Letter from the Chief Financial Officer

Neither Chuck nor I dwell much on the past. For all of my 20 years at Schwab, we have concentrated our energies on the opportunities and challenges that lie ahead, and once we have reached a given objective, we have paused only briefly to acknowledge it before moving on. Yet I believe anyone wishing to understand the Schwab of today – and grasp its potential for future success – must take the time to understand the chapter in our history that began in mid-2004 and ran through the end of 2006. Why? Because understanding how far we’ve come gives tremendous insight into the power of the Schwab organization when we’re all focused on pursuing our core strategies, on improving the client experience, and on maintaining financial discipline.

Clients, stockholders, and employees who’ve been with the company during this chapter already know that 2004 was about coming to grips with – and addressing – systemic issues of complexity, high prices, and an unsustainably large expense base. In turn, 2005 was about committing to and delivering stronger client relationships and financial performance. Last year, we set out to demonstrate our ability to sustain profitable growth while continuing to build client loyalty. So let’s take a look at how we performed in 2006 relative to our financial objectives, and then discuss how we did with clients.

Our planning scenario for 2006 included equity market appreciation of about 4 percent and a relatively flat interest rate environment. Under those circumstances, we committed to delivering low double-digit revenue growth, a pre-tax profit margin of at least 30 percent, earnings per share of “around” $0.70, and a return on equity of at least 20 percent. Bear in mind that all of these goals were set before we entered into the agreement with Bank of America Corporation to sell U.S. Trust and subsequently pulled all of U.S. Trust’s financial results into separate “discontinued operations” lines on the income statement and balance sheet.

Despite some mid-year bumpiness, the equity markets posted double-digit returns for 2006, while the fed funds rate increased by 100 basis points before leveling off mid-year. Against this backdrop, we saw continued improvement in client engagement, and we were able to exceed all of our primary financial objectives for the year. Revenue growth reached 19 percent for 2006, our pre-tax profit margin was a record 34.3 percent, earnings per share hit $0.95, our net income topped $1 billion for the first time in company history, and we achieved a return on equity of 26 percent. These results have been impacted by the pending U.S. Trust sale, but even after adjusting for those effects, we still exceeded every one of our financial goals.

To me, what’s significant about our results for 2006 is that we achieved them by playing our game – by continuing on the path that we think is critical for Schwab’s long-term success. Our reliance on transaction-based revenues continued to decline – with help from the interest rate environment and continued client interest in our mutual fund offerings – and our asset management and administration fees, net interest, and other non-trading revenues together rose 24 percent in 2006 and equaled 83 percent of total net revenues during the fourth quarter, versus 79 percent in the fourth quarter of 2005. Sustained cost discipline limited expense growth to just 9 percent in 2006, which led to our record pre-tax margin. Capital management remained a priority in 2006. We limited net capital expenditures to just $59 million (after receiving $63 million primarily from the sale of a data center), reduced our long-term debt by $74 million, doubled our dividend, and repurchased $859 million of common stock. We continue to believe that our business model is not particularly capital intensive, and that we should – and will – return excess capital to our stockholders.

By virtually any measure, our company is in the best shape ever, and once again, both of our core businesses contributed to the progress we made in 2006. As is the case for the company as a whole, we focus on three main financial metrics – revenue growth, pre-tax profit margin, and return on equity – with expectations for each business based on its specific circumstances.

While Schwab Investor Services (Schwab IS) did not face any major strategic shifts between 2005 and 2006, the significance of their challenge did not diminish in any way. Their objective was to continue improving the client experience and client loyalty while simultaneously driving further enhancements in financial performance. With careful attention to prioritization, resource allocation, and client feedback, the team posted another impressive year of accomplishments: additional price cuts to bolster our competitiveness, a new client concierge program, a Branch Extension Team to provide personalized service to selected clients with less than $250,000 in assets, and new products like complimentary portfolio consultations and our Schwab Managed Portfolios mutual fund wrap offering. Schwab IS also made extraordinary progress with clients. Their “client promoter score,” which we use as a measure of client loyalty, turned from slightly negative at year-end 2005 to solidly positive, and their net new assets rose by 54 percent. These improved client metrics helped Schwab IS post 18 percent net revenue growth, a 32 percent pre-tax margin, and a 25 percent return on equity for 2006, versus 5 percent, 27.6 percent, and 20 percent in 2005.

Schwab Institutional (SI) had a straightforward objective in 2006 – “just” sustain their industry leadership in serving independent Registered Investment Advisors while maintaining superior financial performance. The SI team did exactly that – their accomplishments in 2006 included the introduction of the annual IMPACT Awards™ to honor industry-leading advisors and firms, the launch of a comprehensive program to help advisors plan and manage the growth of their businesses, a new website to assist advisors thinking of establishing their own practices, and enhanced platform capabilities around cashiering and e-document management. With net new assets rising 22 percent over 2005 levels, SI continued to build market share, and financial results included 20 percent revenue growth, a 41.8 percent pre-tax margin, and a 33 percent return on equity, versus 11 percent, 39.5 percent, and 30 percent in 2005.

So, good news on the financial front, but how are we doing with clients overall, since the strength and durability of those relationships will clearly determine our future success? Our 2006 client metrics pointed to great progress in building stronger relationships, as new account openings rose 15 percent to 655,000, net new assets in Schwab IS and SI were up a combined 33 percent to $87 billion, and total client assets rose 18 percent to a record $1.24 trillion. With our momentum continuing to build, we’re expecting to deliver double-digit increases in these metrics again in 2007. Which brings me to my final thoughts. How far have we come together? Since 2004, we’ve accelerated our growth in client assets and revenues, more than doubled our pre-tax profit margin, passed the $1 billion mark in net income, and improved the company’s return on equity by more than four-fold. We have sharpened our strategic focus with the pending sale of U.S. Trust and acquisition of The 401(k) Company, and we have sustained the financial discipline necessary to support growth and contain costs.

What’s ahead for 2007? In a word, more. More strong revenue growth, with another double-digit objective for the year. More improvement in pre-tax margins, with a goal approaching 37 percent. More significant growth in EPS, although the final result for 2007 will be affected by the choices we make in redeploying the proceeds from the U.S. Trust sale. I remain extremely confident in both Schwab’s prospects and in our commitment to following the same formula laid out last year – expense discipline, careful capital management, and a relentless focus on our clients and their needs.

You may already be aware that I’m retiring from Schwab after our Annual Meeting in May, so this is my last letter to you as CFO. I’ve had a wonderfully fulfilling career here, yet I’m especially proud of what we’ve accomplished in this most recent chapter in Schwab’s history. The time is right for me to move to the next chapter in my life, but leaving behind two decades of experience at this remarkable institution is truly bittersweet. I know I’m leaving the company in great shape and in great hands, and I want to thank my fellow stockholders for the support you’ve shown me and the company over the years. It has been an honor to serve you.

Sincerely,

CHRISTOPHER V. DODDS

Executive Vice President and Chief Financial Officer

March 15, 2007