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

And we are live. Good morning, everyone. Welcome to Schwab's Spring 2021 Business Update. This is Rich Fowler, Head of Investor [Audio Gap] still sparsely populated 211 Main Street in San Francisco. Although activity around here is picking up bit by bit, and we, as I believe to be the case with many of you, are now more actively discussing how a general return to office might look and unfold for Schwab. But in the meantime, we hope everyone on the call and your families remain safe and well, and we thank you for spending time with us today. Let's set the stage and get underway. So joining me, both virtually and literally again, are Walt Bettinger, our President and CEO; Joe Martinetto, Senior EVP and COO; and Chief Financial Officer, Peter Crawford. And with the TDA integration process in full stride, it looks like Joe is probably going to be something of a regular around here, at least for a while. And so we'll once again plan to spend a bit longer than normal with this call around or up to, let's say, 1.25 hours so these 3 can bring you up-to-date on life at Schwab right now, starting off with some prepared comments and following up with Q&A until it's time to wrap up. We will follow tradition on questions. We'll do so via the webcast console as well as the dial-in. [Operator Instructions] Walt will start us off today to talk about the strategic picture. Joe is indeed here to share an update on the integration process. And Peter will review the recent financial performance of the combined organization and then move to discussing our current financial outlook before taking us into Q&A, which Jeff Edwards will moderate. Before that, let's spend 1 second on the wonderful wall of words, holding steady at that single riveting page. The main point of which is to remind everyone that outcomes can differ from expectations, so please keep an eye on our ongoing disclosures. Finally, the slides, as we've begun doing, will be posted on the IR site during Peter's prepared remarks. With that, I think we're ready to get going. So Walt, over to you.

Thank you, Rich, and good morning, everyone. Thank you for joining us. The first quarter of 2021 was rather remarkable on many fronts, highlighted by record client engagement, record growth in core net new assets and new brokerage accounts, and of course, record financial results also. The results were made possible by the powerful combination of a surge in investor enthusiasm as well as the no trade-offs positioning we've worked so hard to achieve in recent years. And yet, I think even as we celebrate the successes of the first quarter, we also recognize that the quarter brought challenges as well for our systems, for our service levels and for our people. In many ways, the timing, though, of the extraordinary client engagement and the related volumes of the first quarter was a blessing to us. Where in the past, we might have thought, for example, of technology capacity needs as measured in multiples of peak prior volume and build our infrastructure to support that. I think we now recognize that this approach was likely not the correct path. We now realize that as we progress in the integration with TD Ameritrade, we need to think about capacity in an entirely different light: by taking advantage of the scalability of modern technology, including the cloud, in order to really access, what I would call, massively scalable capacity at a moment's notice so that we can ensure that we're there from a technology standpoint to serve our clients. Our commitment to remaining the leading provider of scaled investment services in the industry never wavers. And despite some of the service challenges we faced in Q1, our mystery shopping of competitors, even greater service challenges throughout Q1, validates that we remained a leader. Now nevertheless, we hold ourselves to a higher standard, a standard of no trade-offs, and we're continuing our pursuit of this aspiration. Our strategy remains consistent. It's client focused and successful, as our Q1 results validate. So the environment in Q1 was friendly to investors, I suppose, apart from certain bondholders. Equity markets climbed, and the yield curve steepened as confidence grew around the post-pandemic recovery in the economy. And that led investors to a positive sentiment on investing, a positive sentiment that rivals their most optimistic view since the pandemic began early in 2020. The combination of positive investor sentiment, strong equity markets and our market-leading strategy and positioning led to record levels of net new assets and new brokerage accounts. You can see here that core net new assets were almost $150 billion in the quarter. That's double the level of Q1 a year ago and higher than the entire 2016 calendar year. Similarly, new brokerage accounts were a record 3.15 million in Q1. That's higher than the entire 2020 calendar year, and approximately, double the full calendar year levels from recent years. I think what's important when looking at metrics like that is that these come as a degree of trust from our clients. And that's both humbling to us as well as a clear message of the confidence that our clients have in Schwab serving their investment needs. Given the extraordinary trading volumes during the first quarter and all the related publicity, it can be easy to ascribe our Q1 results to a onetime trading surge. However, I think when you look closely at our internal metrics, it shows that there's a lot more to Q1 than simply trade volumes. Clients engaged with us at record levels in a variety of areas, including our Stock Slices offering, working with our financial planners as well as taking advantage of margin lending to be able to leverage investment opportunities for the long term during the growing equity market that we experienced. Both our Investor Services and Advisor Services units set records for net new assets during Q1. Investor Services also set records for new-to-firm household acquisition. We exceeded 1.5 million new-to-firm households during the quarter and continuing our appeal to younger investors. About 70% of those new-to-firm households were people below the age of 40. Our overall competitive position remained very strong. We continued with about 30% of our flows -- our inflows coming -- or net inflows coming via transfers from competitors. That's similar to the level that we were in Q1 of last year. And our transfer ratio, a solid measure of our competitive position, remained quite strong at 1.6:1. One of the things that comes up a lot, particularly after an extraordinary quarter like Q1, is we're asked whether this is a new normal, I guess, for trading activity. And if it's not, what do we think that new normal will be, and of course, when might we reach it? And the short answer, of course, is that no one really knows. As we moved into March and now well into April, we did see client engagement moderate to some extent. It still is elevated, but it does appear at levels that may be more sustainable for the long term. Our view is that with the move to 0 equity commissions as well as the popularity and ease of mobile investing and mobile trading, it implies that we're going to see an overall higher baseline level of trade volume than we might have seen in the past. At the same time, our experience suggests that we're likely to see periods of spikes in trade volumes, but often followed by slowdowns in activity as has gone on for many, many years in the investing world. I think when I look at Q1, what is really critical to me is that, where we experienced one of those spikes in trading volumes and asset flows and new client household acquisition, they also create an ongoing growth opportunity. They're not simply about onetime revenue benefits. Go back to my example of adding 1.5 million new-to-firm households. That type of strong organic growth in the first quarter, that should contribute to ongoing revenue streams that should benefit us for years to come. And that's why it's so important to be there for our clients to lead the industry and phone availability and speed-to-answer even if it's during the most challenging times, as part of Q1 was. So these periodic unique opportunities to acquire outsized levels of clients, they often come up unexpectedly. They're really not something you can necessarily anticipate. And yet, they create opportunities that should positively impact our financial results for years to come. So just taking a look maybe a bit more tactically at the first quarter, the metrics here on Slide 10. They paint a picture of just how engaged our clients were. And I think they provide further support on just how critical it is to offer an omnichannel approach to acquiring and serving clients. In addition to record levels of mobile and web engagement, we saw call volumes spike during the quarter to truly unprecedented levels. And of course, as all of you are well aware, trade volume records were set repeatedly throughout the first quarter. Now as I referenced briefly earlier, throughout Q1, we utilized mystery shopping to evaluate the call responsiveness of our competitors and be able to compare it to ours. And -- although there were definitely times that we were not satisfied with our speed-to-answer on calls due to the extraordinary volumes, based on the mystery shopping by third party, we fared well relative to competition with our speed-to-answer on average, noticeably faster than most competitors. At the same time, we were diligent in our efforts to address client service volumes throughout the quarter. We implemented a series of strategic as well as tactical actions. And by quarter end, we'd largely solved the challenges of answering client calls in less than a minute. Now that's still a little bit longer than we historically have targeted and averaged, but we did get that speed-to-answer down under a minute as the quarter drew to a close. We also recognize, though, that we retain our valued clients by serving them well, by serving them in the manner that we want to be served, really, the essence of our Through Clients' Eyes strategy. And maybe to draw a parallel, even in the most challenging of times, we're committed to not simply having the nicest house on a block of dilapidated houses, an argument maybe that we could make about our client service experiences in the first quarter. But our goal is right to have the nicest house on the nicest street and on the nicest block in town at all times. Our clients, frankly, deserve nothing less. And we aspire to deliver that degree of service to them. So let me move back a little bit more to the bigger picture. Our 3 company-wide strategic initiatives, of course, remain intact: scale and efficiency, win-win monetization that benefits clients along with Schwab and client segmentation. And as I stated in early February, each of the acquisitions or project investments or product introductions or enhanced capabilities that we've previously announced or are working on, they all fit clearly into 1 of these 3 initiatives. So taking a look at them. As I think you all know, we are passionate about scale and efficiency. And we're passionate about it because the firm that can deliver an industry-leading level of service and client experience at the lowest operating cost maintains strategic advantages. And you can leverage those strategic advantages to both better serve our clients as well as at the right times to take actions that can capitalize from a competitive standpoint. When it comes to scale and efficiency and the metric here, our goal is to continue to push this operating efficiency metric lower and lower. That enables us to both reward our clients with ever greater value, but also to reward our stockholders with strong margins and profitable growth. And I know Joe is going to discuss here momentarily. We're continuing on our progress toward the TD Ameritrade integration, and at the same time, we maintain all of our existing efforts around the digital evolution of our firm overall. So looking at win-win monetization. We're progressing on a series of tracks. We're actually not going to spend a lot of time on that this quarter, but we'll certainly be spending time in upcoming quarters throughout 2021 and into early 2022 on a number of our efforts here. One area of focus in 2020 and then carrying over into Q1 of 2021 was further developing our investment solutions and advisory capabilities. And we started to see some dividends paid on that in Q1 with about $19 billion inflows into our investment and advisory solutions. Inside that, I was very encouraged by one item in particular, over $1 billion in fixed income flows to our Wasmer Schroeder unit that was just opened up to our clients on the fixed income side. We also had about $11 billion into our Schwab ETF franchise. So that was also very encouraging. As I mentioned, I'm going to share a lot more on our win-win monetization efforts as this year progresses and we move into 2022. We also continued to see positive responses to our client segmentation efforts. Again, I'm going to talk a lot more about that as the year goes on because in the first quarter of this year, we largely avoided introducing new services into our clients so that our people could focus on client service. And our clients had enough going on at that time without new segmentation introduced. But even then, our efforts over the past year have shown some success, particularly on the lending side, on the liability side of our clients' balance sheet. Our mortgage originations grew to about $20 billion in the last year, and our pledged asset lines were up over 60%. So client usage of our capabilities on the lending side of the balance sheet continued. Again, on the big picture, as always, our strategic priorities revolve around our commitment to a no trade-offs approach to serving our clients. And by that, we mean value, service, transparency and trust. Those are the hallmarks of our commitment to clients. They're the North Stars that we follow as we execute on our strategies. So let me go ahead and summarize here. Q1 was very unique. It was a unique and extraordinary quarter. On the negative side, unprecedented industry-wide volumes meant that, as I shared, we did not always live up to the expectations we have for ourselves or that our clients have for us. On the positive side, we saw that record client engagement leading to record client volumes, record organic growth and record financial results, as Peter is going to discuss. I think what's important, though, particularly after a quarter like Q1 of 2021, is that we remember that our view at Schwab is never quarter-to-quarter. We're always focused on the long term. We recognize that the path forward will always have mountains and valleys. That's just the nature of the investment services business. During those periodic times of environmental upheaval, our strategies, our priorities, our strategic initiatives, they remain consistent, and they remain intact. I often say that if it takes more than a few words to explain your company's strategy, you don't have one. And at Schwab, you can be confident that we do, Through Clients' Eyes, yesterday, today and tomorrow, no matter what goes on in any given quarter. So Joe, let me go ahead and turn it over to you to walk through some of the -- where we are with the TD Ameritrade integration process as well as some of the impact of these record client volumes on our planning for that.

Okay. Great. Thank you, Walt. And hello, and thank you to everybody in the investment community that's joining us this morning. I'm sure you'll remember that back in the winter business update, we weren't quite in a position to provide an update on integration timing. So I'm here today to provide that update, to offer some thoughts on what integration will look like and then also update you on some of the projected synergies. Since the transaction was announced, we've been through a pretty remarkable period, which has led to incredible growth. You've read or heard a lot of the metrics already, and I'm not going to repeat them. And while this kind of growth is great for the long-term franchise value, we've needed to reframe the integration planning in light of this level of activity. So for example, our original deal model at the time of acquisition assumes that we needed capacity to be able to handle about 12 million trades. Well, we broke through that 12 million mark with a record high of 12.3 million in Q1 and had several other days that were pretty close to that. And while we were able to maintain pretty solid availability, we definitely felt strains in our systems and our service levels. So we've updated the integration plan to address the higher capacity needs in both systems and service. But as I said, these are good challenges to have. The revenues from the TDA business have also been substantially higher than our original deal model indicated as a result of the higher volumes. And the very strong organic growth that we've seen on the TDA platform over the last 11 months suggests that the long-term revenue potential of the business has increased as well. The revised integration scope covers 3 main areas. First, as Walt referenced, we're building a massively scalable back office. We've now incorporated the completion of the application modernization program into our conversion time line. That alone gets as much of -- gets much of our infrastructure decoupled from the mainframe and configured to run in both private and public cloud. And we expect we'll be using more public cloud for future production environments to allow us to manage infrastructure costs as well as to provide capacity for activity spikes and future growth. Second, we're adding a number of client capabilities to make them available upon conversion. With the growth in clients and accounts, the additional digital and self-service capabilities will help to limit excess demands on our call capacity and ensures a smoother transition for TDA clients as well as adding new functionality for existing Schwab clients. Much of this work was on our post-conversion road map, but we've determined it's necessary to ensure a smooth client conversion. And finally, we're continuing to make investments in process automation to drive scalability into our operations. At the higher volumes, more of this work has a positive payback, and the work will also limit hiring necessary to support growth in the future. You might say that we're addressing some near-term conversion challenges, but in doing so, we're creating an even better client experience for all clients while also increasing scale for the long run. The additional scope pushes us out to the long end of our initial time frame, and we now expect to complete conversion within 30 to 36 months. We also expect that the work will cost more than originally estimated given the increase in scope, pushing the total integration budget up to $2 billion to $2.2 billion. Roughly half the increase -- yes, roughly half the increase is driven by the volume changes alone, and the remainder is the additional work that we brought into scope to provide a superior client experience and mitigate some of the future risks to our service platform. So I'll wrap up by reiterating our confidence in achieving the expense synergies that we previously shared, delivering on 25% to 35% of the total expense reduction in the first year after deal close. And with the added growth and some additional opportunities on the revenue front, we now expect total synergies to reach to $4.3 billion to $4.8 billion, which is an increase of $800 million from our original estimate. Some of this is coming from the franchise growth beyond our original model, largely impacting the IDA repatriation, and some from some newly sized opportunities like additional wealth management, order flow revenues, securities lending and pricing harmonization. Roughly 40% of the increase is coming from these newly sized areas and 60% from franchise growth. So let me take a minute to summarize all of the financial impacts. We've increased the upfront integration cost estimate by $400 million to $600 million, and we've increased the recurring revenue synergy by $800 million. And since the announcement of the transaction, we've seen revenues from the TDA platform exceed the deal model by about $2 billion. We're still within our original time frame for -- even with the added work. We're committed to achieving the cost synergies and looking to outstrip our original revenue synergy estimates. The upfront cost is higher, but for that added cost, we'll have a more scalable technology platform, a stronger client offering a conversion and a more scalable operations platform to support future growth in the original integration model contemplated. We believe we're making the right trade-off decisions for the future of the firm and for enhancing long-term shareholder value. Now I'll turn the mic over to our CFO, Peter Crawford.

All right. Well, thank you very much, Joe. It's great to see you here again. So Walt talked about the unprecedented level of client engagement we're experiencing; about the strong momentum we have in the market, as demonstrated by record new accounts, new-to-firm retail households and core net new assets; and about the steps we're taking to improve our service and press ahead on our strategic priorities around scale, win-win monetization and segmentation. And then Joe, of course, talked about where we are with the TD Ameritrade integration, some of the challenges that we're tackling, but also, quite importantly, our excitement and our confidence about both the financial and the strategic benefits the acquisition has brought and, we think, will continue to bring. So in my time today, I'll talk about how we're able to translate that record client engagement and record business momentum into record financial results as well, also provide an updated outlook for the rest of the year, rolling forward the "mathematical illustrations" we shared back in February, which reflect the difficulties in predicting the evolution of client engagement in the near future. What you'll hopefully hear is that this is a company that is thriving, a company whose actions over the last several years, as Walt mentioned, are combining with some long-awaited tailwinds to produce strong operating and financial results. While we don't know how long this heightened level of client engagement will last nor the future path of interest rates, we feel quite confident in our ability to continue growing and continue producing enviable financial performance regardless of the environment, even as we make appropriate investments in building for the future, supporting our clients and capturing opportunities to serve them better. And that's what fuels our optimism and our excitement about the future. So let's talk about some of the factors that contributed to our record financial results in Q1. It was a quarter where nearly everything lined up quite well: an improving macro environment highlighted by higher equity markets, and finally, interest rates starting to move higher as well; continued positive investor sentiment, reflected in the higher-margin balances and trading; and our no trade-off positioning, producing strong organic growth as indicated by nearly $150 billion in core net new assets and over 3 million new accounts. When robust client engagement, a constructive macro environment and strong organic growth come together, very healthy financial performance should be the result. And indeed, it was. Given that our reported financials didn't include TD Ameritrade in the first quarter of 2020 and consistent with the outlook we shared at the winter business update, we're comparing our results here instead of the fourth quarter of last year. Revenue increased 13% sequentially, driven mostly by a 42% increase in trading revenue due to higher debts or daily average trades, and also by a 6% increase in net interest revenue as higher interest-earning assets more than offset a 7 basis point decline in net interest margin due to reinvestment rates that have improved, but were still below our overall portfolio yield, while asset management and admin fees increased despite a slight decrease in money fund fee waivers due to a drop in short rates. Our expenses increased 9% sequentially, reflecting seasonal items, such as payroll taxes and compensation, which we anticipated and called out in the waterfall chart, you may recall, we shared back in February; and higher volume-related expenses, which frankly, exceeded our expectations, but are a fraction of the revenue associated with those activities. So I think you can say the expense variance is definitely a high-class problem, though I'd argue it's probably not really even a problem at all given the revenue associated with it. With 400 basis points of operating leverage sequentially, our pretax margin increased 6 points, and our adjusted pretax margin increased 2 points to over 47%. Our return on tangible common equity climbed to 24%. And all of this in the midst of an environment where interest rates are still at extraordinarily low levels. This, I think, demonstrates the durability and resilience of our business model. We've all seen how well we can perform in a more normalized rate environment. But with greater diversification now via trading and asset management, there are simply more ways to achieve the same strong level of financial performance. That was the income statement. Let's turn our attention to the balance sheet. Our balance sheet grew by 3% sequentially, reflecting a 9 -- roughly $9 billion increase in client cash on our balance sheet, nearly $7 billion of financing activities in March that we undertook. And that was partially offset by a roughly $4.5 billion reduction in AOCI, reflecting the impact of higher rates on the mark-to-market value of our available-for-sale portfolio. Now the composition of our balance sheet changed somewhat as well. We saw a roughly $10 billion increase in margin balances, mostly on the TD Ameritrade platform, and a 7% increase in bank loans as clients continued to capitalize on the exceptional mortgage and pledged asset line rates offered by Schwab Bank. We benefited from the market's appetite for yield and added roughly $4 billion of debt to supplement parent liquidity and $2.25 billion preferred equity to increase our capital levels. And finally, you'll see we issued a further $600 million in Series J preferred earmarked to redeem our Series C, effectively lowering the coupon by 155 basis points. And with all of that, we increased our parent liquidity to over $14 billion, giving us more funds to support our clients' day-to-day trading needs and support our liquidity coverage ratio obligations. And our Tier 1 leverage ratio climbed to 6.4%, within sight of our operating objective of 6.75% to 7%. Now at the winter business update, we shared 3 so-called "mathematical illustrations," demonstrating how our 2021 financial performance might unfold given changes in trading, margin balances and client cash balances. And we did that, of course, given the difficulty in predicting exactly how client behavior would evolve from the then record activity levels we saw in Q4. Those 3 illustrations shared a set of common assumptions around "normal equity market appreciation," relatively stable interest rates that followed the forward curve at that time, the timing of our initial migrations from the BDA to our balance sheet and our level of CapEx. And as we've discussed, the macro environment has started the year markedly better than contemplating those illustrations. Now as you may recall, where the 3 illustrations varied is in their assumptions about trading, which we flexed plus 20%, minus 20% and flat; margin balances, which we adjusted plus 10%, minus 10% and flat; and then client cash on the balance sheet, also plus 10%, minus 10% and flat, excluding the IDA migrations. Now the year started out with even more activity than the upside illustrations had assumed with trading and margin balances up 45% and 19%, respectively, and cash balances trending consistently with that plus 10% illustration, 1/4 of the way, of course, through the year. So not surprisingly, therefore, revenue, expense and adjusted pretax margin all started off the year higher than the outcomes of that upside illustration. Now given the strong start to the year, we thought it was appropriate to roll forward the illustrations we shared 2.5 months ago. As you've seen in our reported metrics, there has been a lot -- there has been a bit of softening of client trading, while margin borrowing growth has paused for a little bit. Whether these trends are temporary or not remains to be seen. So just as we did at the winter business update, we're once again sharing with you 3 updated illustrations. These illustrations also have a set of underlying assumptions, several of which mirror what we shared previously, including rates that follow the current forward curve, equity markets that grow modestly from here and base securities lending revenue that's consistent with recent levels. We've also now made growth in client cash balances a fixed assumption across all the illustrations rather than a third variable. What we vary once again is trading and margin balances, with Q1 rather than Q4 as our new jumping-off point. But the same variation: plus or minus 20% and flat for trading and plus or minus 10% for -- and flat for margin balances. Each of these 3 illustrations would produce different levels of revenue growth relative to our annualized Q4 revenue. So just to be clear, we're comparing our activity levels relative to Q1, but the financial performance relative to annualized Q4 to be consistent with what we shared previously. And you can see that, depending on how the year unfolds, we can see revenue growth of 18% to 20% in the first illustration to a revenue increase of 7% to 9% in the third illustration. And adjusted total expenses will also vary, of course, from 5% to 7% growth off our annualized Q4 number. Now this is, of course, a few hundred basis points higher than what we shared at the winter business update. But let me assure you that there has been no change, I repeat, no change in our expectations for synergy realization in 2021 or, importantly, in what we're seeing in terms of core expense growth. Rather, the higher expenses are entirely a function of higher volume-related costs, including a couple of percentage points related to higher trading costs, including pass-through fees and a couple of percentage points related to higher bonus funding from the higher profitability relative to the plan we set at the start of the year. And across all 3 of those illustrations, we'd expect an adjusted pretax margin of at least 46% even as we bolster spending to maintain service levels. Now these illustrations, I think, continue to demonstrate the tremendous operating leverage we have on our business. Due to the nature of the drivers being flexed, the implied profit margin on the incremental growth across the 3 different scenarios is 80% or more, which is especially noteworthy given our need to support very strong organic growth we've seen to start the year. With higher reinvestment rates and the early growth in margin lending, those mathematical illustrations, I shared, would result in a net interest margin, or NIM, in the mid- to upper 1.40s for the year and an average yield on our available for sale portfolio that is relatively stable over the next couple of quarters before perhaps increasing a bit in Q4 if prepayment speeds, easy for me to say, is slow, as many expect, and therefore, premium amortization declines, with the usual caveat that the exact trajectory of NIM is influenced by a number of factors, including how soon and to what extent prepayment speeds flow due to the increase in rates; the trends in reinvestment rates; the growth and composition of interest-earning assets, including margin utilization; and what happens with securities lending. Our #1 priority for capital management continues to be enabling the continued growth of our business, supporting our clients who choose to entrust us with their cash allocation. Our March issuances boosted our Tier 1 leverage ratio to 6.4%, still below our operating objective of 6.75% to 7%, but our highest level in a year and well above the regulatory minimum. Going forward, as I mentioned, we've earmarked $600 million to redeem our Series C preferred. And we'd expect to begin onboarding the first of the IDA migrations in the second half -- at the end of the second quarter. Maintaining sufficient liquidity is also critical, as the industry was vividly reminded during the January trading frenzy. Now the primary driver of our need for liquidity is supporting our clients' trading activity as well as maintaining a liquidity coverage ratio over 100%. And as well positioned as we've been, we decided to further supplement our liquidity position out of an abundance of caution with the debt offering and utilization of our commercial paper facility. Let me close with a few thoughts. A year ago at this meeting, I said our objective was to emerge from this crisis in a stronger position than when we entered it. And while the crisis is by no means over, I think it's fair to say that we are indeed a more potent, a more resilient and a more competitive firm than we were 12 months ago, and one with an even more all-weather business model. But we're -- as Walt mentioned, we're not taking any victory last year. I think both Walt and Joe talked as much or more about the challenges we faced and the opportunities before us as they did about our past successes. And those of you who have followed the company for a while know that's very typical for us. We spend a lot more time looking towards the future than celebrating the past. That's how we continue building the company that delivers on the high expectations of our clients, our employees and our stockholders, one that continues to win in the market, continues to drive strong top line growth and continues to improve efficiency and deliver strong financial performance. That's how we deliver for both clients and stockholders over the long term. With that, Jeff, let me turn it over to you to facilitate our Q&A. Thank you.

Great. Thank you so much, Peter, Walt and Joe, for your remarks today. Operator, let's go ahead and open up the lines and start Q&A. Can you remind folks how they may ask a question?

[Operator Instructions] Our first question comes from Dan Fannon.

I was hoping you could provide a bit of a breakdown of the incremental revenue synergies, the $800 million that you quantified in the various buckets that they're coming from. If you could provide a little more color there, that would be very helpful.

Sure. So I know that we're going to get into a lot of detail beyond what we've already articulated. But I think about 60% of it's coming from just the overall growth and the size of the franchise. So a bulk of that's going to get driven by the deposit movements, about 40% coming from some of the items that we didn't have as much clarity around on in terms of sizing. So things like wealth management, asset management sales, securities lending, some of the trading revenue flows, fees, those kinds of things are making up the remaining 40%. So -- and again, piece of it's coming from the -- just the overall growth we've experienced in the franchise. A chunk of it's also coming from things that we now have a clear vision in. I would say that we're going to try to, as always, accelerate as much of the opportunities as we can, see what we can recognize before that client day 1 conversion actually happens. Right now, I don't think we're in a position to provide a detailed kind of update, but I'm sure Peter will be continuing to update everybody as time goes on and how to think about factoring that into the ongoing updates he's providing around earnings and revenues.

Great. And then just as a follow-up, Walt, just wanted to get some additional color around the sustainability and activity. And obviously, we've seen some normalization or slowdown here in April, but you talked about getting comfort that we're maybe getting closer to a flattening of that. So maybe talk about what you're seeing, whether that's the profile of the new accounts that have come on board or the kind of manner in which your clients are engaging with your platform that gives you comfort that we are in this more of a stable period.

Sure, Dan. I mean I don't know that I can comment it when it comes to trade volumes. But I think what you have, and this is going to be somewhat consistent with Joe's comment, response to your first question, is that the base is much larger. And so when we look at historical metrics around, whether it be trade behavior or investment behavior or cash balances that clients maintain, the franchise is just larger. And as a result, I think it gives us a degree of confidence around future performance of the firm. We definitely have -- are tracking metrics around the change in client behavior that began a quarter or so after we moved to 0 commissions. It takes time for that to work through the system and consumers to understand what has changed, even though we all live it on a day-to-day basis. And the trend lines that we've seen, if you take out a bit of the spike that occurred earlier in Q1 around some very, I think, unique behaviors and unique issues, if you sort of take that spike out, you see a trend line that is relatively consistent since the move in -- to the 0 commissions. So I think the combination of those 2 things are what give us the confidence.

Our next question comes from Steven Chubak.

So maybe for my first one, Peter, I have a media question on premium am, if you'll indulge me. You had a great slide at the winter business update highlighting the drag that had been at the securities -- on the securities yield. But it's more challenging converting that into an NII dollar benefit just because you continue to grow the MBS portfolio at a really rapid clip. And if we look at the 2020 premium am, it was more than $1 billion higher than 2019. I think even if we adjust for growth, the premium am headwind is still in the range of about $800 million or so. So prepayment speeds normalized close to 2019 levels. How should we think about the NII benefit in dollar terms? Is that $800 million a reasonable expectation? And how much of that benefit is contemplated in the NIM guidance you gave on this call for the remainder of the year?

Okay. You are right. That is a media question and a difficult one to answer in the -- in this context in a short period of time. So let me maybe take a step back and talk a little bit about premium amortization. So you're right that premium amortization is driven by, I would say, 3 factors. One is just the overall growth in the balance sheet. Second is the fact that we've been -- with low interest rates, we've been buying more securities that actually have an embedded premium in there. And therefore, we need to -- the way that the accounting works is we amortize that premium over time. And then third is the acceleration of prepayment speeds, which has accelerated the amortization of premium on some existing securities. So while we expect some degree of premium amortization, we wouldn't expect that it was going to go down to 0 or anything like that. If you look back on -- from the numbers from roughly Q1 to Q4, that acceleration component, I'm looking at Jeff, I want to say it was about a 30 or 40 basis point increase, if I recall, on the available-for-sale portfolio, somewhere in that range, in terms of the impact of that. And I would say in the first quarter, I think the numbers were plus or minus a few basis points from that. The -- we would expect -- with the increase in rates, we would expect that those pay down -- that pay down activity to slow, and therefore, that accelerated portion of the premium amortization to slow down as well. It typically takes a few months between when you see an increase in rates and that happens. And so our expectation is this is something that will begin to be reflected in our overall available-for-sale yield as well as our net interest margin, more in the second half of the year than in the second quarter. And it is contemplated in the -- those illustrations that we shared with you earlier in the deck.

Okay, Peter. And just for my follow-up, just on the bank lending opportunity, that was touched on a bit more in today's presentation. You talked about the strong growth that you've seen. I think the balances are up about 30% year-on-year, noting just more competitive pricing on mortgage and pledged asset lines. At the same time, your loan penetration is still well below many of your wealth management peers, and I think you're at about 30 to 40 bps versus peers at 100 basis points plus. And how do you think about the opportunity to grow the loan book? And what penetration rate do you believe is achievable over the long term as you start to prioritize this a bit more?

Yes. It's a great question. So we think there's a lot of opportunity there to grow the loan book with those pledged asset lines and the mortgage product. If you look at the rates that Schwab Bank is offering today, they are -- even the rack rates are exceptional. And then we give -- we have something called investor advantage pricing, which gives our clients even better pricing depending on how much business they have with us. And when you add those or subtract those discounts from the rack rate, the pricing is truly spectacular. And it's been great, the last year, seeing the incredible enthusiasm and awareness and confidence that our clients and our client-facing employees have had in Schwab Bank and had a very good experience over the last year. And I certainly remain very hopeful, and I think, we all remain very hopeful that as the market shifts more of a refinance market to more of a new purchase market that, that credibility and that awareness and the experience that more of our clients, more our client-facing employees will be -- will turn to Schwab Bank for their lending needs. And if you look at the penetration, as you say, among some of our competitors and wirehouses and others, you can see penetration rates that are multiples of where we are today. And that -- those products are not only helpful for us financially and offering us a better spread to the securities that we'd otherwise buy, but they're really important to us strategically as well and that they keep our clients from needing to turn to large banks for their lending needs. So we're very enthusiastic about that opportunity. And that's one of those opportunities that, frankly, we also see on the TD Ameritrade side as well and are very eager to pursue that and make them aware and have access to this capability as well.

I just want to jump in and make a very quick comment, if I could, on the part of the question that revolved around goal. One of the things that maybe is a bit unique about the way we approach things at Schwab is we tend to not put goals out there for given products or given solutions because our experience is, if you put a goal out there, then well-meaning people work really hard to achieve that client solution goal or product goal. And that's not necessarily through clients' eyes. That's sort of through the company's eyes. And so rather than putting goals out there, our approach is to try to design solutions that are great for clients. And then if clients agree, then they utilize those products and solutions in a significant way. And if clients don't agree, then they don't utilize them, and that sends us back to the drawing board. So our approach is sort of the opposite of a lot of organizations. We come at it from the perspective of, we don't want to establish a goal. We want to build the best solutions we can, and then clients will tell us if we've achieved that. And if we haven't, we go back and work to fix it rather than having it driven off a top-down goal.

Our next question comes from Ken Worthington.

There's a lot of interest in cryptocurrencies, particularly from younger, smaller investors. What are your thoughts in offering crypto products? And how are you thinking about product capabilities that are important for your existing customer base today balanced with the free crypto trading that might be attractive to a new or younger Schwab investor base for the future?

Walt, would you take that?

So we are looking very closely and, I think, cautiously at the crypto market. We can certainly see some of the client excitement, particularly with certain segments of the market. And I would expect as greater clarity is recognized potentially by regulators that we would consider offering capabilities in the crypto space. I think all of you would probably say that if we -- if Charles Schwab, the company, decides to participate in the crypto market, we will be highly competitive, we will be disruptive, and we will be client-oriented. I think in the meantime, additional clarity from regulators would be important before we would consider offering a retail-type trading experience on crypto. There are ways to invest in crypto today, some of which are available in a derivative basis through Schwab. And of course, we're keeping our eyes closely on whether there would be investment-oriented product, whether it'd be ETF or others, that will be delivering crypto investing to a larger part of the market than can get it today via some of the funds that are out there but may be available on a more limited basis. So we're watching -- I guess, in summary, we're watching closely. We recognize a bit, I'd say, well, what's going on. We would like to see more regulatory clarity. And if and when that comes, you should expect Schwab to be a player in that space in the same way it has been a player in other investment opportunities across the spectrum.

Perfect. And then I appreciated your comments about sort of a new normal. How should we be thinking about minimum and maximum cash balances relative to total customer assets? To what extent are historic highs and lows and averages still reliable for what Schwab looks like today? And any thoughts you have on the direction of client cash balances versus total customer assets given the market conditions, if they remain robust?

Yes. So I'll take that one. Thank you, Ken. So this is the age-old question. Where will cash balances go? And what's the right ratio? And what's the equilibrium level? And I think you've seen in our history, those balances can tend to move around a fair amount. And you've seen the same thing if you look at the legacy TD Ameritrade business, recognizing a bit of a different cash strategy. The numbers aren't totally dissimilar. I'd say a couple of things. So first is the adviser segment tends to keep less uninvested cash than the retail segment. So you -- as those different businesses grow at different rates, you might see some differences there. But more broadly, what -- the biggest factors that influence cash balances are -- really, it's around the attractiveness of the alternatives, and there's really 3 alternatives. So it's how attractive are the equity markets? And that is a function of investor sentiment, which was -- clients were moving out of the equity markets a bit last year, and thus far, this year have been net buyers of equities. Second is the relative attractiveness of money funds, which, of course, is a function of short-term rates. In a period of time like right now where money fund yields are down to 1 basis point, we see more of a desorting process as clients end up being net sellers of money funds and are content to leave that cash on the balance sheet. So you tend to see higher cash allocations in a period like that. And then the third is the relative attractiveness of the fixed income markets, which is, I would say, less -- somewhat less impactful, but still can influence the level of cash allocation. And so as interest rates increase, more clients may avail themselves of the fixed income markets as well. So it really is very, very environmental. And then of course, there's obviously a denominator effect of what's happening with our overall account balance. So we've talked in the past around sort of that 11% to 12% range. It's going to go above that, and it's going to go below that over a period of time based off of those environmental factors.

Our next question comes from Devin Ryan.

I want to come back to the conversation you were having with Steven a minute ago on the premium amortization. I think it's an important topic. And so maybe from just a slightly different angle, if we look at, I think, the fourth quarter, it looks like, I think, there were 60 basis points of observable premium am. And it seems like that increased a bit in the first quarter. And so what I'm just trying to get at here is if rates stay where they are now, I appreciate there's a little noise over the next couple of quarters, but it would seem that there's a stair step higher heading out of the year if rates remain at current levels. So I don't know if it's possible to quantify what that might look like just as we work through or maybe reverse some of the premium am that's been affecting the NIM over the past -- really past year? And then also in the NIM outlook, what are you expecting for your sec lending contribution?

So let me take the second one first because that's the easier one. So for the sec lending contribution, we're assuming it's consistent with the levels that we saw in the last couple of quarters that we reported. So in terms of premium amortization, I'm just not in a position to be able to quantify exactly how many basis points of NIM lift it's going to equate to. But I will say, if rates stay where they are, one would expect that the level of refinancing activity and pay down activity that we've seen over the last year is going to moderate. I think we're not -- certainly not the only ones who believe that. I think many of our -- the banks have been talking about a similar dynamic. That does tend to happen with a little bit of a lagged effect as initially a lot of consumers end up -- they respond to higher rates by rushing to actually refinance. And a lot of the mortgage brokers and the banks sort of rush to get through as much of their -- of the pipeline as they possibly can. So I'd expect -- as I said, I think I'd expect this to become a tailwind and be accretive to our NIM in -- as we get into the latter part of this year and then heading into 2022 as well.

Yes. Okay, Peter. And then quick follow-up just on the BDA yield. Just maybe some of the moving parts in terms of where we are now and where that might bottom? And then just thinking about kind of the ability for that to start to work its way higher via the inputs to drive that?

Sure. So I think you saw -- you've seen in the reported metrics, the overall yield on the BDA has come down just a bit. That's a function of the rates that are -- the roll-off rates and where those are. I think the most recent roll-off rate, I want to say, is in the 160s range. If you look over the next 12 months, I think there's about $20 billion, if I'm not mistaken, that's rolling off. I think the new investment rate, depending on how far -- where we go out on the curve in terms of the fixed allocation, and of course, it's roughly 80-20 fixed-to-floating allocation, and the agreement is in the probably 70 to 115 basis point range. Of course, again, these numbers change because they're tied to the benchmark rates. So they can change day-to-day, and certainly, week-to-week. But -- and then, of course, as we get into the second half of the year, the new investments will be impacted because we'll be bringing on the balances most likely from the IDA onto our balance sheet. And so that -- those IDA, both the balances as well as the rates will be impacted by that activity as well.

And Devin, worth noting that there is some additional detail available on the IR website as well as in the appendix of the materials that have been posted on the BDA.

Our next question comes from Will Nance.

I was wondering if maybe I can ask a question on some of the asset management initiatives. I know you didn't have too much in the prepared remarks on them. I guess just on the 3 verticals that you've talked about on monetization in the past, so thematic and direct and indexing, I know we're kind of waiting on new products there. But in fixed income, you highlighted some of the progress that you've seen. Just wondering if you can maybe talk as well on some of the retail and then it was kind of charging for shelf space aspect and the monetization strategy? And maybe just kind of like a long-term, more financially oriented question, the runoff of some of the higher fee rate products and OneSource and just general fee rate compression has kind of been a structural headwind over a long period of time. When you think about all of these initiatives, do you think -- and recognizing, well, your comments earlier about not wanting to set explicit goals, but in your mind, are these opportunities large enough that they can maybe offset some of the structural pressure that we've seen and help drive asset management revenues kind of grow in line with client assets over a longer period of time?

Yes. So I think the answer is yes. But it does require a bit of a different way of thinking than we have in the past. So you've mentioned a couple of items that have application, certainly, thematic investing, which we expect to talk about quite a bit more over the course of the next year or so; and direct indexing, which we expect to have similar conversations with you, are going to have an impact. We think that there are a series of opportunities in helping self-directed investors and do much more, leveraging some of our rebalancing and tax loss harvesting engines. So that's a significant one. When it comes to third-party asset management, we're in the early stages of an evolution that I would categorize with deference to the companies I'll reference, a bit of a transition at Schwab from maybe a warehouse-shopping model to more of a stitch-fix type of model, where we expect to have deeper relationships with a few select, very high-quality partners. And they would be partners with great track records and low expense levels -- low relative expense levels, consistent with the way we philosophically think about investing at Schwab. And I think that, that along with some of the other things that I mentioned, we believe are going to have a meaningful impact from a revenue standpoint and give us the opportunity to address the headwinds that you referenced.

Got it. And then maybe just one more ticky-tack question for Peter on some of the balance sheet mix. You're talking about kind of some actions that you took on the liquidity front. I think over the past couple of quarters, there's been a bit more of a build-up in, call it, whether it's cash on the balance sheet, cash in the broker-dealers to support some of the trading activities. Just wondering how you kind of felt about the mix of the balance sheet towards the end of the period. Where are we in the process of kind of catching up with some of the outsized cash balance growth that we've seen? And how are you kind of thinking about deployment plans over the next couple of quarters, and obviously, recognize there's a lot of moving pieces with some of the BDA onboarding?

Yes. Great question. So when you look at that cash on a consolidated basis, you -- I think it's important to think about it actually in maybe 3 different buckets because it's an -- there's cash at the broker-dealers, which is the segregated cash, which is a function of the client growth of the cash in their account, minus whatever we're lending out in the margin lending book. So that's influenced, of course, by the growth in margin lending. There's cash at the parent, which we use to support the activities of the affiliates. And then there's cash in the bank. Now in the bank, we have been running a bit higher. Our operating objective for cash in the banks is at roughly 5.5% to 7.5% Fed reserves to total deposits. We were a bit higher than that in the end of the first quarter, and that was in anticipation of tax-related seasonal cash flows that we typically see in April and maybe now that we'll see a bit more in May. So I'd expect that those -- that -- those cash levels would return to more of that BAU operating level over the course of the second quarter.

Let's take maybe 1 or 2 quick questions that we received from the web. First one is for you, Walt. This comes from Jim Tierney, AllianceBernstein. Could you provide a little more color around the still strong but perhaps slightly different TOA ratio, the 1.6 that you spoke to during your earlier remarks? And how that trend compares to perhaps previous numbers we've shared?

Sure. And that's a really good question, Jim. I probably should have referenced that in my prepared remarks. So what you're looking at now are consolidated numbers between Schwab and TD Ameritrade. And TD Ameritrade historically has had net TOA numbers significantly below Schwab's. So when you aggregate the 2, even though the Schwab numbers are very high, the combined number appears that it's softened a bit if you're comparing to a Schwab-only number from years past. Bear in mind, TD Ameritrade's model is a bit different in that it attracts a lot of people who tend to be more trading-oriented, and so they tend to come to TD Ameritrade with cash as opposed to coming with securities. And Schwab's model maybe a little bit different. But the reason you see it slightly lower is all due to the combination, bringing the 2 together and the fact that TD Ameritrade metrics on both the investor side and the RIA side are historically measurably lower than Schwab's.

Great. Thank you so much, Walt. Maybe 2 quick ones also from the web for Peter. Maybe we'll go, and hopefully, order quickness. First, Peter, maybe a little bit of color around the current reinvestment rates within the portfolio?

Sure. So reinvestment rates have certainly moved up over the course of the quarter. I would say they're still probably 10 or 15 basis points below where our average portfolio yield -- on a blended basis, our average portfolio yield in the first quarter. That's a mix of floating rates that are down a bit to roughly 30 basis points, as we've seen some of the benchmark rates come down in the course of the quarter. But fixed rates that have moved up probably 20 to 30 basis points or so over the course of the quarter, up in more of that 130 range. So at an 85%, 90% fixed-to-floating, you get somewhere in that 115 to 120 basis point range on the reinvestment rates.

Great. Thank you for that. And then maybe one more, Peter. Question from the web from Bill Katz at Citi. Is there a natural limit on pretax margin kind of assuming top line backdrop, particularly with what we've been seeing on the rate front, further improvements or need to accelerate reinvestment or other changes around pricing, products, et cetera?

So I guess there's a natural limit. 100% is the natural limit. But I mean I think that we often say that trees don't grow to the sky. But what I would say is we don't have any -- certainly, we don't have any plans to sort of artificially cap the margin or the adjusted margin that we are able to derive. We've seen that we have a lot of operating leverage in our business. We're continuing to try to drive greater efficiency throughout the business, continuing to bring down the cost of providing the services that we provide. And so to the extent that we're in an environment where top line revenue is growing quickly, we're able to generate a lot of operating leverage and flow a lot of that to the bottom line.

Back to you, operator.

Our next question then comes from Brian Bedell.

A lot of my questions have been asked and answered. But maybe just one quick one on the securities portfolio. We've certainly answered a lot of this. Just on the premium am, is -- am I right to be assuming that roughly 3/4 or so of that premium am headwind on the portfolio is from the actual occurrence of prepays on those MBS versus 1/4 or less from scheduled amortization that is amortized over the life of -- expected life of the securities?

Yes. So I don't -- I mean I don't have those numbers in front of me right now in terms of what that breakdown is. But it is -- as you say, it's a mix between the 2. And it gets harder -- what I'd say is we're certainly doing -- we're taking steps -- whatever steps we can to remove some of that prepayment risk, if you will, out of the securities that we're buying. We tend to buy securities that are less likely to prepay. And this is why it gets really, really hard to talk about some of these numbers on a go-forward basis is just that we're making changes to the portfolio that will influence those dynamics going forward. But it is a mix between those 2 different drivers, if you will.

Got it. That makes sense. And then just back on the integration synergies, either for Joe or Peter. Just on some of the nearer-term ones that I think you talked about previously or at the winter business update, the BDA. I -- just correct me if I'm wrong, but I believe you're able to bring about 20 -- or you're expecting to bring about $20 billion over to the Schwab balance sheet on July 1 from that? And -- is that right? Or is there any change of that? And then I think you mentioned, Joe, at the business update about the payment for order flow harmonizing the Schwab and TD systems and leveraging the sort of a better capture rate on that. And I thought you said you start -- you would start working on that in the second quarter. Is that still in play? And is that part of this incremental synergy that we could see sort of sooner this year?

So I'll take the IDA one. So per the terms of the IDA agreement, we have the obligation to bring over the uninsured balances on June 30. And that's -- those are about, I think, $9-ish billion, plus or minus $1 billion. And then we have the option to bring over the balances equal to the difference between where the IDA is at that point in time and the level at Legal Day 1. And that's roughly $10-ish billion. And we have the option to bring that over to our balance sheet over the following 12 months. So we haven't landed exactly how quickly -- what time frame we would exactly do that, but that's -- again, that's an optional. Our intention is to do that, but there's certainly no guarantee that we will.

So on the rate harmonization, yes, we are moving forward with that here in the second quarter. It will take time to get it implemented there. So it won't likely have a material impact in Q2. It is part of those newly sized opportunities that make up a part of the increased total number.

Okay. Thank you all very much. I think that's all the time we have left on Q&A. Apologies for those that we weren't able to get to, but strong demand. So I want to turn it back over to Peter to help close out with any final remarks.

Okay. Well, thank you, Jeff, and thank you all for hanging in there with this extra -- our bonus coverage, if you will, the extra 15 minutes here on the hour. Certainly, appreciate that. And we covered a lot of ground. And I'm sorry, we didn't certainly have time to answer all the questions. I know there was a few others out there. But it's all the discussion about service levels and integration timing and cost and our Q1 financials and so forth. I hope what you see -- hope that it comes through as a company that is driving exceptional organic growth, delivering very strong profitability, has a -- there's a lot of opportunities to both drive greater efficiency throughout our business and greater revenue and stands to benefit tremendously if the surge and trading gives way to higher rate -- interest rates in the future; and finally, a company that is not satisfied, that is pushing forward aggressively on multiple fronts. Thank you very much, and we look forward to talking to you again in July.