Past CFO Commentary

The commentary in this section speaks only as of the date specified below. The company makes no commitment to update any of this information.

July 16, 2014

As you look through today's earnings release, you might notice that the size of our balance sheet (shown in the Financial and Operating Highlights table on page 5) hasn't changed much since year-end 2013, continuing to hover around $144 billion. That's unusual for us—for example, the company's balance sheet grew by approximately $8 billion during the second half of 2013. Given the factors influencing this situation, I wanted to share some perspective on current client behavior and ramifications for our capital management going forward.

First, knowing that client cash balances, specifically Schwab One and bank deposit levels, are major drivers of balance sheet growth at Schwab, you might take a look at the Growth in Client Assets and Accounts table on page 8 to see what's going on. Scanning that table, you can see that the first line—'Schwab One, other cash equivalents and deposits from banking clients'—is down from year-end. So, too, are 'Money market funds' on the second line of the table. While client money fund holdings are not part of the company's balance sheet, we think of them as part of client cash due to their highly liquid nature. Overall, clients are indeed keeping fewer dollars in cash.

What else can you see in the tables? Client assets overall at Schwab have shown solid growth – over $150 billion thus far in 2014 - with approximately $57 billion of that growth coming from net new assets. With that kind of asset growth, the lower cash balances certainly aren't leaving us, they're effectively going into other asset categories. Looking at the client asset table and the SMART report that follows, it's also clear that both mutual funds and ETFs have attracted significant inflows throughout the first half, and that in fact every asset category except for the two cash lines is up since year-end. So clients are currently engaging with their investments and the markets in ways that limit the resulting growth in our balance sheet—in effect, taking cash off the sidelines and putting it into the markets.

It's also worth noting that we have moved less than $900 million year-to-date in client sweep balances from certain money funds to Schwab Bank as part of our cash migration work, where we seek to ensure sweep balances are housed in the most appropriate venue at Schwab based on the client's relationship with the company. In comparison, we moved $2.8 billion from the money funds to the Bank in 2013, and over $8 billion between 2008 and 2012. The reduction in migration work, and associated slowdown in balance sheet growth, reflects the fact that we are essentially fully executed against our existing cash strategy and in maintenance mode, making adjustments just to reflect clients' updated account status.

There are several ramifications to the recent lull in balance sheet growth. First, we shouldn't kid ourselves about this being some sort of secular shift in client behavior and our strategic story—we firmly believe that client-driven growth in our balance sheet will resume, potentially very soon. I have spoken before about how clients very consistently leave around 13% or so of their assets at Schwab in some form of cash, so the current 12% level is not likely to persist as they rebalance over time. Even if the ratio of cash to assets did find a new lower level, as long as we're gathering positive net new assets some amount will be in cash and therefore adding to balance sheet growth through higher bank deposit balances. That's a good thing in any event—even in this economy and rate environment, we can monetize that growth at attractive returns and build stockholder value; we've been talking for a long time about the improved returns available on client cash as the environment normalizes.

What's noteworthy here is that our record first half earnings have combined with the recent lull in balance sheet growth to help move us closer to our desired capital range a bit faster than we might have expected. We've talked about wanting to see our consolidated Tier I Leverage Ratio in a 25 basis point band topping out at 7.0%, which we believe provides an appropriate buffer over our target of at least 6.0%. Our preliminary Tier I Leverage Ratio as of June 30 is 6.8%, so we've arrived at the cusp of our intended level after beginning the year at 6.4%. We're getting to the point where we can assess the potential timing and extent of adjustments to our sweep cash alternatives that might bring more client cash onto the balance sheet, thereby optimizing the monetization of that cash while continuing to provide an appropriate return to clients. We also maintain a target dividend payout ratio of 20-30%, so as earnings improve we're positioned to reward stockholders with higher cash payouts. Finally, if we run out of opportunities to deploy capital at acceptable returns, we'll look to other capital return options, like share repurchases or special dividends.

None of this is news to folks who've been following the company for a while—Walt and I have been discussing these options publicly for months. I simply hope our stockholders will agree it's encouraging to see real progress in approaching the point where we can start turning some of these possibilities into reality.


Forward-looking statements

This commentary contains forward-looking statements relating to client cash balances; balance sheet growth; ratio of client cash to client assets; monetization of cash; Tier 1 leverage ratio; cash migration; target dividend payout ratio; earnings improvement; higher cash payouts to stockholders; and capital return options. Achievement of these expectations and objectives is subject to risks and uncertainties that could cause actual results to differ materially from the expressed expectations.

Important factors that may cause such differences include, but are not limited to, general market conditions, including the level of interest rates, equity valuations and trading activity; the company's ability to attract and retain clients and grow client assets/relationships; competitive pressures on rates and fees; the level of client assets, including cash balances; the company's ability to monetize client assets; capital needs and management; client enrollments in advisory services; the company's ability to develop and launch new products, services and capabilities in a timely and successful manner; the company's ability to manage expenses; the impact of changes in market conditions on money market fund fee waivers, revenues, expenses and pre-tax margins; regulatory guidance; acquisition integration costs; trading activity; the effect of adverse developments in litigation or regulatory matters and the extent of any charges associated with legal matters; any adverse impact of financial reform legislation and related regulations; and other factors set forth in the company's most recent reports on Form 10-K and Form 10-Q.