Letter from the Chief Financial Officer

As I stepped into the CFO role in 2007, I joined a management committee that was determined to remain focused on our clients and their needs. After all, that focus, along with expense discipline and careful risk and capital management, comprise the key elements of the formula for sustained, profitable growth that the company has followed so successfully in recent years. In my first letter to you, I’d like to share some perspectives on how the formula influences our approach to financial management before discussing our 2007 performance — including our success with clients — and then closing with some thoughts on expectations for 2008.

There’s a cornerstone principle that still guides our approach to financial management even after 30-plus years of storied history: Schwab is, and will remain, a growth company. We’ve gone from upstart discount broker to one of the largest financial services firms around, but even now our market share of U.S. investable assets is still under 10 percent. For a long time, our growth story was very straightforward — deliver high-quality products and service at a great value, capture rapid revenue growth, and deliver a comparable rate of earnings growth, since expenses needed to rise along with an expanding infrastructure. Our Annual Report for 1997, my first year at Schwab, offers a classic example: It shows that with revenues up 25 percent, we delivered growth in net income and earnings per share of 27 percent and 26 percent, respectively.

Today, the story is not quite as simple. First, we have to acknowledge that we’re just bigger. That 1997 report showed $69 billion in net new assets helping push total client assets up by 40 percent, to $354 billion — phenomenal for the time. In comparison, our even more phenomenal $160 billion in net new assets during 2007 helped total client assets rise by 17 percent, to $1.4 trillion. Next, our dedication to offering clients better choices at a better value has facilitated a dramatic reduction in our revenue relative to client asset levels. In 1997, our revenues equaled approximately 0.75 percent of average client assets; by 2007, that ratio had dropped to 0.37 percent.

How can we plan for and deliver compelling financial performance in a world where it only gets harder to achieve outsized revenue growth year after year? Here’s where the formula comes in. Given our current mix of businesses and the outlook for pricing our services, we believe we can deliver revenue growth percentages in the low double digits or better on a sustained basis in many market environments. We hope you agree that’s impressive organic growth for a well-established firm. With an existing infrastructure capable of supporting ongoing growth in our businesses without commensurate growth in expenses, and the willingness and ability to prioritize and control our reinvestment in the company, we believe we can limit overall expense growth sufficiently to deliver earnings growth percentages in the mid to upper teens. Careful capital management, including the timely return of excess equity to stockholders, can then help us achieve earnings per share growth and ROEs of 20 percent or more. Environmental factors might prevent us from hitting these marks every year, but this is our baseline for running the company.

Now let’s look at our 2007 performance. Our planning scenario included equity market appreciation of about 6 percent and moderate declines in short-term interest rates. Since we had not yet determined how we would redeploy the proceeds from the sale of U.S. Trust, we limited our financial commitments to 12 percent revenue growth and a 2 percentage point increase in our pre-tax profit margin, to 36 percent. While overall equity market returns for 2007 were in the mid to upper single digits, our clients faced significant volatility as the year progressed and the economic picture darkened, and the Fed Funds rate dropped to a lower than anticipated 4.25 percent by year end. Despite these market headwinds, our fundamentals continued to improve, and we were able to achieve 16 percent revenue growth and a record 37 percent pre-tax margin. In addition, even after excluding U.S. Trust-related impacts, our income and earnings per share from continuing operations were up 26 percent and 33 percent, respectively, to $1.1 billion and 92 cents, setting new records as well.

We believe the formula works, in part, because our commitment to delivering a low-cost, high-value client experience helps build stronger relationships. I’ve already discussed the outstanding growth in client assets we achieved in 2007; our progress with clients is also reflected in a 24 percent increase in new brokerage accounts, to more than 800,000. In addition, total brokerage accounts rose for the first time in five years, by 5 percent to 7 million; banking accounts rose nearly 80 percent, to 262,000; and both acquisitions and organic growth helped us serve 1.2 million retirement plan participants by year end 2007, more than double the 2006 total.

We also believe our formula works because clients recognize and value our commitment to Schwab’s financial health. An important aspect of that commitment is risk management. While conceding that it’s impractical to eliminate all risks in our business, we are extremely thorough and thoughtful in determining the nature and extent of the financial risks we are willing to assume as part of running the company. The absence of any significant damage to Schwab during the mortgage and credit market meltdowns of 2007 stood in stark contrast to the experience of other firms whose financial performance is more dependent on the magnitude of the risks they assume. Careful risk management also limits the capital we need to support business growth, thereby facilitating the return of excess amounts to stockholders. Aided by the sale of U.S. Trust, we were able to return a total of $4.2 billion in excess equity during 2007 via a combination of regular and special dividends, share repurchases, and a stock tender offer.

All in all, a superb year for Schwab, but is meaningful progress possible from here? Absolutely. Based on a planning scenario that assumed a 4.25 percent Fed Funds rate and 7.5 percent equity market appreciation, our initial expectations for 2008 included double-digit revenue growth, a pre-tax profit margin of 39 percent, 20-plus percent growth in earnings from continuing operations, and an ROE in excess of 30 percent. We recognize, however, that short-term rates and equity market returns are currently below the levels assumed in our plan, and that Schwab and its clients continue to face a tough environment. To the extent these conditions persist in 2008, we would expect to balance expense management that addresses the environment’s effects on our revenues against our need to invest appropriately to drive future growth.

Schwab is more capable than ever, and the company is just beginning to demonstrate what it can accomplish in this new era of combined client focus and operating discipline. We hope to continue earning your support as we apply our formula in pursuit of the opportunities ahead.

Sincerely,

Joe Martinetto

Executive Vice President and

Chief Financial Officer