As I closed out my prior letter to you in early 2021, I wrote: “We know what we need to do; we have the resources to do it; and, most importantly, we have a team that was tested...and proved capable of pushing through whatever obstacles the environment throws at us.” Little did I know the obstacles that would come our way over the next few months—a huge surge in volatility, unprecedented levels of client engagement, and the highest levels of inflation in 40 years. But my confidence in our team proved to be appropriate, given the company’s operating and financial performance as 2021 unfolded. Let’s review Schwab’s story for the past year before turning to what might lie ahead in 2022.
Despite the obstacles noted above, a number of things came together for Schwab last year: a fluctuating but generally improving macroeconomic environment; dramatically higher client activity and interest in the markets; competitive positioning that is as strong as ever; and ongoing progress on strategic initiatives all combined to help us produce record-breaking results.
At the beginning of 2021, the macroeconomic environment seemed to be at a crossroads. On one hand, the economy had been regaining strength through year-end 2020, and the equity markets had rallied to erase their pandemic-related losses and close up 16% year-over-year. On the other hand, the pandemic was clearly far from over, and continued economic progress faced major workforce and supply-chain challenges. As we all know now, the recovery did continue, supported by expanding vaccine rollouts and government aid packages. And the markets continued to climb, despite a bump or two along the way, with the S&P 500® Index eventually finishing 2021 up 27% for the year. While short-term interest rates remained near zero throughout 2021, longer-term rates followed the recovery higher, and the 10-year Treasury yield ended the year at 1.52%, up 59 basis points from year-end 2020. So we ended up with an operating environment that remained well short of ideal for our business but was definitely moving in a better direction.
A major source of uncertainty as we began 2021 was whether we’d experience a continuation of the unprecedented level of client engagement that occurred in the last quarter of 2020. Would activity levels increase, decrease, or stay the same? What happened, of course, was a burst of first quarter activity, what we now call the “reopening surge,” as investors greeted vaccine rollouts and the anticipated reopening of the economy with newfound interest in participating in the financial markets as well as bullish trading behavior. Elevated interest in certain technology and other growth-oriented stocks was a marked part of that behavior, as was heightened market attention to certain names via social media—in other words, the “meme stock” phenomenon. Trading activity shot up, with daily average trades at Schwab reaching 8.4 million for the first three months of the year, including a single-day peak of 12.3 million. At the same time, new account openings hit 3.2 million for the quarter—that’s more in three months than in all of 2020, setting aside accounts acquired through our M&A activity. Client asset flows surged as well, with core net new assets hitting a record $148.2 billion. While some measures of engagement eased from these extraordinary levels, clients stayed active throughout 2021, setting yet another quarterly record for net new assets to close out the year. Our full-year operating results also deserve the “extraordinary” label—7.3 million new brokerage accounts, $558.2 billion in core net new assets—representing an 8% annual organic growth rate—and 6.5 million daily average trades, all three of which were records by double-digit percentage margins. We ended 2021 with a staggering $8.14 trillion in client assets across 33.2 million brokerage accounts, annual increases of 22% and 12%, respectively. As Walt said, truly humbling success.
Competitively, our “no trade-offs” approach to delivering value, service, transparency, and trust in our client relationships continued to resonate with investors, as demonstrated by a Transfer of Account (TOA) ratio that remained solidly in our favor, and $1.4 trillion year-over-year growth in client assets.
Our strong competitive positioning was also reflected in Schwab earning industry recognition from J.D. Power, Investor’s Business Daily, and others.
On the business front, we made sure we continued to drive progress throughout the year across our key strategic priorities of scale and efficiency, win-win monetization, and segmentation. We made meaningful progress in preparations for transitioning TD Ameritrade clients to a single platform during 2023 as scheduled, relaunched our Schwab Advisor Network® referral program on a newly combined basis, and improved service levels, in part by hiring thousands of client service professionals. We expanded client access to fixed-income solutions by adding to our lineup of proprietary separately managed accounts, and we worked with Ariel Investments, LLC to launch our first proprietary ESG fund, which is also our first actively managed, semitransparent ETF. We also advanced several initiatives to meet specific needs across our client base, including the introduction of our Schwab Starter Kit™ to help new investors develop knowledge and confidence as they begin to build their financial futures, as well as our ongoing efforts to build awareness and utilization of our advisory services and lending capabilities. Client assets enrolled in one of our advisory offerings rose to $559.2 billion across Investor Services by year-end 2021, up 19% year-over-year. And outstanding balances of mortgage loans and secured credit lines rose by a combined total of $11.0 billion, or 48%, to end the year at $33.8 billion.
So 2021 was messy and challenging but ultimately a great year for our business. As we look at our performance, let’s revisit the expectations we started out with. If you followed us throughout the year, you probably know that we adopted a set of three “mathematical illustrations,” covering a range of assumptions and outcomes, to discuss our financial outlook for 2021, rather than our usual “scenario” approach. The illustrations helped reflect the broader-than-usual span of uncertainties surrounding the unfolding environment, plus the added complication of having just closed the TD Ameritrade acquisition, with the attendant increase in our sensitivity to things like trading, margin loans, and securities lending, all of which had just hit record levels.
"Our ‘no trade-offs’ approach to delivering value, service, transparency, and trust in our client relationships continued to resonate with investors."
As we usually do when building our financial outlook, we started with a set of basic assumptions regarding certain environmental and company-specific factors that we’d hold constant across our illustrations. These assumptions included: equity market appreciation equal to the long-run average of 6.5%; an interest-rate environment consistent with the January 2021 forward Treasury curve, including an average 5-year yield of approximately 60 basis points; securities lending revenue of approximately $160 million per quarter; and the initial migration of client cash to our balance sheet under the Insured Deposit Account (IDA) agreement with certain Toronto-Dominion Bank affiliates beginning at mid-year.
We then layered in assumption ranges for three key client-related drivers that we felt could vary substantially depending on how the environment unfolded—trading volume, margin loan balances, and client cash on our balance sheet. Our illustrations were structured to encompass a further step-up in client engagement, a continuation of late 2020 activity levels, and a pullback, so the daily average trade assumptions ranged between 20% lower and 20% higher than the fourth quarter of 2020, and margin and client cash balances were assumed to range between 10% lower and 10% higher than their year-end 2020 levels. Together with the basic assumptions, these variables yielded a range of (8.0)% to 7.0% for potential revenue growth in 2021, relative to the fourth quarter of 2020, annualized. Using this frame of reference made sense under the circumstances, since that last quarter was the only one during the prior year where TD Ameritrade was included in our results.
We also incorporated our outlook for expense growth in the illustrations, which reflected our ongoing integration work, a full year of operating expense from all four of the acquisitions we closed during 2020, and significant investments in client service capacity to help us keep pace with the demands on people and systems caused by our dramatic recent growth. Including approximately $1 billion of integration spend and amortization of intangible assets, as well as expected progress on TD Ameritrade–related run-rate cost synergies, we thought 2021 GAAP expense growth could range between (5)% and (3)%, or between 1% and 4% on an adjusted basis,1 versus annualized 4Q20 results.
So, how’d things turn out? Well, I think you know where this is going, given the operating environment and success with clients I just described. With equity market returns, long-term interest rates, and client activity generally exceeding the illustration assumptions, our revenues grew almost 11%, to a record $18.5 billion. Our GAAP expenses were flat, and adjusted expenses1 rose by 7%, reflecting higher volume-related costs due to client engagement, including higher bonus funding, but also including a regulatory charge of approximately $200 million which was not anticipated in our initial assumptions. Our GAAP and adjusted2 pre-tax profit margins were 41.6% and 47.5%, respectively, both rebounding strongly over our 2020 results. We combined this healthy financial performance with our ongoing capital management to support consistently strong returns on capital throughout 2021. We delivered a double-digit return on equity and a ROTCE1 of at least 20% every quarter, ending with full-year results of 11% and 22%, respectively. And just to say it, the GAAP and adjusted net income and earnings per share numbers in the following graphic are definitely records as well.
Total net revenues
Diluted Earnings Per Share
Return on equity1
Pre-tax profit margin1,2
1 Further details on non-GAAP financial measures are included within our 10-K filed in February 2022.
2 Adjusted pre-tax profit margin is calculated as adjusted income before taxes on income divided by net revenues. 2021 adjusted income before taxes on income equals net revenues of $18.5 billion less total adjusted expenses of $9.7 billion, or $8.8 billion. Dividing this adjusted income before taxes on income of $8.8 billion by net revenues of $18.5 billion equals an adjusted pre-tax profit margin of 47.5%. 2020 adjusted income before taxes on income equals net revenues of $11.7 billion less total adjusted expenses of $6.8 billion, or $4.9 billion. Dividing this adjusted income before taxes on income of $4.9 billion by net revenues of $11.7 billion equals an adjusted pre-tax profit margin of 42.2%. Further details on non-GAAP financial measures are included within our 10-K filed in February 2022.
3 Adjusted net income calculated as adjusted net income available to common stockholders plus preferred stock dividends and other.
ROTCE = return on tangible common equity
EPS = earnings per share
Financial results include TD Ameritrade from October 6, 2020, forward.
As gratified as we are about our operating and financial performance in 2021, I will echo Walt’s comment that no one here is letting this go to our heads or losing sight of what makes this company successful. We know that all of us—all Schwab stakeholders, including clients, employees, and stockholders—expect the company to keep its focus and to keep moving onward. Schwab has been a growth company since its inception, and that remains every bit as true today as it was back in the 1970s. Even after all our success to date, we’re still serving just 12% of the investable wealth in the U.S., and there are millions of investors who have yet to experience our client-first approach to meeting their needs.
There are many voices out there talking about what it means to be growth oriented, but one that resonates with me is Carol Dweck and the concept of a “Growth Mindset.” She discusses this approach in terms of individuals, but I believe companies can embody a growth mindset as well: Those that thrive are self-aware, never satisfied, not afraid to make mistakes, but rather learn from them and constantly push to improve. Our story in 2022 and beyond will continue to be driven by this growth imperative, and our financial and competitive strength keeps us well positioned to explore the rich opportunities across our strategic priorities.
"Schwab has been a growth company since its inception, and that remains every bit as true today."
This year we will focus on further progress with the TD Ameritrade integration, continuing to make it easier for clients to work with us, and enhancing our operating model and infrastructure to support future growth. We’ll also work to improve our wealth management offerings, expand our proprietary asset management lineup to include new forms of personalized investing, and help build client awareness and utilization of our lending facilities. Additionally, we expect to improve our services for higher-net-worth clients, build on existing strengths in key client segments like traders, and further evolve and improve our service, tools, platforms, and capabilities for the independent RIAs who custody with us.
From a financial perspective, we feel conditions are appropriate for returning to a single-scenario approach to discussing our outlook. While there’s no shortage of uncertainty regarding the remaining path of the pandemic, the trajectory of interest rates and inflation, equity market resiliency, and client engagement and behavior, the overall environment feels like it’s starting out on a more stable footing than last year. Our assumptions include three 25-basis-point hikes in the target Fed Funds rate during 2022, with the 5-year Treasury yield averaging 1.65%, which was consistent with the forward yield curve as of early January. We’re also assuming the S&P 500® rises by the 6.5% long-run average and that volatility remains consistent with the latter half of 2021. On the client front, we’re allowing for daily average trades and quarterly securities lending revenue to remain at their 4Q21 levels of 6.1 million and approximately $150 million, respectively. And we’re allowing for our balance sheet to grow by about 3%. To put it simply, our scenario assumes an environment marked by ongoing economic recovery, the beginning of a return to interest rate normalization, and client engagement similar to the last few quarters of 2021.
Turning to expenses, our planning incorporates the full-year impacts of special compensation increases and incremental client service capacity that we put in place during 2021 given the extraordinary conditions; the accelerated deployment of certain systems hardware and software needed to support scalability and client conversion given our dramatic growth following the TD Ameritrade acquisition; and mid-single-digit growth in fundamental operating expenses, consistent with our longer-term expectations. After setting aside certain expenses specific to 2021 that are not expected to continue, allowing for planned transaction-related expenses such as integration spend and amortization of intangible assets, and including anticipated incremental expense synergies, year-over-year GAAP expense growth could range between 4% and 5%, or 6% and 7% on an adjusted1 basis, depending, as always, on how client activity unfolds.
Before I leave expenses, I want to share what I believe is an important perspective on our current spending outlook. If you’ve followed our story for any length of time, you know we consistently discuss the importance of scale and efficiency, both of which we believe are significant competitive advantages. Our scale allows us to spread our fixed costs over a large base of accounts and to support investment in new capabilities by increasing the benefit for every dollar spent. When that scale is combined with an unwavering focus on operating efficiency, it makes it possible for us to fortify our position as one of the lowest-cost—if not the lowest-cost—providers in our industry on that basis. It’s an industry where pricing matters to investors, so being able to keep costs low allows us to give clients what they want.
bps = basis points
ROCA = revenue on client assets
EOCA = expenses on client assets
1EOCA shown on a GAAP basis
The chart above illustrates this dynamic. The yardstick by which we measure our overall operating efficiency is EOCA, or expense per dollar of client asset. You can see we’ve succeeded in reducing this metric by more than half since 2004. Part of that decline comes from our increased scale, but it’s also an outcome of our deliberate prioritization of being fiscally disciplined and balancing short-term profitability with investing to drive long-term growth and/or greater efficiency and productivity. Our success has enabled us to drive down ROCA, or revenue per dollar of client asset, by a bit more than a third over the same time period—while maintaining and even improving our profitability. Lower ROCA means our clients are paying less for our services over time, even as we’re doing more for them, which results in a much greater overall value. And the better we get at walking this path while continuing to expand and enhance our capabilities, the harder it will be for others to keep up. Here’s the punch line: To the extent our scenario plays out in 2022, we’d expect our EOCA to continue declining, while ROCA would essentially stabilize. In other words, even with the level of expense growth necessary to hit our objectives in 2022— including the integration effort—we’d expect the trend of declining EOCA to continue, allowing us to continue to reap the benefits of our relentless attention to scale and efficiency.
Tying everything together, under the conditions I’ve described, we could see 9%–10% revenue growth and an adjusted pre-tax profit margin of at least 48%, which implies percentage growth in adjusted net income somewhere in the teens.
Finally, I should spend a moment on our approach to balance sheet and capital management during the year ahead. There’s no question that supporting ongoing business growth remains our top priority on this front. While we did increase our outstanding preferred stock by a net $2.3 billion during 2021 to help support particularly strong growth in client cash on our balance sheet, the extraordinary surge in client inflows we experienced late in 2021 reduced our consolidated Tier 1 Leverage ratio slightly to 6.2%, which of course remains well above regulatory minimums. Going forward, we expect to maintain our quarterly common dividend payout ratio within our target range of 20%–30% of earnings—we just raised it by $.02 to $.20 in early 2022—and we’ll continue to shape a path toward our long-term Tier 1 Leverage operating objective of 6.75%–7.00%. That path will take into account not only the increased organic capital formation helped by a rising rate environment, but also the impact of client asset allocation decisions in that environment on our pace of balance sheet growth.
"You can rest assured our focus remains solidly on what we do control—moving Schwab onward in pursuit of the enormous growth opportunities still ahead."
If “things came together” to produce record-breaking results in 2021, can it happen again in 2022? Absolutely, or not—the story for the year will depend in part on factors we don’t control, such as the evolution of the macroeconomic environment and client behavior. That said, you can rest assured our focus remains solidly on what we do control—moving Schwab onward in pursuit of the enormous growth opportunities still ahead. We’ll do this by providing clients with the service they expect and deserve under all conditions; by sustaining our key strategic initiatives of scale and efficiency, win-win monetization, and segmentation; and by driving progress on the TD Ameritrade integration. Above all, we’ll retain our growth mindset. As John Wooden once said, “By applying yourself to becoming a little better each and every day over a period of time, you will become a lot better.” I come to work every day excited to be part of making Schwab better, and I know I’m fortunate to be surrounded by colleagues and teammates who feel the same. We’re all grateful for your ongoing support, and I look forward to sharing our progress as 2022 unfolds.
March 4, 2022