The Charles Schwab Corporation (SCHW) Earnings Call Transcript & Summary

And we are live. Good morning, everyone. Welcome to Schwab's Spring 2020 Business Update. This is Rich Fowler, Head of Investor Relations, coming to you from a sparsely populated 211 Main Street in San Francisco. We hope you and your families are safe and well and coping successfully with all the challenges, both large and small, that this environment entails. On that front, I have a quick story to tell on myself. I think most folks on this call probably know by now that I've had a beard for a while now. I thought I've been doing pretty well in keeping up my grooming routines, even while not necessarily having to be fully inspection-ready every day per usual. But when I kind of glanced at myself in the mirror yesterday and saw Ben Gunn from Treasure Island glaring back at me, I realized that I might have gotten a bit behind here or there. In all seriousness though, thanks for spending some time with us in the midst of this truly challenging environment, and thanks in advance for putting up with whatever hiccups we might have as we go through this in a new setup, reflective of our current realities. Joining me today, both virtually and literally, are Peter Crawford, our CFO; and Walt Bettinger, our President and CEO. Per our usual practice with interim updates, we'll spend a focused hour with these 2, sharing their perspectives on life at Schwab right now, starting off with some prepared comments and then following up with Q&A until it's time to wrap. Our goal, as always, is to keep you current regarding management's thinking as efficiently as possible. Regarding questions, also, as usual, we'll do so via the webcast console as well as the dial-in. And to help us get to as many folks as possible, as usual, we very much appreciate your sticking to a 1-plus follow-on approach to questions. Walt will start us off today to discuss our strategic picture which, of course, includes the company's operating performance during the COVID-19 crisis, and then Peter will review our recent financial performance and current outlook before taking us into Q&A. Before that, let's spend a second on the wonderful wall of words, still at 2 pages, courtesy of shrinking fonts. The main point of which is to remind everyone that outcomes can differ from expectations. So please keep an eye on our disclosures. And finally, per our usual practice, the slides will be posted on the IR site following the prepared remarks. And with that, I think we're ready to get going. Walt, we've certainly got plenty of catching up to do with this group. So please take it away.

Thank you, Rich, and good morning, everyone. Thanks for joining us. I'm going to begin here on Slide 7. We were last together in February, and clearly, a lot has changed in the last 90 days. However, in areas of business that really matter, such as our long-term strategy at Schwab, really nothing has changed. Our focus on Through Clients' Eyes and our execution of the strategy via the virtuous cycle have been at work. And we recognize that the overall world, as we know it, has changed likely forever, with the COVID-19 pandemic. And as a result, our clients have engaged with us at truly unprecedented levels, and we've been there for them, delivering service and access throughout this crisis. And we achieved it critically by -- while protecting the safety of our employees and their families. We delivered record results across many client metrics and our all-weather financial model, as Peter will go through, delivered reasonable earnings despite serious headwinds brought on by another bout of ZIRP or zero interest rate policy and a sharply declining equity market. Our time-tested Through Clients' Eyes strategy proved once again to pass the test that these really unpredictable markets have presented. And we remain on offense with all of our efforts. Now let's go ahead and go to Slide 8 there. We all understand what the pandemic has done to the equity markets and interest rates. And we all know that behind these charts is the real-world impact on investors. Whether new to investing or with decades of experience, the turbulence of these last few months is going to stay with investors in our view for a long, long time. And they will remember those firms that were there for them with service and availability for years to come. In the last 90 days, clients have engaged with us at levels never seen before, particularly in the trading area, but we also experienced higher volumes of phone calls and digital engagement as investors turn to us for help navigating this equity market decline as well as the collapse in interest rates and the volatility in the fixed income areas. Now as has been the pattern during prior periods of high market volatility and bear markets, clients moved to cash. But part of what made this period different is that a significant degree of the movement to cash actually came from fixed income. And of course, important to keep in mind that we were also moving off exceptionally low levels of client cash holdings as a percentage of total client assets. During these difficult times, we continued our track record of serving clients in a manner that is consistently recognized by third parties. In early 2020, we have been recognized as #1 by J.D. Power for self-directed investors investing on their own, #1 for J.D. Power by -- for direct banking. We actually came in #2 by J.D. Power for self-directed investors seeking guidance. We fell a single point behind Vanguard on a 1,000 point scale. So maybe the optimist in me calls that a virtual tie. And although I think we recognize that third-party acknowledgment is helpful from a marketing standpoint. But really, our superior organic growth is a result of a combination of great value, high-quality service, consistent availability, a trustworthy brand, really, fundamentally, when you put it all together, our no trade-offs approach to delighting clients, both on the retail side and on the adviser side. What's critical is that we achieved these results while protecting the safety and health of our employees. And also supporting them, whether it'd be with special financial recognition, assistance with home offices, no-cost COVID-19 testing and a variety of other efforts designed to support them and their families during this crisis. Caring for our clients really begins with caring for our employees. And make no mistake, our employees care deeply about serving our clients. They've demonstrated exceptional commitment, dedication throughout this crisis. And the success that we've enjoyed with clients and our client metrics would absolutely not be possible without the collective service mentality of all of our employees. So taking a look at some of the metrics, $73 billion of core net new assets in Q1. I hesitate to say much more after a number like that. Of course, it is a record for Schwab. It's a rather astonishing number when you compare it to any of the publicly traded competitors we have in brokerage or investment services or asset manager, certainly the publicly traded ones who have audited metrics that they provide to the public markets. I think what makes this accomplishment all the more remarkable is that typically, in times of market stress, investors retreat from investing. And we see net new assets and accounts, new accounts soften measurably. And although certainly, this may still play out in the coming months, so far, what we've seen is the opposite with investors and advisers turning to Schwab at a record level, and we've been there to support them. Now critically, even during this crisis, we have to continue to move the business forward. And we have done so with a number of key initiatives that are designed to grow the firm long term, both organically and inorganically. On Slide 15, our technology investments are certainly paying off. We're now at over 90% straight-through processing rate for key service and operational areas like trading and settlement and custody. And our technology systems capability and capacity to manage high volumes of trades was certainly validated as we saw a doubling of daily trades relative to the prior 4 quarters and of course, bear in mind, this was all done with similar levels of employees to the year prior. In the first quarter, we announced the pending acquisition of Wasmer Schroeder, a high-quality fixed income asset manager that's based out of Naples, Florida. Wasmer is known throughout the industry as a premier bond manager as evidenced by their historical placement on the recommendation platform of a number of our competitors. Wasmer is going to help us better serve clients with quality, low-cost fixed income management solutions as well as over time, contribute to our asset management revenue growth. We also continue to build out our other programs designed to assist clients with key investing and planning needs headlined in the first quarter, again, by our introduction of Schwab Intelligent Income. Our client segmentation efforts were also successful in the first quarter. We continued growing our mortgage lending offering, building deeper relationships with many of our investor and adviser clients. This capability is key as many of our major banking competitors strive to leverage low-rate lending solutions by linking them to the transfer of investable assets. And by offering competitive lending programs ourselves to these same clients, these assets tend to stay with us at Schwab. Our efforts to serve RIAs were rewarded in the first quarter. We had very high levels of engagement in our educational and consulting and market analysis programs and we also build out more capabilities to serve RIAs with our alternative investment enhancements and as well as an introduction of consulting services for smaller RIAs, a key segment of our RIA business. All 3 of our announced inorganic efforts remain on track, with USAA scheduled to close in late Q2 or early Q3. On TD Ameritrade, we are excited as ever about the prospects of bringing our 2 great companies together to better serve clients of all types and sizes. The Department of Justice continues their responsible and thorough review of the transaction, and we continue to provide them information so as to assist them in their review. We remain optimistic about the approval of the transaction, given the substantial benefits to consumers, both on the retail side and on the RIA side. And with respect to Wasmer Schroeder, we are looking for that transaction to close here in mid-2020, again, offering our fixed income clients a level of exceptional professional fixed income management. So on Slide 19, let me just close up before turning over to Peter. I just want to restate a couple of key points from the first quarter. Our strategy works, and it remains consistent. Our execution, in our view, is second to none, and it's illustrated by our client metrics. Our employees performed incredibly well in the first quarter while we implemented efforts to ensure their safety and health. And throughout the quarter, we remained on offense. We're building a world-class company, serving millions of clients with the staying power to thrive through the most challenging of times. So that wraps up the comments I wanted to make. Peter, let me turn it over to you.

All right. Well, thank you very much, Walt. It's certainly great to be here today and seeing Rich and his newly trimmed beard for the first time in, I think, about a month, although certainly maintaining a socially appropriate distance. So Walt talked about the very challenging health and economic backdrop, the record-setting business momentum we have and in spite of what we talked about, the historic market volatility and how we've been focused on helping both our clients and our employees ride out the storm as well as the investments we're making to drive profitable growth in the quarters and the years ahead. In my time today, I'll talk about how that challenging environment influenced our first quarter financial results. And I'll also talk about the actions we're taking to navigate through the crisis, ensuring we continue to deliver for our clients, employees, and stockholders in the quarters and years ahead. And finally, I'll provide an update on the outlook we shared at the winter business update, given how much the world has changed in just the last couple of months. But the overall message you should hear is that even though we are not immune to the financial pressures around us, we're performing remarkably well, we're well positioned, and we're focused on emerging from this crisis even stronger than when it began. And Walt talked about our ability to continue driving strong organic growth in spite of market volatility and about the high engagement level of our clients. Now that success translated into huge year-over-year increases in new brokerage accounts and net new assets. And if you exclude mutual fund clearing, that year-over-year increase jumps to 59%. Total brokerage accounts increased by 950,000 or 8% year-over-year, the largest year-over-year increase in almost 20 years. Unfortunately, the $244 billion in net new assets over the last 12 months was not quite enough to offset the impact of the Q1 market decline on our total client assets. Our financial performance was obviously impacted by the environment and to a lesser extent, by our decision last year to eliminate online equity commissions. Overall revenue fell 9% year-over-year. This was mostly due to a 6% decline in net interest revenue. Average interest-earning assets rose year-over-year, but that wasn't enough to overcome a 32 basis point reduction in our net interest margin as the Fed cut rates by 225 basis points over the past year. Asset management and admin fees were up 10% year-over-year due to increase in demised assets and purchased money fund balances. Trading was down 13% year-over-year as daily average trading nearly doubled from a year ago but the commission per revenue trade declined, of course. And in case you didn't notice, we are now including order flow revenue in the trading revenue line item. And of course, we reclassified the prior periods to ensure an apples-to-apples comparison. Now it's not called out on the page, but other revenue was also down year-over-year due to some unusual items that last year, you may recall, benefited from a gain on our assignment of our lease at 215 Fremont. And this year's number was impacted both by an increase in our allowance for credit losses as well as a loss on the rate locks that we provide to mortgage clients in the pipeline. Expenses were up roughly 8%, but that would have been only about 3% without the acquisition and integration expenses for USAA, TD Ameritrade and most recently, Wasmer Schroeder as well as the COVID-19-related spending on our employees. And yes, I'm aware that 8% minus 4% equals 4% and not the 3% I just mentioned, but that's due to rounding and not some sort of new math. And I may have said revenue was up 4%. I meant revenue was down 4% year-over-year, of course. So with revenue down and expenses up, our pretax margin declined to 40% or 42.5% without the $64 million in unusual items I just referenced. And our ROE declined to 14%. Note, however, that 2 percentage points of that ROE decline from the prior quarter was due to a $4 billion increase in GAAP equity resulting from mark-to-market gains in our available-for-sale portfolio. That's sort of a bad news, good news story. And then another point of the ROE decline was related to the unusual expenses I just mentioned. Now we'll spend a bit more time on the balance sheet today because there has been a lot happening. The biggest thing is, of course, is the unprecedented surge in client cash that came on to our balance sheet in late February and throughout March, driving a 26% sequential increase in assets and a 28% increase in Bank Sweep balances. Though we made investments totaling roughly $30 billion in the quarter, finding some nice opportunities as others were forced to sell, we simply could not keep pace with the rapid influx of client cash which means that we ended the quarter with nearly $70 billion in cash, most of which is invested in excess reserves at the Fed. And we expect to invest a substantial majority of that cash over the next quarter or 2. We have a lot of liquidity, the banks, the broker-dealer and the parent. That being said, our need for parent liquidity is a function of needs of the broker-dealer, which itself is influenced by day-to-day swings and client cash balances. Given the extreme market volatility, client cash movement and trading activity, we thought it was prudent to supplement that strong parent liquidity with the $1.1 billion of debt. The rapid increase in assets helped push our Tier 1 leverage ratio down to 6.9%, right in the middle of our operating objective of 6.75% to 7%. Remember, though, that Tier 1 leverage is measured based off of average assets. So if we were to look at that ratio on a spot basis, the numbers would be somewhere below 6%. We remain paused on stock buybacks. And I'll talk in a few minutes on another slide about how we think about our capital levels moving forward. It wouldn't be a business update without a page on client cash. You saw from our quarterly disclosures the dramatic increase in Bank Sweep and Schwab One balances, which built on our typical seasonal increase in cash in the fourth quarter. As we discussed in the winter business update, we anticipate we might see clients continue to be net sellers of equities. And indeed, that did happen in the first quarter. But as Walt mentioned, what really caused the spike in client cash late in the quarter was clients selling fixed income securities and not reinvesting proceeds from dividends, fixed income they own, CDs and other bonds that mature and that's what it shows in the other column there. This increase in client cash in the balance sheet is quite consistent with what we expected and certainly what we've communicated previously, that we often see client cash balances increase when the equity markets fall, and the portion of that cash sitting on the balance sheet increases as well as interest rates fall. It's an internal hedge within our business model and something that makes us more resilient as a company. It's impossible to say how long that cash will stay here and how quickly it will get redeployed. I'll say though, if history is any indication, it will likely take an increase in interest rates for the trend to reverse, especially given where a lot of that cash is coming from out of the fixed income markets. And even then, our experience after the financial crisis suggests that cash tends to get reinvested more slowly than it got "uninvested." The environment has clearly changed a lot since we laid out our baseline scenario at the winter business update. Interest rates and the equity markets are lower, of course, while trading and balance sheet growth have been much stronger. Given all the changes, we thought it would be useful to update that scenario and show how, in spite of the environment, we are well positioned to weather the storm, continue to grow organically and produce solid financial performance. All right. And now the page I know you've all been waiting for, our updated scenario. So let's start with some basic assumptions. Relatively stable interest rates through the year, with the exception of LIBOR, which we assume decreases to more of its historical premium relative to Fed funds, average market appreciation from the end of March levels and a return of trading activity closer to historical levels versus the pace we saw in the first quarter. The big variable in this scenario, as with the last scenario we shared at the winter business update, of course, is the amount of balance sheet growth from here through the end of the year. Do clients continue selling out of fixed income and equities? Or does that stabilize? Depending on the answer to that question, we could see balance sheet growth of 30% to 40% over the course of the year or relative to 3/31, that could mean up $10 billion to up $50 billion. And based on what happens with the balance sheet, we'd expect revenue comps to be somewhere in the minus 4% to minus 7% range year-over-year. Our expectation is that year-over-year expense growth will be somewhere in the 4.5% to 5.5% range, excluding TD Ameritrade acquisition and integration costs, so about 150 basis points lower than what we expected 2 months ago. And in terms of core expense growth, I'll show this in a moment, that translates to roughly 2.5% to 3.5% up year-over-year. And that would lead to pretax margins of at least 38%, clearly below where we've been in the last few years, but a lot better in the shadow of the financial crisis. And I'd hope you'd agree, quite healthy under the circumstances. Our Q1 net interest margin fell 20 basis points from the fourth quarter of 2019. And we'd expect another step down in NIM between Q1 and Q2, likely bigger than the drop from Q4 to Q1. Let me explain why. Shifting our investment allocation last year from 60-40 fixed to floating to more like 80-20 helps shield us a lot from the impact of the dramatic easing the Fed embarked upon in the first quarter. But even so, our overall balance sheet still is about 40% to 45% tied to short-term rates when you consider margin loans, segregated cash to the broker-dealer and liquidity we maintain within the banks, which you would typically hold as excess reserves at the Fed, but given that short-term rates dropped a lot late in Q1, and again, it was late in Q1, you'd expect some degree of NIM compression from Q1 to Q2. But the flip side of the surge in client cash late in the quarter is that we exited Q1 with a much higher level of excess reserves than typical. And it's going to take us a bit of time to get that cash invested in our usual range of available-for-sale securities. And that also compresses NIM somewhat. The actual exit, and when I say compresses NIM, I mean exiting Q1 with that higher level of cash compresses NIM somewhat in the short term. Now if said another way, having that cash in our balance sheet is negative for net interest margin at least in the short term but positive for net interest revenue. Now adding some assumptions, LIBOR rates drop a bit closer to their longer-term averages relative to Fed funds. And that's why you see a bigger impact moving from Q1 to Q2. But after that point, the NIM should mostly stabilize, perhaps shedding a smaller amount of basis points over the course of the year and settling in the mid-150s by Q4, assuming stable interest rates. We cannot control the environment, but we can mostly control our spending levels. We have communicated to clients and employees that we do not plan to do any layoffs related to COVID-19 or the resulting financial turbulence. We're driving strong organic growth. We have a lot of momentum right now, which creates higher demands on resources. Our clients are highly engaged, which despite the tremendous progress on digital adoption, increases the burden on our people and our systems. And we have some really important initiatives we want to invest in, the integration of USAA and TD Ameritrade and now Wasmer Schroeder, our digital transformation work, application modernization, to name a few. That being said, we would expect our expense growth rate to be perhaps 150 basis points lower than the 6% to 7% we communicated at the winter business update due to what I'd call environmental factors, for example, lower third-party expenses and mutual funds and ETFs, lower incentive compensation, which result in an expected core expense growth rate of more like 2.5% to 3.5%. So pretty good concerning the strong organic growth that we have been driving. I feel very confident in saying that the year will not unfold exactly as either end of that range of possible outcomes and visions. And each of you I'm sure has your own views on how the year unfolds. So let me give you the sensitivities. These are generally pretty similar to the ones we shared at the winter business update, with a notable exception being the sensitivity to Fed funds. And that's obviously increased a fair amount given the fact that we're back in a range where we expect deposit betas to be quite low, our balance sheet has grown a lot, and of course, as I mentioned, we're holding more cash right now, so somewhat more sensitive to Fed funds movements. Last but certainly not least, let's turn our attention to capital. We came into the year with capital levels above our operating objective, which, as you know, are themselves are far above the regulatory minimum. The dramatic growth in the balance sheet has reduced those capital levels. And when we close the USAA transaction, those capital levels will fall a bit further. If the balance sheet stays at the size it currently is, we could find our Tier 1 leverage ratio in the low 5s post-USAA and we're comfortable with that. That's still well above the regulatory minimum for the consolidated company. Fed has encouraged banks generally and us individually to utilize our capital buffers. That's why you maintain them in good time so you can utilize them during stressed environments. And this is what we're seeing right now as very consistent with our capital stress testing and our capital planning programs. And we have levers we can deploy if we anticipate those ratios dropping further, specifically either monetizing some of the gains in our available-for-sale portfolio or as the last resort, utilizing the Sweep Tower to move some client cash balances off our balance sheet into a government money fund. Even so, it's reasonable to expect us to tap the preferred markets in the next quarter or 2 if those markets continue to be constructive. Now due to restrictions related to the TD Ameritrade acquisition, we already faced limitations on our ability to buy back stock. So that's not really a factor anyway. And of course, we'll continue to pay our $0.18 quarterly dividend. Let me close with a few thoughts. This is clearly a very challenging environment for the world and a very challenging environment for the company. At the same time that record low interest rates put some strains on our top line revenue, our clients and our employees need us more than ever. We're not blind to these near-term pressures, but nor are we intimidated by them. We have a strategy that is working and a position in a market that is clearly resonating with investors. And what's going to help us get through this crisis are the same attributes that have made us successful in the past, our focus on clients, the talent and dedication of our employees, the discipline with which we manage expenses and capital and our long-term orientation. That's how even as we work to overcome the near-term hurdles presented by this crisis, we're confident in looking forward towards the future. With that, let me turn it back to you, Rich, for some Q&A. Thank you.

All right, gents, thank you very much. Well, as they say, let's go to the phones. So shall we get started on callers, please?

[Operator Instructions] Our first question over the phone comes from Will Nance.

Maybe I'll start on the rates environment. Given how much cash you're going to be deploying into the portfolio over the next couple of months, could you give us a sense for what the yield on those securities might be in this sort of environment? And maybe just bigger picture, if we kind of stay at these levels of interest rates for a long period of time, where would you expect the net interest margin to bottom out, at the current balance sheet mix or maybe at the target balance sheet mix?

Thanks, Will. So reinvestment rates right now are about 80, 85 basis points below our -- the average investment yield that we saw in the first quarter. Now that's a function of lower benchmark rates, both LIBOR as well as longer-term rates, offset to a certain degree by wider credit spreads that we're seeing across the range of sectors that we invest in. So that's where we are today. In terms of where that NIM could end up, I talked about where we could see it in Q4. I think that's probably a reasonable place to -- given what we're talking about. But it really depends on the interest rate environment, it's hard to say that exactly in terms of where that would land. But I think that's where we're sort of assuming flat rates, assuming relatively stable credit spreads, with the exception, as I mentioned, of what -- where our assumption that LIBOR falls a little bit over the next quarter or so. We think that's an appropriate place to be, expectation in terms of the fourth quarter.

Got it. And then maybe just on the capital front, you mentioned being in the low 5s, I guess, as late as the early third quarter. Could you just give us a sense for how you're thinking about tapping the preferred market? And if you do wind up kind of in the low 5s, where would you kind of like to get it to, to kind of be a little bit more comfortable?

And so our #1 priority from a capital standpoint is having sufficient capital to support the organic growth of our balance sheet. I mean that is our abiding focus and our priority. Our operating objective continues to be 6.75% to 7%. But we're also quite aware and quite comfortable with the fact that we may run below that level for quite some period of time. I think it is reasonable to expect that we will -- that we would tap the preferred markets at some point in the future and again depending on what the -- how the market looks and what the appetite is, that will dictate I think more about what we do in terms of the preferred. But again, our capital levels, we have buffers on top of buffers, on top of buffers frankly, and so this is in a time to -- this is a time to be utilizing those buffers to support our clients and to support the balance sheet growth that we're seeing.

Next question comes from Rich Repetto.

I guess the first question is on the reinvestment rate. Just to make sure I heard you clearly, you said, I think it was 80 to 85 below. So we're looking at reinvestment rates right now around the 155 to 160 range, is that what you were sort of implying?

Yes. I mean, Richard, it's -- so it's a little bit lower on the floating rate than it is on fixed rate as you can imagine, higher on some of the credit, the securities have a little bit more credit exposure than some of the agency MBS that we have. So it's kind of all within a range, I would say the average is a little bit south of that, but not too far below that.

Okay. Okay. And then I guess the other question is, on the deployment of cash, I think it was -- you ended the quarter with $59 billion of cash in excess reserves at the Fed. But client cash overall I think is around $72 billion or something. I think you mentioned that earlier. I guess the question is, you said you would look at deploying that. I thought you said fully but can you tell us the amount that you saw -- you implied by fully over the next quarter or 2?

Yes. So I didn't -- certainly if I said fully, I certainly didn't intend to imply we'd be putting all of that to work. I would anticipate this, we typically run about 5% to 7% of our deposits staying liquid. Today, that number is well north of 20%. I would think in an environment like this we want to keep somewhat higher-level liquidity than that 5% to 7% typical, but certainly well below where we are today. What I was suggesting is that, that excess liquidity that we're holding, we'd expect to deploy that excess liquidity over the next quarter or 2 as we see those investment opportunities materialize. We don't want to -- there's a certain pace at which we can invest that cash, given the fact that we also have ongoing paydown activity and other organic balance sheet growth that we're seeing. So we want to be thoughtful and judicious about that while certainly working towards putting that money to work.

Got it. So that's excess over the 5% to 7% of deposits, that's the excess.

Correct. And bearing in mind that I think we're going to end with, again, with a bit higher levels of liquidity than we might have under a normal environment.

Next is Brennan Hawken.

I just wanted to follow up on that question about the investment rate and cash trends and such. I think you said you ended the quarter 3/31 at about $70 billion of cash. What has -- what have you been able to put to work so far? Like where do we stand now? And have you seen any trends or change in client cash balances since 3/31 to today, just to maybe give us the latest touch point since we've got you in a Reg FD environment and everything?

Yes. So I mentioned we put about $30 billion to work in March. I think that's a reasonable pace to be in terms of expectation. I don't think I want to get into the sort of day-by-day parsing of exactly how much we're investing. But I will say, in April, we have seen a slowdown in that cash balance build. It's still positive for April, but not nearly to the extent that we saw in March. And again, I think that's somewhat consistent with what we've seen in prior periods. If you look at the financial crisis, the cash balances built relatively quickly, and then they built more slowly. And then at some point, they got redeployed. But when the cash moved off the balance sheet, it moved off over a long period of time. It was actually about a 2.5-year period of time. So our view is this cash is, we think, is relatively sticky. That is probably, what it's going to take, as I mentioned, is an increase in interest rates across the curve for that cash to move off the balance sheet. But even when -- if and when that happens, that it won't move off quickly when that time comes.

Yes. Okay, Peter. That's helpful. And appreciate not wanting to get into the granular details, but even a high level of sense is great. And then fee waivers. Could you maybe give us an update about how we should think about fee waivers? I'm guessing, given what we're seeing in some of the treasury markets on the gove and muni side, that we're probably either there or close. What trends have you seen as far as that goes, what should we expect? And what trends are you seeing as far as mix of AUM? Are you seeing some increased demand for prime given the relative resilience of LIBOR?

So on fee waivers, I think the short answer is that fee waivers will not be nearly as big a story this time around as they were during the financial crisis because the average yield on our money funds is lower than it was last time. Last time, we had a lot higher portion of our money funds were in -- or the balances were in Sweep Money funds, which have higher expense ratios. And we -- since that time, we also reduced the expense ratios on all of our funds. So we can support a lower level of interest rates before fee waivers start becoming a factor. You're right that you're likely to see those fee waivers come in to play initially in the treasury money fund and the government money fund before it hits the prime funds and the muni funds. We had a very, very small amount in the tens of thousands of dollars of waivers in the first quarter. I think it's likely that in the second quarter, we'll see that number be somewhat bigger than what we saw in the first quarter, but again, focused on those treasury and government money funds. And as you imagined, you're seeing -- you're definitely seeing some interest money flowing back into some of these money funds, some of the prime funds, given the fact that they are offering more attractive yields.

Yes. That makes sense. Should we think about the floor of that 12 to 13 bps being the right way to think about it that you experienced last time? So that can now adjust for the lower price point that you referenced, Pete?

I'm not sure. Can you clarify the 12 or 13 basis points? I'm not sure what that's referring to.

On a net basis, that was where the money fund, like, on a gross basis, yes, you were higher, like 50 bps for the fee rate, but once you netted down the fee waivers, that actually at a trough, the prior 0 interest rate period, you ended up -- Schwab ended up netting about 12 or 13 bps on the money funds. So is that a decent barometer for how to think about gross versus net this time and where a trough would be?

It's really hard because, I mean, it's so dependent on the money fund and the mix that you see. So I would hesitate to give you a specific number like that. I think you have to look at it on a fund-by-fund basis to see what those dynamics would end up being.

Next, we have Mike Carrier.

Maybe, Peter, first, on expenses. I think in past periods, when you guys were facing a lot of revenue pressure, you -- like eventually, we saw the expense base come down. I know this is early on, and there's a lot of things in place in the short term that probably keeps the 2020 base or the outlook where it is. But where are some of those levers if we're in, in an extended period of weaker revenues? And then I think just on the advertising, it seems like that came in probably less than we would have expected, but the organic growth was still like very strong. So how is that correlation maybe relative to the past and is that something that you can pull on?

So on the expense side, I mean, what I'd say is, remember that we took some expense actions in the third quarter of last year to bring down the rate of our spending growth and made some tough decisions and that certainly adjusted our expense base a fair amount at that point in time. So we came into this period, I would say, with a -- having taken action on a lot of the "easier opportunities" to reduce our expenses, not to suggest that any of those actions were easy by any means. But -- so we felt like we're in sort of fighting shape, if you will, coming into this period of time, which is why I say we don't see opportunities, necessarily big opportunities to make major adjustments right now in the near term. It's also important in an environment like this, there are a number of expense items that do adjust and vary based off of what's happening with the environment. So I mentioned third-party expenses in our mutual funds, our Schwab mutual funds and ETF, sub-advisory fees and our managed account programs, incentive compensation, our compensation for some of our employees is tied to equity -- the equity markets or assets under management. And those end up adjusting our bonus funding, to the extent that our performance is less than our initial planning at the beginning of the year, that adjusts. Given the environment, our travel and entertainment costs have come down. Though we already brought those down a fair amount last year, those have come down further. We're seeing with India largely shut down, we've had a reduction in offshore spending or offshore expenses. And so that's contributing to that reduction in expenses. To go further on that, there are certainly levers that we can pull in the near term. So we could proactively adjust offshore labor more than that. We could reduce advertising, we could reduce our project spending. But to do that, we have to -- we want to be very, very thoughtful about doing that because what we don't want to do is react to a near-term financial situation in a way that, in any way, undermines or decreases our long-term momentum, our ability to grow profitably long term, the positioning that we have in the market. We entered this period with a lot of momentum. And we want to make sure that we exit this period with even more momentum. And I think as we look back on our experience during the financial crisis, I think we did a really good job of that and of managing our expenses in an appropriate way, but not overreacting such that when the environment got better, we exited in a really, really strong position with a lot of momentum. And that's what we really, really want to make sure we stay focused on in this time is to keep focused on our clients and keep focused on that long term even as we obviously keep an eye on the near-term financial performance.

Okay. That's helpful. And then just a quick follow-up. With Schwab, credit risk and provision, it's not something that we typically focus too much on, but just given the environment and the areas that you guys do have a little bit of credit risk, just maybe an update on the balance sheet and how you're thinking about that in this current environment?

Yes, we feel very, very good about where we are. As you know, I mean, the vast majority of our balance sheet is invested in government-backed securities, where we take "credit risk" and our investment portfolio are all also very, very good credits. On our mortgage portfolio, we have very low loan-to-value ratios. These are clients that typically have a lot of assets with us, high FICO scores. We have seen some requests, not surprising, for forbearance, but they are a very small manageable number, under 1% of our overall mortgages. And the vast majority of those clients have low LTVs, high FICO, and assets with us. And our experience suggests in that situation, those clients are very, very likely to pay back those mortgages. So there's nothing that concerns us from that standpoint at all.

Next, we have Ken Worthington.

I was hoping to get a better sense of the capacity you have to grow deposits from current levels, maybe given your current 1Q capital ratios. So you talked about Tier 1 leverage falling lower based on the ending balance sheet. And you talked about the leverage ratios falling further as USAA closes as well as the willingness to operate below that targeted range that you've been putting out for some time. So as we put it all together, how big a deposit base do you feel comfortable managing, I guess, maybe just level set to the 1Q capital ratios that you have?

So Ken, you rightly pointed out that the amount of balances we can support is a function of those capital ratios and maintaining -- and managing those capital ratios. So the regulatory minimum on consolidated Tier 1 leverage is 4%. To be well capitalized at the banks, it's a 5% Tier 1 leverage, both of those measures based off of average assets. What I can't do is give you a number above that, that says at this number, 4-point-x percent, we're absolutely going to cap the balance sheet growth or do something like that because it really is -- it depends. The short answer is it depends. It depends on the circumstances. It depends on the pace of balance sheet growth. It depends on the environment. It depends on our -- as we look out in the future and think about the organic capital formation, what I can say is we don't see right now a need to certainly cap that balance sheet growth. We're going to continue to monitor it and continue to take a look at those capital ratios, both now and into the future. But there isn't sort of a hard number that I can say, here's the point at which we absolutely will not go below that, other than, of course, the regulatory minimum ratios that I just mentioned.

Okay. So getting into the 4s, in the right circumstances is something that would be feasible and tolerable for Schwab?

That is correct. I mean I don't think that's something we'd want to be doing for a long, long period of time. We'd want to be working our way back out of that. But if we see a path to be able to do that for a period of time, we could live with that.

Next, we have Dan Fannon.

A question on organic growth. Obviously, a record quarter. Just thinking about the rest of the year and closing, getting closer to the Ameritrade, closing of that deal, do you anticipate kind of any slowdown as advisers might be debating kind of moving over to your platform or even to Ameritrade's during this time period as the conversion potentially starts to take hold and you go through that closing? Just want to get a sense of how those dialogues are going, how that backlog looks for those prospective advisers.

Walt, you want to take that one?

Sure. I don't necessarily expect a slowdown from business with RIAs. We had a very strong first quarter. I think that the RIA community continues to have success. But what's interesting is that some of the growth rates of RIAs below $200 million or $300 million were actually some of the highest organic growth rates on our platform. And we really think that the notion that RIAs will slow business with us as the date for closing of the transaction with TD Ameritrade approaches is not something that is likely to unfold. We have deep relationships, very positive relationships with the vast, vast, vast majority of the RIAs that we work with. And our belief is that TD Ameritrade does also and that -- and so we're not anticipating any kind of meaningful change in the trajectory of that business as that date approaches.

Our next question comes from Craig Siegenthaler.

So given that you expect Tier 1 leverage to fall into the 5% range, and your response to Ken's question, that would be okay if it temporarily fell into the high 4s. Does this imply that there'll be no share repurchases until it normalizes back up to the 6.75% range?

So as I mentioned, our #1 priority from a capital standpoint is to support the organic growth of our balance sheet. And we would not want to do anything from a buyback standpoint that would get in the way of doing that. Now in the near term, there are some limitations anyway on our ability to buy back stock, as I've talked about a couple of times before, ahead of our -- the stockholder vote for the TD Ameritrade acquisition, potentially as we get further along with the DOJ and might have some information that would close the window on doing that. So I wouldn't say -- I wouldn't go so far as to say we would not put a rule in there and say, as long as we're still below 6.75%, we're never going to buy back stock. I wouldn't say that at all. But at the same time, we don't want to do something, buy -- be buying back stock and then later have to monetize our gains in our available-for-sale portfolio or implement the Sweep Tower in a way that we would regret, I guess, having bought back that stock. I do think it's important, though, to take a step back and say, we continue to believe buybacks and capital return more broadly is a very important part of our financial formula. There are some periods of time where -- when the balance sheet is growing more slowly, where we have more capacity for capital return and buybacks, and in some periods of time, when the balance sheet is growing more quickly and therefore, somewhat less capacity for capital return and buybacks. But over the cycle, our expectation is that cash balances grow, as we talked about many times, cash balances grow consistent with the growth in total client assets and the growth in accounts, and only through the cycle that, that still gives us plenty of opportunity for meaningful capital return. It's an important part of our financial formula longer term.

Got it. And then my last one, I just wanted -- and I know you kind of explained this a few ways, but I wanted a few details in terms of why Schwab has seen an acceleration and actually record quarterly core net new assets despite the volatility in the second half of the quarter. And then as we look ahead into 2Q and 3Q, which generally contains the summer months when things go down a little bit, how sustainable is this strong organic growth going forward?

Walt, do you want to start us off on that one?

Sure. Right. I think as I mentioned in my comments, that we have a strategy that is working. It's consistent. You haven't heard us talk about new approaches, new strategies, changes in 15 years and it works. It is client-oriented. We were there for our clients. I'd like to believe that we are a trusted port in this storm that has been going on for investors. And so when they make that decision, whether you are an end investor or an RIA, and of course, many end investors, investor clients of the RIAs make the decision on where they want the assets custodied. They have great comfort and confidence in coming to Schwab. I do think as you move out into subsequent quarters after a period of extreme volatility or a period of volatility where the market declines, it is not uncommon historically, at least, to see flows begin to moderate. Now we don't know whether that's going to happen in coming quarters. But historically, that was something that we would see after periods like we've just experienced. But I think we feel very confident that whether that starts to unfold industry-wide or not, we're going to continue to achieve organic growth rates that are outsized relative to our market position because of the strength of our franchise and the offer -- the no trade-offs offer that we make available to investors and advisers.

Next, we have Chris Shutler.

Walt, with the Fed funds rate now down to effectively 0, again, and the potential for rates to stay structurally low for a long time. Just, maybe just talk for a second about how you as a management team and Board think about the business model and with a lot of it still being tied to interest rates. Is there any greater desire to diversify the revenue streams, not just around the edges, but more materially in terms of increasing subscription revenue?

I think we feel great confidence, I do and the Board does, in our business model. And we recognize that this is a unique occurrence. I think what's going on now is very different than what went on with the financial crisis, which took from what, late '08 into late '15 for the Fed to move to a different place. But nevertheless, part of our initiatives, as I documented in my comments, involves monetization and segmentation. And a significant part of that monetization part is to continue to grow our revenue streams that are not spread-related. That said, we will only undertake those kinds of initiatives to the extent they are in the best interest of our clients. That is the ultimate business model, the ultimate financial model for us. And so we feel very confident there. I think we also have to recognize that coming out of the second unique governmental support required for money market funds in the last 15 years, that a lot of business models and a lot of revenue sources are likely to be subject to new rules, new oversight. And you really want to see where all of those things shake out also before anyone would look at significant moves around their business model. We don't have any plan to do so. But we think there could be a meaningful competitive restructuring as some of those changes come into play.

Okay. And one for Peter. Maybe just going back to some of the questions from earlier. Could you put a finer point on where for new money right now, you're investing in the fixed rate portfolio and the floating portfolio, what the rough yields are? I just want to make sure I heard those right.

So what we're investing in is very similar to what we've always invested in, a heavy preponderance of mortgage-backs, agency mortgage-backed securities. We're targeting that 80-20 fixed to floating, but we're definitely putting a substantial majority of new investments into a fixed rate. From a duration standpoint, we are edging closer to more like a 3.5 duration. We're in the low 3s today, but edging closer to that 3.5. In terms of the yields we're investing at, we're sort of in the 150s or so on some of the fixed rate and a bit less than that on the floating rate in terms of those reinvestment rates. But again, those numbers have been moving around a fair amount as we see credit spreads tighten and widen and tighten again. We see LIBOR move and so forth. So I just -- I don't want to be -- I wouldn't want to be pinned down to -- for too long on those exact numbers. Those are very much a point in time set of numbers.

All right. Let's squeeze in one last question, and then we'll wrap up.

Our next and last question comes from Kyle Voigt.

Just a couple of clarification questions. Just one on the NIM assumptions. I think you said that you expect in those assumptions for credit spreads to remain relatively constant. Just wondering if you're also assuming that agency MBS spreads also remain relatively elevated at current levels. And then my second question, last question is just on customer margin yields. I'm assuming we shouldn't simply model kind of a one-for-one correlation lower because of different pricing dynamics in the negotiated book. Just wondering if you can help us frame the sort of minimum level where you think that margin book could reprice to in this environment or even in March post the Fed cuts.

Yes. So on the -- let's see, on the NIM question, our assumption in the scenario that we presented is that LIBOR comes down. It's been -- it came down, then it went up, and now it's been trending down. Our assumption is it comes down over the next quarter or so to more of a sort of historical premium relative to Fed funds, 1-month, 3-month LIBOR more in those 20s to 30s basis points. In terms of the margin book, I mean, the margin book, as you point out, a lot of that book is negotiated. Those negotiated rates are tied to different reference rates, some are Fed funds, some are LIBOR, some are prime. Those negotiations -- typically on the way down, those -- when those reference rates come down, clients aren't shy about reaching out to us to have an adjustment and make sure that those rates reset along with that. So a lot of those rates already have felt the impact of the lower reference rate that they're tied to.

Peter, maybe one other thing on the spreads was on the agency side, whether we thought those were going to stay wider or tighter, et cetera.

Yes. So on the agency side, our assumption is those are -- we are seeing those spreads tighten up a little bit as the Fed has been in buying some of those securities and putting a bid in for some of those securities. So we've seen some of those tighten up and our expectation is that, that continues.

Okay. Well, with that, I think it's time actually to turn it back to you to close this out here.

All right. Well, thanks, everyone. Thank you very much for your questions and for your time today. And I'd be remiss if I didn't also thank our clients for really putting their trust in us during this period of time. And also really thank our employees for their just really unwavering and I think, truly inspiring commitment, resourcefulness, dedication and tenacity. I mean it's really remarkable to see how much they have rallied over the last several months. We don't know how long this crisis is going to last or what the recovery is going to look like. We do know is that we're going to continue to focus on the things that we can control, which is looking out for our clients, looking out for our employees, looking out for our stockholders. That's what's made us successful for 40-something, 45 years now, and that's what's led to the incredible momentum, the incredible results that we had in the first quarter. And by doing that, that's what makes us confident that we're going to persevere, and we're going to emerge from this period of time stronger as a company and better positioned than when we entered it. We look forward to giving you updates in July and talking to you all again. And until then, be safe, everyone.

Thank you. And that...