely to be influenced by seasonal patterns, which follow a similar trajectory every year, but can vary in terms of their magnitude. That means we’re seeing some cash getting invested into the markets in the first quarter. And given the large inflows we saw in December, the investment activity could be at an elevated start this year.

And then we’ll likely see a reduction in April as clients pay taxes before we cap the year with an anticipated buildup in December. So what does all this mean for our 2024 financial performance? Given the various moving pieces, we decided to bring back a concept you may recall we last used in 2019, which is to share with you a couple of mathematical illustrations around how our financial performance could unfold, based on what happens with certain and difficult to predict inputs. And those are trading activity. We looked at flat to 2023 levels, plus or minus 5%. And where transactional cash finishes the year relative to the 12/31 levels. Again, flat plus 5% or minus 10%. Those illustrations share a couple of common and pretty conventional assumptions.

Most importantly, normal market appreciation and rates that follow the dot plots. And those illustrations could result in revenue that is plus or minus 5% there are 2023 levels or said another way, revenue that is 0% to 10% higher than our annualized Q4 2023 run rate, even with three rate cuts. We’re planning, as we’ve shared previously, to keep adjusted expenses flat year-over-year. And that would result in an adjusted pre-tax margin of a little under 40% to somewhere in the mid-40s. Now I know it’s tempting to pick the mid-point of the illustrations and interpret that as our outlook. That is not how these illustrations are intended to be used. This is just math. Using some metrics, you can track on an ongoing basis to evolve your own perspectives on our potential performance over time.

And as we typically do, we have included in the appendix a set of sensitivities intended to help you make adjustments as you see fit. Now looking at the range of possibility, it doesn’t apply much of any growth in terms of full year adjusted EPS. But given the consistent pay down in the higher cost supplemental borrowing, it suggests strong sequential momentum in revenue and in earnings. With a potential exit velocity heading into 2025, that is at least 20% better than where we ended 2023. And with increasing momentum as we progress through 2025 as well. Let’s drill a little deeper into the expense story. Schwab has been and always will be a growth company, a company that continually invests in improving the client experience. At the same time, we’re a company that recognizes that one of our biggest competitive advantages, as Walt mentioned, is our industry-leading cost structure, which is measured as EOCA.

Achieving both of those requires careful balance and discipline. And in 2024, even as we’re holding spending flat, we’re still making significant investments that Rick talked about that will help sustain our long-term organic growth, boost our revenue, and increase our efficiency during 2024 and beyond. Our current revenue and earnings are being pressured, of course, by our utilization of the higher cost funding in the form of CDs and FHLB advances. Those are very much a temporary funding source. And as we pay off those, we continue to see a path towards a net interest margin in the 2.20% to 2.50% range by the end of this year and approaching 3% by the end of 2025 even if rates fall roughly 200 basis points from where they are today, as the dot plots would indicate, with a potential for it to expand further moving forward as we reinvest our securities portfolio at higher market rates than what we currently earn.

Now while we pause our buyback in order to build our capital levels, capital return remains a very important part of our financial formula, given our very high return on capital and negligible credit exposure. Our capital levels have already reached the so-called well-capitalized threshold, even if AOCI is included. And we’d expect our consolidated adjusted Tier 1 leverage ratio to reach the upper 6% range by the end of 2024, at which point we’ll be in a position to at least consider resuming opportunistic buybacks. Both Walt and I talked about 2024 being somewhat of a transitional year from a financial standpoint, but we also talked about the steady improvement we expect to see throughout the year. In some ways, I hate to use the phrase coiled spring, but I think that’s exactly what is being set up as we move into 2025, as we complete the Ameritrade integration, creating a true best of breed platform and unlocking both revenue and expense synergies.

We continue to advance our strategic agenda even as we maintain flat expenses. Transactional cash balances inflect and we begin to see sustained growth. And all that plus continued business momentum creates an opportunity for a return to sequential revenue growth and accelerating momentum toward the end of the year and into 2025. And that paves the way for a return to our long-term financial formula. One that is powered by our position as the premier asset gatherer, producing consistent 5% to 7% organic growth through the cycle with industry-leading client loyalty and a leadership position in the two fastest growing segments within wealth management. One that has a proven ability to expand margins through the cycle with the potential for even more dramatic margin expansion in the years ahead, back above 50% as revenue benefits from paying off higher cost borrowings and expenses benefits from harvesting the remaining expense energies.

And one that can combine that strong organic growth and revenue growth with more meaningful capital return as our capital levels inclusive of AOCI march higher. And so when you take a step back and look at our potential financial performance, your perspective depends on your time frame. In the immediate term, we have been dealing with some pressures that have constrained our financial results. But those pressures are temporary, not permanent. So long-term opportunity, the long-term potential remains significant. And as an organization that has a long time horizon, that is what fuels our optimism, our confidence, and our excitement for what lies ahead. And with that, I’ll turn it over to Jeff to facilitate our Q&A. Jeff?

Jeff Edwards: Hi, operator. Can you please remind everyone how they can ask a question and I’ll turn it over to you?

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question in queue is from Ken Worthington from JPMorgan. Please go ahead.

Ken Worthington: Hi. Good morning and thank you for taking the question. I wanted to talk about net new assets. So even when excluding the Ameritrade attrition, core net new assets seem decently lower than it had been over the last two years, despite ultimately what were better market conditions in 2023. As we sort of look at it ‘21, ‘22, core monthly [Technical Difficulty] $50 billion per month. And then the last six months, it’s been, you know, $10 billion to $30 billion and there’s noise there, attrition, CD’s, but it’s still ultimately seems like software engagement over the last six months, so the question. So first, was it 2021 and 2022 that were unusual in the aftermath of COVID or is it really the last six months that might have been unusual? Do you see a cohort or customer segment where engagement might have weakened in the second -half of 2023? And ultimately, can you give us a little bit more color on how you see the outlook for 2024?

Walt Bettinger: Thanks, Ken. I think when you look at NNA in very short periods of time, you have to really evaluate sentiment more so than what the market did. When I spoke at the end of the third quarter last October, sentiment was very negative. And although it slipped by the end of the year, that’s a late change within the year. And so when you have negative sentiment historically, when we look at longer time horizons, you’re going to get lower levels of NNA. And so I think it’s not what the market does. It’s what the sentiment of the investor is. We don’t see any reason to believe that net new assets are likely to be constrained over a longer period of time relative to historic levels. Our promoter scores, when we look at that, as they’re reported on the retail side remain very, very strong.

On the advisor side, we have retained virtually all of the advisors that we wanted to retain post integration. So I don’t see anything on the horizon that would tell me that long-term you’re going to see some form of extended softening in NNA. But short run, you have to look at sentiment and you also have to look at investment options. As rates are higher, people may bring a bit less money to their investment account as opposed to maybe leaving it at a bank where they might just be buying CDs or something of that nature. But nothing structurally gives us cause for concern.

Operator: Thank you. Next we’ll go to Steven Chubak from Wolfe Research. Please go ahead.

Steven Chubak: Hi, good morning. I have a question, a firefighting question, just on the NIM glide path, Peter, that you had offered. So you had previously talked about that 3% NIM, exiting ‘25. You reaffirmed the target here despite the additional cuts in the forward curves. I was hoping you could speak to some of the inputs still supporting that 3% NIM target with the rebasing and rate expectations and the NIM tailwind of $0.80 to $0.90. What is the jumping off point that we should be applying that against?

Peter Crawford: Sure. So, the biggest driver of the growth in NIM from where we are today to 3% is continuing to pay off those supplemental borrowings. We don’t necessarily need deposits to grow, although we obviously expect that will happen between now and 2025. We don’t need deposits to actually grow to be able to do that. Remember, we’ve got probably $11 billion or $12 billion per quarter in cash flow coming from the investment portfolio. That’s cash, that’s earning roughly 2% today and we can use that to pay off supplemental borrowing that’s costing us, lets’s say,on average 5%. And so that’s a significant NIM advantage and NIR [] advantage and revenue advantage that we’re able to generate every month we don’t – that we have even flat deposits. So that’s really the biggest driver between — for the NIM growth between now and the end of 2025 and frankly between now and the end of 2024 as well.

Operator: Thank you. Next we’ll go to Kyle Voigt from KBW. Please go ahead.

Kyle Voigt: Hi. Good morning. Another one for Peter. As we think about a potential Fed cutting environment, I was wondering if you could comment on how you think about deposit betas on the bank sweep on the way down? In other words, should we expect betas to mirror what we saw on the way up, but I don’t think you increased bank sweep rates over the last 100 basis points in hikes or so, or given that the current cash balances that remain on your balance sheet are likely the least rate-sensitive deposits, could there be some leeway to begin to modestly move those bank sweep rates lower even with the first Fed cut?

Peter Crawford: Yes, thanks. Thanks, Kyle, for the question. So I think it’s reasonable to think that the betas could be a bit higher on the way down than they were on the way up. At 45 basis points in bank suite, we’re paying a rate today that is significantly better than what traditional banks are offering on checking accounts. They’re still paying, I think in many cases, 1 basis point or 2 basis points for accounts that have similar liquidity features or in some cases even inferior liquidity features. And so I wouldn’t necessarily assume that the deposit betas on the way down will be symmetrical to where they were on the way up necessarily.

Operator: Thank you. Next we’ll go to Brennan Hawken from UBS. Please go ahead.

Brennan Hawken: Good morning. Thanks for taking my questions. Just a couple questions, Peter, for the path and thinking about NIM and the scenarios. Number one, I think you referenced that these scenarios are based on the dot plot, but you also referenced the forward curve. So maybe could you clarify which rate assumptions underpin the scenarios that you laid out? And also, how should we think about forecasting the interest-earning assets? You referenced $11 billion to $12 billion of principal? Is that the pace that we should be thinking about through much of 2024 until that wholesale borrowing is paid down? Thanks.

Peter Crawford: Yes, thanks for the question. So the map out the illustrations are based on the dot plots, which again, so three cuts over the course of ‘24 and I think it’s 200 basis points by the end of 2025 of easing. In terms of the pace of interest-earning assets, our priority is to pay off the supplemental borrowing. And so as we continue to prioritize that, it’s reasonable to expect that our interest-earning assets would decline. Again, doing so, you can be in a situation where interest rate assets are declining, but revenue is increasing because again, we’re paying off those supplemental borrowings. Of that $11 billion to $12 billion of quarterly cash flow from the investment portfolio, a portion of that is principal and then, of course, a portion of that is interest.

So I wouldn’t assume that the interesting assets are going down by that, necessarily by that level. But I do think it’s reasonable to expect that there will be some decline as long as we have the supplemental borrowings outstanding, we’re endeavoring to pay those off as quickly as possible.

Operator: Thank you. Next we’ll go to Dan Fannon from Jefferies. Please go ahead.

Dan Fannon: Thanks. Good morning. Another follow-up here, Peter. Just in the context of some of the seasonality charts you gave and what we saw in the fourth quarter of FHLB declined slower in the fourth quarter versus third quarter, you had deposit trends got better. So as we think about the start of this year and clearly pace is important, how do we think about the seasonal benefits or cash trends versus those priorities of paying down the shorter-term funding?

Peter Crawford: Yes, so we saw, you know, I think if you look at the end of the year with our — we target in the banks kind of a 5% to 6% overnight liquidity at the banks. That position roughly doubled at the end of the year. We always like to build up extra liquidity. If you look at our prior years, we did the same thing to make sure we have a lot of excess liquidity heading into what is, again, typically the seasonal investment season. So we expect to draw down those liquidity levels. And that will help to support the seasonal activity that we’re seeing. If you look at prior years, over the course of the last several years, you can kind of gauge a sense for that seasonal activity. And I would say this month is progressing kind of consistent with that.

So without getting to sort of specific numbers in terms of what we’re seeing month to day, I would say it’s consistent with what we’ve seen in previous years and consistent with our expectations. But again, it’s not only really clear that the seasonal activity that we see in January through March and then the tax season in April, this isn’t client cash realignment. This is just activity that we see every single year as clients build up their cash balances at the end of the year and then deploy those into the markets in the first part of the year and then deploy those to the IRS, I guess, in April.

Operator: Thank you. Next, we’ll go to Alex Blostein from Goldman Sachs. Please go ahead.

Alex Blostein: Hey, good morning everybody. Thanks for the question. Just another quick follow-up on the funding dynamic. So I appreciate it might be difficult to predict client behavior with respect to transactional sweep cash on new assets, but maybe give us some color on the trends you’ve seen in transactional cash as a percentage of that new client assets. Call it over the last maybe six months or so just to help us kind of with the starting point, because obviously that’s a really important dynamic when it comes to rebuilding the cash balances and deposits?

Walt Bettinger: Yes, so that, I mean that’s why we call that out as I would say an area of uncertainty going forward is because we are seeing, not surprisingly, we’re seeing clients who are coming in are realigning their cash as existing clients are. And so that’s happening, there’s a certain amount of float, if you will, that we typically rely on. That is contributed a little bit less over the previous six months as clients are realigning their cash more quickly maybe than traditionally they would have done. And as rates come down, one would expect that that activity would be a little bit less immediate or timely or to the same extent. And so I think that is one of the uncertainties. What happens with the level of new cash that comes in as the Fed cuts rates 3 times, 4 times, 6 times, whatever it might be.

That’s why we call that out as an area of uncertainty. But we certainly still expect, as we’ve seen throughout history, that over time, as we add accounts, as we add assets, again over a longer arc of history, that those transactional cash balances grow with the growth in accounts and the growth in assets. It’s just over a short period of time, like a quarter over a year, it’s a little bit harder to gauge exactly what the near-term contribution will be. But again, over time, over three years, five years, et cetera, we expect that our total transactional cash balances will grow as we grow our client base.

Operator: Thank you. And our final…

Jeff Edwards: Thanks, operator. I think we have time for one last question.

Operator: Absolutely. Our last question comes from Devin Ryan from JMP Securities. Please go ahead.

Devin Ryan: Thanks so much. Good morning. It gets to a different topic than some of the other questions, but probably for Rick, since you mentioned in your remarks, so obviously the firm has a strong technology background, so I’d love to just talk a little bit more detail about the opportunity you guys see from artificial intelligence investment as we look beyond 2024. So maybe looking out the next three to five years, what are some of the areas you’re most focused on? How much efficiency do you think could be derived from the current use cases you see? How much productivity uplift? And just more generally, how material AI will be for Schwab? Because it would seem like this fits right into the ethos of the company long-term, but I know sometimes things take a while to kind of implement. So just love to hear a little bit more about this strategy there? Thanks.

Rick Wurster: Devin, thanks for the question on AI. I think it will have a meaningful impact in three areas on our employees, on our efficiency, and on our clients. Let me start with employees, I think AI can be used to make our employees even more effective with our clients, to provide them with the ability to have an answer that is really strong and in particular for our newer employees that are coming up to speed, the ability for AI to make them as efficient or as effective as a more experienced employee. I think will be powerful both for the employee and for our clients that are receiving the thought from that person. So I think there’s a lot of benefits in helping make our employees more effective with clients. There’s clearly an efficiency opportunity in AI, and here with 1,000s of phone reps that we hire each year, at some point, we likely will have the opportunity to hire less in a particular year, because we’ve made our reps both on the phone, on chat, in our branches even more effective and efficient, because we’re powering them with information and putting it at their fingertips.

And then I think there’s a lot of client benefits that will come from AI. We have what I believe is the world’s best trading platform in thinkorswim. And a lot of clients invest years and years into building out their platform, into building out their alerts and what types of signals they’re looking at to drive what they may want to buy. And I think the opportunity for our clients to leverage an AI-driven research platform will provide them with even greater insights into how they trade, into what positions they might want to put on, into what risks they may need to be aware of. And so I think AI will directly impact clients in the future. So what I think about both making our employees as effective as possible, becoming as efficient as possible, and driving great, fine outcomes.

I think AI will play an important role in all three.

Peter Crawford: Okay. Well, thank you. Thank you, Rick. And let me just close. You know, Walt and I both said 2024 could be a bit of a transitional year. I’ll be with steady progression and our financial results throughout the year. I think it’s really important to put that concept in an appropriate context. You know, first is that we’re talking about the top line growth versus where we finished 2023. And second and more importantly, as we emerge from this challenging period, we’re not transitioning or changing our strategy, our focus on clients, the discipline with which we run the business, nor should you expect to see us lowering our organic growth aspirations or results or changing the fundamentals of our financial formula. Those have all worked quite well. And we’re confident we’ll continue to serve our clients and our stockholders well in the years ahead. We thank you very much and we’ll look forward to speaking with you again in April.