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

Good morning. And welcome to our second session. I'm very pleased to have Walt Bettinger, the CEO of Schwab. I think everybody knows Walt. He's been the CEO since 2008. Schwab's a $48 billion market cap. We were joking even before we started. He's been through a crisis before, and he's fought a lot of headwinds in his career at Schwab. But he's also had plenty of success as well. So first, thank you, Walt. I think this is your first conference, and it truly is an end of an era.

And that's where my first question starts. You communicated that 0 commissions that you were reducing your dependency on the commissions for a number of years. And so when it happened, I guess, we shouldn't -- I don't think had been surprised. But did you think that it would occur, it would actually initiate the consolidation in the industry? You're already involved in a -- which just closed, the USAA acquisition. Was it as premeditated as what it appeared to be? That would be the era, Walt. Sorry, [indiscernible] with you.

Well, first, Rich, thanks for the opportunity to be with you today. It's an honor. It's also a very unique experience, but of course, I think we're all living in unique times. It was premeditated but not premeditated maybe in the way that some think. It certainly wasn't premeditated as a driver toward consolidation. But it was premeditated in that we have been striving, as you indicated, for a long time toward a 0-commission world. And in fact, if I look back, I think we first began war-gaming and planning for a 0-commission world back in about 2004. And since then, each decision that we've made, we made it while asking ourselves at the same time, would this decision further our efforts to get to 0 commission? Or would it actually work against it? So it's been in the works a long way. When I say it was premeditated, it was premeditated because it's really a fulfillment of Chuck's vision. Ever since May Day, when regulated commission levels were removed, Chuck's objective in the business has been to remove barriers and speed bumps and make it easier for the average investor to invest. So that was the premeditated part of it. Now there are also a couple of secondary factors certainly that we looked at in making that decision. One is that we view that our fiercest competitors long term are likely to be the global banks. And they have certainly indicated that they have a commitment to being in the space that we've historically operated in, largely in that self-directed retail investor space. They may lack scale today in that particular area. They may lack some of the product features, but they seem very committed to getting there, and they were already at 0. So we needed to respond to that. That was the secondary factor. And then just the third one is that we're a disruptor. That's how we were founded. We understand the disruptor model. You start with a niche offering. You generally undercut entrenched prices, gain a foothold, broaden your offering. And that only works if the entrenched providers maybe lack the courage or the will or maybe the long-term planning foresight to be able to respond without upsetting their fundamental economics. And Schwab may be large, but I think our mindset remains that we're a disruptor and a challenger. And so those were the 2 secondary factors competitively. But the primary driver was we just wanted to remove barriers for investors. And long term, we think that's going to make sense for our company, for our clients, for our stockholders.

And you certainly have, throughout the history of Schwab, stood up and made changes that benefited the retail investment without question. And I guess, maybe that's the answer to my next question, maybe already beat me to the punch, Walt. But when we look at these firms that were quite E*TRADE and Ameritrade, they weren't, I would say, not unsuccessful. They were a multibillion-dollar market cap. But I guess, what -- certainly, your less dependency on commission helped you to survive. But could you talk about anything else that you think was that disruptive? And it is amazing that a firm your size can stay that flexible, I guess. But what allowed Schwab to survive when these other firms ended up being acquired?

Yes. You know what, I don't know that I'm the right person to really comment on their thinking. I guess I would categorize it this way, Rich. I wouldn't view it as they didn't survive. I think that the firms that you referenced were disruptor companies just like Schwab. And the difference was they were just simply maybe not as far along on their path to building out that broader array of services and offerings. And so therefore, there was maybe a bit still -- maybe a bit too dependent still on commission revenue, so that as the industry moved in the direction of 0, they didn't have as much flexibility. They certainly had the courage and the will, and we saw that with their price reaction to when 0 became the norm, but maybe just not diversified enough sufficiently to determine that the optimum approach for their stockholders and their clients was to stay independent and it made more sense to partner up.

That makes sense. It's certainly an end of an era -- or let's just say a transition if it's -- we won't use that word survived. It's a transition for those firms. And maybe it's a new phase for Schwab as well when you consider the 4 acquisitions, the closing of USAA and with AMTD pending and also the other 2 acquisition, Wasmer Schroeder and Motif. So I guess the question is, without a doubt, I think when investors and even clients, they look at the strong culture of Schwab and this big scale but still disruptor that you talk about. But how are you able to -- I guess, this is going to be very -- I'm sure you've thought about it. Now how are you able to maintain that culture, the value of the culture and -- but also maintain the innovation of the firms that you absorbed because you got from big -- from large to small sizable acquisitions? And what really will determine the performance in Schwab in some part for the next several years?

Sure. So let me break that apart a little bit because I think the issues are a little bit different with each one. USAA, if I were to identify any very, very large company that I feel has a culture quite similar to Schwab, I probably would have picked USAA. Their culture of service to others and trying to -- even though they don't use the same words but operate through client size is almost identical to ours. And that actually was clear to us, not just in the discussions around the transaction but even in the execution of the transaction. We would run into the issues that anyone would run into and just an attitude of, "Let's figure this out in a way that's going to be best for the clients and move forward." I see the 400-or-so employees who joined us from USAA and 1 million clients. That's just very consistent with our culture. Wasmer and Motif, in many ways, are very similar in that they're smaller. Keep in mind, less than 100 employees total in those 2 firms, all joining -- for the most part, all joining our company and all excited because what they've done there is developed world-class offerings for investors but without the scale and the brand to really deliver them into the marketplace in a way that would allow investors to capitalize on the great things that they've built. So they're very excited and very client-oriented companies. Now Ameritrade is the big one, of course. I think we began from a place -- a common place of striving to do right by our clients. And we acknowledge that there are some differences, structural and cultural. Probably a big one is the fact that we've lived under prudential oversight with the Federal Reserve for a number of years. So our risk policies and procedures may well be a bit more developed and mature. That doesn't -- I'm not saying that they're better. They're probably just a bit more developed and mature. And so that will be an area that we'll reconcile between the organizations. I do think that the key to the cultural integration will be that this is not just an expense play. We're not just going in and saying this is going to be an effort to reduce expenses and that's the only way the math makes sense. The math actually makes sense in a combination of some duplicative expense reduction but also keeping the best of both firms. We have been incredibly impressed with the folks at TD Ameritrade as well as many of the capabilities that they've built. And I think when it's all said and done, you'll see that many of those great capabilities will now be delivered to all of Schwab clients. And of course, some of the things that Schwab does better than Ameritrade will continue on with Schwab and deliver that to all the Ameritrade former clients. I think we feel pretty confident about the cultural integration.

Got it. When you talk about I am a proud member of USAA, it is a strong culture. And to me, it's extremely well with Schwab. Moving on and we're doing speed interviews here, somewhat due to the condensed time. But the current operating environment sort of has a double-edged sword. The client engagement has been truly, for lack of a better word, over the top when you look at your net new assets, your account growth, your debt. So I guess, one of the things that you think might be sustainable from a client engagement standpoint are is this just -- we got the stay-at-home impact. But how are you thinking about it, Walt? And how is Schwab thinking about it?

Yes. So I don't know that the stay-at-home factor is the one that is really -- that has really contributed to the level of engagement with clients. I think that what investors have seen is they have seen an opportunity to enter the market. And they've seen barriers were moved to do so, including the 0-commission side. And so from the investor standpoint, I think that's what they've been capitalizing on. From our perspective, we've been able to see that our systems can handle volumes that were actually beyond even some of the modeling that was being done as part of the TD Ameritrade integration. So we've increased confidence. And again, for investors, the more people we get investing, the better because that's going to give people the opportunity for greater wealth, flexibility, independence for themselves and their family over time.

Got it. Interesting take. So that's been sort of the upside from the current environment, the client engagement. And the not-so-good side is on the interest rate side. That's probably the #1 question we get from investors about Schwab is that how will they fare in a [indiscernible] environment. I know you're doing a number of things that the money market funds aren't, what they -- not like the last cycle. You've done changes to the client cash strategy, your acquisitions. But I guess, the question is, well, how -- is there anything you can do to sort of offset either the spread side of it? Or is there stuff beyond what I just sort of mentioned on the balance sheet side? And you have sort of hinted at some of these new initiatives, I guess, over the past 6 months or so.

Yes. So the first thing I'd say is that, as you know, our model is designed with sort of a calibration and self-correcting, right? So when you get into a more difficult environment, clients tend to increase their cash levels. You saw that in some of our recent reporting. And then that -- those cash levels tend to stay elevated for a number of years before maybe slowly working their way back down toward historic norms. But the big-picture answer here to your question is to us, it's really just all about investing time horizons. You know that we make decisions long term. And if that wasn't the case, we certainly wouldn't have gone to 0 commissions how we did last fall. I think even some of our competitors wanted to understand the timing, but they were thinking of things in a different time horizon than we were. As you mentioned, we enter into this period of ZIRP in a much different place than we were back in the later part of the last decade. We have much higher profit margins, somewhere between 10 and 15 points higher pretax margins. Our revenue stream is much more protected than it was last time because we had such a small balance sheet then, and most of our cash revenue came from money market funds where the fees got waived down effectively to 0, but balance sheet cash always maintained meaningful spreads. I don't think we ever dipped below 110-or-so basis points during the last period of ZIRP. So I think we're better positioned. The direct answer is, again, difficult environments create opportunity. And if your strategy is right and your positioning is right and your time horizon for building stockholder value is long term, I don't think you fear the challenging periods. You actually try to utilize them as opportunities to capitalize on and emerge a better firm and a better-positioned firm. When the environment is great, it's hard to tell who's really winning and who's not. It wasn't Warren Buffett who said something about you only find out who's skinny-dipping or swimming naked when the tide goes out. And certainly, the tide has gone out now. And I think as time will show, we had our swimsuit on.

Yes. I'd tell you what, as we joked or discussed prior, and you swam in the pond before with the 2008 financial crisis and the interest rate headwinds there, so you've been through this. I do -- we got probably about 10 minutes, but I do want to talk about the institutional segments often overlooked. Just to me, as you look at asset growth, stability, what they do for Schwab, and I guess, if you could just generally give us an update because we haven't heard as much. We've heard a lot about the retail engagement during this -- the pandemic period. But what are the advisers -- what are the feedback in your interactions with the adviser space coming out of all this as well in the outlook, I guess? Any advice for us?

Sure. So one of the things that RIAs do incredibly well is when we're in a period of high volatility, they do a magnificent job of working with their clients, communicating with them. I think we all recognize that the fee that an investor pays to an independent investment adviser is not simply for a portfolio work or counsel. It also -- they're buying a little bit of psychological help. And in tough times, it's -- that's a great value to keep investors from making decisions that would hurt themselves in the long run, for example, selling out at the bottom and making rash move. So the RIAs do a magnificent job of that. And so what you see during periods of high volatility is more stability in the way RIAs invest and help their clients manage money. In terms of the RIA segment, it's a critical segment for us. It has been both financially important but also strategically important for us for decades, and it's going to continue that way. Now it's different than the retail channel. The growth in that business is strong on the metric side. But we also know that the financial implications of that business have been under more pressure of late. But our margins there still remain very consistent with our retail channel. So the 2 generates similar profitability. The other thing that's really interesting about the RIA channel is that when you look at our margin percent, they're really the same for the smaller RIA, say, those that are under $50 million or $100 million as they are for the very large RIAs who are multibillion. So the economics of all the RIAs makes sense for us. And we're highly committed to that business and committed to every single segment. We want to help the RIAs continue to grow and operate efficiency. Never take any RIA for granted. What we know is that every new account that an RIA has is like a new competitive battle. And they can place that at any other custodian. So it's a critical business for us, highly committed. And we're going to continue to strive to be the best custodian in the industry.

And Walt, maybe, again, you were here for the last financial crisis. It seemed like investors in the retail side actually moved to more advice. At least that was the impression perspective I had during that crisis. This time around, do you think it's still at least -- I know there's a lot of independence, it seems like, as well with the technology advancement. But do you still feel like people are moving given the volatility in the environment towards the advice channel?

So what happened last time around is sort of playing out this time also, and that is you first get a period where you have a bit of paralysis in that people maybe pull back a bit on signing up for advice or adding assets to advice because they just watched, many of them, their account values decline. And so you get a little bit of a period of paralysis. And then as that wears off, then people start to traditionally sign up more for advisory-type solutions. But you have to go through that adjustment period first particularly among people who already may be involved in advice or people who may have been managing money themselves, and they recognize that not everything is going to just snap back overnight. So I think we're into that period right now. But we feel pretty optimistic about the balance of the year as people move out of that, again, sort of quasi-paralysis stage.

That's helpful. I guess -- and we have 5 minutes here. So I just want to go through sort of a more of an open-ended question. You've mentioned Schwab is a disruptor in itself. And being the scale that you have, it's not easy to accomplish to stay nimble and flexible. So I guess, the question is -- and later in our program, we have a bunch of several companies and new entrants. So the question is how do you balance, looking longer term, Walt, this disruptive capability at Schwab? Does these new entrants drive innovation even at Schwab? That's one part of it. But then what's sustainable? What keeps the pillars and foundation of Schwab that's made it the firm that it has over the last 25 years that retail investors can still recognize the brand and come back to it, I guess, look for Schwab given these pillars that you can describe better than that?

Yes. So I think so much of it is mindset as opposed to size. We all have seen sort of the funny YouTube videos of the little tiny dog who's going after the Great Dane and thinks he's a Great Dane also. It's a mindset. And I think at Schwab, no matter whether we're the small dog or we're the Great Dane, we have that mindset around disruption and innovation. And we just recognize that in the world we operate in, where there is no shortage of VC money available and no shortage of opportunities for niche firms to try to come into the space, we have to have an extra focus on the client and an extra willingness to be disruptive even to ourselves to the extent that action benefits clients. So I guess, I can't envision a Schwab where that mindset doesn't exist, where we always think of ourselves as sort of an underdog and a disruptor and, therefore, are willing to do what needs to be done in order to continue to grow the firm long term. And let me just emphasize. In the world we live in, growth is largely going to come for most companies from adding clients. We know that pricing is under pressure in every industry. There's no industry where there isn't some form of pricing pressure. The key is can you win new clients? Can you add new households? Can you add new assets? That will power growth. And to do so, you have to be nimble. You have to be willing to be disruptive. And I just think that's core to who Schwab is.

And going forward, again, you've proven that you are the stable force in the retail brokerage industry over time. So I guess, going forward, what does Schwab look like, say, 5 years down the road? Is it still -- are you still oriented? Are there new -- will there be a greater move towards technology or innovation that make you look more like the disruptors? Or will it still be to the core of Schwab very much the same, I guess, is the question.

Well, I guess, I'd say that the core of what makes Schwab unique and successful and has is going to remain the same, beginning with the strategy through client size, executing on the strategy through the virtuous cycle. Then you're not going to see us moving away from things like omnichannel or exceptionally competitive pricing for our clients, the strength of the brand, those types of things. Again, I believe that investors are intrigued when they see niche-type providers, but any investor of size and means also recognizes that there are trade-offs in those. And therefore, that's contributed probably to the type of growth and success that we've had as people look for stability but also the innovative types of things that we'll do at Schwab. In terms of the evolution, certainly, there's going to be change. You know of the efforts that we're making in the world of direct indexing. We think that's going to play a major role. We think some forms of socially responsible investing is going to play a major role. We believe that self-directed investors are increasingly looking for help, maybe not advice that we'll run your portfolio for you but tools that help them be better investors themselves. So I think you'll see those types of things continue to be introduced by us, just like the Schwab Stock Slices, but you'll see it applying to all different segments of our clients.

Well, time is up, but I do want to thank you for us -- for helping us sort of, I don't know what you call it, celebrate but certainly feel our way through this end of an era. Again, you and Schwab overall has proven to be sort of the constant force throughout the couple of decades of change. So hopefully, that wasn't as painful as the first time. I do appreciate it. Hopefully, you enjoyed yourself as well.

Thanks a lot, Rich. It's fun to do this. And good luck with the rest of your conference.

Thank you very much. And that will wrap us up. And very shortly, we'll -- now, Walt, we're going to go talk to one of the pioneers of the industry, Glenn Hutchins, who early investor in Datek, which got bought by Ameritrade. So -- later to Schwab, now anyway. Thank you very much.

All right. Thank you, Rich.

Good morning.